Northwest Airlines Q3 2007 Earnings Call Transcript

| About: Northwest Airlines (NWA)

Northwest Airlines (NWA)

Q3 2007 Earnings Call

October 29, 200711:00 am ET

Executives

Brad Ellsworth - IR

Doug Steenland - President, CEO

Dave Davis - CFO

Neal Cohen - EVP Strategy; CEO, Regional Carriers

Tim Griffin – EVP, Marketing and Distribution

Andy Roberts - EVP of Operations

Analysts

Ray Neidl - Calyon Securities

Christopher Kumal - Goldman Sachs

Mike Linenberg - Merrill Lynch

Bill Mastoris - Bank of New York

Kevin Crissey - UBS

Bob McAdoo - Avondale Partners

Gary Chase - Lehman Brothers

Frank Boroch - Bear Stearns

Operator

Welcome to the third quarter 2007 financial resultsconference call. (Operator Instructions) I would like to turn the conference over to Mr. Brad Ellsworth,Director of Investor Relations. Please go ahead, sir.

Brad Ellsworth

Good morning, everyone. I would like to thank you forjoining us today for the Northwest Airlines third quarter 2007 financialresults conference call. Joining me today are Doug Steenland, President andChief Executive Officer; Dave Davis, EVP and Chief Financial Officer; NealCohen, EVP Strategy, International, and CEO Regional Carriers; Tim Griffin, EVPMarketing and Distribution; and Andy Roberts, EVP of Operations.

In today's call, Doug will provide opening remarks, followedby Dave who will review the quarter's results and provide forward guidance.After our prepared remarks we will open up the call for questions from theanalyst community, followed by questions from the media.

During the course of our remarks today we may makeforward-looking statements. You should understand that actual results mightdiffer materially from those in our forward-looking statements. Additionalinformation concerning factors that could cause actual results to materiallydiffer from those forward-looking statements is contained in today's earningspress release.

I would like to remind everyone that today's call is beingrecorded and also being webcast at ir.NWA .com. A replay of this call will bemade available on this website shortly after the call, for one week.

I would like to turn the call over to Doug Steenland.

Doug Steenland

Thank you very much, Brad. Good morning, everyone.Reflecting the success of the Northwest Airlines restructuring, today wereported a pre-tax profit for the third quarter of $405 million, a 57%improvement versus the third quarter of 2006. For the first nine months of2007, Northwest reported a $778 million pre-tax profit, a 153% improvementversus the first nine months of 2006.

Our third quarter pre-tax profit was the highest quarterlypre-tax profit in ten years, and the third highest in Northwest history. Thethird quarter pre-tax margin was 12%, the highest among network carriers. Ouryear-to-date margins were also the highest among network carriers. Our resultsare consistent with those included in our five-year disclosure statementbusiness plan when adjusted for changes as a result of higher fuel prices.

I am also pleased to report that the airline has returned toits historical position of leadership and operational reliability. The lasttime we spoke in late July, Northwest had successfully implemented actions thatresulted in improved operating performance during the months of August,September and October.

November, Northwest system-wide completion factors grew from97% in July to 99.2% in August to 99.7% in September, and 99.4% in October.These operational results were realized even though one of the two main parallelrunways in Minneapolis was closedfor repairs during the third quarter and we're pleased that runway reopened onthe 18th of October. In addition our luggage performance remained strong and isthe best among network carriers so far in 2007.

Our strong financial and operational results reflect thehard work and dedication of our 30,000 coworkers and I want to thank them for ajob very well done. As part of fulfilling our commitment to our employees, wehave accrued $72 million in profit sharing and in performance incentivepayments for the first nine months of 2007. In addition, since the beginning of the year, Northwesthas contributed $95 million to its employee pension plans.

We continue to focus on executing our business plan whichincludes a series of initiatives that generate earnings growth in the yearsahead. Key initiatives include an overall profitability enhancing refleeting.Northwest is halfway through its $6 billion refleeting program, which includesthe delivery of 32 Airbus A-330s; 72 76-seat regional jets manufactured byEmbraer and Bombardier; and 18 Boeing 787s. As these new aircraft enterservice, their lower operating costs and improved performance will driveincreased profitability, particularly in today's high fuel cost environment. These aircraft purchases collectively have aforecast return on investment of greater than 15%.

With the delivery of the 32nd Airbus A-330 on October 17th,Northwest has taken all of the firm deliveries of that airplane. These aircraftreplace DC-10s and 747-200s to make Northwest the operator of the world'slargest fleet of Airbus A-330s. As a result, Northwest also now has theyoungest transatlantic fleet in the industry. So far, Northwest has takendelivery of 14 dual-class 76-seat regional jets, five EMB-175s, and nine CRJ-900s.We expect to have 22 76-seaters by year end and all 72 of these by the end of2008. These aircraft replace the very fuel efficient AVRO-RJ85s that were rejectedduring our bankruptcy as well as retired DC-9s. In addition, the 76-seatregional jets low operating costs, and extended range provide additionalprofitable growth opportunities.

Just one example is the Minneapolisto Vancouver service that westarted on October 15th. Northwest typically would not operate this route duringthe winter, as there is inefficient demand to fill a 125- or 150-seat A-319,A-320; and our 100-seat DC-9 does not have the range to make the mission. As aresult of this new large regional aircraft, we will now have Vancouveron our network year-round. Customer response to the new aircraft continues tobe overwhelmingly positive.

Northwest is also the North American launch customer for theBoeing 787 with 18 firm orders, and 50 options. The 787 will be anunquestionable game-changer and will allow us to increase the profitability ofand grow our Pacific network. We are working with Boeing to refine the deliveryschedule and expect the aircraft to be in service at Northwest by the firstquarter of 2009, well ahead of the peak summer season in the Pacific.

We believe that the refleeting that is underway at Northwestwill put the airline at a distinct competitive advantage versus other networkcarriers that have deferred their refleeting decisions.

With respect to route authorities, on September 25th,Northwest was awarded new route authorities to serve the Detroit-Shanghainon-stop market beginning in March of 2009. When combined with our existing Chinaroute authorities and our industry-leading slot position at Tokyo Narita Airport,Northwest is well-positioned to meet growing demand in Chinaand maintain our leadership position in the Pacific.

We are also continuing to grow our industry-leading Northwest KLM joint venture with the launch of new 757 transatlantic servicefrom Detroit to Düsseldorf, andfrom Hartford to Amsterdam,both of which have been clear successes. The Detroitventure has also announced new service from Dallasto Amsterdam to be operated by KLMand between Portland and Amsterdamand Minneapolis and Pariswhich will be operated by Northwest, all of which will start in the spring of2008; as well as expanded co-sharing opportunities with Air Francewhich would run to 39 destinations beyond Paris.

As you know, we have filed with the U.S. DOT an applicationthat calls for the establishment of a four-way joint venture over thetransatlantic with Northwest, Delta, Air France and KLM which will build on theindustry-leading $4 billion Northwest/KLM alliance which has been in placesince 1991 and celebrated its tenth anniversary this year under the currentjoint venture agreement. We're pleased that on October 18th the U.S. Departmentof Transportation issued a scheduling order establishing a timeframe for theconsideration of this expanded application for anti-trust immunity.

On customer service initiatives, the airline has launchedthe Northwest experience with front-line employees, the largest customerservice initiative in more than a decade, as well as a newly-redesigned captainleadership program for Northwest pilots. Both are designed to better equipemployees to deliver best-in-class customer service. We have also establishedover 60 employee involvement teams to solicit direct in put from our coworkerson the best ways to improve customer service.

Air Franceis making other investments in airport infrastructure, technology, equipmentand facilities to enhance customer services. These investments include systemsto provide a more convenient experience at the airport, such as the ability touse handheld devices to check in for your flights; new customer relationshipmanagement tools; and programs to attract and retain high-value customers; newequipment to build on our leadership in luggage handling, and improvements tothe Northwest World Clubs.

Recently, there has been much discussion of industryconsolidation and also it's been of discussion on earnings calls. We'd like tooffer our big picture thinking on that subject and lay out some of the principlesthat will guide our decision-making going forward. Let me add also that we willcontinue our general policy of no comment with respect to specific matters,rumors or speculation on this topic.

Consolidation has been a feature of the airline industry formany years, particularly since deregulation in the late 1970s. Northwest and ourcurrent network airline peers are themselves products of consolidations. Webelieve that this trend will continue and that further consolidation of theindustry is inevitable.

If it were possible to start with a clean slate today, one wouldlikely conclude that six major domestic network carriers are too many, and thatthis level of fragmentation has contributed to the historic underperformance ofthe airline industry and the destructive boom and bust cycles that serve no one;least of all our employees, our customers, and our shareholders.

There are of course significant opportunities for valuecreation through consolidation. These include improved network economics thatcome from the ability to offer customers seamless travel across a broadernetwork, cost reductions stemming from the elimination of duplicative overheadand infrastructure, and operational improvement resulting from a more stableenvironment for our employees.

In deciding whether any specific consolidation transactionis in the best interest of Northwest constituents, one needs to take intoaccount execution risks that says the uncertainty of the regulatory reviewprocess, the complexities governing the integration of workforces, and therequirements to negotiate combined labor agreements which would likely lead tocost increases.

Regarding the potential for asset spin-offs -- enhancing thevalue of certain assets by spinning them out -- this also has the potential forsignificant value creation. Northwest has executed these types of transactionsin the past, such as the IPO of Pinnacle Airlines in 2003. Monetization offrequent flyer programs has frequently been pointed to as a source of value. Anexample is Aeroplan in Canada, which was spun out of Air Canadabeginning in 2005, and today has a market capitalization of Canadian $4.5billion, as is often cited; Qantas has recently announced its intent toseparate its frequent flyer program. Clearly this is worthy of further analysisand we are undertaking that work.

The Northwest board and management team are committed tomaximizing shareholder value. This commitment together with Northwest'snonreplicable strategic and network assets, our competitive cost structure, ourstrong earnings and our very strong balance sheet make Northwest a keyparticipant in any future industry developments.

With these comments, I would now like to turn the call overto Dave Davis for some further discussion of our specific performance here inthe third quarter.

Dave Davis

Thank you, Doug. To summarize our results, Northwest todayreported a pre-tax profit of $405 million for the third quarter, $147 millionimprovement over the third quarter of 2006. Our third quarter pre-tax marginwas 12%, a 4.4 point improvement over the third quarter of last year; and ourEBITDAR margin was 20%, a 4.2 point improvement over the third quarter of 2006.

As Doug stated, our margin performance was the strongestamong the major network carriers. Our quarterly earnings were impacted by theimplementation of fresh start accounting and exit related items which aredetailed in the financial statements. Also, the changes in the accountingpresentation for our regional carriers that we made at the beginning of 2007continue to affect the comparison and year-over-year results for certainP&L line items. These changes are also detailed in the footnotes to thefinancial statements of our press release.

Operating revenues for the third quarter were $3.4 billion,down 0.9% from last year. Excluding Fresh Start accounting impacts, consolidatedpassenger RASM increased 3.5% on a 0.8% decrease in ASMs. Our RASM performancewas driven by a 2.1% improvement in yield and a 1.2 point improvement in loadfactor during the quarter.

Our domestic main line RASM was up 3.7% on 5.5% fewer ASMs, andour domestic consolidated RASM with regionals was up 4.1%. Reduced capacity,improved operational performance in August and September, and the introductionof 76 regional jets contributed to this quarter's RASM performance.

Our Pacific RASM increased by 4.6% on 0.3% more ASMs. By theend of the quarter, we completed the retirement of our 747-200s from thePacific fleet, as well as the introduction of newer A330 aircraft from Tokyoto the Pacific market. Atlantic RASM increased 2.7% on a 15.5% increase inASMs. Increased capacity in the Atlantic was primarilydriven by the introduction of 757s with transatlantic service, in conjunctionwith our joint venture partner, KLM. Overall, we saw accelerating improvementin our year-over-year RASM performance throughout the quarter.

Cargo revenue was down $42 million for the quarter due tothe removal of two freighter aircraft from scheduled service and a 7.3%reduction in yield. Northwest cargo business generates $900 million in annualrevenue and includes freight carried by 12 dedicated 747-200 freighters, aswell as cargo carried in the bellies of passenger aircraft.

The dedicated freighter business has underperformed the restof our network in recent years. Doug described initiatives that are underway togenerate future earnings growth and optimization of our cargo business providesan additional opportunity. We are taking a number of actions on the sales,revenue management, alliance, and fleet fronts that we are confident willimprove the profitability of our freighter business.

Moving now to costs, continued focus on cost control isclear in our results. Year-over-year operating expenses were down $122 million,or 4%, to $2.9 billion for the quarter. Our main line unit costs, excludingfuel, were approximately flat versus last year on 1% fewer ASMs. Including non-operatingexpense, our total CASM ex-fuel was down 3% versus last year.

During the quarter, we paid an average of $2.11 per gallonfor fuel excluding taxes and before out-of-period hedge gains; down 1.5% versuslast year. Approximately 40% of our Q3 exposure was hedged using a combinationof swaps and collars. During the quarter, we realized $23 million in hedgegains.

Moving to the balance sheet, we ended the third quarter with$3.1 billion in unrestricted cash and $739 million in restricted cash. Includedin the restricted cash balance is $213 million related to our pendinginvestment in Midwest Airlines. Last week, we received $97 million in proceedsfrom the sale of our stake in AIRINC. We expect to end the year in $2.8 billionto $2.9 billion in unrestricted cash.

Our total debt at the end of the third quarter was $9.2billion, including the present value of off-balance sheet aircraft leases. Ournet debt at the end of the quarter was $6.1 billion, which resulted in a 3X netdebt to EBITDAR ratio and a 55% net debt to total capitalization ratio.

Before providing you with guidance, let me update you onshare distributions and the claims resolution process. Following thedistribution of over 30 million shares during the first week of October, wehave 234 million shares outstanding, including 205 million shares to unsecuredcreditors with a total of $7.8 billion in allowed claims; and 28 million sharesthat were issued pursuant to the rights offering we completed upon exitingbankruptcy.

Currently, the company has 1.1 billion of remaining disputedunsecured claims to be resolved. Under the plan of reorganization, our estimatefor unsecured claims ranged from $8.2 billion to $8.8 billion. Based on thecurrent status of the claims resolution process, we now expect our claims tofall between $8 billion and $8.4 billion. The next periodic distribution isscheduled for January 2, 2008and at this time we do not know the precise size of that distribution.

Moving now to guidance, in the fourth quarter, we expectsystem main line capacity to be down 2% to 3%, with domestic main line capacitydown 6% to 7%, and international capacity up 2% to 3%. Regional capacity willbe up 14% to 15%, resulting in consolidated ASMs, down 1% to 2%. For the fullyear, our system main line capacity will be flat to up 1%, with domestic down 2%to 3%, and international up 4% to 5%. Regional capacity will be down 1% to 2%resulting in consolidated ASMs flat to up 1%.

We are still formulating our capacity plan for 2008 and weintend to provide more guidance on this topic on our next earnings conferencecall. In general we anticipate the overall size of the airline to be consistentwith our five-year disclosure statement business plan, with flat main linecapacity and the continued introduction of 76-seat regional jets. Our 2008capacity guidance does not reflect the potential consequences of oil staying at$90 per barrel, and the industry seeking to pass these higher costs on to theconsumer. We have significant fleet flexibility, particularly with our DC-9s,to further reduce capacity should we see an impact on demand.

Regarding CapEx, with the delay in the delivery of 787s, wenow expect 2008 aircraft capital spending to be approximately $1.2 billion, $700million lower than previous guidance.

Regarding costs, our fourth quarter 2007 CASM, excludingfuel, is expected to be up 2.5% to 3.5%. This increase is primarily driven by a2 point to 3 point reduction in main line capacity, and increased profitsharing, as well as the timing of product initiatives which Doug highlightedearlier in the call.

Including non-operating expense, our fourth quarter totalCASM ex-fuel is flat year over year, and is consistent with our business plandespite the fact that we are flying fewer ASMs. Our full year CASM excludingfuel will be down 2% to 3% and also remains consistent with our business plan offewer ASMs.

High fuel prices continue to be a challenge for Northwestand the industry. Based on the forward curve we expect our fourth quarter 2007fuel price to be $2.40 per gallon, excluding taxes, and our full year 2007 fuelprice to be $2.06 per gallon, excluding taxes. These estimates are based on theforward curve as of October 26th, and assume a spot price of $2.51 per gallonexcluding taxes for the unhedged portion of Q4.

Approximately 50% of our fourth quarter consumption ishedged; 40% collared, with an average floor of $56 per barrel and an averageceiling of $75 per barrel and a 10% swap at approximately $63 per barrel.Additionally, we have hedged 10% of our estimated first quarter 2008 fuel usageusing collars with a floor of $63.50 per barrel, and a ceiling of $84 perbarrel.

The effective tax rate for the fourth quarter is expected tobe 40% for book purposes; however, due to our large NOL position, these taxesare primarily non-cash.

Bookings remain strong through the remainder of the fourthquarter and we have seen no evidence of slowing demand.

With that, we are now ready to open the call for questions.

Question-and-AnswerSession

Operator

Your first question comes from Ray Neidl - CalyonSecurities.

Ray Neidl - Calyon Securities

Good morning. Regarding consolidation and spin-offs, thefrequent flyer program to me at least seems like it is a really intricate partof the airline and I'm a fan of the virtual airline but the frequent flyerprogram seems to me that you would be poking out one of your eyes by spinningthat off into an independent company.

Delta made the remarks about that, that it was a matter tobe considered after consolidation, and U.S. Airways said that spinning offassets could sidetrack consolidation, which he thinks the industry shouldconcentrate on first of all.

So, regarding the frequent flyer program, what is youropinion on that? Is it an intricate part of the airline and would spinning itoff hurt the airline?

Doug Steenland

First, you would only spin it off if you came to theconclusion that it would not hurt the airline and that the airline wouldcontinue to have a competitive, meaningful program to attract and retain itsmost loyal frequent flyers.

I think if you look at the results of what has happened in Canadawith Aeroplan and Air Canada,they have succeeded in doing that. Also I think if you just think aboutspinning off the loyalty plan, as a frequent flyer plan as a financing type ofstructure, I think one would conclude that that would be a less attractiveoption.

But if you look at the results of Aeroplan, if you look at howQantas is considering its spin-off, with that plan really becoming a loyaltybusiness separately managed, it does clearly drive value, and here we'recommitted to looking to maximize the value of the assets that we have withrespect to our shareholders.

For that reason, we're giving it a look. I think those planscan be looked at and those decisions can be reached independent of any otherconsideration of consolidation. I don't believe the two are linked.

Ray Neidl - Calyon Securities

How about the cargo operation? Northwest is really the onlybig passenger U.S.carrier that has pure cargo and you do a lot of cargo in your belly, and thePacific operation lends itself well to that. You're having some problems withyour cargo operation right now. Could that be a candidate for a spin-off or asale?

Doug Steenland

I will answer thelatter part and I will ask Neil Cohen who runs the cargo business to answer thefirst part. Any spin-off or sale are clearly complicated because thecertificate of authority that we use is linked to our passenger authority, andthe ability to disaggregate that is a challenge. So we don't have any currentplans to spin that out. Our plan is to continue the cargo business and tomaximize its value to us.

Neal, if you could add some extra color to that?

Neal Cohen

Just to go back to your original premise, if you look at theuniverse as the universe of large international airlines around the world, infact, the majority of those airlines do operate dedicated cargo capacity in theform of freighters or combis so when you look compared to just the U.S.carriers, it looks more exceptional; but when you look at the total worldairline business, it is not unusual for large international carriers to operateit.

Having said that, as Dave talked about in our comments, it'sclearly a piece of our business that has underperformed, and frankly, a pieceof the business that we need to focus the energy on delivering a better productto the customer and seeing the results of that. We're very focused on that,Ray, and took a lot of action in the third quarter to see that businessimprove, the product that we deliver to the customer, and then the yields andthe revenue that we derive from that.

So we're very focused on that. Probably we weren't asfocused on that during our restructuring as we needed to be, but we've made achange in the leadership in that area, brought in a leader whose got a veryproven track record in producing revenue on the domestic side of the business,and we will talk more and more about that as we go forward on more calls onthings that we're doing to improve our revenue and our earnings in ourdedicated freighter business.

Ray Neidl - Calyon Securities

Just to clarify the guidance going forward, main line ASMsare probably roughly flattish and regional will be up in the low teens? Is thata good guesstimate?

Dave Davis

It will probably be up a little bit more than that on theregional side, given the fact that we are taking all of our remaining76-seaters next year.

Operator

Your next question comes from Christopher [Kumal] - GoldmanSachs.

ChristopherKumal - Goldman Sachs

You commented on your Q2 call that the Detroitlocal market was seeing some moderately weaker PRASM trends than the rest ofyour system. I was just curious if in Q3 if you saw similar trends there? Couldyou comment on any pockets of relative strength or weakness in the rest of yournetwork?

Tim Griffin

I think if you look at the domestic market in its entirety, Detroitis a bit weaker as we suggested in Q2 than the rest of our network. I wouldstill characterize the overall network as pretty strong and Detroitjust a bit weaker; versus Q2, no meaningful change.

ChristopherKumal - Goldman Sachs

How about in Pacific? You've mentioned the over gauging in theresort markets out of Japanthat had some negative impacts on your RASM in Q3 and Q2 in the Pacific market.Is there anything else that is going on? Because it does look like Northwest RASM in the Pacific versus peers is lagging somewhat.

Neal Cohen

The primary effectgoing on in the third quarter is in fact that we were over gauged in the Pacific Beach market. The company made adecision early in the year to accelerate the retirement of the DC-10s in favorof the A-330s. In the process of doing that, to make all of the ends meet, wehad some 747s in the Beach markets. At the same time, the Beach markets areflat year-over-year, so that proved to be probably a very significant impact onour RASM.

The good news is that we've replaced all of those aircraftwith appropriately-sized A-330s. We're seeing very positive load factor trendsin the Pacific, in the Beach market, because of that. So you will see that turnaround a little bit.

I think the one thing also to keep in mind is thosecomparables for the Pacific are somewhat impacted by the fact that some of ourcompetitors have reduced capacity; eliminated, in fact. American reduced asubstantial percentage of its Japancapacity, so that's obviously impacted their RASM and allowed their RASM tosubstantially go up year over year.

For us, our real focus is on getting ready to introduce the787s, and the opportunity that provides us to participate in new markets like China,Korea andmarkets in addition to Japanwhere we greatly participate today. So you will see us be very focused onmaintaining focused capacity in the Pacific until the 787 comes on, an thenallow us to grow very modestly with the right-sized units on a go-forward basis.As Doug talked about, it's game-changing capability.

ChristopherKumal - Goldman Sachs

On fuel, what should we be assuming on a per gallon basisfor taxes?

Dave Davis

I would assume anumber of $0.06.

Operator

Your next question comes from Mike Linenberg - MerrillLynch.

Mike Linenberg - Merrill Lynch

Dave, you gave us the new CapEx number for '08. I think yousaid $1.2 billion. Do you have a cash number or is the cash number similar tothat?

Dave Davis

Cash, you mean total CapEx?

Mike Linenberg - Merrill Lynch

A cash CapEx.

Dave Davis

The aircraft portion is largely financed. The cash number, Idon't have right in front of me, Mike, but I think we can get it during thecall.

Mike Linenberg - Merrill Lynch

Doug, with the 787getting pushed back it sounds like now the first quarter of '09 and I think youwere going to take your first one in August of '08, are you guys in a positionto receive payments from Boeing because of the delay?

Doug Steenland

To this particular event, no.

Operator

Your next question comes from Bill Mastoris - Bank of NewYork.

Bill Mastoris - Bank of New York

Dave, could you breakdown the CapEx a little bit more for'08? How much of that is the aircraft portion; $800 million, $900 million? Whatshould we be looking at there?

Dave Davis

The $1.1 billion that I quoted is the aircraft CapEx number.

Bill Mastoris - Bank of New York

And the non-aircraft CapEx?

Dave Davis

Non-aircraft CapEx weexpect right now to be essentially consistent with what we had in our five-yearplan which is approximately $250 million.

Bill Mastoris - Bank of New York

You mentioned that all of the '08 deliveries aresubstantially financed?

Dave Davis

That's correct.

Bill Mastoris - Bank of New York

Might we see some more debt coming down the pipe with asimilar transaction to finance the 787s at some point during '08?

Dave Davis

We are always lookingfor the most efficient way to finance our aircraft, and if we conclude that themost efficient way to finance the 787 is with something like a double ATCpotentially, but we have not made a decision on that yet.

Bill Mastoris - Bank of New York

On the unsecured distribution, you mentioned $1.1 billion. I'msorry, maybe something might have faded out, but do you have a lot ofconfidence that essentially most of that $1.1 billion is going to be resolvedwhen the January 2nd distribution is actually complete?

Dave Davis

I didn't comment onthat and talk about sort of the additional shares that are going to bedistributed in January because I just don't have a lot of confidence right now ingetting all of that done by January.

Operator

Your next question comes from Kevin Crissey - UBS.

Kevin Crissey - UBS

When we think about the frequent flyer program, can you giveus a sense for the size of the miles, the number of miles issued to the creditcard, versus the airline versus other partners?

Doug Steenland

We have decided notto break that down, Kevin. As we think about the degrees of transparency toprovide to that going forward, that is an issue that we will address, but atthe moment, we are not going to break that into its specific components.

Kevin Crissey - UBS

What's the sensitivity there? I guess I'm just not clear onwhy that is sensitive information, not just for you but for other airlines?

Doug Steenland

It's competitive, to some extent, because we all do things alittle differently and to the extent that we may believe we may have negotiateda little better deal than others, we like to keep that amongst ourselves.

Kevin Crissey - UBS

When I think about the four-way anti-trust immunity, ifDelta or another airline were to pull out, is there a penalty? There is alwaystalk of Delta and United or you guys or someone else, is there a penalty for abreakup of that relationship?

Doug Steenland

First of all, the four-way joint venture agreement does notexist yet. It would have to be negotiated. There are bilateral agreementsbetween ourselves and KLM and bilateral agreements between Delta and Air France.We are not privy to those agreements. The Northwest/KLM joint venture agreementis basically an evergreen agreement, but either side has the right to provide atermination notice of three years.

Operator

Your next question comes from Bob McAdoo - AvondalePartners.

Bob McAdoo - Avondale Partners

When you talked about bringing on the last of your 76-seatairplanes and how they replaced the Avros and the DC-9s, when you get these in,what percent of the DC-9s will have been grounded? How many will you have left?

Tim Griffin

The total size of theDC-9 fleet is about 103 aircraft today. The size of the fleet by the end ofnext year when we have all of the 76-seaters in will be smaller than that. Givenwhere fuel prices are, we are in the process of finalizing our 2008 capacityplan right now, so I'm not going to quote a final DC-9 fleet count number for2008 on the call. But it will be smaller than the 103 that we have today.

Bob McAdoo - Avondale Partners

I'm not really worried about the exact number but trying tofigure out, if fuel stays where it is today, is it cut in half, or do you haveone-third gone or 20% gone or just round numbers, what order of magnitude arewe talking about?

Doug Steenland

We would still have asizable DC-9 fleet at the conclusion of the 76-seat deliveries.

Bob McAdoo - Avondale Partners

The other thing is, obviously we read a lot aboutfrequencies between the U.S.and China beinglimited and very restricted in terms of the U.S.carriers. What kinds of limits are there for you guys between Japanand China? Whatkind of limits are there in terms of your ability to increase capacity there?

Doug Steenland

It is governed by theChinafrequencies. There's effectively no limit that's imposed upon us as a result ofour Japanoperations, but frequencies that operate between Narita and Chinaare governed by the U.S./China bilateral and come out of our total frequencypool.

Bob McAdoo - Avondale Partners

So to the extent thatyou added Japanto China, itcounts against in terms of U.S.to China?

Doug Steenland

The one exception is,if you recall, the frequency limits basically apply only to the largest citiesin China. TheShanghais, the Beijings, and the Gongjus. Certainly a possibility is there area large number of cities in Chinathat require no frequency to operate to them. Clearly, we would have theability via our Tokyo hub toprovide service to those cities since they don't require any frequencies to beallocated under the U.S./China bilateral.

Bob McAdoo - Avondale Partners

So therefore it isjust a slot limitation in Japanthat causes any limitations there if you wanted to grow?

Doug Steenland

We today operate 757 aircraft out of our Narita hub andthat's what we fly to Gongju, that's what we fly to other cities. Clearly, inthe future an expansion tool available to us in China is to use smaller-gaugedairplanes to fly into secondary cities -- secondary to us -- but cities of 20million, 30 million population that are growing economic centers in China thatcan't quite justify nonstop service to the U.S. but where we can aggregatetraffic in Japan coming from all of our U.S. gateways, then we can clearlycreate a sufficient demand for an airplane to operate into those cities inChina.

Bob McAdoo - Avondale Partners

Do the U.S./Chinesebilateral allow service to those same smaller cities nonstop from the U.S.if you were to use a 787?

Neal Cohen

Yes. But we believethat the most economic way and the attractive way to serve them in the marketwould be via our Narita hub, and we think that as Doug said, that represents avery interesting economic opportunity for us to continue to work to furtherdevelop our position there.

Dave Davis

Just following up on Mike's earlier question, Mike, of the $1.2billion in aircraft CapEx next year, you can estimate, let's say $225 million to$250 million as being a cash number.

Operator

Your next question comes from Gary Chase - Lehman Brothers.

Gary Chase - Lehman Brothers

I don't know how much you've calculated in terms of impactyou suffered in the quarter from some of the operational hangover. I think youthe sized June at about $25 million; July, I don't think I've seen an officialnumber, but $20 million sticks out in my head. Where do you think that was inAugust and September? I am just trying to get a sense of what the real run rateis from what we're seeing in the quarter.

Dave Davis

What we said last time was that we thought June cost us $25million, and that July was a bit less than that. So I think you can use anumber sort of in the $20 million to $25 million range for July. I think it isour assessment that by August, the impact of the operational disruptions waslargely gone. We saw some at the beginning of the month but we really caught uptoward the end.

Gary Chase - Lehman Brothers

I would have thought with August booking forward as much asit does that you would have seen a pretty significant impact through the month.

Dave Davis

In the first week or two of August we saw some fairlysignificant book-away. But then at the back half of August was very strong, andwe seemed to largely catch up.

Gary Chase - Lehman Brothers

So it sounds like it was still a drag and you think it wasgone in September?

Dave Davis

I think ourassessment is by September, there was no impact.

Gary Chase - Lehman Brothers

On the cost side could you talk about what has beenhappening? As we look at the plan that you put out, you appear to be beatingit, obviously, non-fuel costs; but you appear to be beating the non-fuel costson less capacity and you've kind of hit a couple of speed bumps with thecustomer service initiatives and things like that.

Is there anything about the performance we've seen this yearthat we ought to be thinking is unsustainable or is that progress that ought tocarry forward into 2008 and beyond?

Dave Davis

I think generally thecost performance that you've seen from us this year, you can assume it willcarry forward. I think what I said a few minutes ago is that for 2007, weexpect our CASM to be consistent with our business plan CASM -- our total CASMex-fuel, that is -- and I think it is our intention to hit the numbers that yousee in the business plan that we published.

Doug Steenland

I think, also, Gary,as the fleet transition occurs, everybody needs to keep in mind the very lowcompetitive cost structure of our regional carriers as they contribute more ofthe overall consolidated ASMs and departures for the network.

Gary Chase - Lehman Brothers

Is there anything in particular that sticks out as a sourceof upside that you captured from when you formulated the plan to where we aretoday?

Dave Davis

What I think on a go-forwardbasis, as Doug just mentioned, the continued refleeting is a source of upsidefrom where we are today. Some of the potential sources of upside, I think,versus maybe the business plan, we had two wholly-owned regional carriers andwe see ourselves being able it to take some costs out in the combination ofMesaba, Compass and Northwest.

I mentioned earlier that I think we probably see some upsidein the cargo business as well versus what we had in our plan.

Gary Chase - Lehman Brothers

Do you have any sense of what currency impact was in the Atlantic?As well, is there any way to strip out the new service you had and give us acore Atlantic number versus what you reported?

Dave Davis

The currency impactin the Atlantic in the third quarter was really quitesmall. It was a single-digit number. So it really wasn't that substantial inthe currency side. A lot of the movements in the currency had already occurredbefore the third quarter. We also had, on the flip side, some positive currencyimpact in the Pacific.

We did begin to grow in the Atlanticin the third quarter. We operated more capacity as we had both introduced our757 product and took delivery of A-330s. So we did have some, as you would say,green ASMs in the third quarter but in general, we saw pretty strong results.

I don't know that I can break out the pieces but as we goforward, and look at some of that growth, we will try to think about that fornext calls and for next meetings, Gary.

Operator

Your final question comes from Frank Boroch - Bear Stearns.

Frank Boroch - Bear Stearns

Dave, maybe you could give us some more color on theprogression you saw in unit revenue throughout the third quarter? I was tryingto get a better feel for the recovery in the operations.

Dave Davis

I think what we sawduring the third quarter was, as I said in the script, consistent strengtheningto the point that September was our best month year-over-year during thequarter.

I think we talked about here what some of the issues werewith the RASM performance, and the specific Beach issue, as Neil alluded to,we've completed that transition process to A-330s and we were doing that duringthe quarter, so that definitely helped with the performance as we moved throughthe three-month period.

As well, clearly we had the operational disruption issueswere most significant in July, so as those went away in August and September,that improved the performance, also.

Frank Boroch - Bear Stearns

So September was better than even August year over year?

Dave Davis

September was betterthan August and August was better than July.

Frank Boroch - Bear Stearns

On unit costs with all of the change and the build-out ofthe wholly-owned regionals, is there a way you can give us some equivalent inconsolidated CASM ex-fuel for the fourth quarter related to the passengerguidance you gave up to 2.5% to 3.5%?

Dave Davis

I can give that toyou. I don't have it right in front of me though. I can have Brad follow upwith you.

Frank Boroch - Bear Stearns

The run rate for interest expense that we saw in the thirdquarter, is that reasonable to use for the next couple of quarters?

Dave Davis

I'm sorry, could yourepeat that question?

Frank Boroch - Bear Stearns

The interest expenseon the gross amount, we saw about $107 million in the third quarter. Is that areasonable…

Dave Davis

Yes, that's a good number to use going forward.

Operator

Thank you very much.

[End of Financial Analyst Call]

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