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Alaska Air Group, Inc. (NYSE:ALK)

Q3 2008 Earnings Call

October 23, 2008 8:00 am ET

Executives

Shannon Alberts - Managing Director of Investor Relations William S. Ayer - Chairman, Chief Executive Officer

Bradley D. Tilden - Chief Financial Officer

Jeffrey D. Pinneo - Chief Executive Officer of Horizon Air Industries, Inc.

John Schaefer – Vice President, Finance, Treasurer

Gregg Saretsky – Executive Vice President, Flight and Marketing

Brandon Pedersen – Vice President, Finance, Controller

Analysts

Raymond Neidl - Calyon Securities

Michael Linenberg - Merrill Lynch

Dave Simpson - Barclays Capital

Daniel Mckenzie - Credit Suisse

Peter Jacobs - Ragen Mackenzie

Operator

Good morning, my name is Jennifer and I will be your conference operator today. At this time, I would like to welcome everyone to the Alaska Air Group third quarter 2008 earnings conference call. (Operator Instructions) And now I’d like to turn this over to the Managing Director of Investor Relations, Ms. Shannon Alberts.

Shannon Alberts

Hello everyone and thank you for joining us for Alaska Air Group’s third quarter 2008 conference call. Alaska Air Group Chairman and CEO Bill Ayer, CFO Brad Tilden, and Horizone Air, CEO, Jeff Pinneo will provide an overview of the quarter, after which we will be happy to address questions from analysts and then from journalists. Other members of the senior management team are also present to help answer your questions.

Today's call will include forward-looking statements that may differ materially from actual results. Additional information on risk factors that could affect our business can be found in our periodic SEC filings available on our website.

Our presentation includes some non-GAAP financial measures, and we provided a reconciliation between the most directly comparable GAAP and non-GAAP measures in our earnings release. This morning, Alaska Air Group reported a GAAP loss of $86.5 million for the third quarter excluding the impact of mark-to-market adjustments for fuel, fleet transition, and restructuring charges as well as the one-time benefit from the change in our mileage plan expiration policy, Air Group reported an adjusted net profit of $39.9 million or $1.10 per share. This compared to a recently increased First Call mean EPS of $0.93 per share and to a net profit of $78.8 million or $1.93 per share last year.

Again excluding special items, Air Group’s loss for the first nine months of this year is $12 million or $0.33 per share compared to a profit of $109.5 million or $2.67 per share for the first nine months of 2007. Additional information about expected capacity changes, unit costs, fuel hedge positions, capital expenditures, and fleet count can be found in our investor update which is included in our form 8-K available on our investor website at alaskaair.com.

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

William S. Ayer

We are pleased to be one of only a few airlines so far to report an adjusted profit for the third quarter. While our net profit is only half of what we posted last year, earning a profit at all in this difficult environment indicates that our efforts to respond to high fuel costs and softer demand are paying off. We were able to increase Air Group revenues and reduce non-fuel operating expenses during the quarter, but those improvements were not enough to make up for the $110 million increase in economic fuel cost for the quarter.

Oil was now down to around $70 per barrel, about half of where it was in July, and that’s good news. However, oil was being driven lower as a result of a slowing economy which results in less demand for air travel and makes it more difficult to sustain the meaningful passenger RASM increases that we’ve begun to experience.

The biggest issue facing airlines today is the uncertainty surrounding customer demand and fuel prices for 2009 and beyond. The key is to control what we can and to continue to adapt our business to the changing conditions. Our fleet, our balance sheet, and our strong customer following put us in a great position to do just that.

Last quarter we discussed five things that we’re doing in response to the challenges we face. Maintaining healthy liquidity and a strong balance sheet, reducing and re-deploying capacity, boosting revenues through fare increases, improved load factors and ancillary fees, conserving fuel efficiency through our highly efficient fleets and operational improvements, and finally controlling non-fuel costs.

Let me spend just a minute on three of these that are particularly relevant right now. First, I’m happy to say that our liquidity remains strong and is improving. We ended the quarter with $1.07 billion in cash and short-term investments, and at the moment, we have just shy of $1.2 billion, up from almost exactly $1 billion at the end of the second quarter.

Second, we are pleased with the early returns from the scheduled reductions that we implemented in late August. In September, we saw an almost immediate double-digit unit revenue increase across all lines of business in response to our scheduled reductions. The third area of particular relevance is fuel conservation. Our hedge portfolio has been a great asset, but the best long-term hedge we have against high fuel costs is a fuel-efficient fleet.

Now, in terms of ASMs per gallon which you might think of as comparable to miles per gallon for your car, we achieved fuel efficiency of 75 ASMs per gallon in September following the retirement of our last MD-80 on August 25th. With Southwest third quarter number at 69, United’s at 62, and Americans at 61, we believe we lead the industry in this measure.

Last quarter we noted that as we shrink our capacity, we will also need to decrease the number of people we employ. It is always difficult to take this kind of action, but early indications are that we’ll be able to significantly reduce the number of frontline furrows to early out and voluntary leave arrangements.

While we’re aggressively reducing capacity in some markets, we are re-deploying capacity where we see opportunities. Alaska will begin service between Seattle and Minneapolis this Sunday, between Anchorage and Mallie on October 31st, and we’re looking forward to starting service to Kono, Hawaii on November 17th. Horizon will start seasonal service to Mammoth Lakes, California in December, and has recently announced its intention to expand service to Everette Paine Field, a satellite airport just north of Seattle.

We’re seeing excellent operational performance at both airlines. For the third quarter, Alaska’s on-time performance jumped 12.6 points to 81.9% and Horizon’s was up 6.4 points to 87.3%. Alaska’s performance for the month of September represented a 14.5-point improvement, and its best on-time performance in a decade. Of course, the credit for these improvements goes to Alaska and Horizon employees who have received $10 million year-to-date under our share rewards program. And it’s even more gratifying when customers recognize the good service provided by our employees as they did this summer. In a customer satisfaction survey conducted by J.D. Power and Associates, Alaska Airlines tied for first place among North American network carriers achieving top marks in 5 of 7 areas including overall customer service.

This remains the most difficult period in commercial aviation history. Through all the upheaval, our basic strategy to build a greater line for employees, customers, and investors, and to do it for the long term has not changed. The tactics required are varied, but our commitment has not wavered. In spite of the current economic uncertainty and the magnitude of change, our employees have kept their focus on delivering a safe and enjoyable travel experience. I couldn’t be more grateful to them.

With that I will turn the call over to Brad.

Bradley D. Tilden

Alaska Airlines reported an adjusted pre-tax profit of $56.6 million for the quarter compared to $123.4 million last year. As is our usual practice, our adjusted figures take fuel on an economic basis and exclude fleet and restructuring charges. We also excluded the significant gain that resulted from the change in the expiration policy for our Mileage Plan miles. Air Group’s after-tax GAAP loss this quarter includes $137 million in mark-to-market hedging losses as we started the quarter with oil at $140 per barrel and ended it with oil at $100 per barrel. We’ve excluded these paper losses from our adjusted results.

In the second quarter, our GAAP result included $97 million in mark-to-market hedging gains as we started the quarter with oil at $102 per barrel and ended it with oil at $140 per barrel. Like the paper losses in the third quarter, we excluded those gains from our second quarter-adjusted results. Our adjusted results always exclude mark-to-market gains and losses, and only include the cash benefit of settled hedges.

We know that many of our competitors have fielded questions recently regarding the fuel hedge portfolio as oil prices have declined substantially from their record highs in July. We have been relatively conservative with our hedging program, and I would like to ask our treasurer, Jay Schaefer, to walk you through how lower oil prices will affect us.

Jay Schaefer

Air Group’s hedge program has been based mostly on the use of call options, commonly called CAPS because these instruments cap the price we pay for oil. For the 94% of our portfolio that is capped, we will fully benefit from any decline in oil prices. When using call options, the only payment we make is the upfront premium paid for future fuel price protection. So, under any future fuel price scenario, there will be no additional cash obligation. This includes both cash settlement and cash collateral.

We generally don’t try to time the market, but instead have a program of layering in hedges 3 years in advance, so we’re 50% hedged 6 months before the fuel consumption takes place. We view our hedge program as an insurance policy which when consistently applied buys protection that helps us manage the volatility of rising fuel prices while allowing us to enjoy the benefit of falling fuel prices.

For the quarter, we had $44 million in cash inflows from hedges which was $27 million more than in the same quarter last year, and year-to-date we have received $129 million of cash inflows. Since July 2002, Air Group’s hedge program has provided approximately $500 million of net hedge benefit, this is actual cash received from our counterparties to reduce our fuel bills, and is net of the premiums paid.

The program has been systematically executed to not only provide adequate hedge benefit in period of rising prices, but it was constructed so that it would not disadvantage our company in periods of falling prices as well. For the great majority of the portfolio, we are not at risk for paying any additional cash to counterparties as the price of oil declines below our hedge prices.

With that said, call option premiums have become quite expensive as oil volatility has increased. As oil prices fall, the downside risk may moderate to the point where a more diversified portfolio of call options, collars, and swaps becomes appropriate, which is similar to how our portfolio was constructed in the 1990s when we began our hedging program.

With that, I’ll turn the call back to Brad.

Bradley D. Tilden

Now I’d like to take a closer look at Alaska’s P&L.

Mainline passenger revenue increased 3.6% this quarter on a 0.8% decline in capacity and 4.4% increase in passenger unit revenues. Our passenger RASM lagged the domestic industry by about 3 points, but again this quarter, our capacity decline was less than the industry’s and our stage length increased 6%. If you adjust for these differences, our unit revenue performance was in line with the industry.

More importantly, our unit revenue performance improved as the quarter progressed. In July, our passenger RASM improved by 1%, in August it improved by 1.9%, and in September it improved by 11.9% as our August 25th schedule reduction began to have an impact.

Geographically, nearly all of our regions posted double-digit PRASM increases for the quarter except the Bay Area, Southern California, and inter-mountain regions where PRASM fell marginally. The results in these markets reflect the competitive landscape coupled with the weak economy and depressed housing values. However, in September PRASM increased in every region with Mexico, Alaska long haul, and Transcon leading the way with both healthy yields and unit revenue gains.

I want to caution that a lot has changed in the last 3 weeks, and September’s results may not be indicative of a trend that we should extrapolate.

As we finalize our 2009 plan, we’ve agreed in the leadership team that our No. 1 initiative is to focus on revenues. Our goal is to maximize unit revenue gains that should result from reducing capacity, implementing new ancillary revenue streams, and increasing preference for brands. Some of the things we’re considering include an investment in new tools and practices for schedule planning, revenue management, and mileage plan, higher planned advertising to increase market share, and new revenue streams such as in-flight Wi-Fi, trip insurance, and previously announced changes to a mileage plan including new award redemption levels, and fees for partner award travel.

We expect capacity to be down 7% to 8% in the fourth quarter on a 14% decrease in departures as our average trip length is growing significantly. We’re currently expecting first quarter capacity to be down between 10% and 12% and full year 2009 capacity to be down about 8%. These capacity plans are dependent on what happens with the Boeing machinist strike and the economy.

Although we’ve not included the amount in our adjusted result, I want to quickly say a word about the $42 million benefit from the change in mileage plan expiration terms. We deleted about 7% of the total miles outstanding. We expect that the policy change will result in revenue increases in the future, perhaps as much as $2 to $3 million per quarter.

Now turning to cost, our unit cost ex-fuel was $0.0714 per ASM which was significantly better than our initial guidance of $0.074 to $0.075. Our non-fuel spending for the quarter was actually $7 million lower than last year. The better than forecasted results are due to lower maintenance costs, lower wages and benefits, better ASM production, and a significant reduction in passenger remuneration cost as our folks ran a terrific operation this summer.

For the fourth quarter, we’re currently forecasting mainline CASM ex-fuel of $0.081 to $0.082 per ASM, about 5% higher than last year. That would put us at about $0.0755 for the full year, up marginally over 2007.

We’re not yet ready to give cost guidance for 2009, however, I can tell you that we are focusing on finding ways to covert as much of the capacity reduction as possible into cost reduction. We’re setting aggressive goals for employee productivity and real estate utilization, and we’re targeting a 10% reduction in overhead spending.

With that, I’ll turn this over to Jeff.

Jeffrey D. Pinneo

While I’m pleased to report that Horizon posted an adjusted pre-tax profit of $12.7 million compared to a profit of $7.5 million in the same period last year, fare increases, capacity reductions, and non-fuel cost improvements are helping to offset the cost of fuel which while significantly lower than it was this summer, remains at levels unheard of prior to this time last year. While we are pleased to report profit for the quarter and a significant improvement over last year’s results, our year-to-date results reflect a loss and business conditions remain very challenging.

Our revenues grew 3.7% on a 12.8% decline in capacity and a 20.2% system yield improvement. System wide RASM was up 18.9% and as in previous quarters, line of business mix played a key role on the year-over-year comparison as we’re no longer flying low RASM, low CASM missions for Frontier.

Looking at lines of business more closely, brand capacity was up 1.1% and RASM increased by 9.8% due to a 9.5% increase in yields and a marginal increase in load factors. Ancillary revenues were up nearly $1.3 million or 70% from last year. Purchase capacity flying for Alaska was down 1.8% on a 14% decrease in departures, a function of scheduled trims and larger gauge aircraft than in the prior year.

In preparing our year-over-year results, it’s important to keep in mind the impact of the landing-gear inspection related grounding of our Q400 fleet in September last year which negatively impacted profitability by several million dollars in the quarter. The inspections and related disruptions lasted several weeks with collateral impacts spilling over into the fourth quarter.

On the expense side, our $19.8 million increase in fuel expense was offset by focused non-fuel cost management, which held CASM ex-fuel in check, up just 0.7% despite the sizable decrease in capacity. Maintenance cost decreased $5.4 million partially due to timing of events, but also more importantly due to continued successes in streamlining heavy checks and implementing lean processes.

Wages and benefits were down $3.1 million as we reduced our employee base relative to our flight schedule reductions. For the quarter, FTEs were down 7% versus prior year. These actions combined with fleet mix changes drove an 8.3% productivity gain to 180 passengers per FTE, making this quarter the 25th out of the past 27 with year-over-year productivity improvements.

Lastly, aircraft ownership costs decreased $4.4 million due to the disposition of additional Q200s from our fleet.

Shifting the focus to operations, our teams once again worked their magic in delivering outstanding experiences for our customers during the busy summer season. Working together, they posted an 87.3% on-time rating for the quarter, a 6.5-point improvement over 2007. Were we a DOT reporting airline, we would have earned the top spot among all mainland US carriers in July, an extraordinary accomplishment that every one of us who depend on the performance of our frontline teams is extremely proud of and thankful for.

Earlier this year, we announced our plan to transition to an all Q400 plane. We’re still on track to retire our entire fleet of 37 Q200s next week, at which time, we will have only three of the original 28 aircrafts unassigned. That leaves us with the 20 CRJ700s we’ve committed to remarketing, two of which we’re currently finalizing a sublease agreement for. We will continue to operate the remaining 18 aircrafts during our remarketing effort. To-date, we’ve had exchanges with a number of parties, both domestically and abroad, yet it’s clear that the market has softened somewhat from our original forecasts due to the changing economic landscape. Accordingly, we’re in discussions with Bombardier to explore timing and the re-timing of our deliveries of Q400s next year to coincide with the retirement of CRJ700s from our fleet.

Looking ahead, the prospect of softening demand adds urgency to the capacity and cost reduction strategies we’ve developed. We previously announced capacity reductions of about 21%in Q4 and approximately 9% for all of 2009.

Early returns on the factor reductions thus far have been encouraging with significant positive impacts on yield and PRASM emerging across all of our key regions. As we move to an all Q400 fleet, we will continue to adjust frequencies and re-allocate some capacity from underperforming markets to higher potential opportunities as necessary. This affords us the flexibility to adjust to the current downturn while laying a firm base from which to build as conditions improve.

The current economic environment coupled with our transition out of Q200s has resulted in the suspension of service to a few markets that we’ve served for decades. I’d like to thank the customers and employees who made Klamath Falls, North Bend/Coos Bay, and Pendleton very proud parts of our systems for many years. A silver lining to these capacity reductions has been the availability of aircraft for re-deployment to some unreserved current markets including the Seattle/Portland and Seattle/Spokane shuttles as well as to a few promising new markets including Le Pas, Mexico and coming this December Mammoth Lakes, California.

We anticipate our fourth quarter CASM ex-fuel will come in between $0.0161 and $0.0163, that’s up 10% to 12% from 2007’s fourth quarter. For the full year 2008, we’re forecasting CASM ex-fuel to be 1% to 2% higher than in 2007 with capacity down 9%.

Now let me turn the call back over to Brad who will update you on the Air Group balance sheet.

Bradley D. Tilden

Once again, we closed the quarter with cash and short-term investments of $1.07 billion compared to $823 million at the end of 2007. Our cash and short-term investment balance on Tuesday was $1.18 billion. We generated $141 million of operating cash flow during the first 9 months of the year, down from $373 million last year. The decline was simply a function of the deterioration of results because of $267 million increase in our economic fuel cost. In addition to the $141 million of operating cash flow, we had proceeds for new financings of $640 million for total cash inflows of $781 million. These were offset by capital expenditures of $410 million, debt repayment of $73 million, and share repurchases of $49 million. Together these items explain the $244 million increase in cash and short-term investments.

We expect our full-year capital spending to be $445 million this year and $405 million next year. Last month we modified the terms of our $185 million line of credit to eliminate all existing financial covenants and replace them with a simple minimum cash requirement of $500 million. While there was a cause to do this, we believe that maintaining our borrowing ability under the line is an important part of preserving our flexibility. Last week we drew down $75 million on the line due to expected temporary delays in our aircraft-financing plan.

With debt financing commitments in place for all of our firm Q400 and we’re working right now on a number of options to finance our 737 and 800 deliveries.

And finally, turning to our pension funding, we’ve contributed $52 million to our defined benefit plan this year bringing our post 9-11 funding to $420 million. We have no required funding in 2009. At the end of 2007, our funded status was 86% on a PBO basis, which is the most conservative measure. Given the activity in the market this year, we believe our PBO funded status has declined to roughly 70% at the moment, meaning that we’re under-funded by approximately $300 million, and again, this is on a PBO basis.

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

Shannon Alberts

We’re happy to address questions from analysts at this time. Jennifer, would you please assemble the roster for us?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ray Neidl from Calyon Securities.

Raymond Neidl - Calyon Securities

Congratulations on Horizon. Looks like it is finally turning around, but with the weakening economy and other things happening in the Pacific Northwest, what other further actions might have to be taken or do you feel you are pretty much on the track for solving the problems completely now?

Bradley D. Tilden

The things that characterize the actions we have taken thus far will lay a real firm foundation to weather this storm. We’ve done significant capacity shifts and in many cases reductions although the mix change between Q200s and Q400s has had some effect, but in all of those cases the frequency reductions that we made and down to levels that preserve a pattern that is suitable for both the local and network support are what we consider to be sustainable levels, and we’re working very closely with all the communities we serve to engage in whatever stimulative activity is appropriate there, and I feel that the adjustments were made in terms of trending markets was foreseeable given the updates for Q400s, but that we’re at a place now that we think is pretty sustainable going forward.

William S. Ayer

And Ray, I might just add that the fleet moves at Horizon are very significant and we’re not quite done with the Q200 as you heard and there are identifiable expenses that go away when that fleet type goes away and even more so with CRJs. So we’re looking forward to getting Horizon to a single fleet of Q400s and we think that will be the most efficient, clearly the most fuel efficient, and we’ll get some specific savings as we make those transitions.

Bradley D. Tilden

And we estimate between the two, the overhead reductions are in the order of $10 million as a step function once the two fleet types go away.

Raymond Neidl - Calyon Securities

Okay great. And you’re doing a great job in that area which had been a drag on the company. The other thing is, just to clarify the fuel hedges, you guys are smarter than other airlines, it sounds like your fuel hedges were less risky from other airlines with oil prices coming down, and why did you decide to do it that way and what was the trade-off as far as the cost goes?

Jay Schaefer

We were smarter than anyone else. We have a conservative philosophy in the company and we think of the fuel hedge program a bit like an insurance policy where you pay the premium that is a sub-cost and candidly had we not had fuel run up against us that would have been an expense that we would have had on our books quarter after quarter, but we benefited from fuel going up but because of the hedges that their call options will participate on the downside.

Operator

Sir, looks as if he needs to press *1 again. He did go out of queue.

Jay Schaefer

Just a recap of that question, we have hedged primarily with call options, which means we pay a premium where we benefit fully from the downside. I think some of our competitors have hedged with swaps and collars, which puts them at some exposure as the fuel prices come down.

Operator

Our next question comes from Michael Linenberg from Merrill Lynch.

Michael Linenberg - Merrill Lynch

Two questions. You talked about drawing down part of the revolver of $75 million, this temporary delay in your aircraft financing plan, can you elaborate on that? Is that tied to just the airplanes coming in late because of the strike and the number of airplanes that you’re anticipating in taking delivery out for 2009.

Bradley D. Tilden

It is not really related to the strike. It is related to the disruption in the financial markets in the last 3 or 4 weeks and so we had a four-quarter financing plan that did get pushed back a little bit, what we hope is a temporary delay, and given that, we decided that the conservative thing to do was to pull down $75 million up the line.

Michael Linenberg - Merrill Lynch

Okay. And the size of that line and what’s the rate that you pay on that line?

Bradley D. Tilden

The size is $185 million and the rate, Jay, have we disclosed the rate?

Jay Schaefer

We have not.

Michael Linenberg - Merrill Lynch

Is it fixed or floating? I am just getting to it because we had seen the huge run up in LIBOR and of course we’re getting a bit of a pullback.

Jay Schaefer

It’s floating.

Michael Linenberg - Merrill Lynch

Okay. That’s helpful. My second question, when I think about your positioning in Seattle, we have a proposed merger in the works and just from the commentary that we go from Delta Northwest, it seems like it is on the tracks, so it looks like the deal is going to go through, and when I think about your relationship with Northwest, you have a relationship with Delta, you also have relationships with Air France and KLM, Alaska in my view as a partner will become an even more attractive partner post the merger of those two companies, given the historical relationships that you have, and the fact that it seems like Sky Team is making this focus on Seattle, you have the French flying from Seattle to Paris, and you have Northwest with KLM at Amsterdam, and just recently, the Heathrow flights. So when I think about your positioning and the importance of feed to those markets, that there’s maybe a bigger opportunity for us. So, I know you don’t talk about it much of late, but what’s your thinking on that, how should we think about that, any commentary would be helpful.

Gregg Saretsky

That’s a good question. In fact, we do have partnerships existing with both Delta and Northwest, and our geography plays well because of our strong position on the west coast to feed Northwest’s existing network at Seattle and more of that feed goes to Delta frankly at Los Angeles. So, having strengthened both those points makes us, I think, a good partner for all of our Alliance carriers, and we expect that that will continue post the merger.

Operator

Your next question comes from Dave Simpson from Barclays Capital.

Dave Simpson - Barclays Capital

As I look at your advanced booking guidance, I see mainland November down 3 points, December up 5. Capacity pulls where you seem to get bigger during the quarter and better the capacity it seems to get better. Should we read anything into that November number other than seasonality or is that reflecting maybe weaker build in Thanksgiving than you were expecting?

Bradley D. Tilden

October is up 1, November is down 2.5, December is up 5 at the moment. There is a little squiggle this year with the Thanksgiving return traffic. The Monday is going to fall into December this year and it was in November last year, so that might affect some of the November-December numbers. So that’s what we’re looking for. One of the things we might say with respect to advanced bookings is in the aggregate they look good. We’re up a couple of points if you looked at the next 100 days or something like that. I think probably like a lot of airlines that make a lot of business is, the last 3 weeks have been lighter. So, as we said in the call, I think it would be appropriate to be a little cautious with how much folks extrapolate from these advanced bookings that we’re looking at today.

Dave Simpson - Barclays Capital

Just to come back to the line of credit pull, when you say the financing plan got pushed back, was that committed financing that you are having difficulty closing or was that non-committed financing that you’re looking to close?

Jay Schaefer

No, it isn’t committed financing that we didn’t close. We have received term sheets from commercial banks for both debt and sale leasebacks, but given the credit market dysfunction, it was candidly at prices that we didn’t like, and so one of the benefits of having a strong balance sheet is we have the time and the patience to wait for the credit markets to return to normal and then we’ll go back into the market, and the credit facility was priced a couple of years ago, and so it was the perfect tool for us to use to bridge that.

Operator

Your next question is from Daniel McKenzie from Credit Suisse.

Daniel Mckenzie - Credit Suisse

I am sensitive to the fact that you guys have been very good about transparent guidance with respect to the quarter, but one thing that jumped out of my model this quarter was the field estimate, which actually turned out to be $0.10 higher than what you had guided to. Are there any thoughts that you can share about what might have caused that to move around at the last minute?

Bradley D. Tilden

I don’t have anything specific on that. I think one thing that worked into the overall price for the quarter was the fact that we had some very high-priced fuel in inventory at the end of the second quarter that bled through to the average cost of that inventory driving up the overall price which was perhaps a bit higher than the spot price that we’re paying at the end of the quarter, and there may have been a bit of a confusion on that on our end.

Daniel Mckenzie - Credit Suisse

Given the Boeing strike, maybe a different wrinkle here, I’m wondering if that’s resulting in a detectable change at all perhaps in corporate travel in and out of Seattle?

Gregg Saretsky

We are seeing a slowdown in corporate travel across our network not only in Seattle. I would say though, however, the Seattle market is a little bit more buoyant than what we’re seeing in California, and we’ve met recently corporate travel managers who tell us that they are introducing or enforcing compliance with travel policies that are requiring booking further in advance of travel. So, we will see in addition to a reduction in demand some reduction in ticket prices as a result of them taking advantage of 14-day advance purchase versus 7.

Daniel McKenzie - Credit Suisse

And then just one final question. I’m wondering if you could just comment a little bit about what you’re seeing from Virgin, the competitive dynamic from Virgin?

Bradley D. Tilden

I think what we’ve done against them is worked quite well. You know that we went through the hourly LA schedule and an every-other-hour schedule in San Francisco. We’ve fortified our presence against Virgin while we were livening up in California generally, and they’ve gone from 4 flights LA-Seattle and 5 San Francisco-Seattle to 3.3 and 3.4 flights respectively. So, they’ve been pulling down gradually over time.

Operator

Our next question comes from Peter Jacobs from Ragen Mackenzie.

Peter Jacobs - Ragen Mackenzie

First of all, Brad, you had made a comment about the mileage plan gain would also result in positive revenue going forward. Could you explain that and did I hear that correctly?

Bradley D. Tilden

You did hear it correctly Peter, and Brandon Pedersen is expert on this and so we’ll ask him to address your question.

Brandon Pedersen

You’re right. You head Brad correctly. We think the change in the policy will result in additional $2 or $3 million per quarter in the future because of that more aggressive expiration policy. When those miles expire, we take that through our P&L at the time.

Peter Jacobs - Ragen Mackenzie

Are you saying that you think that passengers that would have used the miles are now going to pay for the tickets or is there some kind of additional accounting mechanism that you’re also going to see benefits going forward? I’m a little confused on this.

Brandon Pedersen

Yes, it’s really the latter what I’m talking about. It’s just how we do the accounting. When we have that more aggressive policy, those miles break faster for lack of a better term.

Peter Jacobs - Ragen Mackenzie

Are you saying the fall off each subsequent quarter will be close to $2 to $3 million in revenue, the key word is basically non-cash revenue that you’d be recognizing right?

Brandon Pedersen

Exactly.

Peter Jacobs - Ragen Mackenzie

That explains that. Secondly, on the pension plans, given that on a PBO basis you estimate that you’re looking at probably about $300 million deficit right now versus the liabilities, why wouldn’t there be a mandatory cash contribution next year?

Jay Schaefer

The Pension Protection Act has new requirements regarding how plan sponsors make their contributions, but we have two things working in our favor, one is the airline industry receives specific relief for contributions as well as because we’ve made contributions historically in excess of our requirement, we build up a credit balance that we can use for future contributions, and so, between both of those and it is primarily the airline relief we have the ability to skip a payment next year.

Peter Jacobs - Ragen Mackenzie

Could you tell me what the raw fuel prices are that you’re seeing at CTAC?

William S. Ayer

Peter, I don’t have CTAC specifically, but right now, based on yesterday’s oil, we pay approximately 2.25 per gallon.

Peter Jacobs - Ragen Mackenzie

Now conceptual price shift for Jeff, the retirement of the CRJs, given that you’re having difficulty finding homes for those and that oil prices have come in quite a bit and still probably not at the level that you’d like to justify the cost of CRJs, but is there a price of oil that it makes sense to keep some of the CRJs for routes such as Seattle to Fresno or to Santa Barbara or some of the longer range, lower density routes?

Bradley D. Tilden

And certainly as fuel has come down in some of the cost inefficiencies have been mitigated, but having said that, the price of simplicity and everything that accompanies that in terms of our efficiencies is still much greater than that and so we’re pursuing, and as we look at the capability of the Q400, both its range and passenger service capability, mostly its fuel economy, it represents probably the greatest chance we have against fuel fluctuations, so while fuel is down now, the only thing we know for sure is that it’s very volatile, and in terms of building for the future we think single type fleet, the economies that come with that, and leveraging the capabilities of that aircraft both in terms of where it can fly and how cost efficiently it can fly is our best bet.

Peter Jacobs - Ragen Mackenzie

And the last one relates to some of the fuel hedge accounting and the discussion brought up another question in my mind and that was when you put these hedges in place and you paper these caps or call options, do you expense the cost of those when you put those hedges in place or do you approve for those and do we see those expensed then at settlement?

Brandon Pedersen

We expense those premiums at settlement.

Peter Jacobs - Ragen Mackenzie

So it’s just baked into the overall cost then that we see as netted out.

Brandon Pedersen

Yes.

Operator

We have no questions from the reporters.

Shannon Alberts

Thanks Jennifer, and we’ll hand it back to Bill to close the call.

William S. Ayer

Thanks for joining us and we’ll talk to you next quarter. See you later.

Operator

This concludes today’s Alaska Air Group third quarter 2008 earnings call. You may now disconnect.

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Source: Alaska Air Group, Inc. Q3 2008 Earnings Call Transcript
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