Chris Berry - Managing Director of Investor Relations Bradley D. Tilden - Chief Executive Officer, President, Director , Chairman of Management Executive Committee, President of Alaska Airlines, Chief Executive Officer of Horizon Air and Chief Executive Officer of Alaska Airlines Brandon S. Pedersen - Chief Financial Officer, Principal Accounting Officer, Vice President of Finance, Member of Management Executive Committee and Vice President of Finance-Alaska Airlines Inc Andrew Harrison - Member of Management Executive Committee and Vice President of Planning & Revenue Management for Alaska Airlines, Inc. Benito Minicucci - Member of Management Executive Committee, Chief Operating Officer of Alaska Airlines and Executive Vice President of Operations for Alaska Airlines Joseph A. Sprague - Vice President of Air Cargo and Member of Management Executive Committee Mark Eliasen - Vice President of Finance

Hunter K. Keay - Wolfe Research, LLC Savanthi Syth - Raymond James & Associates, Inc., Research Division Jamie N. Baker - JP Morgan Chase & Co, Research Division Helane R. Becker - Cowen Securities LLC, Research Division Michael Linenberg - Deutsche Bank AG, Research Division Duane Pfennigwerth - Evercore Partners Inc., Research Division John D. Godyn - Morgan Stanley, Research Division David E. Fintzen - Barclays Capital, Research Division Stephen O'Hara - Sidoti & Company, LLC Daniel McKenzie - The Buckingham Research Group Incorporated Glenn D. Engel - BofA Merrill Lynch, Research Division

Good morning. My name is Megan, and I will be your conference operator today. At this time, I would like to welcome everyone to the Alaska Air Group's Second Quarter 2013 Earnings Conference Call. Today's call is being recorded and will be accessible for future playback at www.alaskaair.com. [Operator Instructions] Thank you. I would now like to turn the call over to Alaska Air Group's Managing Director of Investor Relations, Chris Berry.

Thanks, Megan. Good morning, everyone, and thank you for joining us for Alaska Air Group's Second Quarter 2013 Earnings Call. I know it's been just a couple of weeks since we spoke to you last, so today's prepared remarks will be a bit briefer than usual. On the call today, Brad Tilden, our CEO; and Brandon Pedersen, our CFO, will provide some highlights from the quarter and our outlook for the third quarter and the full year. Several members of our senior management team are also here to help answer your questions. As usual, today's comments will include forward-looking statements regarding our future expectations, which may differ significantly from actual results. Information on risk factors that could affect our business can be found in our SEC filings available on our website. We will refer often to certain non-GAAP financial measures, such as adjusted earnings or unit costs, excluding fuel. And we have provided a reconciliation between the most directly comparable GAAP and non-GAAP measures in our earnings release. This morning, Alaska Air Group reported a second quarter GAAP profit of $104 million. Excluding the impact of mark-to-market adjustments related to our fuel hedge portfolio, Air Group reported an adjusted net income of $105 million or $1.47 per share. This compares to a first call mean estimate of $1.51 per share, and to last year's adjusted net income of $111 million or $1.53 per share. Additional information about cost expectations, our capacity plans, fuel hedging, capital expenditures and other items can be found in our investor update included in our Form 8-K issued this morning and available on our website at alaskaair.com. And now, I'll turn the call over to Brad.

Thanks, Chris, and good morning, everybody. It's good to be talking with you again. Things are tracking along really well at Alaska as we had a solid second quarter. We reported adjusted earnings of $105 million or $1.47 per share, as Chris said, and that represented a 13.5% pre-tax profit margin. This was our 17th consecutive quarterly profit. We continue to produce very solid cash flows from operations and industry-leading returns on invested capital. We have a long record of quarterly profits and our belief in the sustainability of these profits provided the foundation for our announcement 2 weeks ago that we will begin paying a quarterly dividend of $0.20 per share on August 22. This dividend represents a yield of 1.3%, and it's an affirmation of our commitment to providing shareholders with appropriate returns. The dividend is in addition to our $250 million share repurchase program. Our adjusted profit fell from last year by $6 million due to the negative impact on unit revenues from some additional capacity in our markets. Our capacity increased 7.5% this quarter while total revenues increased 3%. Much of the unit revenue shortfall came in the State of Alaska where, over the years, we've seen airlines and flights come and go. Given the importance of the state, we obviously plan to staunchly defend our turf there. And given industry dynamics, with respect to supply and demand which are generally quite positive, we expect this capacity to normalize in the years ahead. We also have additional capacity in some of our North-South markets on the West Coast and, again, given the industry's more rational approach to supply and demand, we're optimistic that this will stabilize as we move forward. Our profit was also impacted by several unusual items that Brand -- on the cost side…

Thanks, Brad, and good morning, everybody. As Chris said, Air Group reported an adjusted net profit of $105 million, down slightly from the $111 million profit last year. However, our trailing 12-month after tax return on invested capital improved to 13%, up from 12.3% at the end of the second quarter last year. On an adjusted pre-tax basis, we earned $170 million for the quarter compared to $179 million last year. The $9 million decline was the product of a $42 million increase in revenue, offset by a $45 million increase in nonfuel costs and an $8 million increase in economic fuel costs. Revenues increased only 3% even though capacity increased 7.6%. PRASM declined 3.8%, largely on the well-advertised increase in competitive capacity in long-haul Alaska flying, which represented about 12% of our ASMs. Yield fell 10% in those markets. System PRASM was also pressured by the 43% increase in transcon capacity in markets such as Seattle, Philadelphia and Seattle -- or excuse me, San Diego, Boston. These new markets have longer than average trip lengths and are still in the development stage. Many of the factors that caused the second quarter unit revenues to be negative will still exist in the third. As a result, we expect unit revenues to decline again in Q3 on a year-over-year basis, although at a rate less than the 3.8% decline in Q2. I do want to quickly elaborate on the modified Bank of America affinity card deal. We'll be required to apply some new accounting that is complex and we expect to record a very large one-time favorable revenue item, perhaps in the neighborhood of $150 million to $200 million in the third quarter that we're planning to call out as special. We're also finalizing our estimate of how much of the…

[Operator Instructions] And your first question comes from the line of Hunter Keay with Wolfe Research.

Let's talk about your codeshare. As much as you can, I'm curious to know what the -- how the decision-making process kind of unfolded. And when you announced service from Portland to DFW in Atlanta, when you make a decision like that, do you do it with the intention of sort of how can we be complementary to our existing codeshare partners into their fortress hubs? Or is it more just simply a matter of, we think we can make money on this, and if we happen to have a codeshare benefit down the line, then that's great. So how do you think about those specific routes to use? Maybe we can extrapolate how to think about that for future decisions like this.

Hunter, it's Andrew. A couple of things, we look at our network and we make decisions about it like a Portland, Dallas as it stands alone on that route. I cannot -- don't have discussions with any partner prior to making those decisions. Once we've made those decisions, we then go and talk to our partners to see if they would like to participate where we think it might be mutually beneficial. The big thing with American, as you know, is adjustments to their scope language has allowed us to, with confidence, look at additional markets that before, we knew full well, they weren't going to be able to work with us on. So big picture we look at, is it complementary to our network? Is it going to help build our hubs on the West Coast? Is it going to help us, our partners, and overall, mostly our customers? And if the answers to those are yes, and it's economically healthy for us, then we'll go do it.

And how does it work with the codeshare? I mean, you start flying and then the code goes on the flight? I mean, when can you start talking about that process with the partners?

We will publicly announce a flight, get it in the schedule, start selling it and then go ask for code.

Okay, great. Another question for you, maybe a little bit obscure, but the $50 million benefit from the bag and change fees. First, I'm curious with the breakdown as between bag and change, and also have you guys done any analysis or any work on the associated fuel savings? Because we think it can be material, not just for you guys but bag fees in general, in terms of the weight savings that you get. And I realize that some people just pack heavier on carry-ons, but have you done any analysis as part of that $50 million for sort of unintended cost savings from those things, or is that just a revenue number?

Hunter, just on the fuel savings, what I can tell you, ever since the industry started charging for bags, we've seen a considerable number of lesser checked bags below a significant amount, 30% to 40% less. What I can tell you is. upstairs when you fly, we have a very intricate process to manage carry-ons like we've never had before. Every space in the bin and under seat is taken up, so when I look at payloads, for example, on our flights, payloads are pretty much the same as they were before. In fact, we've had to increase the ratio of a passenger and a carry-on upstairs relative to the total payload of the airplane, so I'm not sure it's that significant.

And how does it split? For your modeling purposes, I'd say, $35 million for bag and $15 million for the change.

Your next question comes from the line of Savi Syth with Raymond James. Savanthi Syth - Raymond James & Associates, Inc., Research Division: On your last call, the update call, you mentioned having opened 19 markets and 16 markets over the last 2 years, and then that maybe you're slowing down that opening as we move forward. Just wondering what drove the number of new markets over the last couple of years, and why -- what's the thinking about slowing down going forward here?

Savi, it's Andrew. As you've seen, I think for the last -- in fact, in the last 3 years, we've started 30 new markets. And you'll see a lot of them at transcon and midcon and, obviously, a lot of Hawaii filling in capacity that was no longer there. I think in the second quarter, we have 21 new markets that we -- are in our unit revenues this quarter, if you go back to the beginning of the second quarter of last year. Going forward, you're going to see that significantly come down. We're going to get about 2 new airplanes next year. That's about 6% growth, give or take. And we may not start any new markets next year. We are going to digest and do better things with what we have. I will tell you, on the Hawaii front for instance, we've seen unit revenues stabilize. In fact, Hawaii now is in positive unit revenue situation and, in fact, in the third and fourth quarter, we continue to reduce capacity while not having exited 1 single market since we started this journey in 2007. So in short, we feel very confident about our new markets, the upside that is continuing to occur and more of a dialing back of new market growth over the next 12-or-so months.

Savi, it's Brad, and I'll just jump on there a little bit. I think if you look at -- and I think the analysts that follow us like you know this, but if you look at us over a longer time period, Alaska has been really contrary. And if you go back to 9/11, that was when a lot of the industry was contracting. That was the opportunity we found to supply to New York and Washington, D.C., and Boston and the East Coast. 2008 and 2009 is when we had another recession, [indiscernible] and Aloha had pulled out of Hawaii, that was the moment this company chose to sort of open up our growth into Hawaii. If you -- and those were -- in Hawaii, as you know, we've put in maybe 22% of our -- the flying we have today. Those 2 regions together are 40% of the flying for Alaska. So I kind of think this notion of not pushing it when it's not there, but going forward in a big way when the opportunities are there has really served the company and our owners well, and that's how we're thinking. And so right now, we've done terrific with Hawaii. Andrew and his team have done some great adjustments to sort of refine Hawaii and get it working better. But we don't have to push something that's not evident to us that it's going to work out of the gate. So that's maybe sort of a longer-term perspective of how we think about capacity growth. Savanthi Syth - Raymond James & Associates, Inc., Research Division: Yes, that makes sense. Just one follow-up then on just you're moving to Q400s in the State of Alaska. Just wondering what the potential cost savings or positive impact to earnings could be from that change in fleet?

So Savi right now, as you know, we're putting about 3 planes up there, which is small in the scheme of Air Group. That said, getting the right airplane in the right markets, the cost per departure for the routes we're going to fly is down 30%, and we will accommodate all the same passengers. So our plan is to continue to work this and grow this, so I think in short, this will be very positive for Alaska Air Group as we continue to grow. And we are also doing this by increasing frequency. So I think it's a win-win for customers, lower air fares, lower operating costs, right airplane in the right market, and we can redeploy mainline, I mean, the growth markets and not have to maybe buy another airplane or so as we do that.

Your next question comes from the line of Jamie Baker with JPMorgan. Jamie N. Baker - JP Morgan Chase & Co, Research Division: I don't normally ask a lot of RASM questions on these calls, but in fairness to every other cylinder in the Alaska engine seems to be firing with the exception of that one. I guess, I'll leave it to you whether you describe your operations as a V8 or a V12, or maybe a V6 with Ecoboost. But you cited better RASM in the third quarter than in the second. That's consistent with what other carriers are saying. Is it simply an improved -- is it a rising tide phenomenon or are there some specific shifts in the markets where competitive dynamics have proved more aggressive?

Jamie, we like to think of ourselves as V12s but that may not be the reality. Anyway, that's coming from the 3% carrier here. So what I would say is that, as Brandon has mentioned, unit revenues in Alaska long-haul were down and our yield was down 10%, so competitive pressure there to be certain. We also had 13% unit revenue increase last year in Alaska because there was something like 3,000 military during this period who came back into the state with their families, so we had very strong unit revenues last year. The unit -- the competition going forward, there's 7.5 extra flights this summer. By November, there will only be one. So we see that abating significantly. But I think the core of your question is that I personally believe we are going to see continued material improvement in the many, many new markets that we've started that right now, the industry just doesn't have. And so the challenge for my team and our team is to get those markets matured, and we'll be way back on par with the industry, I believe, sooner rather than later. Jamie N. Baker - JP Morgan Chase & Co, Research Division: Okay, that's helpful. And the second, just a question on consolidation. If you were to ever look at another airline, what would be on the shortlist in assessing the attractiveness of the dance partner? And look, I'm setting aside, okay, it needs to be accretive. You're going to be what's in the best interest of shareholders and all that. But I'm just thinking kind of size and shape, would you rather look at a larger carrier or a smaller one than Alaska? Would you want to look at one that's already in an alliance or, all else equal, an unaligned carrier? One with a modern fleet or perhaps one where you could do the refleeting and create some value? Just wondering what might make that attractive dance partner, if ever, was to sashay past you.

There are a lot of folks smiling around the table. We're wondering how we're going to handle this question. Jamie N. Baker - JP Morgan Chase & Co, Research Division: Look, in fairness, I'm deliberately asking it this way because I don't want to name names, and I don't want to put you in a position where you think I'm trying to extract a name that you might be attracted to.

I think it's a good question. It's obviously one that we're probably not going to talk a lot about. The -- I mean, what we would say is that this company is very focused on producing returns on invested capital, and that's what we want to do. We want to be known for kind of building a great business that's safe, that operates well, that does good things for customer, brings them value and kind of helping the industry move to a place where we begin to produce honest to gosh returns on invested capital for owners. So that would be a big factor in anything that we might ever look at. It's not -- this is -- isn't an area where we'd never say never. The company did 2 acquisitions in the mid-to-late '80s, an important part of who the company is today, this is Jet America and Horizon Air. But I think by our actions over the last -- what is that? 10, 30 years, or something like that, it's -- you can see that we haven't seen anything that quite meets our criteria. So it's a good question, probably not one that we can provide a lot of detail on, but I think I have shared with you what we -- what our primary objectives are and where our primary focus is.

Your next question comes from the line of Helane Becker with Cowen Securities.

I think -- I have phone issues so I think one of the questions might have been answered. On the Q400s, did you say what you're going to do with the cargo [indiscernible] between the markets that they're going to fly?

Helane, this is Andrew. Did you just say cargo in the markets?

Yes, because I think the -- right, I think the issue with having the larger planes was to handle the cargo, so you're going to smaller planes. So I didn't hear if you responded to that question.

Right. So where we're putting them mainly obviously Anchorage, Fairbanks where we still have mainline metal [ph]. I will tell you cargo has been front and center of the overall Q4 analysis going forward and how we can grow. And we also -- the Q400, has also seasonal bins that can add 800 pounds worth of baggage and cargo baggage that we're looking at. So we feel very good about increasing the cargo capacity of the Q400 going forward while utilizing the mainline fleet, our freighters and our mainline frequency. So it is a little bit of challenge, but we think we have a path to making that successful.

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

Just a few here. I want to go back to the seating reconfiguration, where I think you get the benefit of like a 2% CASM across the fleet. When -- and the $47 million on the revenue, when is that completed? How does that phase in? Like do we see that by the end of this year? Is that 2014? What's the timing on that?

Mike, it's Ben. We begin the reconfigurations this fall and they'll run to the end of 2015, '14 -- sorry, 2014. So it will take this almost 18 months to get through the fleet. Two lines of mods working, and we're pretty excited about where we're going to be at the end of that.

And Mike we'll have half of them done before the summer and we think we're going to get about 27 million plus dollars of benefit in 2014. And then, at the run rate, you've heard Brandon say $47 million. So we're going to be halfway done before summer and selling those this coming summer in 2014.

Okay, great. And then just my second question, I want to go back to the point, I think, Brad, you mentioned about airport costs going from 5% to 10%. And I guess the question is, I mean, what's going on here? I mean, are we seeing airports exercise their ability to monopoly price, or is there just other areas of cost inflation? Maybe they're just not being -- they're just not running these businesses like they should, or maybe they're not being run like businesses? And I would say that when you think about a big cost for an airport, financing cost is a big chunk, but when you look at what they're financing at -- what their financing rates are today and what they've been over the last few years versus 10 or 15 years ago, it seems like that those numbers have come down significantly. So what's going on here?

Mike, it's Ben. I'll be really honest. We learned a lot about airports and where costs get created in the airport world. And essentially, there's 2 big areas. One is how much money they borrow to build big capital projects, and the second is their own internal cost. And so it varies airport by airport. But when they build terminals and add runways, somebody has to pay for it and it ends up on the backs of the airlines. So part of what you're seeing costs go up is infrastructure being put in. And in Sea-Tac, we saw the third runway, we're looking at expansions and a new international FIS. We're looking at improvements on our side. So all these capital costs plus what they spent in the past are coming to catch up at least with us at Sea-Tac. And that's part of the problem. Now we've learned a lot. So I mean there's a bunch of other elements in the lease that can benefit us, and we've worked hard with the Port of Seattle. And I think we have -- our costs are going up. There was no way to get around it because of the capital spending that was done and what's going to happen. But we have a lease structure that has some provisions that protect the airlines going forward, and it's our problem [ph]. We've got to make it work and we're pretty happy with, like Brad said, we're happy with the team and the lease we have. And with every airport we have, we're going to make sure that we understand the capital projects that are being done and we're going to make sure that we understand their O&M costs, so that we can contain these costs as best as we can.

Your next question comes from the line of Duane Pfennigwerth with Evercore.

I may have missed it. You sounded pretty upbeat about demand improvement on your last call before earnings. What have you said about kind of the demand environment into the third quarter here? And should we be thinking about kind of the same level of pressure on unit revenue near term?

Duane, it's Andrew. I think in Brandon's prepared remarks, we're still expecting unit revenues to be down in the third quarter, but certainly less than what you just saw in the second quarter. And then, September is September obviously, and it's a little ways out. So we're not -- we can't really comment good or bad. But what I can say is that July and August, we continue to see yield improvement as we bring in summer, and the demand is very good for summer. So we feel very good right now about how summer is shaping up.

And then just on your response to the capacity in your markets. I mean I understand you're going to defend your turf, specifically State of Alaska. But as you look across your entire network, has there been anything that you've pulled back on and to what degree has what's occurring made you kind of reconsider the growth rate of the airline longer term?

So most of our pullbacks have been within our own supply and demand world, if you will, so Hawaii, transcon and those sorts of things. Honestly, with the State of Alaska, already in June, I can personally see where we took the yield hits, where the passengers disappeared, which markets work from all over the country. So we're going to be very well-positioned, if this occurs again next summer, to do a much better job. So I think there's only upside from there. The rest of that, you've seen some West Coast actions, but again, we feel really good with our core network running high load factors, and again with the changes to our business, that $150 million of undergirding of our economic model coming forward and all the things we're doing, we're just feeling quite optimistic looking out about our network and the competition we're dealing with.

And then I guess just the longer-term question. Has this series of events caused you to kind of reconsider the growth rate of the airline longer term?

Duane, the only thing we might add to what Andrew has already said is that, one of the phenomenas is that we are dealing with right now is I think Hawaii is getting kind of built out in terms of what we're -- the capacity we're capable of putting in Hawaii. If you look at the Pacific -- the Anchorage, Bellingham, Seattle, Portland, Hawaii is fully served and California, I think it's the needs, the market needs, are largely satisfied. So that has been a big growth driver for this company for 5 years now. And so not having the Hawaii opportunity probably says growth is going to be a little bit slower in the next couple of years than it has been in the last 3 or 4 years. And as we kind of said in response to an earlier question, I think we just kind of keep our head down, keep focusing on being safe and running a good operation, a compelling proposition for customers and low-cost and more opportunities will come our way. When they do, we'll pounce on them. But for now, maybe not for the near term, the next 1, 2, 3 years, maybe not the same level of opportunity that we saw in the last couple of years.

And I'll just sneak one more in. I mean, to the extent that you're done with deleveraging in '14, does the initial dividend that you've put forth -- I mean, should we view that as a starting position or did that already contemplate you sort of being done with paying down debt?

It's Brandon. We said 2 weeks ago that we wanted to first, do a dividend, and we're almost there a couple weeks now until we make the payment, but we said that we had an interest in growing the dividend on some regular basis. And we want to design our business in a way that we can do that. You're right, we are getting to a point where we're probably done deleveraging and that further positions us to change our capital allocation strategy and return more to shareholders, whether it be through repurchase or dividend, that's our option.

Your next question comes from the line of John Godyn with Morgan Stanley.

I wanted to also follow-up on this idea of fewer new routes next year. I don't think the stretch to imagine that, the more mature markets operate at significantly higher profitability. It sounds like simplistically holding macro constant, fuel, interest rates, we should be expecting a nice bump in margins in 2014 just based on that factor alone. Is that the right framework? Is that logical? Or am I missing something?

John, I love the thought process and I would embrace that answer. I think, at the end of the day, you have actually capsulated ultimately the macro plan. There's a lot of things that are outside of our control, obviously, and we're going to work it hard. But on a pure theoretical basis, that would be the direction that I think we would like to head with this.

Okay, excellent. And then maybe more practical, less theoretical, is there anything you can tell us about what -- how the profitability of an immature route or how the slope might look like a year out or something like that versus a mature route? Is there anything you can help us think about the differential there?

A couple of things I can tell you. And if you take a Fort Lauderdale and a San Diego, Orlando in the second quarter, they both ran about 88%, 89% load factor and we're moving both of those red eyes to primetime daytime flights. And we've seen continuing improvement there and I expect that to accelerate. As far as the new markets goes, what we're seeing is that, especially in the first year, very significant profitability or let's just say moving towards profitability in those first years. So I think by year 2, we should have in many of these markets, good results contributing to the business. And by year 3, those that are not, or even before that, they will be gone.

Okay, great. And just one more follow-up on the topic. I can go and calculate this, but I'm not sure if you have the number sort of available. What percentage of your capacity approximately today is the new routes or that you would consider new?

That's a hard one.

I can probably get back to you on that John.

Even if it's a general number.

You stumped me there. It's depending on what's new, to be honest, and then a number of these new routes are like regional routes, so they're in the scheme of the economics, much smaller.

Yes, we could run it, but all new transcons like a San Diego, Boston or a San Diego, Orlando or a Seattle, Philly, it's 4%, 5%, or 3%, 4%, something like that. But it's an easy number to run, we should do that.

Basically, the ASM growth or another way to look at it is essentially new markets, give or take, so.

Hawaii is actually down, you were telling me for the fourth quarter.

Yes, Hawaii will be down 5.5% in Q3 and 11.5% in Q4.

Your next question comes from the line of David Fintzen with Barclays.

Question, I think for Andrew, if I recall, I think it was you Andrew, a couple of weeks ago you said competitors come and competitors go in the State of Alaska. And I mean, obviously you see sort of Seattle to Anchorage type stuff. I'm curious when you look out beyond the sort of Anchorages of the world, into like the Juneau, into the smaller cities or the intra-Alaska, is there something about airport facilities or the difference in operating in a place like Alaska or operating year-round in Alaska. Are there things that are different that we should be thinking about that would mean sort of if somebody wanted to come trying to replicate something more similar, it would be tougher than say replicating something in a city in the lower 48? I'm just curious how to think about that.

David, this is Joe Sprague from marketing. And I might take that one. It's a great question. I'm not sure if you've been around to some of those other communities or not. It's -- they're pretty unique places, obviously. We serve 19 cities in the State of Alaska with 737s, only 3 of which are actually connected to any sort of road system. So that the -- it's a real sort of unique setup in terms of the way we serve the State of Alaska and the reason we're flying though to those communities is because they are so isolated. They need air service to get just basic goods and services in and out of the community and then just if somebody's got to go to the doctor or the dentist, they pretty much fly us to get into the major city for that service. But as a result, those communities are pretty small. Much smaller than you'd normally see for commercial service in the lower 48 for instance. They don't have facilities. I mean a Juneau, or a Fairbanks would have more of a traditional municipal airport terminal building. But in a lot of the other communities, we are the terminal building. It's an Alaska Airlines building that serves as the sort of the city airport terminal. So that's different. We've also invested a lot in those communities. You mentioned Juneau specifically, that's one that definitely stands out in terms of our investment in the flight operations technology that allows us to effectively serve those communities. So we have the special R&P approaches for Juneau and several other communities in Alaska. And they're not proprietary necessarily, but we're far and ahead of anyone else in terms of being able to operate those kind of approaches. And given the weather and the terrain and so forth, that's a pretty unique advantage that Alaska Airlines has in serving those communities. So it's different and we've spent 80 years sort of perfecting how we serve those communities and we've got improvement yet to make. And that's why you see us doing things like bringing the Q400 to the State of Alaska. But I think overall, we feel good about our position in the State of Alaska. We have Club 49, which helps to reinforce our loyalty with the residents of the State of Alaska. So on the customer front, the operations front and even the facilities front, it's a lot of unique things that we do to set ourselves apart.

And just to quickly follow up. In that sort of next tier down from an Anchorage like a Juneau or a Fairbanks, are there -- it's been a while since I've been to, say, Fairbanks, but I know it didn't seem like it was an airport that was sort of chock full. I mean is that -- is it fair to think that they're fairly full airports, but there's some space if somebody wanted it, or are they -- is it you like you were struggling to find some space particularly as you're ramping up frequency yourself?

I think that just from a facility standpoint, they do not have a lot of extra space. I think we've seen in the case of Fairbanks, in particular, there's been some other airlines that have dipped their toe in the Fairbanks water during the busy summer tourist season and then when the temperature goes below 0, they retreat pretty quickly. So I think if somebody wanted to come, I'm sure the airports would try and find space for them but that's sort of the way the setup has worked.

It's a great question, David. The other thing about the Alaska market is that a lot of those folks do connect. So like Seattle, Anchorage is a huge market for us, but the last number I remember is something like 65% of the customers on that route are connecting on either the Alaska end or the Seattle end. So having this network into the smaller communities in Alaska really helps you make these flights work.

Your next question comes from the line of Steve O'Hara with Sidoti. Stephen O'Hara - Sidoti & Company, LLC: I was wondering in terms of the impact from the seats. I didn't quite catch that. When do you start seeing that impact from the seats and it seems like the ASMs per gallon is up or improving fairly well in the third quarter? Is that part of that or not?

The mod lines start in October, Steve. So it will be 2 airplanes at a time and once we have the prototypes, you'll see them pop out a week at a time. So you'll start seeing airplanes, the extra seats starting in November and then increasing from there. So by the end of '14, Andrew just mentioned by the summer, we'll have half our fleet reconfigured and then the rest will be by the end of '14. Just to give you a sense. Stephen O'Hara - Sidoti & Company, LLC: Okay. And then what's the -- I think you'd mentioned the x-fuel impact. What's the CASM impact? I mean is some of that offset by weight and depreciation, or what's the full CASM impact?

Steve, it's Brandon. On the CASM impact, it's basically the same as the CASM x-fuel impact. Brad used the number, 2.5% on a fleet wide basis, about 3.3%, 3.5% on the airplanes that are being modified. You do get some incremental passenger related costs when you fill the extra seats. There is the depreciation as you point out. You have a little bit of weight on the fuel. But in the grand scheme of things as you think about those costs in relation to the $47 million of annual benefit that we're going to see once we get the thing fully implemented, it's really, really small. And so I think those are probably fair percentages to apply on a CASM basis or a CASM x fuel basis. Stephen O'Hara - Sidoti & Company, LLC: Okay. And then just as a follow-up on the Q400s, I mean do you see other opportunities for that type of move in other areas? I mean is there any desire to maybe increase the size of that fleet for that reason?

Steve, for start, in the State of Alaska, we absolutely see more opportunities. And for now, we are very, very happy with the lower 48 deployment. If you look at our unit revenues in our regional business, you'll see the very impressive increases year-over-year and has been. And for now, we're looking at the State of Alaska and how we can maximize the use of these Q400s. And as the Alaska fleet gauge increases, the 400s and the 700s leave, the ERs come in, we need the Q400s to help feed these markets out of the Pacific Northwest and we'll use them for that.

It's Brandon. One other thing I might add to that as we think about long-term Alaska fleet plan, we have a specific need in that we have to replace the 5 737-400 combi aircraft that we operate. That's slated to happen in a few years. But ultimately, the Q400 might be a very important part of that solution because those combi airplanes fly into some of the smaller markets in the State of Alaska.

Your next question comes from the line of Dan McKenzie with Buckingham Research.

A couple of questions here. I guess the first is really housecleaning, very simple. The Recaro seats, are those -- is that going to be expensed or capitalized?

Dan, it's Brandon. Welcome back. The Recaro seats will be capitalized.

Got it, okay. And then second here, you guys have all done a great job of keeping your codeshare partners happy. But as Delta continues to expand out of Seattle, looks like it's increasingly bumping up against one world. So I guess, it looks like there could be a little friction. From your perspective, what's the trick to keeping both partners happy longer term? And what do you -- do you think you can keep them happy longer-term? And I guess what I'm really getting at here is does it possibly require further investment at Seattle to perhaps bring even more value to both members?

Yes, Dan this is Brad. As Brandon said, welcome back, it's good to have you covering us again. I think absolutely. I think both partners, both Delta and American, understand our strategy of having alliance relationships with both Delta and American, and both are okay with that. I do think that these alliances are complicated and that once in a while, there are little skirmishes, or little frictions that arise. What you need to have is a couple of things. One, you need to have a relationship where you sit down and you talk and you understand each other's needs and you work them out. And you also need to have a natural reason for the relationship to exist. And we have that with both American and Delta. If you take Delta as an example. They really want to grow international widebody flights out of Seattle and they've gone from 4 or 5 widebodies a few years ago. I think they announced Seattle, Heathrow this week and they're at 10 today maybe going to 11 or something like that. So anyway, so there's -- and that's a relationship where we do have natural opportunity to help Delta and I think helping Delta will help Alaska as well. So I don't see any -- I think it's a good strategy for Alaska Air Group to be -- to have deep relationships with both American and Delta. And I think that we're going to have to pay attention to this over time and make sure that we're doing things that are kind of supporting both folks and helping us grow the revenue pie. And that's going to take some work. But I'm confident that we're going to get the work done and that this is going to work out and this is a good, stable long-term strategy for us.

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

Questions on fuel. When I look at your hedge book, I guess 2 things stand out to me. One, your WTI hedges, which looked dumb earlier in the year now look brilliant. And I don't really seem to see that in your fuel guidance. Given at $101, I would have thought you'd see a bigger drop. And two, your refining crack spreads at $0.52 third quarter look relatively high and I want to know when those stop hurting you?

Glenn, this is Mark Eliasen. And your observation, we have changed our hedging program over the last few years actually, and we're confident in the long term, like you said. Some months it looks bad, some months it looks brilliant, but over the long term, it served us very well. In terms of specifics, yes, we are starting to get in the money with the WTI hedges that we had in place. Those are performing just as expected. And on the crack side, we're benefiting actually the airline is benefiting a lot from LA jet prices coming down. So that's working the way we would expect it to as well [ph].

But you're using the $106 average Brent for the -- or fuel for the third quarter and yet half of your hedges are at $101, so I'm curious why you use such a high number for your jet fuel for the third quarter?

Yes, well the -- say that again?

I thought you're 50% hedged at $101 WTI in the third quarter, and yet implicit in your third quarter estimates that the update says you're using $106 per barrel to get to the $325 forecast.

Yes. We got $0.08 basically in as hedge cost. So the hedges are benefiting us somewhat.

That $106, Glenn -- this is Chris, that $106 in the guidance on the fuel, that's a raw WTI. And then we split out that the hedge benefit or costs separately. So that when you see what our guidance is, when we break out the components, it's always the raw cost and then we put the hedge in sort of that separate $0.08 cost for the quarter.

And I guess that still seems somewhat surprising to me given that at $101, you would think that the benefits of the hedge would be now more than offsetting the cost.

Yes, they're in the money, but they're not totally offsetting it.

So what's going on? Is there a benefit from the crude oil hedge in the cost of the refining hedge?

Yes, there is a benefit in the crude oil but it's not totally offsetting the cost.

The cost of the refining hedge?

Yes. And the refining hedges...

And the refining hedges hurt you how long? How much longer?

We just go out one quarter with those. So those are working their way through very rapidly.

And while you said that third quarter Alaska -- this is on the revenue side, the third quarter PRASM on Alaska should I guess hopefully get better in the fourth quarter the impact is as the capacity comes out. Does the Seattle markets that you're seeing pressure on, do those get worse in the fourth quarter when you start moving in the off-peak?

As you know, we're always a little seasonal here. But we believe we've taken action to implement new, never been done before by us cuts. A decent part of our capacity in transcon and Hawaii as we move into the fourth quarter, that should help us going forward. I can't comment on what unit revenues are going to be in the fourth quarter, but we have actions that we've put in place for the fourth quarter that we didn't have last year, and I think they're going to be good.

But your full year capacity really hasn't changed much with those cuts?

Glenn, it's Brandon. It came down a little bit, if you look at our annual guidance on a consolidated basis I think it came down from 7.5 to 7 or so.

There are no further questions at this time. I'll turn the call back over to the presenters.

Thanks, Megan. Thanks, everybody for being on the call this morning and we look forward to talking with you next quarter.

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