Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Alaska Air Group, Inc. (NYSE:ALK)

Q3 2010 Earnings Call

October 21, 2010 11:30 pm ET

Executives

Shannon Albert - MD, IR

Bill Ayer - Chairman and CEO

Brandon Pedersen - CFO

Brad Tilden - President

Glenn Johnson - President, Horizon Air

Andrew Harrison - VP, Planning and Revenue Management

Joe Sprague - VP, Marketing

Analysts

Bill Greene - Morgan Stanley

Hunter Keay - Stifel Nicolaus

Jamie Baker - JPMorgan

Duane Pfennigwerth - Raymond James

Michael Linenberg – Deutsche Bank

Dan McKenzie - Hudson Securities

Helane Becker - Dahlman Rose

Steve O'Hara - Sidoti & Company

Kevin Crissey - UBS

Glenn Engel - BoA/Merrill Lynch

Michael Derchin - CRT Capital Group

Tom Banse - KUOW Radio Seattle

Operator

Good morning, my name is Brooke and I'll be your conference operator today. At this time I would like to welcome everyone to the Alaska Air Group Third Quarter 2010 Earnings Conference Call. Today's call is being recorded and will be accessible for future playback at www.alaskaair.com. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session for analysts and journalists. (Operator Instructions). Thank you. I will now turn the call over to Alaska Air Group's Managing Director of Investor Relations, Shannon Albert.

Shannon Albert

Thanks, Brooke. Hello, everyone and thank you for joining us for Alaska Air Group's third quarter 2010 earnings call. Today Alaska Air Group's CEO, Bill Ayer, Alaska Airlines President, Brad Tilden and Air Group CFO, Brandon Pedersen will share their thoughts on the quarter, our financial results, the operating environment and our future initiatives. Other members of the senior management team are also present to help answer your questions.

Today's call will include forward-looking statements that may differ materially from actual results. Additional information on risk factors that could affect our business can be found in our periodic SEC filings available on our website. Our presentation includes some non-GAAP financial measures and we have provided 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 net profit of $122.4 million. Excluding the impact of mark-to-market adjustments in connection with our fuel hedge portfolio as well as fleet transition and restructuring cost at Horizon. Air Group reported an adjusted net profit of $118.1 million or $3.21 per share. This compares to a first call mean estimate of $3.11 per share and to last year’s adjusted net profit of $83 million or $2.33 per share. Again excluding unusual items Air Group reported a year-to-date profit of $215.2 million or $5.87 per share compared to $84.1 million or $2.32 per share for the first nine months of 2009.

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

With that I will turn the call over to Bill.

Bill Ayer

Thanks Shannon and good morning everyone. This quarter’s results represent Alaska Air Group’s best adjusted quarterly profit in our history displacing last quarter’s record. Our financial performance was driven by increased traffic, stable yields and good cost management through improved productivity and lower overhead and our employees continue to provide customers with a travel experience which is among the best in the industry.

I am proud and honored to work with such dedicated people and the credit for our quarterly results really belongs to the 12,000 employees of the Alaska and Horizon. Turning to the operation, both companies had a very good summer and Alaska’s was particularly noteworthy. In July and August Alaska finished first among the top 10 U.S. carriers with more than 88% of flights arriving on time and in September where industry rankings are not yet available. More than 90% of our flights arrived on time.

Unofficially extending our number one rank among the top 10 airlines to 17 over the last 18 months and every month in 2010. In addition we are heading our 20 minute bag guarantee over 90% of the time in our top 14 cities. I want to spend a minute updating you and the changes we’re making at horizon. One of the most important components of our plan is to accelerate the move to an all Q400 fleet and we now believe we can achieve that in 2011.

This will allow horizon to capture the same trends of efficiencies that Alaska realized when it transitioned out of the MD80s. During the third quarter we announced that horizon will move to an all capacity purchase model in 2011 further optimizing Horizons route system to benefit Air Group. We reached a tentative agreement with Horizon pilots on a new contract and we are optimistic that agreement will be ratified in the fourth quarter. We have outsourced the last of our heavy maintenance with a significant dedicated oversight function.

We are working with Bombardier to improve the scheduled reliability of the Q400 and we are working to eliminate any remaining redundant functions between Alaska and Horizon. Glenn Johnson and his team have done a great job managing the pace and magnitude of these changes and I want to thank the entire horizon employee group for their dedication and understanding as we move the company to a more competitive and profitable long term outlook.

As we look at the industry environment we are encouraged the traffic is holding up despite the continued economic uncertainty. One of the keys has been our ability to adjust our schedule quickly to match capacity with demand and to take advantage of opportunities. And just to give you a little perspective in the last 30 days we have initiated service in three new markets and we'll begin serving eight additional markets by the end of the first quarter. We are doing this through increased utilization and a delivery of three additional aircraft next year.

We are just now wrapping up our 2011 planning process in addition to changes of horizon that I have mentioned we’re focused on increasing revenues again next year. We’re making changes to alaskaair.com to better merchandise our products including rental cars and hotels, developing a new mobile phone application and building on the success of our employees have had this year getting involved directly with our customers and communities and even though our major focus is to increase revenue we know we must continue to reduce unit costs.

Since its inception in 2003 one of the goals of our long term strategic plans has been to position us for profitable growth. Our results over the last several years give us confidence that our plan is working and we can begin evaluating growth opportunities with the requirement that any growth produce appropriate returns.

We will be working on this over the next several months and will share more with you on future calls. And with that I will turn the call over to Brandon.

Brandon Pedersen

Thanks Bill and hello everyone. As Shannon said Air Group reported an adjusted net profit of $118.1 million compared to an $83 million net profit last year, an improvement of more than $35 million after tax and $55 million on a pre-tax basis. Not only is the absolute profit a record, these results translate to a record 17.9% adjusted pre-tax margin for Air Group which brings our trailing 12 months return on invested capital to 9.2%.

With nearly 10 months behind us, we are optimistic that we will reach our 10% ROIC goal this year or get darn close absent a sudden change in the revenue environment or a major spike in oil prices. This is a significant accomplishment and one that all Alaska and Horizon employees should be proud of. The $55 million improvement in our adjusted pre-tax result was mainly due to a $100 million increase in revenues.

Consolidated passenger unit revenues fared well increasing 3.7% on a 6.1% increase in capacity. The revenue improvement was offset by $31 million increase in economic fuel cost and a $13 million increase in non-fuel operating expenses. Absolute non-fuel costs increased just 2% on a 6% increasing capacity resulting in a 4% decline in consolidated CASM X fuel. We are quite pleased with our cost performance this year. Our challenge for 2011 is to not let 2010 solid profit distract us from our focus on driving unit cost down by improving productivity and keeping overhead in check.

As we look ahead, we are concerned about rising fuel prices. To mitigate volatility in this area we continue to maintain one of the best fuel hedged positions in the industry and our young fuel efficient fleet gives us a natural hedge. In fact, a recent Wall Street journal article likened our fleet to a (priest) with wings, making reference to Alaska’s position as the most fuel efficient and lowest emission producing operator in the country.

Turning to the balance sheet, we closed the quarter with cash and short term investments totaling just over $1.3 billion. That puts our cash at 35% of revenues which remains among the strongest in the industry if not the strongest. We generated approximately $500 million of operating cash flow during the first nine months of the year, a first for us, up from just over $300 million last year.

Cash generated from operations was offset by about $150 million of capital spending bringing free cash flow for the nine months to approximately $350 million or about 12% of year-to-date revenues. We have said many times that we are trying to build a good company, not just a good airline and good mature companies generate free cash flow. In most years we would like to see this company generate free cash flow. I recognized that earnings and capital expenditures can be lumpy and there maybe years when we don’t achieve the goal but as a general rule, we plan to focus more on the free cash flow metrics.

In addition to funding future growth without leveraging the company too much, maintaining a healthy amount of free cash flow would allow us to return cash to shareholders, consider additional contributions to our pension plans or take advantage of opportunities that come our way. To that end, we continue to execute on our $200 million debt prepayment plan bringing aggregate prepayments at September 30 to $115 million and to $169 million if you count October activity.

We ended the quarter with a debt to cap ratio of 68% the lowest leverage since 2000. Our plan was to spread the program over most of 2011 but we’ve stepped up the rate of prepayment and now expect to finish during the first quarter of next year. Besides reducing our leverage more quickly it will reduce our negative carry resulting in a slight EPS benefit.

We also continued our share repurchase program. During the quarter we bought back 102,000 shares for $5 million under the $50 million program that our board authorized in May. During the first nine months of 2010, we’ve repurchased $31 million worth of shares under the current and prior authorizations. I also want to take a moment to touch on Horizon’s results for the quarter. Horizon posted an adjusted pretax profit of $18.8 million. This result excludes nearly $7 million in charges related to four CRJ aircrafts that left the fleet during the period and $3 million in restructuring charges related to outsourcing the last of the heavy maintenance function.

As part of our plan to accelerate the Horizon fleet transition we are working on a deal that would allow us to move another eight RJs to a third party carrier in the first half of 2011. If we are able to get this done, we will accelerate delivery eight Q400 aircraft from 2012 and 2013 into 2011 to replace those RJs on a one for one basis resulting higher capital spending then originally planned over the next six to nine months. Because we don’t yet know the final structure of the deal for the eight RJs, it’s possible that we may incur more fleet transition costs. We expect those charges if any to come in the first half of 2011 when those aircraft are likely to leave the fleet. Assuming we do bring the Q400 deliveries forward air group CapEx would increase to $211 million in 2010 and $312 million in 2011. Again this is just a timing issue as those aircraft are already scheduled for delivery in 2012 and 2013. Now over to Brad.

Brad Tilden

Thanks Brandon and good morning everyone. This was a great quarter for Alaska Airlines. We reported an adjusted pre-tax profit of $173 million compared to a profit $118.7 million in the third quarter of 2009. In year-to-date our adjusted pre tax profit is $328 million which represents a margin of 12.8% and a 140% improvement over last year. We have had a goal of a 10% pre-tax margin for many years now. And if we are able to produce a margin between 1.5% and 2% in the fourth, will hit our goal.

These results are a huge credit to the people of Alaska Airlines, who have been working very hard for several years to make fundamental changes in our business. It's very rewarding to see the company executing so well on so many fronts. Alaska's mainline passenger revenue increased by 90 million or 11.6% for the quarter. The increase was driven by a 7.3% increase in capacity and 11.2% increase in traffic. So our load factor continued to show nice year-over-year improvement. Our yield for passenger mile was flat. But given the significant increase in average day’s linked and strong 2009 comps we’re very pleased with the absolute unit revenues we are seeing. Nearly everyone one of our regions posted unit revenue increases.

We saw significant strength in Mexico, Hawaii and in our flying between the Pacific North West including Vancouver and Southern California, Arizona and Nevada. Our Mexico services benefiting from the shutdown of Mexico on the Airlines and to take advantage of the void we have been out new redeye service from Sacramento and San Jose to Guadalajara that will start mid December pending regulatory approvals and the second trip between LAX and Guadalajara that is scheduled to begin in February.

And we increased frequency in the LAX Mexico City market earlier this month. More broadly we have just launched new service between Honolulu and Portland between Seattle and St. Louis and between San Diego and Maui. We look forward to starting Portland-Kona and adding frequency to the Seattle-Kona market in November. And we are starting service between Bellingham and Honolulu and between both Oakland and San Jose and Kauai in the first quarter.

We expect Alaska’s main line ASM to grow 9% in the fourth quarter brining our full year ASM growth to 5.5%. Our October advanced growth factor is up about 4 points November is up 2.5 points and December it is currently tracking dragging under last year by a point and a half. We have seen our year-over-year load factor comps increase as we get closer to travel dates and we would not be surprised this is the case again in the fourth quarter.

Turning to costs, we ended the quarter with CASM X fuel of $0.000752 down 4.7% on our 7.3% increase in capacity. Productivity increased by more than 10% to 174 passengers per FTE for the quarter and our people are doing a good job controlling overhead as well. Due to first 9 months our overhead spending is down 8.6 million or 4.4% from 2009. High productivity and low overhead have been important focus areas for us and we are very pleased with the results.

We are forecasting 2010 full year CASM X fuel of between 7.9 and $0.000795 which is a bit lower than the 7.9 to $0.08 range that we have been talking about most of the year. The only significant risk to this target is on the ways in benefit and incentive pay lines which could move if we get a deal with our cost employees that includes participation in the performance based paid program among other things.

We currently expect mainline ASMs to grow 8 to 9% in 2011 with a 6% increase in departures, nearly all of the added capacity represents the annualization of flying with either initiated or announced in 2010. We are working on extending leases for three 737-400 aircraft into 2012 and that would result in a net increase of 3 year planes next year.

We working on the 2011 budget as we speak, we currently expect CASM X fuel to be down at least 3% compared to 2010.

At this point I would like to turn the call back to Bill.

Bill Ayer.

Thanks Brad and before we get to the Q&A, I want to tell the analyst and investors on the call that Shannon Alberts has accepted a new position in our corporate affairs group so this is her last earnings call and I want to thank Shannon for her outstanding work over the last 5 years in the IR role.

Chris Barry who currently serves as our Director of Accounting and Financial Reporting and Shannon’s main backup has been promoted to Managing Director of Investor Relations. I want to wish both Shannon and Chris the best in their new roles and so Brook I think we are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Bill Greene with Morgan Stanley.

Bill Greene - Morgan Stanley

Hey there. I am wondering if I could talk a little bit about Horizon. Some of your peers in the past have shed their regional partners. AMR is looking at it and you are going through this restructuring. I know in the past you said that this is an integral part of Air Group but does some of this restructuring at least open the possibility, you consider that or no, that's sort of, not even on the table in any way?

Bill Ayer

Yeah Bill, this is Bill. No, we are going through a lot of work at Horizon because we think it’s a great part of Air Group and can become even more significant and more profitable and contribute in a bigger way. So our intent is to continue to keep it as a wholly owned subsidiary and create more value to the actions that we are taking.

Bill Greene - Morgan Stanley

And the capacity purchase arrangement on it is really just for internal purposes then?

Glenn Johnson

Hey Bill this is Glenn. Yeah the move to CPA is really just coming in line with the model that's common across the industry as you know. It will make it simpler I think across Air Group. It puts all the pricing and scheduled decisions at Alaska where they should be and we are really just focusing on Horizon than on producing safe reliable low cost ASMs on half of the group.

Bill Greene - Morgan Stanley

Brandon just a quick question on pensions, I know it’s early but do you have a sense for kind of what those will look like in 2011 in terms of expense and funding?

Brandon Pedersen

Yeah, I think given the decline in interest rates and what we see now in terms of investment performance we’re probably looking at a $20 million to $25 million increase in pension expense next year, I think as you know we don’t exactly figure that out until the end of the year but that’s kind of what we are seeing right now based on the information that we have.

Bill Greene - Morgan Stanley

Does it change the funding?

Brandon Pedersen

Does it change funding (inaudible) that one.

Brad Tilden

It doesn’t change our funding requirements, the funding rules are a little bit different than the GAAP rules and so we actually are taking advantage of some airline pension relief that we received a few years ago and so we don't have any funding requirements next year but we continue to make contributions. We made $45 million this year.

Operator

Your next question comes form Hunter Keay with Stifel Nicolaus.

Hunter Keay - Stifel Nicolaus

Sort of verifying, did you guys say mainline ASMs up 89% in 2011 year-over-year?

Brad Tilden

We did.

Hunter Keay - Stifel Nicolaus

Okay. And sounds like you are, I guess, extending operating leases or taking out new operating leases on three or four aircrafts. So that’s going to be incremental for the previous fleet plan right?

Brandon Pedersen

Yes, so we had three new 800 schedules for delivery, that stays the same and then we had three lease returns. We are extending those 2011 lease returns into 2012.

Hunter Keay - Stifel Nicolaus

Okay. I guess it seems like, help me reconcile there seems like a lot of growth and I know you said that some of its going to be sort of annualization or something you’ll achieve out in 2010 but where are those planes going? Are they going to be for new routes you have haven't announced yet and I know Bill you mentioned some growth initiatives in your prepared remarks. So are these frequencies based or how should we think about where these plans are going to be going?

Andrew Harrison

Hi, Hunter this is Andrew. As it relates to the 8% to 9% growth, on average we have about 100 or so airplanes flying at any point in time so every point of growth is about one airplane. So if you round it to about eight airplanes 5.5 of those will be going to Hawaii and Mexico, the majority to Hawaii and then the other 2.5 aircrafts that are just spread around our system, We annualized the new St. Louis. So big picture really this is all the markets we’ve announced this year and carrying them over to next year plus the new Hawaii in the first quarter is basically makes up that entire growth.

So that airplanes work mostly in Hawaii and Mexico and we’ve been very pleased with the performance of those regions.

Hunter Keay - Stifel Nicolaus

Okay thanks Andrew I appreciate that and maybe Bill one for you, I was going to ask you about this anyway and you mentioned it in your script. Sort of as you think about the next leg for your company particularly as it pertains to your stock price I would say, these initiatives your talking about and you are not prepared to give us much color on them right now as we stand. But can you maybe help us sort think about how these initiatives would rank. I don’t want to oversimplify but maybe on the scale of one to 10, with regard to sort of calculated risk, are we talking about something that's, something maybe way out of the box here for you guys or is it kind of more sort of organic growth into new market. Or we maybe thinking about some sort of strategic asset acquisitions or M&A. What kind of calculated risks are we talking about in the context of some of these growth initiatives that you referenced in your remarks?

Bill Ayer

Well as I said, we are really just starting to turn our attention to this subject in a more serious way to look at opportunities and alternatives. But I mean historically what we've done and its worked very well is this incremental approach to building of strong point of sale presence in the Pacific Northwest and by the way that's an important role for Horizon to make sure we've got the smaller cities covered as well in the Pacific Northwest and building from that base. So the guiding principal here is improving, continue to improve long term shareholder value and take measured actions that we can do that.

So beyond that I think it would be premature to say anything, we are just really starting to get into this where we are talking to the Board on a continuing basis now about looking at and to the uses of cash question as well that you have all brought up appropriately so. And so we are looking at it and we are in a great position, that is what we have said when we laid out this 2010 plan back seven years ago. We said we are not going to grow the company until we can do it from a good profit foundation and we need to make sure that the results we are seeing now really are sustainable and we’ve only had a short period of time where we have been operating at this level. So we are not going to rash and rush into anything, but we do think that we are in a position to look at opportunities and as much as anybody in the industry well positioned to take advantage of some things if they are out there.

So that’s more general than you probably wanted, but I think that’s where we are at the moment.

Operator

The next question comes from Jamie Baker with JPMorgan

Jamie Baker - JPMorgan

On a consolidated basis, how much revenue do you believe comes through your numerous co-chairs with airlines outside of Alaska Air Group? In other words and this is purely hypothetical if American, Delta and everybody else were to stop feeding you revenue, how much lower would air group revenue be?

Brad Tilden

We have not historically disclosed that figure. One thing I can tell you is that interline volume has been about 15%, give or take a points for 20 years in this company. So interline has long time been a big part, in the old days it was just inteline ticketing and then it because co-chair and alliances, but that’s a general volume indication, I think what we have disclosed about these alliances.

Jamie Baker - JPMorgan

And as a follow-up, whether your 15 partner agreements, today have changed in control provisions, for example and again I am just throwing this out. If Delta Airlines were to buy Alaska Air, now suggesting that’s likely one way or the other, but would that automatically sever the relationship that you have with American, with Qantas, with everybody else hypothetically?

Bill Ayer

Again I don’t believe that we’ve shared the details of what’s inside those co-chair agreements and they differ from airline to airline and they are complicated. So I think it’d be hard be to answer simply anyway.

Operator

Your next question comes from Duane Pfennigwerth with Raymond James.

Duane Pfennigwerth - Raymond James

Just wondering in terms of your ASM guidance for next year, did you give a consolidated number as well?

Brandon Pedersen

We did not give a consolidated number. The main line number is 8% to 9%. We are still finalizing the Horizon number.

Andrew Harrison

I think for Horizon’s fleet next year it’s about flat to 90 down a point as where it’s looking right now, but it’s about it and it’s about 89% of our ASMs will be main line next year, the remaining 11 is the Horizon fleet.

Brandon Pedersen

So just doing the rough math using flat I think if 8 to 9 is main line, I think consolidated is probably just shy of that.

Duane Pfennigwerth - Raymond James

Okay and can you just give us an idea I mean it feels like an increase in growth expectations always relative to what we were thinking, one is it sort of increased growth relative to what you were thinking and two what is really driving that? I mean is it competitive displacement that you are seeing. What is driving the decision to grow faster next year?

Andrew Harrison

So couple of things, number one, we have just seen opportunity this year and so really what we are doing is dialing up the utilization of their aircraft which we pulled down very significantly over this past cycle. And then really if you look at the growth, a lot of the Mexico growth is filing in voyage in some of our core markets where capacity is going away and then what we think here, I'm really to be honest is Hawaii and really we are growing Hawaii, annualizing year-over-year and again in the Bay area, in the Pacific Northwest and in San Diego and so that’s really where the growth is coming and the new revenue is coming and we have been very happy with the results today.

Brandon Pedersen

This is just annualizing everything that we have already announced and/or started and in terms of the fleet, there is really no change to the fleet with the exception of small extensions of three leased 400s.

Duane Pfennigwerth - Raymond James

Okay, just on the Horizon restructuring. Bottom line, is this is about saving cost or an ability to more tightly integrate that to reduce expense or is this about a top line opportunity you see in replacing brand flying with an Alaska brand?

Glenn Johnson

You have really hit on all three pieces of it. It is absolutely about finding synergies between Alaska and Horizon; it's also about improving the efficiency of Horizon particularly through the fleet transitioning getting to the all key 400 fleet. So, I think there is a broad range of benefit that will come out of this business transformation plan that we have talked about and the goal is to get Horizon, the Horizon unit to the same level of return on invested capital as Alaska is now enjoying.

Brandon Pedersen

One other thing is that we have operated Horizon in a way that’s different from everyone else in the industry and so by putting Horizon on an all CPA basis, Horizon's P&L can look like the P&L of the other regionals around the country and so gives us a better comp to understand where we may or may not be competitive from a cost standpoint.

Operator

Your next question comes from Michael Linenberg with Deutsche Bank.

Michael Linenberg – Deutsche Bank

Maybe this is a question for Andrew, just to follow up on some of the capacity. Andrew we think about, maybe a same store sales basis, you are going to be up 8 to 9% capacity in 2011. A lot of that is new, maybe all of it is new, if we look at on your current system is that flat is that down. What can you tell us about that?

Andrew Harrison

As far as Michael big picture if you go through most of the rest of our regions, I look at the growth within those regions only at 2 or 3 points, so a fairly modest when you take into account news market and I suppose one of things that I sort of reflect on is really if you use Q4 as bit of a proxy, we are going to grow at about 9.5% and the majority of all of these new markets are in Q4. And we are very happy with what we are seeing as far as advances and yield and how that is starting to play out.

Michael Linenberg – Deutsche Bank

Did you give us a feel for where RASM trends were heading through the December quarter I mean I see the advanced book loads and I see some of the information in the investor update, maybe I just skipped over it or didn’t hear it?

Brandon Pedersen

We don’t normally we give that, but what I would share is that we are very pleased. We see continuing strength in the advances. And you see December is down, 1.5 points, but from where we stand, we are very happy with the quality of traffic that’s coming onto our books for December.

So we are very comfortable with the fourth quarter.

Michael Linenberg – Deutsche Bank

December being down, how much of that is a function of maybe a booking curve, that’s becoming a bit more elongated because I feel like at least coming into this holiday period and I realize this is anecdotally, but I do hear from co-workers and others that people seem to be booking a lot earlier because of the upward movement and the fair structure. I mean is that partly what’s going on here is that what we are seeing?

Brandon Pedersen

I think for Alaska Airlines specifically, upward price increases in the fare structures haven’t been that acute. I think what you are seeing a little bit is confidence as we get closer in. Last year, different story, weak economy, we were happy to sell seats, but I think this year what you are seeing is we have a little bit more confidence in holding out and making sure we build good yields.

Brad Tilden

I might just jump in on this capacity question. There has been a lot of questions about it and a couple of things that we would say is one, we are very supportive of the industry effort to keep supply in line with demand. And if you look at our network, a lot of the margin improvement that people are talking to is a result of this. So if you look at over 2.5 years now ASMs that we put into southern Cal, the Bay area, Arizona, Nevada, Mexico, all of those efforts have been aligned capacity with demand. So to the extent Alaska has grown, it’s been, is a market like Mexico comes back or putting airplanes into Hawaii or even in the mid-continent regions, so that’s one comment.

The second thing is I think while the industry, while we are very supportive of this industry effort to kind of keep capacity in check. I think we would all agree that while that happens industry wide, there might variances from airline to airline. If you look at Alaska’s history over 20 years now, our capacity growth has been almost three times the industry average growth rate and I am not signaling that that’s where we are headed, but I am signaling that this company has done a good job of finding good profitable places to put airplanes for a long, long time now. And that’s what we are talking about as we look at the five years.

Operator

Your next question comes from David McKenzie with Hudson Securities.

Dan McKenzie - Hudson Securities

Just a couple of house cleaning questions. What impacted the liquidation of Mexicana have on overall unit revenues in the quarter?

Andrew Harrison

We don’t probably get too specific, but I think it’s not only just Mexican but also the H1N1 with I think sort of May-June of last year. But our Mexican region was only extra 4.5% of our capacity in Q3. But it says very well.

Brad Tilden

We really just had one LA-Guadalajara and one LA-Mexico City that overlapped during the quarter. We are adding in now in the fourth quarter to take advantage of the Mexico cessation of operations, but with only two plus than 1% of our network with only two flights, it wouldn’t have much of an impact on system results.

Dan McKenzie - Hudson Securities

Then the second house cleaning question just you know with respect to the aircraft deliveries that are coming next year, should we expect any lumpiness in labor expense just from training costs ramping up for the new planes?

Brandon Pedersen

I don’t think so. It’s three airplanes in the first quarter and then that’s basically it. I wouldn’t expect any lumpiness in training cost or anything like that. Certainly nothing at the level that would be visible on the consolidated P&L.

Dan McKenzie - Hudson Securities

Got it and then finally just kind of more a broader question here. Bill given the economic uncertainty reference in your remarks and you role on the Seattle branch and the San Francisco fed, wondering if you can comment on how you are thinking about overall local business activity as it drives economic trends next year in the Seattle area?

Bill Ayer

I'm not sure I have got any great insights in that Dan, I think the Seattle area has faired better than much of the rest of the country because of the diversified nature of the industries here and housing has been a little bit better but we certainly have been impacted, no question about that. The biggest thing we talk to business is even our own corporate accounts is people I think there is just an uncertainty out there. The fundamentals maybe not that bad, but people are just uncertain about so many aspects of what's going on they are just being very, very cautious. And that in fact slows the recovery of the economy all by itself. So, Seattle is fairing okay through this but I wouldn't say that it’s outpacing anybody particularly and we are cautious because of that.

Dan McKenzie - Hudson Securities

Got it, so in particular no business net inflows or new business activity just in terms of business is coming to Seattle but the standout in particular?

Bill Ayer

Yes.

Operator

The next question comes from Helane Becker with Dahlman Rose.

Helane Becker - Dahlman Rose

Andrew could you just, I think you said 4.5% of your capacity now is in Mexico and I think prior to H1N1 something like six, so with all the changes they were making over the next say six months in Hawaii and Mexico. Can you just update us on where that capacity falls?

Andrew Harrison

Sure. So, for the summer we’re about 4.5 and then actually it will peak in the first quarter of 2011 and Mexico will represent about 8.5% of our capacity. One of the things Helane and in all of this is that you see that Guadalajara, Mexico City has but we have also eliminated the Seattle Cancun LA, which was a very long six hour flight. So that’s 12 hours of flying being replaced by more two to three hour late so overall our capacity for 2011 in Mexico will be up a point or two or something like that but not huge.

Helane Becker - Dahlman Rose

Okay and then are you seeing any shift from core days away from Mexico actually to Hawaii given what is going on there from a political stand point?

Andrew Harrison

We struggle with that question all time Helane I think the problem is what is going on. Is that we have a very rough year last year with H1N1 in the economy and now with the strength coming back in Mexicana no longer flying. What we’re just seeing net is good strong Mexico demand.

Bill Ayer

The key to it Helane is what we’ve done everywhere in the system is we’ve gotten very nimble with capacity and quickly understanding what’s going on with demand matching capacity. And so we moved quickly and so Mexico up, Mexico down we take advantage of that or we can minimize the impact and put airplanes in other places and we have just been Andrew and Steve have been very quick with that it’s helped us a lot. So we spend more time looking at that we have capacity matched right and we do asking the question about demand.

Helane Becker - Dahlman Rose

Okay alright and then just in terms of looking at your overall root structure now and your earnings production. You really changed the seasonality of the airlines. So for being sort of break even first half to making money all year long. So we should consider that trend kind of continuing as we think ahead 2011 and so on.

Brandon Pedersen

Certainly the goal of what we are trying to do I don’t think you should necessarily conclude that the trend because there is too many things in the macro environment that we can’t control. But the idea behind all of the restructuring that we’ve done is to get out of the habit of creating a loss in the fourth quarter like you said in having this huge profit in the third and really spreading operating over the course of year so we can generate profit in all four quarters.

Andrew Harrison

And the other thing I would add is that out of the Pacific Northwest, Hawaii is a good add for us and also some of the Mexico as a seasonal. Like Puerto Vallarta and the San Diego so we do continue in our seasons that are normally difficult for us to put that medal in the markets we think can do well for us.

Helane Becker - Dahlman Rose

Are there any other Central American markets that might make sense for you? From Seattle then?

Brad Tilden

It’s possible Helane, this is Brad but we don’t normally talk about that stuff in advance of announcing it.

Operator

Our next question comes from Steve O'Hara with Sidoti & Company

Steve O'Hara - Sidoti & Company

You had mentioned the CapEx for next year, could you just or like an intro to it can you just give that one more time for me and that’s about all I had?

Brandon Pedersen

Our CapEx next year would be just over $300 million, if we are able to complete this deal to have 8 RJs leave the fleet next year and replace those on a one for one basis, with 8 Q400s that’s really a shift of CapEx out of 2012 and 2013 in the 2011.

Steve O'Hara - Sidoti & Company

And that doesn’t get done can you give me a ballpark on that?

Brandon Pedersen

I forget exactly what the number is but I think it was probably more in the $150 million range.

Operator

Your next question comes from Kevin Crissey with UBS

Kevin Crissey - UBS

Any thoughts on a legion as it regarding Bellingham and the competition you are seeing there and then maybe as it relates to Hawaii?

Joe Sprague

I think we have seen some good performance out of our own Bellingham to Las Vegas service that we are operating and that we are really excited about the new Honolulu service that we are going to start on January 7 from Bellingham. I think the realization for us has been that Bellingham in another self is a decent market but importantly the traffic is coming from north of the border and the lower mainland area of Vancouver, British Columbia is really where the majority of the traffic is going to come from for these flights. We are seeing that already on our Vegas flight and so credit to Allegiant for maybe recognizing that themselves but maybe credit to Alaska for recognizing it also and learning from Allegiant and I think we are excited about what lies ahead for us up in that market.

Kevin Crissey - UBS

I guess it's not really a question on the capacity but it just seems like there's never an airline that grows. They always just annualize flying from the year before.

Operator

(Operator Instructions) Your next question comes from Glenn Engel with BoA/Merrill Lynch.

Glenn Engel - BoA/Merrill Lynch

A few questions please. One, on Horizon margins seem to be declining for regional. So how do you, since an entirely internal company, how do you asses what their margins will be?

Brandon Pedersen

Glenn its Brandon. One other things, and you probably heard my comment a bit ago was to, by going in an LCPA model we wanted the Horizon P&L to look like other regionals and when we set the inter-company CPA rate we are going to try to do that in a way that is represented above the market. So the goal is to have market costs and market revenues between the two companies.

Glenn Engel - BoA/Merrill Lynch

So the rate will be set on market cost as well even if Horizon’s are above or below that?

Brandon Pedersen

Yeah that’s the idea.

Glenn Engel - BoA/Merrill Lynch

Second you mentioned a little bit on incentive what is the current incentive bonus plan now for 2010?

Brandon Pedersen

In terms of what our projected cost is for the whole year?

Glenn Engel - BoA/Merrill Lynch

Yes.

Brandon Pedersen

So through nine months we had accrued on an Air Group basis I believe the number is $62 million and so we are on pace to about $82 million this year for incentive pay. Its been a very strong year, I think you are probably familiar with our performance based pay plan that has goals that are not only financial but operational in nature and the company really as two companies we are exceeding the operational and financial goals set by the board at the start of the year and so it’s a very good year from an incentive pay out basis.

Glenn Engel - BoA/Merrill Lynch

Finally, can you talk about how well Transcon did in the third quarter into how well your business, however, your measure of business improve relative to the overall system?

Andrew Harrison

This is Andrew, Glenn. We were very happy with Transcon performance. It actually performed on par with many of the regions during the summer. As you know, we only have one or two flights a day in the peak season so they perform very well. The other thing is a mix of traffic; summer is a big leisure time for us. So we carry a lot of leisure travelers versus may be more of the business focus outside of that.

Glenn Engel - BoA/Merrill Lynch

And how much that business improved this year? Last year it was pretty depressed.

Joe Sprague

Glenn this is Joe. You are right about that. We don't, as Andrew mentioned, maybe carry as many corporate business travelers as a lot of other network airlines do but what we have carried has certainly increased over the last year. In fact most of our regions are seeing about a 30% increase in terms of managed corporate travel.

Glenn Engel - BoA/Merrill Lynch

And do you have an estimate for what percent of your traffic you think is business?

Joe Sprague

I think on the managed corporate side it’s probably 10% or a little less than that.

Operator

The next question comes from Michael Derchin with CRT Capital Group.

Michael Derchin - CRT Capital Group

One of the few airlines who actually has higher returns than you is Allegiant as you mentioned. I was wondering if you've looked at their model and are there any lessons that you could learn from them.

Joe Sprague

Mike, this is Joe again. One thing that they clearly do very well is merchandize on their website and one of the main things that they are merchandizing is vacation packages and car and hotel opportunities. So that's something that we are going to try and learn from. We are doing a little bit of that this year and our numbers here over the last month or so are increasing. We are going to put a lot of focus on that in 2011 and that is trying to evaluate whether that really is a good opportunity for us.

Michael Derchin - CRT Capital Group

And how much of your Hawaii expansion is related to that type of opportunity.

Joe Sprague

Well clearly Hawaii is an entirely leisure market and with the point of sales strength that we have here on the West Coast we know folks who were going over there on vacation and so absolutely when we look at trying to build our hotel business Hawaii is the first source that we are going to look forward to build.

Operator

Your next question comes from Tom Banse with KUOW Radio Seattle.

Tom Banse - KUOW Radio Seattle

Hi gentlemen, like you've seen here, in the Pacific Northwest, my hometown airline mentioned as an acquisition target, and even again this week, can you talk about how many real inquiries from other airlines have come in since say the United Continental merger, to have a conversation about merger or acquisition.

Bill Ayer

Hi Tom this is Bill. We don’t talk about that. What we do say about this whole topic though is its about shareholder value and what we want to do here is have a company that we think pursues strategies that optimize overtime value for shareholders and so as we talk about plans for the future and the whole universe of things we believe that the path that we are currently on, the development that we have had, the work that we have done over the last 7 years to really transform the company and first Alaska and now Horizon to build a more competitive business model, a lower cost company, a company that has greater customer value, that flies places, that the places that people want to go, that has a single fleet, a very fuel efficient fleet, all the things that we have been working on for so long, we think that now we are starting to see the results in terms of earnings and we think the path that we are on is the right one for shareholders.

Being a public company, you have to say that if that were to change and we thought there was a better alternative available for shareholders. We would look at that alternative, but where we sit right now and particularly with this quarter’s record results were very encouraged that we are on the right path and we are going to keep at it.

Tom Banse - KUOW Radio Seattle

And then just a completely big picture question, what accounts for the discipline of the airline industry that’s here and maintaining or avoiding fare wars and keeping a cap on supply. I mean how that really happened in the previous 10 or 15 years, but it really seems to be working this year?

Brad Tilden

You are right about the historical part of this which is the difficult thing in this part of the cycle as people start making money and then buy airplanes and then they have too many seats and fares go down and airline start losing money. I think part of it is the fact that you have got management teams in place that have been through this cycle a couple of times and people don’t want to replay the movie and so it’s encouraging and there is not guarantee that the industry continues to be disciplined this way, but that’s certainly the way it’s going right now and in fact the consolidation that has happened probably helps that, helps the discipline and it’s encouraging because this industry needs to be profitable, it’s a key part of the economy and the history is not a good one, as you know. So we are encouraged, we are certainly trying to do our part to be disciplined about everything we do and we are encouraged that the industry will be so as well and we will have a long period of profitability in the industry.

Operator

At this time there are no further questions. I will now turn the conference back to Bill Ayer for closing remarks.

Bill Ayer

Okay well let me once again congratulate all of Alaska Air Groups, both Alaska and Horizon are poised for a great third quarter and to our audience we like to thank you for joining us today. We look forward to talking with you again next quarter. Thanks very much and take care.

Operator

Thank you for participating in today’s conference call. This call will be available for replay beginning at 11.30 pm eastern standard time today through 11.59 pm eastern standard time, on November 21, 2010. The conference ID number for the replay is 38153246; again the conference ID number for the replay is 38153246.

The number to dial for the replay is 1800-642-1687 or 1706-645-9291. Also the call will be accessible for future playback at www.alaskaair.com. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Alaska Air Group, Inc. CEO Discusses Q3 2010 Earnings - Call Transcript
This Transcript
All Transcripts