Alaska Air Group Q3 2022 Earnings Call Transcript

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October 20, 2022

Key Takeaways

  • Air Group reported record Q3 revenue of $2.8 billion and an adjusted net income of $325 million, delivering a 15.6% pretax margin—within two points of its 2019 level despite high fuel prices.
  • The airline led the industry in operational reliability with a 99%+ completion rate and #1 DOT on-time performance from June through September, while guest satisfaction exceeded targets.
  • Alaska is accelerating its single-fleet transition, retiring all A320s and Q400s by January 2023 and growing its fuel-efficient MAX fleet from 35 to 78 aircraft by year-end 2023, targeting $75 million in annual savings.
  • The company ratified three major labor contracts—including its mainline pilot group—becoming the first major U.S. carrier to secure a new pilot agreement, which supports stability and future growth.
  • For Q4, Alaska expects revenue up 12%–15% versus 2019 on capacity down 7%–10% (implying ~24% unit revenue growth), and it maintains a full-year adjusted pretax margin guide of 6%–9%, with further cost reductions and margin gains anticipated in 2023.
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Earnings Conference Call
Alaska Air Group Q3 2022
00:00 / 00:00

There are 16 speakers on the call.

Operator

Ladies and gentlemen, and welcome to the Alaska Air Group 2022 Third Quarter Earnings Call. Today's call is being recorded and will be accessible for future playback at alaskaair.com. After our speakers' remarks, we will conduct a question and answer session for our analysts. I would now like to turn the call over to Alaska Air Group's Vice President of Finance, Emily Halverson.

Speaker 1

Thank you, operator, and good morning. Thank you for joining us for our Q3 2022 earnings call. This morning, we issued our earnings release, which is available at investor. Alaskaair.com. On today's call, you'll hear updates from Ben, Andrew and Shane.

Speaker 1

Several others of our management team are also on the line to answer your questions during the Q and A portion of the call. This morning, Air Group reported 3rd quarter GAAP net income of $40,000,000 Excluding special items and mark To market fuel hedge adjustments, Air Group reported adjusted net income of $325,000,000 As a reminder, our comments today will include forward looking statements about future performance, which may differ materially from our actual results. Information on risk factors that could affect our business can be found in our SEC filings. We'll also refer to certain non GAAP financial measures such as adjusted earnings and unit costs excluding fuel. And as usual, we have provided a reconciliation between the most and we will be conducting a replay

Speaker 2

of the comparable GAAP and non GAAP measures in today's

Speaker 1

earnings release. Over to you, Ben.

Speaker 3

Thanks, Emily, and good morning, everyone. Today, we released our Q3 results, closing out the busiest travel period since the pandemic began. Demand was resilient, planes were full, Our people were busy and our results were strong. Our 15.6% pretax margin is likely to top the industry and came within 2 points of our 2019 margin despite the impact of exceptionally high fuel prices and multiple new labor contracts. We ran the best operation this summer, leading the industry with the number one DOT on time performance from June through September.

Speaker 3

Our $2,800,000,000 in revenue marked the highest quarterly revenue ever recorded in our history. Our unit revenue was up 27% 2019, which we also believe is best in the industry and underscores that our commercial initiatives are delivering. And last but not least, we ratified 3 major labor contracts becoming the 1st major airline to reach a deal with our mainline pilot group. Our leadership team has been very deliberate about our priorities this year and setting ourselves up for continued success. We are seeing results as we focus on moving rapidly to a single fleet, delivering operational excellence, securing labor contracts and configuring our business for profitable growth.

Speaker 3

Our financial results are strong and our underlying business model is resilient. To put it simply, we are poised to continue to outperform and are excited about what the future holds. Now let me give you a quick update on our top priorities. Our fleet transition is progressing well and we are closing in on getting back to a single fleet. All A320 and Q400 aircraft will be out of the fleet by January of 2023 and the 10 A321s will follow by the end of 2023.

Speaker 3

Today, we have 35 MAX aircraft that are 25% more fuel efficient per seat and the smaller A320s they are replacing. We expect to have 78 MAX aircraft by end of next year, representing over 30% of our mainline fleet. As we focus on reconfiguring our business back to a single fleet, Transition training for nearly 500 of our pilots will continue through May of next year, after which we expect to begin to ramp toward the $75,000,000 single fleet savings we outlined at Investor Day. Our operation is also back on track. This summer, we returned to delivering a reliable operation with a completion rate over 99% each month of the quarter despite flying record high load factors throughout the summer.

Speaker 3

Horizon has also posted fantastic operating results with the number one completion rate in the industry at 99.5%. And importantly, our guests have noticed with our guest satisfaction score improving and exceeding our target for the quarter. We locked in 3 major labor deals, a huge milestone for us that has been a primary focus of ours for several months. Following the ratification of a contract extension with I'm in September, We are excited to have reached ratified deals with both our Horizon and Alaska pilots as well. Securing a new contract with our Horizon pilots provides us a Strong foundation for our efforts in attracting, retaining and building a robust pilot pipeline.

Speaker 3

Also Monday of this week, Our Alaska mainline pilots represented by ALPA ratified a new 3 year agreement that recognizes their contributions to our success and the market for pilots in the industry. We are excited for the stability and alignment this brings our organization and and we'll prioritize getting our upcoming labor agreements done as well. We have a lot to be positive about here at Air Group. We are delivering on our goals and demand remains strong. We also realize there are challenges our industry is facing, including an uncertain economic backdrop and a structural step up in wages.

Speaker 3

Going forward, we are uniquely positioned to offset this pressure by leveraging initiatives we already have in place. One of the most impactful will be harnessing the structural efficiencies that come with our return to single fleet, a tailwind that will be unique to Alaska. This includes increasing productivity as we eliminate cross training events, more efficient scheduling by moving to our preferential bidding system for our mainline pilots and cost effective growth through up gauging. We are not immune to the challenges of the industry, but remain committed to keeping our cost advantage relative to our competitors as we move forward. We are fortunate to be on solid footing as we look to finish out the year and build on our performance into 2023.

Speaker 3

Our priorities not only this year, but throughout the pandemic have centered on preparing our airline for profitable growth and we have taken strategic steps to bolster our competitive advantages. As these initiatives continue to fully ramp up, they will support our results both in the near and long term. Near term, this is already evident in our unit revenue outperformance and the fact that we are still tracking to deliver a 6% to 9% Full year adjusted pre tax margin unchanged despite now including the impact from our new labor deals. And longer term, the foundational strength of our balance sheet coupled with our commercial roadmap and commitment to operational excellence will continue to support strong Financial performance. To close, I am excited to see all of our hard work begin to come to fruition and for the opportunity that we have ahead of us over the coming quarters years.

Speaker 3

Lastly, before I hand things over to Andrew, I want to thank all of our Air Group employees for a great summer and everything that they do. Running a safe, reliable operation is critical to our success on all fronts and serving our guests, connecting our communities and delivering on our financial performance. And our success would not be possible without their tremendous effort and the care they continue to show day in and day out. And with that, I'll turn it over to Andrew.

Speaker 4

Well, thanks, Ben, and good morning, everyone. My comments today will focus primarily on our 3rd quarter results along with Q4 guidance. In the Q3, we achieved our highest recorded revenue in our history, $2,800,000,000 This revenue performance, up 18% versus 2019 on 7% less capacity, resulted in very strong unit revenue performance. Unit revenues were up 27% versus 2019, A sequential improvement versus an already exceptional second quarter despite yields having peaked from the levels seen back in June July. Load factors also remain strong, exceeding 2019 levels every month of the quarter and coming in at 86.5% for the full quarter.

Speaker 4

Our network and revenue teams did a fantastic job partnering together to maximize revenue performance, which was also fueled by revenues generated from the commercial team's initiative. These factors, coupled with capacity constraints Across the industry during a period of elevated demand has translated into a strong pricing environment. Moving to product categories. Our premium products continue to show strength as they have all year. 1st class and premium class revenue were both up approximately 28% versus 2019.

Speaker 4

Paid load factors continue to exceed 2019 levels with 1st class up 4 points and premium class up 9 points, both on higher average fares. The strong cash flow generation from our loyalty program has also continued throughout the year. Cash remuneration from the bank was up 37% versus the Q3 of 2019. While total loyalty revenues finished the quarter, up 34% year over 3. Recently voted the number one best airline rewards program by U.

Speaker 4

S. News and World Report. We believe our credit card and our loyalty program offer exceptional value to our guests and are a continued source of growth for our business. These strong results are included in our product and loyalty initiatives this year. We are tracking ahead of plan and are set to recognize approximately $135,000,000 in incremental revenue on our long term goal of of $195,000,000 This initiative is one of the key reasons for our unit revenue outperformance.

Speaker 4

Turning to corporate travel trends. After taking a step up earlier this year, business travel volumes have remained around 75% to 80% covered from 2019 levels, while revenue is approximately 10 points better than this given the yield environment. Notwithstanding a slower recovery of corporate demand across the West Coast, we believe our business recovery is in line with the majors, underscoring the improved business offering we have versus pre COVID. Additionally, while some of our corporate partners have been slower to return to travel, We believe we are benefiting from employees at these companies taking more personal and hybrid travel as they move around and work remotely. I fully expect that we can restore 100 percent of business revenue.

Speaker 4

Year to date, we've improved our share levels through our corporate distribution channels because of the increased opportunities we have from working with Amex, GBT and joint contracting with American. And finally, our OneWorld and international partnerships have continued their positive momentum from what we shared last quarter, sustaining a high single digit contribution to our total coupon revenue for the quarter. As we sit today, international and business travel have not fully recovered, which we believe only offers more revenue upside from these partnerships. It will take a few more quarters to get a more complete sense for the impact, but there is no doubt that the strength of these partnerships is real and that this is an accretive revenue source for our business going forward. Looking ahead to guidance for the Q4, we expect total revenue to be up 12% to 15% on capacity that is down 7% to 10% versus 2019.

Speaker 4

By a wide margin, our go forward We will be most constrained in the Q4 as we retire 45 aircraft across our mainline and regional fleets by the end of January and execute training events in preparation for 2023 growth starting in the Q1. This guidance implies 4th quarter unit revenue performance of approximately 24% versus 2019. As we look to the Q4, bookings remain healthy as guests continue to book holiday travel. As has been the case throughout the summer, We are booking solidly ahead of 2019 load factors through the end of the year and are on track to fly a record load factor for the Q4. We are currently holding yields at approximately 20% higher versus the Q4 of 2019.

Speaker 4

On the network side, We will continue to focus on deepening the spokes of our system as we fully restore our capacity to 2019 levels by spring and grow from there. As we look at our network, the competitive backdrop is still favorable as the West Coast remains the least recovered with competitive Capacity down over 20% versus 2019. As we move into 2023, we are looking forward to taking more MAX deliveries to upgrade and grow efficiently in some of our strongest and capacity constrained markets such as Seattle. And to wrap up, we remain in a remarkable demand environment and we look forward to closing out a strong year of revenue performance. We've configured our business for incremental improvement and already seeing the benefits from joining OneWorld, our partnership with American and our new credit card deal.

Speaker 4

More importantly, the commercial drivers we have in place are poised to unlock in even greater way as we move into 2023. I look forward to sharing more details during our year end call. Our $400,000,000 of commercial initiatives is proven and tangible, and we will continue to support our revenue performance over the coming quarters years. And with that, I'll pass it over to Shane.

Speaker 5

Thanks, Andrew, and good morning, everyone. Our $325,000,000 adjusted net profit this quarter reflects Both the strong demand backdrop we are experiencing and the strength of Alaska's business model. We are encouraged by the return to operational stability and reliability this quarter and we are also encouraged by the absence of the extreme COVID related volatility that had challenged us for more than 2 years. Our results largely landed within previously guided ranges with no major disruptions causing Significant and unanticipated revisions, which seems like a small thing, but it's actually quite refreshing. Not only did we deliver a very strong quarter operationally and financially, but as Ben mentioned, we ratified 3 key labor deals as well.

Speaker 5

Completing these deals is an important step in ensuring we have contracts that recognize the contributions of our people and also allow us to fully focus on running a great operation, taking care of guests and pursuing our growth and financial performance roadmaps. I'll briefly walk through highlights of our Q3 performance before discussing costs and labor contracts that are incorporated in our results and our 4th quarter guidance. On the back of the continued strong demand We generated $174,000,000 in cash flow from operations during the Q3, bringing our year to date operating cash flow to 1,400,000,000 Total liquidity, inclusive of on hand cash and undrawn lines of credit, remains at

Operator

a healthy

Speaker 5

$3,600,000,000 providing us 2 times the cash we need to run our business and ample funds to pay for our Boeing aircraft deliveries over the next year. Our balance sheet remains strong with debt to cap at 49%. Debt payments during the quarter were approximately $100,000,000 and Maining payments for the year are $50,000,000 And as you know, shareholder restrictions associated with our CARES funding also officially rolled off at the end of September. With our strong operational and financial performance and solid balance sheet, we look forward to discussing potential shareholder returns with our Board next month. Turning to costs, CASM ex increased 19.3% in the Q3 versus 2019, 30 basis points above our guidance range.

Speaker 5

As a reminder, our practice is not to include new contract impacts in our guidance until ratified. Our new labor agreements added $35,000,000 of costs that were not in our original guidance and excluding these, our CASM ex would have been up 16.8%, which would have been below the midpoint of our guidance range. Other transient cost drivers in the quarter include $30,000,000 associated with issuing each of our employees 90,000 Mileage Plan Miles in recognition of all of their extraordinary work during the pandemic and our 90th anniversary as an airline. And approximately $15,000,000 in costs associated with carrying higher staffing compliments relative to our flying that we believe we'll need in the future. These two items represent a 3 point impact to CASMx in the quarter.

Speaker 5

Turning to Q4 guidance and our longer term thinking into 2023, let me begin by saying that our Q4 capacity remains artificially constrained as we focus on transition training our pilots to meet our deadline for retiring Q400s and A320s in January.

Operator

We will have both the added cost

Speaker 5

of these training events and have fewer pilots available to fly in revenue service during the quarter and into the Q1 of next year. We expect 4th quarter capacity to be down 7% to 10% versus 2019, approximately 2 points sequentially worse versus the 3rd quarter, where we were down 6.7%. We still expect full year capacity to be down 8% to 9% versus 2019. Our absolute costs will increase from the 3rd to 4th quarter, entirely driven by our new labor agreements and expected Strong payouts for our performance based pay program as we continue to expect to meet a number of our strategic and financial goals, including being amongst the top margin producers for the full year. We expect CASM ex to be up 20% to 23% in the quarter.

Speaker 5

Approximately four points of this are structural costs related to our new labor agreements, two points are related to anticipated strong PVP program payouts and lower capacity and higher staffing complements are an approximate 4 point headwind during the quarter. Turning to fuel, while oil prices have moderated some over the quarter. They remain elevated and crack spreads continue to be both elevated and volatile. We expect Fuel price per gallon to be $3.50 to $3.70 for the 4th quarter. Our hedging program is expected to provide a significant benefit this year of around $170,000,000 For the full year, we now expect CASM ex to be up 19% to 20%.

Speaker 5

However, we are reiterating our full year adjusted pre tax margin guide of 6% to 9%, and we continue to expect to close the year with amongst the top pre tax results industry wide. Last quarter, we outlined that we were They're also the foundation of being able to deliver higher levels of productivity and cost leverage going forward. Having solidified our operational reliability, On continued productivity and capacity drag from fleet transitions in the first half of the year, our business plan for next year will include a return to our 2019 size during the first half of twenty twenty three and will also include a reduction in unit costs year over year. While we won't share specifics on 2023 guidance until our Q4 call, we are very much looking forward to leveraging the benefits of single fleets at Alaskan Horizon, higher levels of aircraft utilization and the significant benefits of up gauging from A320s to 730seven-9s and ultimately 730seven-10s. These are all consistent with the roadmap we shared at Investor Day back in March And along with our commercial roadmap that is already producing and has further upside from here, I believe we are well positioned for continued improvement in our business in 2023 and beyond.

Speaker 5

And with that, let's go to your questions.

Operator

And our first question comes from Mike Linenberg from Deutsche Bank. Please go ahead, Mike.

Speaker 6

Yes. Hey, good morning, everyone. Can you kind of give us an update now that you have both of your pilot contracts done? And this is to you, Ben, what you have seen on the attrition Has it completely sort of done a 180? And where are you with respect to having an appropriate number of both Check airmen and trainers, you did mention that there's going to be a lot of training as pilots move off of the Q400s and the A320s.

Speaker 6

Are you ready as we enter into the New Year?

Speaker 3

Hey, Mike. Good morning. Yes, you know what, we're really Pleased with both contracts on both the regional side and the mainline side. And these are really great deals for us on the attraction retention side of the business. In terms of what we're seeing for attrition, it's a little early to tell, but early indications are we are seeing some benefit on both the regional and mainline side.

Speaker 3

So, I think this is really pivotal for us. It's going to really help us long term in terms of growth plans. In terms of check airmen, in terms of the training output, we've seen a lot of improvements since the spring. We're producing about 65 pilots out of the schoolhouse a month with the goal being 100. We're increasing the number of check airmen to help us improve that throughput, but we are on track right now to deliver our pilots, the pilots we need per month on both the regional and the mainline side, and we're pretty confident on executing that plan going forward.

Speaker 3

Anything Joe you

Speaker 2

want to add or? Okay.

Speaker 5

Mike, go ahead if you have a follow-up. Yes.

Operator

Do you have a follow-up, Mike? I'm sorry, Mike. We took him out of the queue. I thought he was done. Mike, if you wanted to Ask another question queue up again, please.

Operator

In the meantime, our next question comes from Duane Pfennigwerth from Evercore ISI. Please go ahead, Duane.

Speaker 7

Hey, thanks. I appreciate it. There was a lot in there in terms of guidance points. Can you just refresh Us on what you said about the first half and kind of the rate of capacity recovery in the first half. Is it sort of comprehensively First half, back to 100% or is that something like you'd hit in 2Q?

Speaker 5

Yes. Thanks, Duane. Good morning, Tiu. Yes, I think, it's likely to be sort of in the middle of the first half of the year. I'm not we're still finalizing our gen Feb plans, but we'll be back to 2019 size confidently sometime in the latter half of first quarter or early second quarter.

Speaker 5

With the transition training, it will be a little bit sort of choppy in terms of how the capacity comes back online, but we're excited to get Aaron, we've got a lot of aircraft coming in the first half of the year that can then take us ultimately above the 2019 size, and we feel like there's demand for it to the second half of the year.

Speaker 7

Thanks, Shane. And on that delivery stream, can you just walk us through what you expect next year and your line of sight or confidence on those deliveries, just given the environment. Appreciate you taking the questions.

Operator

Hey, good

Speaker 8

morning, Duane. It's Nat Pieper. Hey, Nat. We've got 35 MAX airplanes now and We think by the end of next year, we're projecting to have 78. Boeing obviously is 5 miles down the road and we meet with them weekly to understand delivery constraints, etcetera.

Speaker 8

We're confident that they're going to deliver and give us the airplane We need to hit our targets.

Speaker 7

Thank you.

Speaker 5

Thanks, Wayne.

Operator

Our next question comes from Savi Syth from Raymond James. Please go ahead, Savi.

Speaker 9

Hey, good morning. Thanks. Just on the Just a follow-up on some of the pilot training and costs and the elevated staffing costs. Just How much of a drag is that still in 1Q? I'm guessing the pilot training costs will Drop off after kind of the 1Q or early 2Q.

Speaker 9

I'm just kind of curious how much of the what size of a drop off There will be and then the kind of elevated staffing, when do you see that moderating back to kind of historical levels?

Speaker 5

Yes. Hey, thanks, Savi. Good morning. It's about just to put context around it for Q4, the Overstaffing and transition training is about 1.5 points of our Q4 year over year CASM or year over 3 CASM guide. It's likely to be similar ish in Q1, and then it will start to taper and be completely gone by the end of Q2.

Speaker 9

Both costs will be gone?

Speaker 5

Correct. Correct. Yes.

Speaker 9

Okay. Got it. And then just A follow-up with the on the Boeing deliveries and things like that. Just any kind of revised thoughts on CapEx? I know the CapEx came down a little bit here in 2022.

Speaker 9

And you can view on 2023, 2024 CapEx and the financing of that?

Speaker 5

Yes, I'll have Emily sort of update. One thing I would just say and it's intuitive and I know you're hearing it from everybody, but not only on aircraft on every capital item we're buying things are shifting Right. I think supply chains everywhere are elongated still. New SIMs are taking a little bit longer. GSE equipment is taking longer.

Speaker 5

Things what we plan to buy, it just seems like they're taking longer to get in right now, but Emily can give you some more on the totals.

Speaker 1

Yes. I think Shane covered it pretty well. You saw that our guide for 2022 came down about $100,000,000 You should expect most of that to shift into 2023. When we give our full year 2023 guides, we'll refresh you guys from the numbers we gave you at Investor Day, which we had originally said was around $2,000,000,000 for 2023. So Expect that to go up a little bit.

Speaker 9

And is the financing, Emily, is that debt or cash or any thoughts on the financing side?

Speaker 8

Hey, Savi, it's Nat. It'll all be cash. We still continue to hold more than 2x the amount of liquidity we need to run the airline. So best thing we can possibly do is pay cash for airplanes.

Speaker 9

Makes sense. All right. Thank you.

Speaker 5

Thanks, Stephanie. Thanks, Stephanie.

Operator

Our next question comes from Andrew DeDora from Bank of America. Please go ahead, Andrew.

Speaker 2

Hey, good morning, everyone. Shane, a lot to unpack on the CASM front here in 4Q and for the year. Just stepping back when we think of 2022 CASM up 19% versus 2019, Can you kind of break out for us of that up 2019, like what are the kind of the one time items that you feel like will not repeat as we move into 2023? And how much of your CASM this year is just from not having your network fully restored? Just trying to get a good run rate potential for 2023

Speaker 5

Pause? Yes. No, I appreciate the question, Andrew. Number 1, I just want to remind folks that in terms of the updated cost guide, the only thing that's change for full year for us is the new labor deals. Everything else is tracking exactly as we expected it to.

Speaker 5

And then Andrew, you hit on it. The biggest drag To CASM, our headwind for us this year is not producing the ASMs that we had wanted to originally. We made a very deliberate decision. Obviously, in Q1, we were all impacted by COVID waves and the entire industry had to take capacity out. We had a big snowstorm here in Seattle that dragged into January.

Speaker 5

But we made a deliberate decision to pull down the schedule by 6, 7, 8 points during the summer and to hold it lower during Q4 as well as we prioritize operational Stability in. Now that we're stable, we've got terrific completion rates. We've got great on time performance. We feel really good about our staffing complement levels and our ability to fill new classes across every role in the company. We're ready to get much more growth minded and begin to leverage sort of the goodness that comes with growing and getting back to productivity next year.

Speaker 5

As one data point, I think we're still 10 points below our historical norm for productivity. I don't know that we'll get all of that back next year, but we're going to make a big We'll get a big chunk of that back coming next year. So that's really the biggest thing. Everything else, the only structural real change is the labor deals. I think We're unique right now, having been the first to get the mainline pilot deal done, I suspect we won't be unique for very long.

Speaker 5

And so that is something that the entire industry will ultimately have to do. And on a relative basis, we'll be in really good position versus everybody as we have been historically.

Speaker 2

Got it. Thanks for that. And just a second question for Ben Or Andrew, I think, look, having the scale that you have in your hubs in the Pacific Northwest, you have really, I think, Really solid driver of your overall margin performance. I know you'll never get to the share in LAX or that you have in Seattle and Portland. But I guess how long do you think it will take to build out those geographies?

Speaker 2

As I think As you build up there, your margins should see a tailwind as you scale up there over time. Any thoughts on kind of The timeframe of those California markets.

Speaker 4

Yes. Thanks, Andrew. I think how I would answer that is that As we move into next year and we give better guidance on our growth, we are returning more growth back to California. I think we feel really good about where we are, the markets we serve and as we've shared all along, it's about frequency and depths of those markets. It's about unlocking global connections with both our One World partners and with American And I think, we have a Head of California, Neil Thwaites down there.

Speaker 4

I meet with him every month and I'm really excited about the focus And the discipline that we have down there where traditionally as a Pacific Northwest company, we focus a lot up here. So overall, I don't think you're going to see a material Change overall in the scheme of things, but what we do, do down there, I fully expect to get better and stronger over the next few years.

Speaker 2

Thank you.

Speaker 5

Thanks, Andrew.

Operator

And our next question comes from Dan McKenzie from Seaport Please go ahead, Dan.

Speaker 10

Hey, good morning. Thanks, guys. Shane, 2023 capacity is Choppy as it comes back online, just going back to I think an earlier comment. Does that tie to a choppy earnings recovery from here? And I guess related to this, we are seeing some of your peers lay out pretty big earnings goals in 2023.

Speaker 10

And setting aside the 11% to 13 And pre tax margin goal, what's your conviction that you can at least improve on your 2022 pre tax margin as we move into next year?

Speaker 5

Yes. Hey, thanks, Dan. I don't think it portends a choppy earnings recovery. A lot of the sort of choppiness will be the base Comp, like on a year over year basis, we've just had so much unexpected schedule pull down this year. And by the way, next year, we're going to comp to 2022.

Speaker 5

And so I think it'll be fine. I don't think the earnings trajectory necessarily will follow the return of capacity trajectory. Really confident we can improve our margins next year, really strong demand backdrop. I think the commercial team is doing a really good job of participating in that backdrop and currently outperforming the industry. And then we've got a lot of things that we need to go do on the cost side to Take advantage of the strategic decisions we made around single fleet and getting back to historical norms on productivity.

Speaker 5

And so I think Absent a major economic pullback, I think we feel really good about our ability to get improved margins next year.

Speaker 10

Terrific. Andrew, second question here, I guess, turning to you, dollars 400,000,000 in revenue initiatives outlined at the Investor Day, so loyalty, network, This is fleet up gauging. What percent of revenue from what is the percent of revenue from premium products today, say versus Discounted leisure and how can we think about that premium revenue target as we move into 2023 given the fleet transformation?

Speaker 4

Yes. I think, off the top of my head, I think both premium and first All in coupon and upsells are 1,000,000,000 plus businesses each, just to give you a rough size of magnitude. I think our challenge is always given the strong demand, we believe and we continue to believe the importance of taking care of our leads and upgrades, but we're also recognizing there is opportunity to continue to get more out of our premium products. We're opening up new distribution channels. And most importantly, as we up gauge our fleet and we get 25% plus increase in 1st class seats from the transition.

Speaker 4

We still see significant upsides. We're looking at some other things, which I won't go into today. But overall, My expectation is we continue to show good things in the premium product space.

Speaker 10

Thanks for the time you guys.

Speaker 2

Thanks, Dan.

Operator

Our next question comes from Scott Group from Wolfe Research. Please go ahead, Scott.

Speaker 11

Hey, thanks. Afternoon, I guess now. Can you just clarify the do we have the Full impact of these of the pilot deal in Q4 costs or is it from the date of ratification? And then I just you made a comment that The only change is with CASM is this new pilot deal, but I thought you said it's there's a 4 point headwind from The pilot deal in the Q4, but the full year CASM guidance coming up 3 points. So it feels like it's more than just labor, maybe just I'm not sure I'm following.

Speaker 5

Yes, sure. Thanks, Scott. Yes, and I would say labor deals, not just the mainline pilot deal is what we've been sort of Speaking to those are fully baked into the 4th quarter ratably. So that 4 point headwind is The structural sort of number that we're going to go forward with at this point. No, I think in terms of the full year CASM ex guide, The real change between prior guidance and current guidance is the labor deals being incorporated.

Speaker 5

As you know, We don't guide to labor deals as we're negotiating, and so we closed 3 this quarter and And that's what we had to bring through our full year CASM ex guide. There was one other category that went up a bit and it is our performance based pay because we do expect to be on the better end of many of our financial targets that we had set forth in that program. So we took a larger we expect to take a larger for that in Q4 as well.

Speaker 11

Okay. And then so when we think about next year, we'll have, I guess, 3 more quarters of labor will have capacity up, which should help Maybe some of the inefficiencies go away. When you add it all up, would you think that CASM X is up or down 23 versus 22?

Speaker 5

Yes. No, it will be down. As I said in my script, our business plan will be to have a Reduction in CASM ex in 2023 versus 2022.

Operator

Okay, great.

Speaker 11

All right. Thank you, guys.

Speaker 12

Thanks, Scott. Our

Operator

next question comes from Jamie Baker from JPMorgan. Please go ahead, Jamie.

Speaker 12

Hey, good morning. So Shane, following up on that Last question, the pilot impact in the 4th quarter. So there's a look back to September 1 on wages and then the $33,000 $22,000 bonuses for captains and 1st officers respectively. So that's in the guide. You're not going to take that as a one timer in the Q4.

Speaker 12

Is that correct?

Speaker 5

So the look back to September 1 is in the Q3 result that was reported through the P and L. The ratification bonus sort of lump sum payments, those were special in the quarter as well.

Speaker 12

Okay. Sorry.

Speaker 5

They're in the adjusted they're not in the adjusted number.

Speaker 12

Yes. Okay. Got it. So the Q4 guide is clean of that. And then second, and it's a question on a preferential bidding system, and I really hate asking Stupid questions, but here we go.

Speaker 12

Why does it take until April of 2024 to go live?

Speaker 5

I mean, isn't it just like software? Yes. And it may be before that, so that you're Exhaustive reader of our agreement, Jamie. That is the outside drop dead date we need. We have to go live by that.

Speaker 5

We have to negotiate a timeline and just agree with our union counterparts what the last day we would go live. Our hope is to do it much sooner. I know Ben would like to do it much sooner. There's only the real drivers, there's only a couple of providers for these systems and they have other demand on them as well. So you have to get in line.

Speaker 5

And then, Jimmy, you just try to avoid the peak season. So there's only a handful of months in the year that you actually want to go live. You don't want to be doing it In December, you don't want it to be doing it in peak summer. So that's why these end up taking a little bit longer than everybody would Suspect they should.

Speaker 12

Okay. I haven't thought about the peak season aspect. Do you expect Question, apologies. When it does go live, do you think it's something we would be able to identify on a Well, on a margin basis, but on an ex fuel CASM basis, I'm sure it matters to you guys and I'm sure that was a win. I'm just wondering if it rises to the level of materiality for those of us modeling the company.

Speaker 5

Yes. I think it's something you'll probably have to ask a detailed question of us

Speaker 12

Okay. Okay.

Speaker 2

If it's

Speaker 5

a specific number when we get there, but it's not going to be inconsequential and I'm sure you'll hear us at least speak to the benefit of it once it's Live and we're starting to see the benefit. It really cleans up the transitions month to month and sort of the conflict drops as you know, and that can be a significant benefit both for pilots and for the company on a productivity basis.

Speaker 12

Okay. I appreciate it. Thanks very much everybody.

Speaker 5

Thanks, Jamie.

Operator

Our next question comes from Brandon Oglenski from Barclays. Please go ahead, Brandon.

Speaker 13

Hey, good afternoon. Good morning, everyone. Thanks for the question. Can we go back to your analyst meeting targets? You said pre tax margin 11% to 13% long term and above industry peers.

Speaker 13

Can Can you guys just remind us, I'm assuming that inflation is coming in a little bit higher than that. So assuming it's still relevant, what are some of the favorable commercial

Speaker 4

Yes. I think we're As we've talked about all along on the $400,000,000 of course inflation has its Impact certainly on credit cards for instance. I mean, we get paid for every swipe and those swipes are up 7% just inflation alone give or take. I think what I would say commercially and Shane and Ben hit on it is what I'm most excited about is that as we've worked really hard to reconfigure This business, airplanes, labor, that we're going to set ourselves up next year to really operate this airline, like a Swiss watch. And I can tell you the revenue goodness that comes from that, the efficiencies that come from that and all the good things that come from that versus what we struggled with this year It's really going to come into being.

Speaker 4

We're going to give you an update on as we continue to look at our initiatives. But overall, I think outside of that, Operating this airline efficiently is going to be huge.

Speaker 13

Okay. I appreciate that, Andrew. And I guess, along those lines, you guys did talk about earning above your cost Capital, obviously that has moved higher this year. How do you think about the long term growth of the business been? Is it right to still target 4% to 8%, Especially with the higher cost base and higher cost of capital as well.

Speaker 5

Yes. Ben can jump in on this. I think, Brandon, we're sort of fortunate. I think the equity valuation we'll have to see over time what the cost of equity On the debt side, we still have a very, very low cost of capital. And because of our cash position, we don't need to access capital markets anytime soon.

Speaker 5

So I think on the debt side, we feel incredibly sound in terms of the ability to finance ourselves going forward. You know our balance sheet story. If anybody should and can be investing, it's us. And I think there's still a lot of like demand that we feel like we could be taking in our core markets that are highly accretive in terms of returns above cost of capital, but Ben can speak to the longer term sort of plan.

Speaker 3

Yes. I think our long term plan is still to grow to 2025. We have a great order book from Boeing, which we plan to execute. So, I think exactly what Shane said. I think we're on track for that and feel good about the long term growth.

Speaker 5

Thanks guys.

Operator

Thank you. Our next question comes from Connor Cunningham from Melius Research. Please go ahead, Connor.

Speaker 14

Hey, everyone. Thank you. Just in 2Q, you talked a fair bit about the alliance initiatives, and I I don't think I heard much about that this quarter. And I would just assume that from one world in particular, you would see a huge benefit, given like international is coming back in a major way. So if you could just kind of update us where you're at with that?

Speaker 8

Connor, thanks for the question. It's Nat Pieper. I think you go back to why Alaska joined OneWorld and carry their loyalty benefits, carry their status in our mileage program and get any place on the globe that they wanted to go, either on our airplanes or on somebody else's. And so as international traffic has come back, Europe especially, we're seeing Real tangible benefits from that. Year over year, we're up 40% from a contribution perspective from these partnerships.

Speaker 8

And I think the second benefit to it, which is harder to see in the P and L, is really keeping our most important guests within the Alaska family, whether it's on our airplanes domestically or it's using their One World partners that have their loyalty status. We're not losing those Passengers are most important guests to our critical competitors here in the Pacific Northwest anymore because we've got a global network that we can sell and market as our own.

Speaker 14

Great. And then just on the cost structure, I mean, there's a lot of noise going on and I kind of get 1st, the labor stuff. But when I think about Alaska historically, it's always about really highly productive employees. The world's different now. Your productivity has probably changed in the last.

Speaker 14

So I'm just curious on how you get back to high productivity levels that you had historically.

Speaker 11

Like to me, is it really just

Speaker 14

a function of capacity or is there something else at play there? Thank you again.

Speaker 5

Yes. Hey, Conor, thanks. A couple of things that I think were unique to COVID and transient and time will tell if There's a new normal or not, but one, as we were re ramping, we were having to hire larger volumes than we've ever had and get those folks through training. That is all a sort of relative drag to our normal staffing posture. And then we had incredibly high attrition, which every airline has seen and every industry has really seen.

Speaker 5

And so Those two things, I think, stabilize over time for the economy and for us. We're in a much more stable place today. And I think you'll go back to the sort of more normalized training, a complement in terms of overall staffing as we get through 23 and beyond. And then as I had mentioned sort of in my script, we carried we didn't reduce our staffing levels at all even though we took 6 or Our eight points of capacity out of the system for the second half of the year. So we've got the people we need to do a lot of this growth next year.

Speaker 5

There's still a lot of hiring that has to happen because of attrition, but we're in a really good place. Whereas last year, we were trying to hire just in time to meet the new capacity, and then we'd get hit with a COVID wave and people would be sick and absent and we couldn't operate. And so we've we like others in the industry have totally done a 180 on that. We're now carrying more people than we need and it's time to go get the growth in the SMs in the air and enjoy the productivity benefit from that. I don't know if we'll get back to pre-twenty 19 productivity.

Speaker 5

I don't know if there's like a new normal of absenteeism, but we're going to be much better than we are today as we get into next year and beyond.

Speaker 3

But I just want to add, Conor, like this company has a low cost mindset. We're building budgets now that we're going to build productivity targets into the budgets. And we just we're setting the company up for 20 I mean the labor deals, we got 5 labor deals done this year. We're getting the single fleet done and behind us where there's a capacity drag on us. Heading into 2023, this company is going to go back to where we were in terms of this low cost, high productivity, low overhead mindset.

Speaker 14

Appreciate it. Thank you.

Speaker 5

Thanks, Connor.

Operator

Our next question comes from Helane Becker from Cowen and Company. Please go ahead Helane.

Speaker 15

Thanks very much, operator. Hi, everybody. So as you think about The record revenue that you're reporting and your guidance for the Q4 and maybe how you're thinking about 2023, How are you thinking about where revenue can go over the next few years? Like do you have a new Target for where you think you can see that number?

Speaker 4

Yes. Helane, I think I've shared on previous calls, I think we can learn a lot about revenue as much as we thought we did. We learned a lot more during COVID. And I think my team specifically, I think just the way our network and RM team works Together, is it a different place? I think on the corporate side, we're in a different place.

Speaker 4

I think on the alliances and partnerships, We're in a different place. We're working a lot on the distribution. And again, we're very, very focused on initiatives and generating more revenue. I I think our natural we're going to be a growth airline. That's what we do and we're going to be well positioned to do that both on the capacity side, but I still believe, as I personally look at all of this that there is upside on our products, Our types of products and especially I don't think we fully untapped the loyalty and the card growth and I think there's a lot of goodness there.

Speaker 4

So All these things we know going forward that there will be a step change in costs on an absolute basis mostly because of labor and we're going to go get that on the revenue side.

Speaker 3

And Alain, what I'll add is regardless of what the revenue environment does and I do think it'll change for the better, We still need to focus on what we've done so well for 2 decades is a highly efficient, low cost operation, highly productive. Those things benefit you in a good revenue environment or not so good revenue environment. So those are things that we're getting back to. And Andrew, of course, everything Andrew said makes sense. So

Speaker 15

Okay. That's

Speaker 3

Helen, do you have another question?

Speaker 15

No, I'm good. Thank you.

Speaker 3

Okay. Thanks, Helane.

Operator

And our last question comes from Chris Stathoulopoulos from Susquehanna Financial Group. Please go ahead, Chris.

Speaker 2

Good afternoon. Thanks for taking my question. Shane, so I just want to The 6% to 9% pre tax margin guide with the new pilot contract or these 3 new deals. So Could you help us square that versus the moving pieces of the 4 to 8 ASM guide? And also any it sounds like you're fairly confident around the order book, But if there are delays, how does that change the mix that you outlined last year, the 70 percent frequencies, 5% stage or perhaps more importantly, the 10% new markets.

Speaker 2

Are you just planning right now with these new deals at 6 to 9 for some level of sustained momentum in yields or the benefit of the operating leverage you referenced as your utilization returns in the first half of next year.

Speaker 5

Yes. Thanks, Chris. I'll make sure I try to answer each of those. On the Delivery stream, I'll tell you when we do give you guys guidance on capacity for next year, it will be appropriately buffered for What Boeing believes they can deliver versus what we may plan for them to deliver. And so we'll build upside in if they actually hit The delivery dates they're telling us that would be a benefit to us and would give us the ability to add some incremental ASMs.

Speaker 5

We're not going to overstress the system and assume every delivery comes on the exact day, even though we know that they're trying hard to do that. So We'll be really confident in our ability to operate the schedule that we tell you guys we're going to next year. I think it's both. I think primarily, we look to get the cost structure moving in the right direction, get unit costs going back down, which will be a big Sort of a tailwind to margin. And yes, I think right now, we do expect the revenue environment to be different than pre COVID for a period of time.

Speaker 5

I think structurally, there's relative to the size of GDP or demand, I think supply continues to be constrained and Our teams continue to do a good job understanding the revenue environment and getting appropriate yields and pricing in it. So I think both are going to help drive us. But really, we were sort of talking to you guys at Investor Day prior to a lot of this inflation stuff coming in, and We knew that labor was going to reset. We knew where we were in the market. We had a sense of where it was going.

Speaker 5

And when we laid out our long term targets, We specifically put together a strategy on both the cost and the commercial side to make sure we could get into those ranges long term. So nothing has changed For us from that perspective, we're going to deliver what we told you guys in Investor Day and get to these margin targets.

Speaker 2

Okay. Just a follow-up here. The four points on the structural labor side, is that just the base rate piece? I think you said that the ratification bonus and look back for September is in 3Q. And then Part B, should we assume that we would see elevated PVP accruals into or for full year 2023?

Speaker 2

Thank you.

Speaker 5

Yes. The 4 points represents all the labor deals we've done to date. And just as a reminder, in 3Q, the wage rate increase back to September 1 for our mainline pilot deal is in OpEx. The sort of lump sum bonus is in special.

Speaker 12

What was the second part of the question?

Speaker 5

PVP next year, too soon to tell. I mean, I think we have a strong commitment to Being one of the best margin producers in the industry and we believe if we do that, our employees should benefit through PPP, their PPP program. We do think it drives a lot of alignment. I think that's been proven out over a number of years, and it's appropriate to recognize folks when they're working hard and achieving. But the Board sets those goals.

Speaker 5

They do that in sort of as we get through the end of the year. So it's too early to know where we'll come out on that for next My strong inclination is the goals will be a little tougher next year than they were this year and we'll have to work harder to get to them. Thank you.

Speaker 1

Thank you, everyone. That marks the end of our Q3 earnings call.

Speaker 3

Thanks, everybody.

Operator

This concludes today's conference call. Thank you for attending.

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