阿拉斯加航空 (ALK) 2011 Q3 法說會逐字稿

Good morning.

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

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

Today's call is being recorded and will be available 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).

Thank you.

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

Sir, you may begin.

Thanks, Simon.

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

This morning, Alaska Air Group's CEO, Bill Ayer, Air Group's CFO, Brandon Pedersen, and Alaska Airlines President, Brad Tilden will comment on third quarter financial results, our operations and our expectations for the remainder of this year and a first look at 2012.

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 some non-GAAP financial measures, such as adjusted earnings or unit costs, excluding fuel.

So, 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 third-quarter GAAP profit of $77.5 million, excluding the impact of mark-to-market adjustments, related to our fuel hedge portfolio and some fleet transition charges, Air Group reported a record adjusted net income of $131.1 million or $3.58 per share.

The result is compared with the first call consensus of $3.33 per share and beats last year's adjusted net income of $118.1 million or $3.21 per share.

Similar to the second quarter, we reported a large mark-to-market loss in the value of our fuel hedge portfolio, resulting in a significant difference between our GAAP and adjusted earnings.

We are required to revalue our hedge portfolio on the last day of each quarter and we record that change in value in our P & L.

The $84 million mark-to-market loss this quarter was caused by the difference in crude oil prices on June 30, when oil was $95 per barrel and on September 30, when oil had fallen to $79 per barrel.

Because of this type of volatility, we exclude these mark-to-market adjustments from our adjusted earnings.

Additional information about our unit cost expectations, capacity plans, future fuel hedge positions, capital expenditures and other items can be found in our investor update, included in 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 everybody.

This quarter marks our sixth consecutive record quarterly adjusted profit and the highest adjusted quarterly profit in our history.

Our 12,000 employees continue to deliver award-winning service and produced outstanding operational and financial results.

The hard work and changes we have made over the past several years have led to the success we are now seeing, and I want to thank our team for their efforts.

We know that the hard work is not over.

We can't get complacent and we'll keep pushing for continuous improvements in unit costs and productivity, network and revenue enhancements, and the customer experience.

We saw strong demand in all of our regions during the third quarter, leading to $130 million increase in operating revenues.

Like last quarter, however, fuel prices were much higher and offset much of the revenue gained.

Traffic gains outpaced the 5% capacity growth, leading to higher load factors in all three months of the quarter.

These record load factors combined with improved yields in each month drove the 7.5% increase in passenger unit revenue for the quarter.

These revenue gains, along with the higher advanced book-load factors for the fourth quarter, give us a measure of confidence that the demand environment is stable.

However, should things soften, we'll be ready to make the adjustments necessary to match capacity with demand.

Our proven ability to make network decisions quickly is one of the primary factors in our long-term improvement in load factor and yield.

Operationally, both Alaska and Horizon continue to lead the industry in on-time performance with the third-quarter DOT number of 91%.

Alaska is the top performer in this category, among the 10 largest US airlines on a rolling 12 month basis and has led this group for the last 17 of 24 months.

Horizon improved 8 points over the 2010 third quarter and I want to congratulate the entire Horizon team on the tremendous turnaround in operational performance.

We're just now finalizing our 2012 plan, which Brandon and Brad will tell you more about.

Our current mindset is to grow Air Group capacity by about 5% next year.

As we continue our growth into the Hawaii markets and opportunistic growth in markets that competitors have recently pulled out of.

For example, we will add regional capacity in the Seattle to Spokane and Seattle to Boise markets in January.

And just last week, we announced new service from Seattle to Kansas City.

Given that most of our growth is backfilling competitive capacity that has left the market, we're very comfortable with our growth plans and believe this measured growth is consistent with our profitability goals.

We don't know what the economic environment will bring or what fuel prices will do.

What we do know is, we will continue to make course corrections with the network, our fleet and our cost structure to meet whatever challenges the future holds, fully applying the learnings from the last decade of changes.

I have a great deal of confidence in our people, and I know that, together, we are taking the steps today to set us up for continued success in the years ahead.

And with that, I'll turn the call over to Brandon.

Thanks, Bill and hello everyone.

As Chris said, Air Group reported a record adjusted net profit of $131 million of this quarter, compared to a $118 million profit last year.

This represents a 17.7% adjusted pretax margin, virtually unchanged, compared to the third quarter of last year.

Our trailing 12 month return on invested capital stands at 12% and appears very likely that we will exceed our 10% after-tax return on invested capital goal for the second consecutive year.

The increase in our profit was driven by the $130 million or 12% increase in operating revenues, largely offset by a $98 million or 41% increase in our economic fuel costs.

Average crude prices were up 17%, but it's the massive increase in the refining margin that's the bigger problem right now.

Between 2004 and 2010, the refining margin, or crack, as it is sometimes called, has averaged around $0.40 a gallon compared to about $1 a gallon today.

The rise in that component alone hits our fuel costs by nearly $250 million annually.

As a reminder, we hedge crude costs with all caps, but we also use swaps close in to manage the volatility of the refining margin.

In the third quarter, the benefit of our refining margin swaps more than offset the net cost of our WTI call options, resulting in a net benefit of $1.6 million.

Looking at the fourth quarter, we are 50% hedged on a refining margin at $0.93 per gallon and $86 per barrel for crude.

As always, we've included a table in our investor update with more detail about our hedge portfolio.

Air Group's adjusted non fuel operating costs increased by $12.4 million or just under 2% compared to last year.

Consolidated cost per available seat mile, excluding fuel and fleet transition costs, declined by 2.6% on the 4.8% increase in capacity.

Mainline CASMex fuel was $0.0727 for the quarter down over 3% on a 6% mainline capacity increase.

In our most recent investor update, our guidance was $0.073 to $0.074 per mainline CASMex.

Actual results were beneath the low end of the range by roughly $2 million, and the midpoint by just over $5 million.

Because we saw favorable closing adjustments, in most areas, that resulted in third-quarter cost being better than expected.

Having said that, we are maintaining our full year CASMex fuel guidance of $0.076, down 3% from 2010, and exactly equal to our 2011 guidance, given last January.

We expect Q4 mainline unit costs the up 1% to 2% on the 4% capacity increase.

We recognize that it's imperative that we continue to drive down unit costs for us to be competitive with the low cost carriers.

With our planned measured growth in the next few years, our goal is to achieve unit cost reductions by keeping tight control over overhead and maintaining high productivity.

It is notable that productivity, as measured by passengers per FTE improved again this quarter, our ninth consecutive quarterly improvement in this area.

As we look to 2012, we are not ready to give costs guidance quite yet.

However, early roll ups indicate that our unit costs will be down next year, but not at the same rate as this year's decline.

We are dealing with some headwinds as we go into next year.

Pension expense is a particular concern given weak investment returns and the low interest-rate environment.

We won't know the exact amount until year-end, but if we snapped the chalk line at September 30, the year-over-year increase would be in the $25 million range.

This kind of increase illustrates the importance of continuing to move away from legacy-style benefits such as DB plans, in favor of generous, but less volatile DC plans.

As a reminder, all of our DB plan are closed to new entrants and we recently announced that the DB plan covering our nonunion employees will be frozen in January of 2014.

We, also, expect contractual wage increases, and maintenance costs, IT investments and training costs to create additional cost pressure in 2012.

Despite these hurdles, our leaders recognize the importance of lower costs and are working hard right now to finalize aggressive budgets.

Looking at the balance sheet, we ended the quarter with nearly $1.3 billion in cash and short-term investments, which equates to 30% of trailing 12 month revenue.

Our cash, our 23 unencumbered 800s, and our 2 $100 million undrawn lines of credit, give us what we believe to be one of the best liquidity positions in the business.

On that note, during the quarter, we modified one of those lines by extending the term from March 2014 to March 2016 and reduced the commitment fee.

Through September, we've generated approximately $615 million of operating cash flow, compared to just over $500 million last year.

Capital expenditures totaled $295 million in the first 9 months of the year, as we took delivery of 3 737's and eight Q400's, bringing free cash flow in the 9 month period to nearly $320 million.

Our full-year estimate for CapEx is approximately $370 million.

Lower debt balances and strong earnings continue to drive down our adjusted debt to cap ratio.

It now stands at 61%, the lowest level we have on record and 17 points better than we were just two years ago.

With the exception of the recent financing we completed through Canadian EDC on six Q400's, it's notable that Air Group hasn't borrowed any money since the fourth quarter of 2009.

We're, also, well underway on the $50 million share repurchase program that our Board authorized in June.

At September 30, we had purchased just over 518,000 shares for $30 million, bringing our total repurchases in the first 9 months under this and the prior program, to approximately $61 million.

As a reminder, since 2007, we have acquired 8.1 million shares for approximately $240 million.

As we consider the broader question of capital allocation, we continue to believe that a balanced approach is best.

We'll allocate capital with growth as long as we can meet our return goals.

We'll fund pension obligations above minimum required contributions.

We'll deleverage our balance sheet and consider various methods of returning capital to shareholders.

Looking to Horizon, I want to remind you that 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.

Fortunately we only have 1 more quarter to finish and then we can start talking about year-over-year results.

But, I will tell you that Horizon team continues to make great strides in the airlines transformation.

On a standalone basis, Horizon reported an adjusted pretax profit of $6.4 million for the third quarter, representing a 6.9% pretax margin on $93 million of revenue, nearly all of which is CPA revenue from Alaska.

The Horizon team is working hard to achieve its goal of generating a 10% pretax margin.

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

Thanks, Brandon and good morning everyone.

With the summer travel season behind us, I would like to take a moment to reflect on our operational performance.

Looking back just 5 years ago, none of us would have expected operate at 90% plus on-time with load factors that are in the high 80's, for an entire summer.

But, our people have done just that.

Both Alaska and Horizon produced excellent numbers this past summer, so our hats are off to the hard-working folks in both companies that made this happen.

We very much appreciate their efforts.

Alaska Airlines had strong financial performance again this quarter resulting in record adjusted pretax profit of $206 million, a $33 million improvement from last year's third quarter.

As Brandon mentioned, the increase comes from strong revenue growth, that was largely offset by the significant increase in the price of jet fuel.

We believe our 17.2% mainline pretax margin will, once again be among the best in the industry.

For the quarter, mainline passenger revenue increased by $108 million or nearly 14%.

The improvement was driven by a 6% increase in capacity and a 7.4% increase in passenger unit revenues.

Unit revenue improvements were due to increases in both yields and load factor.

Our mainline load factor reached a record high in the third quarter of 87%, almost 2 points better than last year.

September saw the largest increase of the quarter at 2.5 points, contributing to the 8.4% PRASM increase.

Over the past 4 years, we have taken the equivalent of 21 aircraft out of our core North-South mainline markets and redeployed these aircraft into new markets, primarily in Hawaii, but also including some mid-con and trans-con markets.

The result of this redeployment has been increased profit margins in every 1 of our 12 regions.

Our 6% mainline capacity growth in the third quarter is lower than the 12% growth we had in the first half of the year as we are annualizing new Hawaii and Mexico services started in the second half of 2010.

As we look into the fourth quarter, we expect mainline capacity growth of about 4%.

This will be driven, in part, by our new daily service between San Diego and Honolulu which is launching on November 17, and which, by the way, is booking up very well.

And this new service, combined with the increases to daily frequency for service between both San Jose and Oakland to both Kauai and Kona will bring us to 22 round trips each day to Hawaii at our winter peak.

Hawaii will represent about 20% of our network in 2012.

Turning to our regional operation, which includes flying by Horizon, SkyWest and PenAir, we continue to see positive results.

Overall, our regional capacity was down 4.5%, helping to drive the load factor of 2.4 points and yields up 9.5%.

Our PRASM was up nearly 13%.

It's hard to compare profitability because we have apples and oranges between years.

But, it's clear that with the changes we've made, including the right-sizing the network, this flying is doing better for Alaska Air Group.

Also, during the quarter, we reached a tentative agreement with our aircraft technicians, who are represented by AMFA, the Aircraft Mechanics Fraternal Association.

The TA is for a 5 year contract and was reached prior to the amendable date, thanks to hard work by teams on both sides of the table.

The agreement will be voted on by our technicians in the next several weeks.

Looking forward, our consolidated advanced book load factor is up about 1 point from last year for October, up 1.5 points for November, and up 0.5 point for December.

We expect consolidated capacity growth of 3% in the fourth quarter.

As we look forward, we are excited about 2012 and beyond despite continuing uncertainty in the macro environment.

Our people are working together like never before, and that is the key reason that we're having this current success in the marketplace.

We plan to grow mainline capacity by 6% and Air Group capacity by 5% in 2012.

We're confident that we have profitable markets in which to deploy incoming aircraft.

As Brandon mentioned, we're feeling significant cost pressure and our focus on the 2012 budget is intense.

We're holding the lid on overhead and management staffing, while increasing employee productivity and utilization for both aircraft and facilities.

It's never easy given all the things we want to do, but, more than ever, our customers want low fares and to give them low fares, we must have low cost.

On the subject of low fares, we announced an exciting program for residents of the state of Alaska on Tuesday.

It is called Club 49 and it's being offered exclusively to Alaska residents.

It will provide benefits including 2 free bags, an urgent travel certificate, and exclusive e-mail promotions for a weekly series of fare sales.

The intent of the program is to say thank you to our customers in our namesake state, to a improve our value proposition for them, and to further establish their loyalty to Alaska Airlines in the years ahead.

It is our believe that this is a great investment that will enhance our long-term relationship with our customers who live in Alaska.

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

Thanks, Brad.

I want to once again thank all of the Alaska and Horizon employees for their tremendous contribution to another great quarter.

Just before we get to questions, I want to remind everyone of our Investor Day at the New York Stock Exchange on November 16.

Several members of our team will be on hand to meet with you and we'll spend some time updating you on our business plans and outlook for the future.

So, Simon, I think at this time we're ready for questions.

(Operator Instructions).

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

Thank you.

Good morning.

If I remember correctly, a couple of years back I think, there was a bit of an unfavorable surprise in the fourth quarter on CASM of which was largely due to some of the variables in incentive pay.

Is the cost guidance in the fourth quarter, maybe a little bit of a conservatism to avoid kind of an unknown on that?

Brandon here.

Good morning.

You know you're right.

A couple years ago, there was an unfavorable surprise in the fourth quarter.

Much of that was variable pay rate, but, candidly, it was one of those quarters where everything came in with bad news.

Over the course of closing the books, you normally expect the law of big numbers to work out; where you have some positive news and some negative news and it all works out.

But you're right, a couple of years ago in the fourth quarter everything came in one direction.

In the third quarter of this year, it was a little bit the other way; where we had everything come in on the good side, if you will.

As we look forward to the fourth quarter, you're obviously picking up on the fact that we have not changed our full-year guidance.

We have been absolutely fixated on hitting that 7.6% ASM on the mainline goal, that we set out back in the early part of the year.

In terms of conservatism, I don't think that it's fair to say that we are being overly conservative in our guidance because of the sensitivity around what happened fourth-quarter a couple of years ago.

I will point out that maintenance is expected to be up year-over-year, in the fourth quarter and that's the first time that,that will have happened this year.

There is, as you're pointing out, a lot of sensitivity in the variable pay line, but we pride ourselves in high-quality guidance, and that's where the numbers are shaking out.

That's totally fair, thanks Brandon.

I was thinking, if you wanted to be a total optimist about this that you were so bulled up on what you are seeing in your demand trends that you were afraid you were going to blow it out on variable incentive pay.

So you were just including a little conservatism.

(laughter)

No, I think that is probably a tiny bit over the top to say.

But, you are right that the variable pay final trips, that come at the end of the year, can swing several million dollars out of what we expect and that can have an impact on a quarter's CASM.

I will say, also, that our folks are working very hard on making sure that costs come in as favorably as they can, in the fourth quarter.

Our fixation on cost isn't just in the fourth quarter, it goes to 2012.

We commented a little bit on that in the prepared remarks, but it's not just Q4 that we are focused on.

We are focused on Q4 and 2012.

Thanks, Brandon.

The other thing, I'd just love to, maybe, spend a minute or two talking about is you're backfilling a lot of capacity.

Seattle-KC being one of the most intriguing ones in my perspective.

I can't for the life of me figure out how you guys do this.

You're flying almost the same type of plane Southwest flew, your cost-- your non fuel CASM is about 12% higher than Southwest, and presumably Southwest pulled out because they weren't getting yield.

How do you fill these roots at margin accretive levels?

Is this a bag fee play here?

How does that work?

This is Andrew.

I will take a shot at that.

A couple of things.

Number 1 for us, at Kansas City, as we look at it the daily demand is about 95% of St.

Louis and Austin and we know how we do there.

And secondly, they have very low airport costs.

We can fly there and back in the day.

We have no hotels or no crew rest.

Just given our Pacific Northwest network and the demand that we see and our aircraft.

We feel very good about that, filling that.

We've also seen another competitor pulled down.

They're only about 4 days a week.

We think something like that we can make work.

I might just add -- and Andrew said this Pacific Northwest network is pretty important.

We've had, since 2000-whenever, a focus on Seattle, our Seattle strategy, going more places out of Seattle, starting with DC and Newark and so forth.

So, we really have become a more important carrier.

And from a network utility standpoint for folks that live in the Pacific Northwest, we're just seeing a higher share.

So, as we add new markets, we're more confident in our forecast because we've done it so many times, the spokes out of Seattle.

And frankly, the fee from Horizon is an important part of this, as well.

Great.

Thanks very much guys.

I appreciate it.

Bill Greene, Morgan Stanley.

Hello there.

I was wondering if you can remind us as you look at your long-term plans, what's the right long-term growth rate for capacity for Alaska?

Bill, it is Brad.

I might take a shot at that.

I guess, we would start with an industry view, and you guys spend time on this, but it depends on what's happening with fuel prices obviously.

Maybe there's an industry view that the industry grows roughly inline with GDP or the economy, so that's where Alaska would start.

And then we would say to grow more than that, we need to be successful at stealing -- moving into new markets and stealing shares from our competitors.

As we look at our position; the preference that are customers have for our product, the way we are operating, the way our employees are delivering this product and importantly, our cost structure, we think we are in a position to gradually improve our share of the US airline industry over time.

Our basic mindset, now, is a growth somewhere in the range of 4% to 8% over the next many, many years.

And in some years it may be slower, it may be on the low end of that on some years, as in this year, we're going to grow 8.5%.

That's generally how we think about it.

We think that we've a very strong competitive position.

We think we've done a lot of good things to position the Company to be successful and we think that we're demonstrating that we're doing that right now.

Absolutely.

We think about all the puts and takes, obviously it was a solid quarter from a revenue perspective for the industry, but also for Alaska.

When you think about the uncertainty that exists for 2012, what are the things that you watch for that say that we need to think about being at the lower end --.

I realize you're no really talking much on guidance for '12, but we need to be at the lower end of some of those capacity numbers for '12.

What is the thought process or what are the data points that you watch pretty closely to say, this is a sign that things are not okay?

A couple of us mentioned it during the prepared comments, that we look at that there were performance very carefully, every city, every month.

We are looking for strength or weakness in our markets, in particularly in places where there's natural growth opportunity for us.

Hunter asked about Kansas City, -- it's a natural place for us to grow.

If there's opportunity that looks like they are coming our way, kind of, in our core service areas, that might create an opportunity for us.

If we don't, competitors aren't making moves that present opportunities like that, that might put us to the lower end of the growth range.

And then, just generally, we're all, I think every airline management team, is looking at unemployment rates and the economy and the macro environment.

And we're all just trying to balance a general concern about our country and getting moving again and getting growing again, with some of the short term indicators that we're seeing.

It's complicated.

One of the specific things that's going to work in our favor of the 737 900ER that we start taking delivery of late next year.

We are fairly confident we can replace existing 800 round trips with 900ER's, and that's 181 seats on the ER versus 157 on the 800.

So, there's some natural growth there, that is really very low risk growth, because it's existing markets that we're currently flying the exact patterns with the 800's.

Over time, that will give us a little bit of a tailwind with some of this growth.

This is Brandon here.

I will add one more comment.

A good rule of thumb and way to think about this is, each 1% growth is about 1 airplane and that's 1 Transcon flight or 1 flight to Hawaii.

So in the context of 5% consolidated growth or 6% mainline growth, that might sound like a big number if you're comparing it to the big guys in the industry, but for us it is pretty limited.

That's helpful thank you for the time.

Thanks, Bill.

Will Randow, Citigroup.

Good morning and congratulations on the quarter.

Brandon, can you share with us where Horizon's ROIC is today?

Potentially, quantify the level of invested capital and how long that may take to get to the hurdle rate your thinking about?

And, also, any progress with the pilots that may have occurred in the last few weeks?

Will, maybe Glenn can start with the second part of that with the pilots while I look for a piece of information.

Sure, I'd be happy to do that.

Good morning, Will.

With our pilots, I would just remind you that we have a 5 year agreement with International Brotherhood of Teamsters, which are our pilots.

Part of that agreement, which we struck just a year ago, was for 2 wage resets, the first being 2011, the second in 2013, each for the success of 2 years.

That's the process that we're in right now, the first wage reset.

Our objective, of course, is to set our pilot wages at market, and so there was a negotiation phase and an agreement that we put out for vote, as a result of that.

It did not pass.

That took us to the second part of the process, which is an arbitration.

It's a baseball-style arbitration - where the Company presents its case and the Union presents its case and the arbitrator is bound to choose 1 side or the other.

No blending of the solution or the arbitrator choosing his own solution set.

We have presented those cases and we would expect to have the arbitrator's decision by December 1.

The Company's position is a 5% reduction in the wage scales across the board.

The Union's position is a 2.8% increase in the wage scale across the board.

And that would be implemented, whatever the arbitrator's decision is, would be implemented mid-December, this year.

And that wage rate will be in place until the next reset, which is then September, 2013.

Hi, Will.

Brandon, coming back to your ROIC question, and I apologize for the delay, I just had a look back at some notes.

For internal accounting purposes, we think Horizon has about $800 million of invested capital, which is about 24% of the Air Group total of $3.3 billion.

Currently on a rolling 12 month basis, Horizon's ROIC as we calculate it, is about 4%.

What we have been trying to do is, we've been trying to steer the conversation toward pretax margin because A., it is really easy for folks to understand, and B., there are a ton of complexities when you get down to allocating the capital base between 2 operating subsidiaries of that have many many shared services, as well as, inter-company payables.

So, that's the number, but like I said we are trying to focus the conversation on Horizon's pretax margin taking that from the current goal, and I think, year-to-date, we're in 5.9% on a year-to-date basis up to the goal of 10%.

And that's probably going to happen over the next couple of years, I would say.

Thank you.

Bill, 1 follow-up, in terms of when we were speaking last month, you mentioned how Alaska could be nimble during a downturn or very focused on profitability.

Could you share a couple of recent examples of how you've either pulled out of the market and introduced aircraft into another market, or how you monitor profitability per aircraft?

Brad mentioned and I'll have Andrew chime in here too, Will.

But, Brad mentioned the reallocation of 20-some airplanes that we essentially moved off the West Coast to do new things and this redeployment idea.

I'll let Andrew talk about what he and his team do.

Up front, we have a very good process of close in monitoring of market performance.

We have a watch list of markets that are underperforming.

Marketing takes that it figures out what are some things that we can do to improve the situation.

Ultimately, if we can't improvement it, we look at making moves.

Andrew.

Will, one of the joys of being a smaller company, is the Chairman actually knows route by route what some of these markets might do, so my job gets really tough sometimes.

The reality is that we look at these things every month route by route by route.

The profitability, we fully allocate the whole thing.

I think the bigger thing to note over time is that, essentially since 2008, when we really significantly pulled down our core, we really haven't added much back to that at all.

We've just continued to redeploy, as Brad mentioned earlier, into new markets.

We look at our cost.

We look at airport costs, and we get the whole marketing, revenue management network, all the teams.

So given the size of our Company, we have a very close knit relationship across all divisions, including the operating division.

That's a little bit of the back story about how closely we work together and how granular we do get at looking at markets and right up to the most senior levels.

And I might just add from a longer-term perspective, I've been around here long time.

In the old days we used to hang onto losers.

We weren't, first of all, clear what was making money and what was losing money.

We'd hang onto things and hope that they would get better.

We used to call those markets, strategic.

Now, we understand where we need to be strong, and that we're going to move quickly out of places where we need to have a presence.

But, on the other hand, with some things are just not working, we have a better opportunity and we're much faster to make it move and reallocate.

Thanks guys.

Congrats on the quarter.

Thank you.

Helane Becker, Dahlman Rose.

Thanks very much, Operator.

Hello everybody.

I just had a fleet-related question.

I think you have 6 aircraft to due in for 2012, and 3 that you're going to either be retiring or returning to the source.

Can you just tell us how we should think about those aircraft financing's, number 1?

And number 2, do you have quarters for when those are coming in?

When we should think about how to move these into our models?

Sure, Helane, it's Brandon.

I can give you the estimate of when those are coming.

You're right, there is 6 coming in 2012.

We will have 2 in the first quarter, 1 in the second quarter, none in the third quarter, and 3 in the fourth quarter.

And you're also right that we have 3 airplanes that we're scheduled to return.

Those are all scheduled to go out in the late third or fourth quarter.

Candidly, we are thinking about whether it makes sense to do a very short-term extension on 1 or 2 of those.

Okay, and what about the financing for those?

Are we putting those into owned aircraft or leased aircraft or what?

Yes, I would not expect, necessarily, to see those as leased aircraft.

Our bias right now has been toward owning.

Although, we think about that lots of different ways.

I don't see us really having a need to finance those based on our view of 2012 currently.

Okay, great.

Okay, that's really the only question I had.

Thank you very much.

Duane Pfennigwerth, Evercore Partners.

Good morning, guys.

Question for Bill.

What is your business telling you about the economy right now?

We're seeing strong demand, and we're seeing no signs of weakening, as we look forward to the fourth quarter.

I guess, the caveat to that would be that, as we discussed here, we've made a lot of network changes to sync up capacity with demand.

We're not necessarily a proxy for aggregate demand and the health of the US economy, by any means.

But, in terms of our markets and the amount of capacity that we have allocated to them, we see very strong demand, as evidenced by the record load factors and PRASM's.

Should we read into any change on how you're managing your revenue?

I think, coming into this last quarter, we saw load factors and advanced book loads down, you were holding out for yields- How should we interpret up advanced book loads?

Duane, this is Andrew.

I think, one of the things that we have been doing, which you saw in the third quarter, is that we found opportunity on the Tuesdays, Wednesdays and Saturdays, to significantly improve load factor, while holding out on more of the peak days.

That strategy will continue into the fourth quarter.

Another thing, that we've done, which we're really excited about, is that for the first time, we're going to split December into 2 periods.

The first 2 weeks of December are significantly different and weaker than the last 2 weeks in December.

So, we have pulled down flights and capacity in the first 2 weeks and added additional in the back end.

So, that's sort of the process, and to Bill's point, we're seeing the environment continue as we've seen it recently and that's how we're going to manage the revenue.

Andrew, that first half of December is a normal seasonal reductions within the month, right.

That's normally what we see in a December and this year, we're able to do something about it with capacity.

Yes.

And perhaps the most important thing is to recognize that we can't control what happens to this economy.

So, the fact that we have a track record and a good history of moving quickly and reallocating, assessing market conditions route by route and moving quickly to reallocate capacity, when necessary, gives us the most confidence of all.

Thanks for that detail.

Jamie Baker, JPMorgan.

Good morning, guys.

So, strategic is the new loser?

I think I might actually have to steal that one from you.

I trust you'll agree that the industry here in the States, at least, is undergoing some pretty significant change in the past years, but one of those changes doesn't seem to be a function of anything the airlines themselves have done.

It's the phenomenon that fuel prices are much more highly correlated to changes in economic output and than historically was the case.

As the economy softens, fuel was down and so forth.

I'm wondering, in light of this increasingly natural fuel hedge that airlines enjoy, why you haven't made any more substantive changes in how you hedge, or to put it more bluntly, why you continue to hedge at all?

Hello Jamie, it's Brandon.

And let me caution you, most managements respond by saying that hedging is of strategic importance.

I'm not to use that word here.

Okay, go ahead.

I will start by saying that hedging is really important to us.

If you think about hedging as insurance, we are protecting our balance sheet, we're insuring our shareholders against a massive run-up in oil prices.

You're right.

Recently there has been more of a correlation between economic views of the world and where fuel prices go, but the swing seems to be almost daily or weekly.

Long-term, we still believe that it's a good idea to think about this as insurance.

We can afford it, we believe it's a good use of capital, it's saved us more than $400 million and since we started doing this back in 2001.

Even this year, it's a best better than $30 million.

I'm very comfortable with what we are doing and our philosophy around that.

Having said that, if we develop a longer-term trend of either a reduced volatility or perhaps a better correlation with the economy, we will think about changing our approach.

And we do look at this relatively frequently.

We talk to our Board Finance committee about this.

We think about it internally.

But to date, we haven't seen any compelling reason to steer off of what we think has been a pretty successful strategy over the last decade.

Yes.

And I can do this math myself, but since you have the numbers at your fingertips, you said $400 million in savings since 2001.

You wouldn't happen to know what that figure would be, if you exclude what occurred in 2008?

Yes, I have that at my fingertips.

Let me look here real quick.

It will take a minute to get through this larger book.

If I look at the chart, so if we look at the cumulative savings of the program through, say the middle of '08, we were in $500 million of cumulative savings.

So, through now, we're as I said, better than $400 million, I think it's more like $410 million, so over the period of since July of 2008 through today, it has probably been a net cost of $80 million or $90 million.

Okay, fair enough.

Thanks for your thoughts on that.

Michael Linenberg, Deutsche Bank.

Thanks.

Good morning, everyone.

I want to go back when you were talking about maybe some potential cost headwinds next year.

You talked about the pension.

Can you give us a feel, this year where was the pension expense as a cash contribution, and as we think about 2012, can you give us a rough feel for how those numbers look at?

My sense is, maybe they deviate or they spread apart in 2012.

Yes.

Deviation is an understatement.

So, if we look at the pension expense in 2011, it is right around $42 million.

$42 million or $43 million.

If you look at what it was in 2010, I think it was right around $50 million.

So, we had a little bit of a tailwind this year, going into pension expense.

I don't know if you heard in the prepared comments, as we look at 2012, based on what we saw as of September 30, we would've seen a year-over-year increase in 2012 versus 11 of about $25 million.

So it is extremely volatile.

That is a very big headwind that we are facing next year.

Let's say that it's $67 million of expense.

What would be the cash contribution?

Because I believe you do benefit from some of the legislative relief that airlines have been the beneficiaries of over the last few years.

So the cash piece, how does that compare to that?

Next year, we have no required cash contribution, although the Company's practice has been to fund basically the service cost.

And so, I would expect us to continue with that practice and have a cash expense in the neighborhood of $35 million-$40 million, absent any top up funding that we might do.

We have had a history of that too.

If you look at what has happened over the last few years, and in every single one of the last few years, we haven't had any required contribution.

But, as part of our normal funding practice, we have done it anywhere from $35 million-$50 million.

But then at the end of 2010 and the end of 2009, we made additional $100 million contributions, not only because there is a P&L benefit to doing that, but it's consistent with our values of when things it really good, we share it with our employees.

And our employees care about pension funding, so we felt like it was an important thing to do.

And just my second question, since you provided some clarity on this and it was the first that I heard.

Where you talked about the return on invested capital for Horizon you talked about 4%?

You were pretty open about the fact that there is obviously some complexity and some transfer pricing issues.

When we think about that number, that 4%, is that pretty much based on the segment revenue?

And what I'm getting at, is it sounds like you are not giving Horizon any credit for whatever amount of beyond revenue that Horizon delivers to Alaska.

Say, the guy who fly's Horizon Bellingham to Seattle and then fly's Seattle first-class on Alaska to the East Coast.

You're not giving them that credit in that 4% number.

Is that right?

That's exactly right.

Here's how we think about it.

We think about it as, what would the return be or the pretax margin or what have you, looking at Horizon, as a standalone business, that is a CPA provider.

What we really want is for Horizon's number to be comparable with other all CPA providers in the business.

That's on that basis.

And as I mentioned and as you reiterated, there are lots and lots of complexities of inter-company allocations that makes our ROIC numbers difficult.

What we are really focused on is getting Horizon to a very important 10% pretax margin on that basis, which is CPA revenue from Alaska, which is at a market rate minus actual Horizon costs.

Having said that, there is a separate measure that we look at, which is really stripping away the boundaries of what Company you are putting the revenues and expenses on.

How is the regional business doing?

We haven't really given it any numbers on that because we don't measure our ROIC on the regional business, but Brad alluded to it.

So if you take true market revenue, such as that Bellingham example minus a regional cost whether it's at Horizon's actual operating costs or what we pay SkyWest.

The regional business is, actually, doing quite well.

Okay.

Very good.

A great quarter.

Thank you

And I might just add, on the Horizon front we really are making great progress.

And like a lot of things we've done over the past decade, writing down a goal, like a CASM goal, or an ROIC goal, writing that down and working on it consistently year after year making progress, we will get there.

Horizon will be a significant contributor to Air Group when we get done with this.

The single fleet transition that we've done over the last year is really important.

We've got a single fleet of Q400's.

We're convinced that's exactly the right airplane for these markets.

The fuel burn is the phenomenal.

It's the most efficient regional airplane out there.

Glenn and his team are working on bringing cost down.

We've made a lot of network changes with this CPA approach that are working out very well.

I'm just real confident that we will continue to make progress and Horizon will be a significant contributor.

Bill, I hope you succeed because I like 20% plus operating margins.

Thanks.

Thanks, Mike.

Gary Chase, Barclays Capital.

Good morning, everybody.

Good morning Gary.

I wanted to just ask a couple quick ones.

First, the peak off peak pricing that you were describing in answer to a couple questions back, I'm wondering how long you've had that in effect and whether or not that is something that you think has reached maturity or you are still tweaking that for improvement?

Gary, this is Andrew.

I'd suppose I'd answer that in 2 parts.

The first part is, in my mind at least, this last year is where we've really been getting really good at filling the weaker days.

The other big thing, just to be frank, with all these new markets we've started, our revenue management systems, our RM analysts, have been starting to learn them and learn them better and as every quarter goes by we understand the traffic flows, the business patterns, we understand Hawaii much better.

We are getting much smarter about how we manage our business.

And so, Bill mentioned about process and tools, we also have improved the quality of the tools and the analysis and the transparency of the analysis that we have.

And so, one of the confidences that I have, is that outside of macroeconomic conditions, I still see opportunity for us to manage our markets better with what we are working with today.

Andrew, another angle on that as the schedule.

In the old days, we would produce a schedule and fly the same schedule every single day of the week.

Now we produce a schedule and if Saturday night is weak, we will pull the Saturday night flight or the Tuesday night flight, or the Wednesday night flight.

It's a little more tactical on the scheduling side and then you guys are doing a good job on the RM side, as well.

That was my question.

So there is a capacity driver here, as well.

Then when you guys said, and I'm pretty sure the answer to this would be no, but when you talk about those roll ups being negative for next year on CASM, ie.

positive, down CASM.

There's nothing we should understand about the nature of the flying -- you're not saying, for example, doing a lot more long-haul flying.

You're talking about true cost reduction, apples to apples, right?

Yeah.

It's Brandon.

I am looking at Andrew here too.

No, the flying is what the flying is.

Our network has continued to evolve, as we have entered Hawaii in a big way and as we have added Transcon flying.

So, if you look at our average stage length, it certainly has grown.

Next year in the fourth quarter, we will get two 900ER's, and so, that's adding a little bit of gauge if you do the math.

But, generally speaking, I don't think there's anything big that you can't see right now that would tell you anything other than we have really keen focus on getting our unit cost down.

I'd just add to that, I think we've now seen the peak of our trip length increase, which in 2010 was up 5% a quarter and we've been trailing down into the 4%s and 3%s so I think that's where you'll see us.

And also, for Brandon or maybe Bill, if you look at the level of your earnings it has definitely been impressive and I wouldn't deny you that, but I think more impressive has been how stable they've been now.

They aren't as stable as maybe some industries, but when you consider the industry that you're in, the earnings stability over the last several years has just been remarkable.

And I'm curious if you would consider a dividend, as a way to get cash back into shareholders hands, as opposed to a buyback.

Even if maybe, the dividend was at a much lower level than what you intended to return to give you some flexibility.

Gary, It's Brandon.

I can't speak for our Board, but I do know that our Board thinks it's really important to return capital to shareholders one way or another.

And because the industry is very volatile, the Board has sided on the side of repurchase.

We know the pros and cons one way or another.

I would love to tell you that we have clarity to know that this industry or this Company will be stable for the long-term, but the reality is that we don't.

We've had 2 really good years and I think what we need is just more time to see that stability, before we really get into that question in a more serious way.

Okay guys, thanks very much.

Thank you.

Jim Higgins, Ticonderoga Securities.

Good morning, everyone.

Great quarter.

Gary took my dividend question, but I'll ask another.

Which is, it appears that your full year and fourth quarter consolidated non fuel CASM guidance is up from prior guidance.

It must be coming from the regional side?

Can you tell us what's driving that change?

Yeah, hi Jim, it is Brandon.

It's not necessarily coming from the regional side.

I would say it's coming from the reporting side.

We are very good with the mainline CASM number, but I would tell you that we have had some internal growing pains around getting really good with consolidated numbers, having moved Horizon to an all CPA business, moving our disclosure to a consolidated disclosure, and recognizing the appropriateness of rounding.

So if you look at our last disclosure, I think our consolidated guidance was 8.5, and the latest investor update we were at 8.53 with profit capacity down just a tiny, tiny bit.

But the real driver is that maybe, if you look back at September, we were probably at 8.52 and we rounded that to 8.5, really not being smart and recognizing that, that 2/10 of a cent on 29 billion ASM's turns out to be real dollars, particularly when you jam that in the fourth quarter.

There's really no cost creep on the regional side that you should be aware of.

It's more of a refinement in the way we rounded the guidance.

Okay.

You're - not to get into the weeds here, but your guidance was actually 8.45 before, so it's a meaningful jump when you cram it into the fourth quarter.

I think, if you looked at our September 13 investor update, we were at 8.5, at that point.

Okay.

Your point is fair.

Okay, thanks very much

Thanks, Jim.

Glenn Engel, Bank of America Merrill Lynch.

Good morning, a few questions please.

First on variable pay, if I look at the first 9 months your variable pay is down 15%, even though your operating profit is down only 5%.

Yes.

Is that -- surprised me, why would people get a bigger cut if the profit is down and fuel has been even higher, which isn't their fault really.

Well, Glenn, the way the variable pay program works is that it doesn't pay based on the absolute level of profit.

It pays based on how we do in relation to the goals that are set by the Board, at the start of the year.

And coming off of a very successful 2010, we naturally, like any good Company would, raised the bar and the goals got a little bit harder.

So, even though, we are having a better year on an absolute basis, the lower payout is simply due to the fact that our goals were harder on the profit metrics.

You mentioned that you were going to cut more the first half of December.

Would that mean that my ASM growth would be much smaller in December than the quarter as a whole?

This is Andrew.

I'm looking on my little cheat chart here.

The ASM growth is, roughly, at a high level 5, 4 and 3, so I think it's the smallest level of growth of the quarter will be in December.

And on the RASM side, which was so strong, were there any leaders and laggards in the different regions?

You know, we don't specifically comment, Glenn, on the regions, but what I would say, is that for all 12 regions every single one of them had what, I viewed, as very good unit revenue improvement across the board.

So, that's why we feel good about all of our regions performing, not just any 1 or 2 bringing up the average.

And a final sort of follow-up to Jamie's question, premiums have gone from 5 to 15.

Are there any levels of premium where it would cause you to change your strategy on hedging?

I suppose there is a level that we would want to really evaluate that.

I guess, the bottom line for me is that the premium costs have gone up because this is an option and options price in volatility.

To the extent that the volatility continues to drive premium cost up, it makes it even more important to have that insurance in place.

Thank you very much.

Dan McKenzie, Rodman and Renshaw.

Yeah, hey, thanks.

Good morning, guys.

One quick house cleaning questions on the cost guidance.

Does it factor in the pending arbitrator decision one way or the other?

So under the scenario where the arbitrator rules in favor of the pilots, I wondering if we should plan for a negative cost surprise?

Hi Dan, it's Brandon.

No.

There is nothing factored in one way or the other on the pending arbitration.

Okay, fair enough.

And then, the worry is, what we have seen, historically, that demand always likes the economy, of course, for the airline industry.

The worry is not that demand will fall off a cliff in the fourth quarter, but it falls off a cliff in the first part of 2012.

At least, if this was a rerun, that's what we've seen historically.

But, the capacity strategy for 2012, at least at this point, seems to suggest that, that's not going to be the case.

I guess, how accurate is that logic?

This is Andrew.

I suppose, one thing is that we still have decisions to make.

We've shared our guidance, but if you just pulled the tape right off of APG DAT and looked at it, you'd see we're only up about 3.5% next year, in capacity.

So, we're still very closely watching this.

If things change or become negative, there is nothing that we are seeing in January and February -- although load factor bookings are very low.

There is nothing really seen today that would concern us.

Okay, that's terrific.

Very helpful.

Thanks guys.

And Andrew, we're also seeing some competitive reductions in the first quarter?

That's true, Bill.

The industry, as a whole, is really showing discipline, and really for the industry, January and February are really bad months.

And the industry, we saw more come out again that there are more cuts in January and February by many carriers in our markets, which is what we've done as well, so we feel good about that.

Okay, thanks again.

Appreciate it.

Kevin Crissey, UBS.

Thanks.

Was there anything that changed that allows you to do this adjustment of capacity in December?

It seems like a logical thing to have done, over maybe this 60 year history or whatever the number of years is.(laughter)

Kevin, as I continually learn from my mistakes, so no, I think to be honest with you, the reality is and a credit to the operational groups, our focus was on from '05 on and specifically in '08 was getting the operational back to excellence.

As we have been able to achieve that, that's allowed us, in my team, to have more flexibility to throw these curve balls to the operation.

Because it requires them to do very different things with their staffing, with a whole lot of complexity.

The operation is in a place today where they can handle these split schedules within a month.

Terrific.

Thanks, good answer.

How about on the online traffic - some of the other carriers have seen less sales through the OTA's.

Is that something you guys are also experiencing?

Kevin, this is Joe from Marketing.

Actually, it is.

We had a terrific month in September.

53% of all our bookings at alaskaair.com.

For us, that's a place where putting a lot of focus.

We've got a great group that is not only introduced a completely redesigned website this year, which is functioning really well.

A lot of focus on the mobile space as well and some other areas of online search that is driving more and more traffic to alaskaair.com.

So a good share percentage and a large increase in traffic visitors to our website.

So yes, that is having a corresponding impact in online travel agency bookings and that's the direction we want to go because we think we can provide the best possible service to our customers when they visit us directly at our website.

Okay, thank you.

Ted Reed, theStreet.com.

Thank you.

I just wondered about these routes you're adding in, pulling out of.

Could you give me some examples of routes you have pulled out of recently?

And if you look ahead to routes that you're adding, are you mainly talking about Hawaii and routes vacated by others, or is there some other guideline?

This is Andrew.

The good news is that we have reduced routes that we have pulled out of more recently.

I think some of them that come to mind on the mainline side is Austin-San Jose, Anchorage- San Francisco, Arcata - Los Angeles, LA-Redding, Los Angeles-Reno, Spokane- San Jose, Spokane -Sacramento, and in 2010, we pulled out of a lot of markets.

And so, we have seen that abate and we feel good about our regional network and our mainline network, and so for now, it is a balance between controlling growth in the core and then redeploying into new markets.

So, recent times, less cuts, which is good, but really going forward, we continue to monitor that.

We will pull if we need to pull.

And Ted, this is Bill.

There have also been a lot of frequency trimmings.

Probably more than whole market pull outs they've just been reductions in frequency and reallocations.

Increases some places, decreases others.

And as you look ahead, are you mainly looking at routes that others are vacating, or more Hawaii capacity, or anything specific like that?

We don't comment on future growth markets.

Okay, thank you.

Thanks, Ted.

Okay, I think we're about all the time for questions.

In fact, we're over.

We appreciate people's patience with the time here.

We want to thank you all for joining us.

We look forward to seeing many of you on November 16 at the stock exchange.

I hope you will join us there and if not, we will talk with you again next quarter.

Thanks for a much everybody.

Take care.

Ladies and gentlemen, this concludes today's conference call.

You may disconnect.

And I thank you very much for participating in this call.

This call will be available for replay beginning at 11.30PM today at through -- on November 20, 2011.

Number for the replay is 38154667.

The number to dial for the replay is one 800 642 is 1-800-642-1687, or 1706 or 1-706-647-9291.

Also, the call will be accessible for future playback at www.alaskaair.com.

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