阿拉斯加航空 (ALK) 2011 Q2 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the Alaska Air Group second quarter 2011 earnings conference call.

Today's call is being recorded, and will be accessible for future playback 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).

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

Thanks, Sarah.

Good morning, everyone and thank you for joining us for Alaska Air Group's second quarter 2011 earnings call.

This morning Alaska Air Group's CEO, Bill Ayer, Air Group CFO, Brandon Pedersen, and Alaska Airlines' President, Brad Tilden, will comment on our second quarter financial results, our operations, and our expectations for the remainder of this year.

Other members of our senior management team are also here to help answer your questions.

Our discussion today will include forward-looking statements regarding our future expectations, which may differ significantly from actual results.

Information on risk factors that could affect our business can be found in our SEC filings available on our website.

We will refer often to certain non-GAAP financial measures, such as adjusted earnings or unit costs excluding fuel, so 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 $28.8 million, excluding the impact of mark to market adjustments related to our fuel hedge portfolio, and charges related to Horizon's fleet transition, Air Group reported an adjusted net income of $89.6 million, or $2.44 per share.

The result is in line with the First Call Consensus, and surpasses last year's adjusted net income of $84 million, or $2.29 per share.

Additional information about our unit cost expectations, capacity plans, future fuel hedge positions, capital expenditures, and other items can be found in the investor update included on our Form 8-K, issued this morning and available on our website at AlaskaAir.com.

Now I will turn the call over to Bill.

Thanks Chris, and good morning everyone.

We are pleased to report a record second quarter adjusted profit.

This is the fifth quarter in a row that we have been able to report record results.

Strong demand throughout the quarter led to a 14%, or $134 million increase in operating revenues, which was enough to offset the nearly 50% increase in our economic fuel bill.

The right capacity allocations contributed to load factors, again hitting record levels, on top of a 7% increase in Air Group capacity.

Yields improved by 4% because of the efforts of our revenue management team to set fares and manage inventory at levels sufficient to cover the higher cost of fuel.

We are very pleased that we were able to produce an improvement in the bottom line.

We could not achieve these results if it weren't for the incredible employees at Alaska and Horizon.

This is a people business, and I believe that we have the best people in the industry.

They have a passion for service and genuinely care about our customers and the Company.

That is why Alaska Airlines recently earned the JD Power Award for Highest in Customer Satisfaction among Traditional network carriers in North America for the fourth year in a row, and notably Horizon is included with Alaska.

I couldn't be more proud of our people and this great accomplishment.

We all hear daily commentary about the strength of the economic recovery.

We don't have any unique insight, but I think it is important to remind folks of what our strategy has been over the past decade.

We recognize that there are things we can control and things we can't.

We can't control the economy and the price of fuel.

But as a team we can control our network and capacity, our fleet, our approach to ancillary revenues, our frequent flyer program, our operational performance, our productivity and overhead, and our customer service.

And the measures we have taken over the past several years have been instrumental in our success, and are building a platform for a future of sustained profitability and appropriate growth.

Our size gives us the flexibility to reallocate capacity quickly as market conditions change to grow opportunistically and pull back capacity if necessary, and we have done each of these in the past several years.

We believe that even in the face of economic uncertainty, there are additional profitable opportunities in the markets and regions we serve.

Once again, Alaska turned in the best on time performance for the quarter among the ten largest US airlines, and Horizon's on time performance has also significantly improved over the last few months.

Finally I want to again congratulate and thank the 12,000 Air Group employees who come to work every day with a commitment to serving our customers and contributing to the success of the Company.

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

Thanks Bill, and hello everyone.

As Chris said, Air Group reported a record adjusted net profit of $89.6 million this quarter, compared to an $84 million profit last year.

This result brings our trailing 12-month return on invested capital to 11.5%.

For the first six months of the year, our adjusted pretax margin was 9.3%, compared to 8.7% in 2010.

The nearly $10 million increase in Air Group's adjusted pretax profit for the quarter resulted from a $134 million improvement in revenue, largely offset by $106 million, or nearly a 50% rise in our economic fuel cost.

Our average WTI per barrel price of oil in the second quarter was $102.

This combined with a very high $32.50 per barrel average for the refining margin, resulted in a year-over-year increase of $117 million in our raw fuel costs.

Our fuel hedges saved us $16.5 million during the quarter.

And for the remainder of 2011, we are hedged at $86, with an average premium price of $11 per barrel.

So, with an all-in price of $97 per barrel, we feel very well positioned given where oil prices are today.

Although we generally focus on adjusted earnings we did report a 51% decline in our GAAP results, and I wanted to provide a bit of context around that.

Two items impacted our GAAP results.

First as is routinely the case our GAAP earnings include mark to market adjustments to the carrying value of our fuel hedge portfolio.

This quarter's mark to market loss was $71 million.

Although fuel prices were volatile during the quarter, the large adjustment was driven by the lower price of WTI and thus the value of our portfolio on the last day of the quarter compared to the last day of Q1 when WTI was higher.

This quarter's mark to market loss largely offsets the sizeable mark to market gain recorded in the first quarter.

As a reminder, we exclude all of those mark to market true-ups from our adjusted earnings, which are based on economic fuel expense, which most closely resembles our cash costs.

Second, as we have previously reported, Horizon completed its transition to an all Q400 fleet during the quarter.

As a result, we recorded a charge of $21 million associated with transition out of the remaining RJs.

We also recorded a charge of $6 million reflecting a change in estimated costs related to the 16 Q200 aircraft that were previously operated by Horizon, but are now subleased to another operator.

Air Group's nonfuel operating costs increased by $24 million, or 4% over last year.

Consolidated cost per available seat mile ex-fuel and the transition costs declined by just over 3% on the 7% increase in capacity.

We are generally pleased with our cost performance.

We have successfully reduced unit costs through a focus on productivity gains and keeping overhead in check.

Productivity improved again this quarter where we saw a 5.5% increase in passengers per FTE across Air Group.

This is the eighth consecutive quarterly improvement in our productivity.

Productivity gains were offset by volume related increases in selling and distribution costs, contracted services, and other areas.

Selling expenses for example were up nearly 20% on the 14% increase in passenger revenues.

Planned increases in advertising account for a significant part of the increase, but we also recognize that our distribution costs are too high, and we need them to come down either through industry changes, or by driving more share through AlaskaAir.com.

With respect to overhead it was up slightly in the period which is not in line with our recent trend.

We have made great progress lowering overhead over the past few years, and need to maintain our focus on these costs.

We are committed to doing so by tightly controlling management head count and discretionary spending, and not getting complacent because of our recent financial success.

Turning to the balance sheet, we ended the quarter with nearly $1.2 billion in cash and short-term investments, which equates to 28% of trailing 12-month revenue.

In the first six months of the year, we generated approximately $395 million of operating cash flow, compared to $334 million last year.

Operating cash flow was partially offset by $270 million of capital expenditures, as we took delivery of three 737s and eight Q400s earlier this year.

Just last week we financed six of those Q400s with very attractive financing available to us from Export Development Canada.

We will use those proceeds to pay off higher rate debt over the next couple of months.

Through the first six months we generated $125 million in free cash flow compared to approximately $220 million in the first half of 2010.

The decline is primarily due to the higher number of aircraft deliveries in the first half of this year.

For all of 2011 we still expect total capital expenditures to be approximately $385 million.

We have repaid $125 million of debt so far this year, including the $52 million of first quarter debt that we prepaid in the first quarter.

Our adjusted debt to cap ratio stands at 63%, the lowest level since 1999, and 17 points better than where we were just two years ago.

In April, we completed our $50 million share repurchase program that began in 2010, and in June our Board authorized an additional $50 million program.

Under the new program, we have used about $5.5 million to date.

This brings our total repurchases under both programs to approximately $33 million thus far in 2011, or approximately 540,000 shares.

Our Board continues to believe that repurchase programs are the best mechanism to return capital to shareholders at this time.

We don't typically talk about our defined benefit pension plans mid-year, but I want to briefly mention one important change.

In June, we announced a freeze to the management DB plan effective January 1, 2014.

This impacts roughly 800 management employees hired prior to 2003.

Instead of future service credit after that date, affected employees will receive an additional contribution to their 401(k) plans.

As a reminder all of our DB plans are closed to new entrants, and this change represents one more step in our long-term plan to reduce volatility, and move away from legacy style benefits.

Pension expense should remain about the same for the balance of the year.

And finally, I want to touch on Horizon's results.

As I said last quarter, the comparability of financial results to last year is difficult, as we work through the first year of Horizon's transition to an all CPA carrier.

However, we are pleased with the progress that the Horizon team has made on the airline's transformation.

On a standalone basis, Horizon posted an adjusted pretax profit of $7.4 million in the second quarter, representing a 7.8% pretax margin on $95 million of revenue, nearly all of which is CPA revenue from Alaska.

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

Thanks, Brandon.

And good morning everyone.

I want to start off by congratulating and thanking our people, who are just shooting the lights out in terms of performance.

We are in the midst of an extremely busy summer travel period, and Alaska is performing really well.

Our unofficial DOT on time performance for the second quarter led the Top 10 US airlines at 90.5%, with two of the three months coming in over 90%.

As you have seen, we are flying with record load factors which are coming on top of an almost 10% increase in mainline capacity.

Our folks are continuing to take good care of our customers and each other.

We were extremely grateful and proud to win our fourth consecutive JD Power Customer Satisfaction Award.

This performance is not coming without a lot of hard work and some strain on our people, as we all adjust to the new realities of our industry.

The productivity figures Brandon mentioned continue a trend that has been underway for a couple of years now.

It is worth noting that if we were still operating at the productivity level we had in the second quarter of 2009, we would need another 1,300 employees to operate our mainline schedule.

To be clear, we are doing some hiring now, and we look forward to more hiring for volume related positions as we grow, but continuing to deliver on our strategy of high productivity and low overhead is the way we are going to compete and win against the low cost carriers, and it is also how we have been producing the profits that drive our growth in markets like Hawaii.

Financially we had another good quarter at Alaska with a record adjusted pretax profit of $138 million.

$10 million better than last year.

Our pretax margin of 12.5% was down 2 points from last year, because with the rise of fuel prices, both expenses and revenues are higher than last year.

We have more work to do to reduce our vulnerability to low cost carriers and the reconstituted legacy airlines, but we are happy with our progress to date.

For the quarter mainline passenger revenue increased by $118 million, or nearly 17%.

The improvement was driven by a 10% increase in capacity, and a 6.4% increase in passenger unit revenue.

Our unit revenue was up due to increases in both yield and load factor.

We kept a tight grip on inventory and focused on increasing yield, sacrificing load factors in some cases, and it has been working.

We produced year-over-year increases in PRASM and profits on top of increases in both capacity and stage length.

Our PRASM gains lagged the industry in April and May, but beat the industry by a bit in June.

And notably if you compare our PRASM improvement to the second quarter of 2008 before the recession hit, we exceeded the industry's performance by over 7 percentage points.

Even as we have had a recent bias for yield, we reported a record mainline load factor for the second quarter, up 2 points from last year and continuing a trend of record load factors for the past 11 quarters.

Our biggest growth markets have been Hawaii and Mexico, where capacity increased 47% and 21% versus the second quarter of 2010.

And you probably saw that on Tuesday we announced new daily service between San Diego and Honolulu, which will begin on November 17.

We will now have 19 round trips a day to Hawaii at our winter peak, and this represents 17% of our mainline network.

Before they ceased operations, Aloha and ATA together had 17 daily round trips between the West Coast and Hawaii.

One of the great stories of the second quarter was the performance of our regional business, which includes Horizon, SkyWest and PenAir.

Capacity was down 10% as we trimmed the lower performing flights.

Load factor was up over 3 points, and yield was up 12.5%.

Together these produced an 18% increase in PRASM.

As of today, our advanced booked consolidated load factor is up one point from last year for July, down a point for August, and up 1.5 points for September.

We are working both yields and load factors and we are optimistic about our continuing ability to recover increased fuel costs through higher revenues.

Our mainline ASM growth will slow during the last half of the year, as we expect growth of approximately 6% in both the third and fourth quarters, resulting in full year growth of between 8% and 9%, the same range we have talked about all year.

On a consolidated basis, our full year growth should be about 1.5 points lower than this.

I mentioned Alaska's operational performance earlier.

Horizon also had excellent DOT on time performance for the quarter at 87.1%,10 points better than the first quarter.

For the second quarter we reduced mainline unit costs by 4.5% to 7.44 cents with our productivity improvement, our wages and benefits increased 3.5% on the 10% increase in flying.

We are maintaining our full year CASM ex fuel guidance of 7.6 cents, which is down 3% from 2010.

As I think everyone knows by now, we believe that reducing the gap between us and the lower cost carriers is critical for our long-term success.

As Brandon mentioned, Horizon completed its transition to an all Q400 fleet this quarter, leaving five lines of flying not ideal for either a 737 or a Q400.

We contracted those five lines of CRJ 700 flying to SkyWest in mid-May, and the transition has gone well.

We will talk more about this in the future as we gain more experience.

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

Thanks, Brad.

This was a very good quarter, there is always more to do and what gives us the most encouragement as we look to the future is our enhanced understanding of the business, and the important improvements and changes that we have made and continue to make in all area of the Company.

I want to once again thank our employees for their efforts leading to this quarter's record results.

So at this time I think we are ready for your questions.

(Operator Instructions).

Your first question comes from the line of Hunter Keay from Wolfe Trahan.

Your line is open.

Thank you.

Good morning.

Good morning.

Good morning.

I would like to talk about Hawaii for a little bit here.

The new service from San Diego to Honolulu, I know that you guys have said that San Diego Maui isn't working well.

But I believe that is because Hawaiian pulled out of the market.

But now you are going head to head against them.

Please tell me why I should not conclude that this is not just a classic turf war that is about to develop.

You guys made the comparison to Aloha and ATA, but they liquidated.

How do you think about not getting engaged in turf battles, which I think is part of the reason I think you have been so successful in the past.

Hunter, it is Brad.

I would really agree with what you are saying about our strategy here.

This is not going after any particular carrier.

If you look at what we are really doing in Hawaii, we have a unique asset in the 737 800.

It is 157 seats.

It has enabled us to fly from secondary cities really on the west coast.

We don't fly out of SFO or LAX, and we are flying primarily into the outer islands.

We think San Diego/Honolulu in particular, we think that there is a huge connection there with a Navy connection on both ends, and I think it is a big market.

My guess is a couple of years from now you will see two airlines flying between San Diego and Honolulu.

I think if you look at a lot of our growth off the West Coast, it is end markets where we are in there by ourselves, we are not on top of anybody else.

That is kind of my question exactly.

It makes me wonder the rationale for doing this.

It feels kind of like growth for the sake of growth, and it feels like a deviation of what made you so successful in the first place, because you are in fact going against Hawaiian, and I do expect Hawaiian to defend that market pretty vigorously.

You never know, Hunter.

We forecast that we are going to do quite well in this market.

We are not forecasting a bloodbath in losses by both carriers.

Our forecast is this will be a good market for both airlines.

It appears to be greatly underserved.

Thank you for the color.

I appreciate it.

Brad, you also mentioned I think you said something about vulnerability to low cost carriers.

I appreciate that.

I don't know if you were alluding to JetBlue's new service on LA Anchorage.

I realize that is kind of red eye flying.

Can you maybe give us a little bit of color sort of how you are thinking about that?

If there has been any impact on your service net market, and how you think about them as a competitor longer term particularly with flights to the state of Alaska?

This is Joe Sprague from marketing.

Obviously Alaska is a critical market for us, and one that we are going defend very aggressively and that is what we have been doing this summer with all of the various airlines flying to Anchorage, and I think we are holding our own.

Alaska has had a pretty good summer with more independent travelers coming to the state this summer, so we are doing okay, but the focus is definitely on making sure we can compete aggressively with anyone coming up there.

Alright.

Well, thank you very much for the time.

Thanks, Hunter.

Thank you.

Your next question comes from the line of Bill Greene from Morgan Stanley.

Your line is open.

Hi there.

I am wondering if we can talk just on the business versus leisure mix.

Obviously you guys have a little bit different footprint, and so I am just trying to think about as we go through the summer and into the fall will seasonality differ for you on a PRASM basis?

How do we think about that mix, and how it affects how we perceive your PRASM?

Hi, Bill, this is Andrew Harrison.

A couple of things.

I think big picture we view ourselves more as a leisure carrier than a business carrier, and especially in the summer leisure really peaks.

What I can tell you from the business perspective both our first-class and our business inventory buckets, if you will have remained flat year-over-year.

And in fact, we have actually increased our paid first-class load by two points, and in fact we have increased our first-class revenues by 20% on a 7% increase in seats.

So as we go, so we feel that the business traffic is holding up.

As we go into the fall that is very normal for us, just with the little bit lighter demands.

But again, with the new Mexico and Hawaii flying, and the distribution of our network, we feel that we are fairly well positioned, but we primarily have carried the leisure travelers versus the business.

Andrew, did you see sort of the weakness that some of the other carriers saw seems like it was in leisure travel in June.

Do you see that in your trends as well?

What we did, Bill, was at the end of the day we felt very good about our June.

If anything we got a little bit smarter about how we managed our capacity, and what we did was we held out on the peak days and took advantage of the higher yields, and then what we did is we went after volume on the weaker days.

Overall if you look sequentially, May was a bit of an anomaly, but our June PRASM was higher than our April PRASM, and we did really well on both loads and yield in May.

But really it was a yield story in June at 5.8% up, and only a load factor of 1.

We traded a bit of traffic for the yield.

That is great.

Brandon, I just had a quick question for you on fuel.

Do you think, okay, give than you have got a little bit of a different mix with leisure here.

Can you get a similar kind of pass through on fuel as the rest of the industry has been able to achieve, such that sort of the hedging gains that you can accrue, essentially go to shareholders?

How do you think about that pass through?

We have worked hard over the last quarter or so especially almost on a market by market basis to make sure that we are setting prices at sufficient levels so we can cover the increased cost in fuel.

I feel good about what we have done so far.

Andrew, do you want to add anything to that?

The only thing that we have seen historically, Bill, is that when the market collapsed and the economy collapsed in 2008, the business travel completely dried up, and the leisure travel was something that we were able to stimulate and work with.

A little bit we have the stimulation play as it relates to demand drying up on the business side that helped us cover fuel costs.

But again, it is a balancing act.

Okay.

Thank you for all the time.

Our next question comes from the line of Helane Becker from Dahlman Rose.

Your line is open.

Thank you very much.

Hi, everybody.

Good morning.

Thank you.

Two questions.

One, with respect to Mexico, a big part of your capacity is in there, and I notice you have been adding capacity there.

And I know there have been issues with respect to, I don't know if security is the right word, or safety.

So could you just talk about how you are thinking about some of those markets, especially like Guadalajara where there have been incidents recently?

And then my other question is, can you talk about any new markets other than your Honolulu/San Diego, that you are intending, or thinking about adding?

Thanks.

Hi Helane, Ben Minicucci here.

There have been security issues in Guadalajara and Mazatlan and Mexico City.

I can tell you it hasn't affected our load factors at all.

What we have done is we have made our airplanes on quick turns.

The airplanes go in and they come out, and the airplanes don't lay over.

From a security perspective we have taken care of our operation that way.

Load factors have not been impacted at all.

Those markets are doing very well.

And Helane, this is Andrew.

As you probably are aware we don't specifically comment on new markets, but what I will say is through the rest of this year as Brad mentioned about our approximately 6% growth, the majority of that is just the existing Hawaii markets, and to a lesser extent Mexico markets.

I think on the third quarter call we are going to talk a little bit more about the 2012 capacity, and where we may be heading next year.

Okay, great.

Thank you very much for your help.

Thanks, Helane.

Thank you.

Your next question comes from the line of Will Randow from Citigroup.

Your line is open.

Good morning.

Hey, Will.

Hey, Will.

Just comparing unit revenue to fuel cost per gallon it seems like you more than recaptured the rise likely owing to your burn managed as well as the peer group.

Related to that I want to get your thoughts on Boeing's reengine announcement.

How does that impact the Company to maintain that fuel burn advantage, and more importantly, does it drive another CapEx cycle at Alaska?

I might take a shot at that Will, this is Bill.

We don't know that much about this airplane.

This was an announcement yesterday, and caught a lot of people by surprise I think.

We are very much in favor of lower fuel burn, and if Boeing can do this sooner rather than later, that is a good thing.

So we will be very interested to learn more about this airplane, and we look forward to taking delivery of some if everything looks right in terms of the cost, and the fuel burn, and so forth.

We have a fleet plan and an order book with Boeing right now that we are happy with in terms of numbers of airplanes and timing of airplanes, and I think the idea would be that this new airplane would slide into that whenever it is available.

Makes sense.

Thanks, Bill.

In terms of when you think about this is for Jay or Brandon, what is the appropriate level of cash, and how should we think about priorities for excess cash flow?

Obviously your share repurchase announcement a little while back is the [sum deal].

Hi, Will, it is Brandon.

We have talked about this a couple of times in the past.

We feel good about a cash balance that is in the 25% to 30% of revenue range, and I feel like we are in the sweet spot right now, at 28% cash to revenues.

We do have a nice problem to have and that is the question of what to do with our excess cash flow.

I think that the Company's approach over the last few years is pretty representative of what we would do going forward.

And that is take a balanced approach to share repurchase.

Paying down some debt.

Funding pensions.

We did some of that last year, and paying cash for airplanes.

So it is really this balanced approach to utilizing excess cash that serves all of our constituencies that works well for us.

Thanks, guys.

Sorry.

Just going to try to slip one in.

What is the Brent versus WTI and that is the last one, thanks, in terms of hedging?

We do all of our hedging on WTI.

It has worked well for us over the last decade that we have been doing this.

We have saved over $400 million program life to date really.

In terms of the dislocation between WTI and Brent, it has happened, we acknowledge that.

We are seeing it in the crack spread.

A fundamental shift in strategy from WTI positions to Brent positions, it seems like you don't get much out of that because the dislocation has happened, and it is baked into the market.

We are comfortable with what we are doing right now.

I will tell you that we do take a look at that.

We aren't fixated on our program so much that we don't have eyes open in terms of what is going on.

We like our program as it is, and don't feel a compelling reason to change right now.

Thanks again.

And congratulations on being the first US airline to report profits up.

Thanks.

Your next question from the line of Ray Neidl from Maxim Group.

Your line is open.

With the Boeing 737 reengine, I guess you are not one of the airlines that was putting pressure on Boeing to do this, but it is going to be a big money saver.

And you just said that you are going to probably switch some of your orders to this.

Have you heard anything about it that Boeing is going to be charging a premium possibly for this new aircraft, being that it is going to have so much more greater fuel efficiency, or haven't you had time to take a look at that yet?

Ray, Brandon here.

No, we haven't had time to take a look at that yet.

As Bill alluded to, we just learned about this really yesterday like everybody else.

I think you might have misunderstood.

We didn't stay say that we were going to switch any of our delivery positions from existing NGs to the NEO for lack of a better word.

We will look at that as we learn more about it.

We have a wonderful relationship with the Boeing company.

As Bill said, we are all in favor of saving money on our fuel bill.

In terms of how that affects our order book, our fleet, our CapEx, it is just too early to tell.

And your cash flow is so strong that this may not bother you, but AMR is financing their huge order of over $13 billion a lot of it through Boeing and aircraft leasing companies and other institutions.

Have you taken a look at that?

Is that going to dry up the financing market for aircraft, or put a crimp on it and drive up the rates?

I know with your cash flow you can probably buy your airplanes for cash.

Wondering if that is a concern to you, Brandon?

Not really, it certainly is a big ask of the overall market to finance that many airplanes.

As you point out we have the cash flow where we can currently just buy airplanes with cash, and I hope that continues going forward.

That is certainly the intent of the big picture plan that we put together.

In our experience we have a pretty good reception when we go out into the market, 737s, particularly 800s act as great collateral.

We have got a great reputation on the credit side.

We have plenty of folks around the country and in Europe and Asia that want to lend to us, so I don't think it is problem right now.

Great, thank you.

Your next question comes from the line of Duane Pfenningwerth from Evercore Partners.

Your line is open.

Hi, guys, good morning.

Good morning.

Good morning.

Wondering if you would just review as sort of you look at it your competing capacity trends in the second quarter, and what you are seeing in your markets in the back half of the year third and fourth quarter?

Duane, this is Andrew.

We are seeing a little bit all quiet on the western front if you will as it relates to competitive capacity trends.

We are seeing some increases in a couple of our markets, but overall the industry as well as ourselves other than some of our unique growth are fairly stable on the capacity front competitive-wise.

Okay.

Thanks.

And then just on the yield front, are you seeing any resistance as we move forward into July and August on your ability to pass through higher yields?

What we are doing right now as we shared earlier was really focusing on yields as we start to have very high load factors into the summer.

What I can share is that if you go back to the June investor update, at that time we were saying that loads were going to be flat but June was up two points.

In July, we were looking at being down a point, and as you can see from this morning we are likely going to be up a point.

And in August we were saying is down a point, and we hope to see that gap narrow while focusing on yields on the peak days, and then focusing on the volumes on the weaker days.

And to go back to an earlier comment that Brad had shared.

Over the next little bit here, we continue to strive to maintain revenues higher than the increase in fuel costs.

Okay, thank you.

Thanks Duane.

Your next question comes from the line of Michael Linenberg from Deutsche Bank.

Your line is open.

Hey, good morning, everyone.

Good morning.

Just two questions here.

When you started out, Bill, I think it was you, Bill, mentioning about distribution costs being high and then talking about AlaskaAir.com.

Can you talk about maybe what the mix is now of AlaskaAir.com, and maybe how that has changed over the last the 12 months, and then maybe, some of the things that you are doing to reduce your distribution costs?

Mike, this is Joe.

I might touch on that.

As Brandon mentioned in his comments we do think that the GDS costs are too high, and so we are taking some pretty active steps to address that.

We are in negotiations with two of the big three GDS providers right now, and we are seeking rate reductions.

Not sure where those will end up, but for sure a key focus for us currently and over the last several months and increasingly so over the next several months is moving more share to AlaskaAir.com.

We have a little bit of a leg up in that regard because of our business leisure mix.

We are just simply not as reliant on managed corporate travel as some of the other network carriers are, and so that allows us to really pursue more leisure traffic which we can pull more easily over to AlaskaAir.com.

A lot of focus there, a lot of focus on the search, online search, online advertising.

Even our offline advertising has a heavy focus on showing what the value is for people to do their shopping and purchasing at AlaskaAir.com.

So that is what you can expect to see more from us in the months ahead.

And then Joe, did you have the share numbers maybe how that has evolved?

Yes.

Sorry, we have about 50% of our bookings come through AlaskaAir.com, which I think is comfortably the highest of any of the network sort of legacy carriers, and this has trickled up over the last several months, and we would expect to see the trend continue to go upwards.

Just my second question I want to go back to I know we were talking about Honolulu, San Diego.

A few years back, I mean you did have two carriers in that market and I know Delta had a sizeable 767-300.

Is there any thought about because of your relationships with Delta and/or American, any thought about putting their code on either that flight or any of your other West Coast/Honolulu or West Coast/Hawaii flights?

Yes, this is Andrew.

We actually, it varies but in general, we have in southern California, we have our code on, say, American's Hawaiian flights.

out of the Bay area, I am just going off memory here.

I am almost certain we have Delta's code on our flights.

So where this is not head to head competition and we can help feed each other, we certainly are very open and always open to having two partners American and Delta having their code on our flights, and vise versa.

So San Diego would be a good candidate for that?

We just recently announced and I have not talked with our partners about that flight yet, but that is something we will obviously be looking at this.

Good then.

Okay.

Thank you.

Good quarter, guys.

Thank you Mike.

Your next question comes from the line of Glenn Engel from Bank of America Merrill Lynch.

Your line is open.

Good morning.

A couple of things.

One, if you looked to the June quarter and broke out by region the Interwest, the Alaska to 48 states, and the east to west flying, can you talk about which ones led the way, which ones lagged?

And I guess added to that it seems like the Alaska market looks pretty tight for the summer.

Is that going to be a market where you will see better than average gains?

Hey, Glenn, it is Brad.

We have not been giving a ton of color regionally just kind of for competitive reasons.

I think what I would say is that we had like a 6.5% PRASM gain, and it was generally well spread throughout all of our regions.

Alaska was actually a little lighter than the rest of the network.

Your question when you say Alaska tighter for the summer, are you saying tighter capacity?

Correct.

I am not sure we would comment on what we are seeing specifically for the state of Alaska.

The second quarter lagged the rest of the network by a little bit but still had very strong performance.

And Glenn, this is Andrew.

Just a little bit of color on that.

I know we talk all about Hawaii growth and other areas, but I think one of the things that we see internally that we are very proud of, is that all of the regions are rising with the margins that you are seeing, what I can comfortable tell you, is that there is no one or two regions carrying this.

That all of our regions are improving and getting better, and that is what we really feel good about.

I might just add kind of a shout out for our network planning and yield management folks here, we are really learning the value of getting capacity right.

Whatever happens with demand and competition we are looking at these things, looking at our performance on a very active basis and moving things around, not hesitating to make changes to get it right and make sure that every market is contributing to the degree that it can.

It doesn't mean that we have strategic interests and we are willing to invest in certain markets.

We need to do that.

But by and large we have been much more active with making changes, understanding what is working and what could be improved, and we are just getting better and better at this, but capacity is really, really important.

Secondly, smaller question.

If I looked at salary and expenses it was up about a percent, and yet headcount was up 3%.

Why would the headcount grow faster than the salaries?

George, you want to take that one?

Are you looking at Air Group or at Airlines?

Group.

Glenn, I think you caught me on that one.

I don't have a good answer to that off the top of my head.

I know we had a favorable couple of adjustments in medical and workers' comp, so we had some good performance there.

I am not sure what is driving it beyond that.

Thank you very much.

Congratulations.

Thanks, Glenn.

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

Your line is open.

Hi, good morning.

Could you talk a little bit about the long-term game plan for Horizon?

Is this a business that could survive on its own, and is it a business that could grow using the Q400?Is this something that I think some of the scope clauses don't include the prop aircraft.

Steve, this is Bill, let me start a little bit and then turn it over to Glenn.

We don't believe there is any reason why Horizon can't perform similarly to Alaska, in terms of ROIC and other important metrics.

If you recall what we did at Alaska with this 2010 plan was to go after all of the things that we could to improve performance in financial and every other area.

We are doing the same thing at Horizon.

The same model.

The same order of things, starting with making sure that we are safe and compliant.

That operational performance is good, and that we have got the right fleet.

We think the Q400 is the right airplane, it is a simple fleet, but it is a very fuel efficient fleet and it does most of the markets really, really well.

The whole network side things and then you get into costs, and so Glenn and his team are working hard on reducing CASM and customer service and revenue.

We are pulling all of the levers just like we did in Alaska over the last decade, and we are seeing really good results.

Still a work in progress and Glenn can talk more specifically about what we are doing.

Our intent is to have Horizon perform the same ROIC level as Alaska.

Thanks, Bill, hey Steven, it is Glenn.

I would just add to that last year has been a year of incredible transition for Horizon.

We have moved to the all CPA flying model versus 50% brand flying this time last year.

I think that has been an important structural and philosophical change for the Company.

We have stabilized on the all Q400 fleet which Bill already mentioned, we think is exactly the right type airplane for the types of markets that we are doing now.

Our focus now is on producing reliable safe low cost ASMs for Alaska and by extension for Delta and American, and then our focus in the short-term is on completing the business transformation plan.

We need to get costs out of our maintenance and flight ops areas.

Those are above market, and we need to fix that.

Our performance has improved operationally in the last few months.

We need to sustain that, and particularly through the difficult winter season which is often troublesome for Horizon.

And then we continue to look at ways to avoid duplication between Alaska and Horizon, and our back office and support functions, and we have had good luck in consolidating some of that in the last year as well.

I think the Company has come through a lot of transition over the last year.

There is more to do and that is our focus is ensuring that we sustain what we have done so far, and that we continue to improve the Company's performance.

Okay.

And then just real quick as a follow-up.

I mean a lot has been written about your valuation discount for some other carriers in the past.

I am just wondering, do you think this is a possible reason for some of that discount?

I mean I know it is probably not the whole thing, but there doesn't seem to be any love of let's say regional carriers out there at this time?

Steve, it is Brandon.

I don't know.

I don't think there is a clear answer to that.

Our strategy is to let the market price us the way the market prices us.

We will do the best we can telling the story which I think is a great one, and then internally we are focused on making Alaska as profitable as we can, and making Horizon as profitable as we can.

When we get Horizon to a point financially that it should be at, then maybe the market will recognize that.

But like I said, we will tell our story and the market will price us as the market prices us.

But I don't think owning our own regional is a drag on the Company at all.

Plus, I guess the other thing is Horizon represents a pretty small part of Alaska Air Group, 10%, 15% by most measures.

I just don't see the connection there necessarily.

Okay.

Thanks a lot.

Thank you.

One more thing, it is Brandon.

I want to come back to Glenn's question on wages and benefits.

Glenn, if you are still on the line, wages and benefits on a consolidated basis is up 1.3% and our FTE count is up about 1% on a consolidated basis.

It synchs up pretty well.

We did have good experience on the medical side.

That was a lower cost year-over-year.

I just wanted to clarify that I didn't think I adequately answered your question on the first pass.

Your next question comes from the line of Jim Higgins from Ticonderoga Securities.

Your line is open.

Good morning, everyone.

Congratulations on a great quarter.

A couple of questions.

I haven't heard anything, but have you picked up any intelligence that says Mexicana might be reorganizing and getting ready to start flying again over the next several quarters?

Jim, this is Andrew.

I have personally heard nothing and the DJAC and the DOT are handing out Mexicana's slots to Volaris.

So at this point there is nothing that we see to believe us, and folks down in Mexico haven't seen anything to support any claim that they are coming back.

Great, thanks.

Secondly, I know I harped on this a bit over the past year or so, but as I look at your cash flow and your cash levels, I am wondering what does it take for you to get to a point where paying a dividend makes sense, something you can be comfortable with?

Hey, Jim, it is Brandon.

I think the answer to that is frankly time.

Internally we know all of the arguments for and against paying a dividend versus a repurchase, a regular dividend versus a special dividend.

And I have said before publicly that I would love to get to point where this Company could pay a dividend based on its outstanding performance.

Or supported by its outstanding performance.

We had a super year in 2010, we are on track to have a very good year in 2011.

But that is two years of us achieving returns in excess of our cost of capital.

I would like to get to a point where we could say we have done it three, four, five times, and at that point we will talk seriously about a dividend.

There is nothing wrong with a repurchase program.

Again as I said, we know all of the pluses and minuses of dividend versus repurchase.

We feel good about the approach that we are taking, but our streak of having returns in excess of our cost of capital while excellent is still pretty short.

Brandon, I might just add that the big picture is we are committed to a return to investors.

And whatever the form of that is, we can debate.

Make no mistake that this Company is committed to investors, just as we are to employees and to customers.

And so far, so good, and we are going to stay focused on it.

Great.

Thanks very much.

Thank you.

Your next question comes from the line of Kevin Crissey from UBS.

Your line is open.

Hi, guys.

Most of them have been answered.

Going back to Mexico quickly, maybe for Andrew, the Mexicana not coming back into existence doesn't necessarily mean that you won't see increased competition from Mexico, you mentioned Volaris.

How about other airlines picking up that capacity, what is your plan for capacity, and are you seeing any of that hitting your network yet?

I would definitely agree with that statement.

These seats are in fact in large part having been replaced with Mexicana's demise.

You are seeing Virgin out of San Francisco, Cabo, adding Puerto Vallarta, and you are seeing the Mexican carriers in Volaris.

We continue to watch that very, very closely, and I think we are feeling the effects a little bit of basically of all of those seats being filled back.

We are excited about Mexico and continue to monitor that closely.

Thank you very much.

Our next question comes from the line of Gary Chase from Barclays Capital.

Your line is open.

Good morning, everybody.

Good morning, Gary.

Most of mine have been answered.

I was interested in one of the comments Andrew made about the paid first-class load factor.

I wondered if you could give us a little more context on that?

Maybe where it is and sort of how that has trended over a longer period of time than just over the last year?

And probably more importantly, what is it that you think is driving the increase?

So a couple of things.

Number one, we have seen very good and healthy load factor increases in our first-class cabin on all of our Hawaii flying.

Essentially as we have continued to work the first-class cabin, we are just seeing in general, we believe our prices are very, very reasonable in our first-class cabin.

I think if you look across the industry on some of the routes other carriers fly our fares are very, very reasonable and working with Delta and American and our partners, we are seeing in especially in mid-Con and Transcon and Hawaii good healthy increases in our first-class cabin.

Gary, I think it goes back to a few years ago.

We recognized that we had the first-class cabin on the airplane earning a very small premium over the main cabin and we had very high first-class fares.

One of the first things that we did is we brought the first-class fares way down, I think our current add-on over the wide fare is $150 in the longest stage length market.

I think our customers have really responded to that value.

We have gone from maybe from 1 to 1.5 F seats per airplane to four or five F seats per airplane.

And we have also done a lot better with the upgrades, the fares that our mileage plan customers are paying to sit in first class.

And if neither of those work, we are selling first class upgrades at the gate.

So combined I think we had a 20% increase in first-class revenue in the second quarter, and we are doing it in a way that our customer I think feel like they are getting really good value.

If you look back a few years ago, not like this is a cyclical thing like pre-crisis you were at a similar level, right?

Brad, where you are pointing to, one F ticket, I think that would have been something that has been in place for a long time previously, correct?

That is correct.

Okay.

Thank you very much.

Yes.

Thanks, Gary.

Your next question comes from the line of Dan McKenzie from Rodman Renshaw.

Your line is open.

Hey, good morning, everybody.

One of your partners Delta has made some significant international network changes in the Seattle market over the past year.

I know you won't talk about any partner specifically, but as we think of your revenue production for the quarter how much of that was aided by the partner relationships in total?

Related to that have you seen any kind of ramp-up in this area over the past year?

Dan, this is Andrew.

As you acknowledge, we really don't get into specifics, but I think what I will say is that, Delta as it increases its Asia service out of the Seattle gateway has obviously been a really positive thing for us.

We helped feed that, and it just goes to the great story we are experiencing here, is that it generates more volumes for us, and it gives us more opportunity to work on yield and fill the first-class cabin, and it diversifies the type of passengers that we have.

Without getting into specifics it has obviously been a positive thing for us.

You get both the connecting traffic and then just the fact that folks can accrue miles on our mileage plan and fly anywhere out of the world out of Seattle, keeps their loyalty with Alaska we think.

So it helps us even in our core network when the passenger is not connecting.

Okay.

I appreciate that.

Secondly here, how is Alaska thinking about direct connect with respect to the GDS relationships?

Does that represent an opportunity, or how should we think about that?

Dan, this is Joe again.

We are obviously watching some of these industry trends with respect to direct connect very closely.

There is technology that will allow direct connect and allow for airline fares and schedule information to be placed alongside those of the information provided by GDS' on travel agency desktop computers.

The technology has come a long way in the last few years.

I think the best application for that probably at this point is with the managed corporate travel segment, which as I mentioned earlier is not as big for us as it is for some other carriers, and so we may look at some aspect of direct connect.

I think, again, the bigger opportunity for us is to continue to pull share from some of the other sources, and have folks shop directly with us at AlaskaAir.com.

Okay.

Thanks.

Appreciate it.

Your next question comes from the line of Jamie Baker from JPMorgan Chase.

Your line is open.

Good morning, everyone.

Good morning, Jamie.

Most of the issues that interest me have been addressed.

Do I have one for you.

Once the Hawaiian roll-out is mature and steady state, and however you want to describe it, it is unclear what your next network move is going to be.

Obviously still a lot of opportunity in the lower 48.

I admit it would represent a departure from the current plan, but we all know Frontier is for sale.

I am not asking if you have any interest, I am curious if they have approached you?

Yes, we just, it is not productive to speculate or talk about things like that.

What we have always said about this Jamie, is we like what we are doing here.

We like growing organically.

We like getting our own house in order first, and then looking at these growth opportunities, and that is kind of where we are, and that only works if we continue to produce good results.

We think we are producing good results, and we think we can create our own path here, and we don't need the complexity of somebody else either doing it with us, or to us, or for us or whatever.

We like where we are.

We like the path that we are on.

There are plenty of airlines out there that I would certainly compel to think outside the box, and thankfully you are not one of them, and that is a compliment.

Thanks.

Take care.

Bye, Jamie.

Your next question comes from the line of Michael Derchin from CRT Capital Group.

Your line is open.

Hi, everybody.

You guys clearly march to your own drummer to your shareholders' benefit and we all recognize that.

One related to that and your excess cash that you seem to have.

Have you thought about your unfunded pension, and using some of that to take that down more aggressively as an alternative to a share buyback, which the credit agencies might like that better than they might like the share buyback?

Hey, Mike, it is Brandon.

Yes, we have thought about that.

As you probably remember, we made a couple of really significant contributions to the pension plans over the last couple of years.

I think $150 million in 2009, and then another $150 million or so in 2010.

We have a practice of funding the normal service costs which would be about $30 million this year.

In terms of using the excess cash to top it up, I don't know that is something that we are looking to do right now.

Our unfunded liability is about $200 million.

That was the case at December 31.

And that liability is calculated using extraordinarily low by historical standards discount rate, and so that liability is pretty high, to the extent rates normalize which I acknowledge might not happen here in the next year or two, but certainly would eventually happen, that liability would come down and we could find ourselves in an overfunded position, and at that point you can't ever get that cash back.

You can certainly work through that overfunded position over the next few years.

I think we are close enough now that we are comfortable with our strategy of funding kind of a normal amount every single year, and funding the pension liability with another big top up doesn't seem like the best option right now.

Thanks very much.

That is not so say we wouldn't consider that sometime in the future.

Okay.

Your next question comes from the line of Hunter Keay from Wolfe Trahan.

Your line is open.

Hey, thank you for squeezing my follow-up on.

I appreciate it.

Andrew, on the last earnings call you mentioned you gave us a metric that the average ticket sold I think over the prior three weeks I think you mentioned in April that carried yields that were about 10% year-over-year.

Yields came in at 3.8%.

I realize there were a lot of puts and takes, but a two-part question.

Can you maybe give us a similar metric for where we are tracking in July?

And B, what was the difference between what you saw there and what actually came in on the yield line at the end of the quarter at 3.8%?

Any color you could provide would be helpful, thank you.

Hunter, Brandon here.

I have officially muzzled Andrew on the forward guidance of yields.

Chris Berry and I have had three months to pick up the pieces after that one.

We are going to not do a lot of forward guidance.

I think your question is valid on the prior quarters comment versus where we actually came in, and I will remove the muzzle from Andrew so that he can answer that questions.

I am trying to get you into trouble, Andrew.

No.

I got myself into trouble.

Hunter, and I fully communicated this.

What we are trying to say was that as we looked at all of the bookings over the past three weeks for travel out 330 days, on average we were seeing yield of 10%.

Really had nothing specifically related to the next month, two or three months.

It was a whole blend, and we were really seeing the effective fare increases that we had all instituted early in the first quarter starting to come to fruition.

So that is sort of what happened.

I think Hunter, the other thing just at the time, I think that fuel was $110 or $115 a barrel, and everyone was pushing fare increases, and fuel following the call had moderated and I think that there was less industry support for fare increases.

No, no, no, I appreciate that.

I thought I would just give it a shot.

Thank you so much for the color.

I do appreciate it.

Yes.

Thanks.

Okay.

So I think we are out of time, and I want to thank everybody for joining us today, and we look forward to talking with you next quarter.

Take care.

Thank you for participating in today's conference call.

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