Oct 24, 2013
Executives
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. Joseph A.
Sprague - Vice President of Air Cargo and Member of Management Executive Committee Benito Minicucci - Member of Management Executive Committee, Chief Operating Officer of Alaska Airlines and Executive Vice President of Operations for Alaska Airlines Mark Eliasen - Vice President of Finance
Analysts
Duane Pfennigwerth - Evercore Partners Inc., Research Division Hunter K. Keay - Wolfe Research, LLC John D.
Godyn - Morgan Stanley, Research Division Savanthi Syth - Raymond James & Associates, Inc., Research Division Helane R. Becker - Cowen and Company, LLC, Research Division David E.
Fintzen - Barclays Capital, Research Division Michael Linenberg - Deutsche Bank AG, Research Division Jamie N. Baker - JP Morgan Chase & Co, Research Division Glenn D.
Engel - BofA Merrill Lynch, Research Division Daniel McKenzie - The Buckingham Research Group Incorporated Stephen O'Hara - Sidoti & Company, LLC Tom Banse Glenn Farley
Operator
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 Third 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.
Chris Berry
Thanks, Megan. Good morning, everyone, and thank you for joining us for Alaska Air Group's Third Quarter 2013 Earnings Call.
On the call today are CEO, Brad Tilden; and our CFO, Brandon Pedersen, will provide some highlights from the third quarter and our outlook for the fourth quarter. We will also provide capacity growth projections for 2014.
Several members of our senior management team are also here to help with the Q&A. Our comments today 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 to certain non-GAAP financial measures, such as adjusted earnings and unit costs excluding fuel.
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 third quarter GAAP profit of $289 million.
The GAAP result includes a $192 million pre-tax or $120 million after-tax noncash special revenue item related to the accounting for our recently modified affinity card agreement. Accounting rules required us to revalue the deferred revenue associated with miles previously sold to our bank partner, with a corresponding benefit to revenue.
Excluding this special revenue item and the impact of mark-to-market adjustments related to our fuel hedge portfolio, Air Group reported a record adjusted net income of $157 million or $2.21 per share. This compares to a First Call mean estimate of $2.14 per share and to last year's adjusted net income of $150 million or $2.09.
Additional information about cost expectations, 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.
Bradley D. Tilden
Thanks, Chris, and good morning, everyone. We're very pleased to report our best quarterly profit ever.
Our people worked together to produce these results in the face of significant competitive incursions into our core markets on the West Coast and in the State of Alaska. I want to thank them all for operating safely and on time and for continuing to provide JD Power-caliber service to our customers.
Our people at Alaska led the major airlines in on-time performance for the most recent periods available, both for the 3 and 12 months ended August 31, 2013. And in the month of September, they achieved the highest customer satisfaction score we have received in the 7 years that we've been tracking this metric.
Our record adjusted earnings of $157 million marked our 18th consecutive quarterly profit and represent an 18.4% pre-tax margin. We believe this will be one of the highest margins in the industry.
Our trailing 12-month return on invested capital is 13% and 2013 will be our 4th consecutive year in which we'll exceed our 10% after tax target. As you know, we're also returning significant capital to shareholders as we continued our share repurchase plan during the quarter, and as we initiated our first quarterly dividend in 21 years.
Let's talk for a moment about the competitive incursions we saw this summer. Although total industry domestic capacity in the third quarter was only up slightly, nearly 1/3 of all additions took place in city fares where Alaska flies.
Specifically, our long-haul Alaska routes and our North-South West Coast routes were impacted disproportionately causing significant yield pressure. In fact, yields were down about 15% in the long haul Alaska markets.
In the face of these significant increases, we posted our best quarterly result ever, a result which speaks to the strength and diversification of our route network. Unit revenues increased in nearly every other region during the quarter, and we were especially pleased with Hawaii.
You'll recall that we've talked in the past couple of calls about a surplus of capacity in our California-Hawaii routes. We made scheduled adjustments which were effective in late April and unit revenues in this region responded nicely, especially in the Bay Area.
We know that many of you are wondering about Delta's capacity additions in several of our markets, including Seattle-Los Angeles, Seattle-Las Vegas and Seattle-San Francisco. United has also added capacity to the Seattle-San Francisco market by adding frequency and up-gauging their service to mainline jets.
There's really not a lot we can say about this, except that we're focused on the situation and we're confident in our ability to deal with it as we dealt with new competition in the past. Alliances can be complicated.
It's likely that in the future, there will be markets where it's in our interest to work together with Delta and there will be markets where we will compete because it's in the best interest of Alaska Air Group to do so. We have a long-standing alliance with Delta, but many of their recent domestic additions are in core Air Group markets, and we intend to compete aggressively and defend them vigorously.
We talked about cash generation and the improvement in our balance sheet in other quarters, but it's worth emphasizing again as both continue to improve. For the past 12 months, our operation generated $940 million of cash flow.
We've used this cash to buy 8 new aircraft free and clear, to pay down $175 million of debt and to repurchase $91 million of stock. As we sit here today, we have essentially no net debt, we have $1.4 billion in the bank, we have 46 unencumbered 737s and our pensions are almost fully funded.
This is all made possible by our profitability. And at this point, we're expecting to post a record full year result in 2013 and we're optimistic about 2014.
We've been working hard to ensure that we have a plan for next year to continue this strong performance. As we look forward, we'll have typical inflationary cost pressures and rising pressure from competitive capacity adds.
But these will be offset by our baggage and change fee increases, which will take effect in the next couple of weeks; by our cabin upgrade project, which will come online beginning in December; by our new affinity card agreement, which was signed in July; and by what we believe will be a material reduction in pension expense in 2014. Switching gears, Alaska was recently named the most fuel efficient airline in the U.S.
by the International Council on Clean Transportation. This was the first study of its kind done in the U.S.
and the recognition is gratifying. Our goal is to be the industry leader in environmental stewardship and this award validates that the work we've been doing is paying off.
Fuel-efficiency is important, not only in protecting the environment, but also in protecting our bottom line. When we declared a dividend back in July, we did so with the confidence that our financial success was sustainable.
We have loyal customers who view Alaska as their hometown airline. We earn this loyalty with low fares, with industry-leading operational performance and with award-winning customer service.
We have single fleets of fuel-efficient aircraft at both Alaska and Horizon that are well-suited to flying in our markets and that have better cost than the legacy airlines. And most importantly, we have great employees who have helped us restructure this company and who are fiercely proud of what we have built.
Of course, this business is challenging but we're in this together, and we're very much looking forward to the future, a future where we plan to continue to perform for our customers, our communities, our employees and our owners. With that, I'll now turn the call over to Brandon.
Brandon S. Pedersen
Thanks, Brad. Hello, everyone.
The $251 million adjusted free tax profit this quarter represents a $7 million improvement over the third quarter of 2012. Excluding the special revenue item that Chris described, total operating revenues increased by $93 million or 7% on the 7% increase in capacity.
Passenger RASM declined by 1.2%, largely on the competitive pressures that Brad described, partially offset by 0.6 of 1 point of PRASM benefit from the modified affinity card agreement. Total RASM was about flat, helped 1.5 percentage points by the affinity card agreement, including $8 million related to additional compensation received for miles sold in the first half of the year.
We'll continue to see favorable impacts to unit revenue comps for the next 3 quarters as we annualize the deal. Total nonfuel operating cost increased by 9%, resulting in a 1.4% increase in CASM x fuel.
Wages and benefits were the primary drivers of the year-over-year increase. This was mostly related to the new long-term agreement with Alaska's pilots.
The quarter included about half a year's worth of annual increase because the contract was effective back to April 1st, even though it was ratified in July. Productivity continues to improve.
On a passenger per employee basis, Air Group's productivity increased by 4% this quarter. This was consistent with our guiding principle that we want to pay our people well with a goal of reaching the industry's best productivity over time.
Our productivity today is 43% better than where it was back in 2003. This has been a significant factor in our financial success and I want to acknowledge our employees' contributions and openness to change that made that kind of progress possible.
Landing fees and other rents were higher in the quarter as we continued to accrue the higher rates imposed on us by the Port of Seattle that we told you about last quarter. We just recently signed a new lease with the Port that has lower rates than those imposed, but it still needs to be signed by enough carriers for it to be effective in 2013.
We'll know much more in the fourth quarter and we're hopeful we can record the favorable adjustment to reflect the lower rates in this fiscal year. Based on what we see today, we expect full year nonfuel unit cost to be about flat to up very, very slightly.
Estimated incentive pay has increased, which reflects healthy profits but puts pressure on CASMex, and we had hoped to have the Sea-Tac lease resolved sooner. Looking forward, our system level of growth will slow from the pace we've seen recently.
For Air Group, we expect capacity growth of just under 5% in the fourth quarter and just over 5% in 2014. With much of that growth coming from larger 900 ER airplanes and the impact of the extra seats that we'll be adding to the 800 and 900 fleets.
Right now, we're deep into the 2014 budgeting process. We're not ready to give guidance on next year's costs just yet, but as our growth slows, bringing unit cost down may prove to be challenging.
Some of the headwinds are familiar: higher wages, much of which is associated with new labor agreements; medical cost inflation and additional significant investments into important IT infrastructure and innovation projects are all putting pressure on costs. Our 2014 profit will be helped, however, by the powerful profit drivers we announced back in July.
The seats, the bag and fee changes and the modified affinity deal that together, when fully implemented, are worth $150 million or more per year. Turning to the balance sheet, we ended the quarter with $1.4 billion in cash and short-term investments.
Through the first 9 months of the year, we've generated $820 million of operating cash flow compared to $638 million last year. Capital spending was $395 million, resulting in free cash flow of $425 million.
We've used that free cash flow in a balanced and deliberate way to strengthen the business by paying off $139 million of long-term debt, which has dissolved normal maturities, using $14 million to pay the first dividend since 1992 and repurchasing over 1.5 million shares of our common stock for $83 million. We currently have $150 million remaining under our $250 million authorization.
Our goal of finishing the program by the end of next year remains. However, we do have the authority to accelerate buyback activity and may do so, especially if we see any significant pullback in our share price.
We're now projecting CapEx to be $520 million this year, up a bit because we just exercised options for 5 aircraft that will be delivered in 2015 through 2017. We also worked with Boeing to move options for 5 additional aircraft out of 2015 and '16 and into 2018 and '19 where we previously had no options.
This gives us a bit more flexibility with the fleet in those later years, slows closer in growth, allowing us to digest all of the recent new markets and helps us lower CapEx somewhat in 2014 and 2015 to maximize free cash flow generation. Our adjusted debt to cap ratio now stands at 47%, which is comparable to high-quality industrial companies outside of our industry.
Improving operating results and a stronger credit metrics were cited by Standard & Poor's recently when the raised our credit rating a notch to BB. Our strong balance sheet and access the liquidity will continue to and have served this company well.
With the de-leveraging basically complete, a larger percentage of future free cash flow will be available to return to capital providers. I want to mention one other item before we go to Q&A.
We're happy to report our pensions were about 95% funded on a PBO basis at September 30. This is because of our multi-pronged strategy to address our pension obligation, including the $575 million that we've contributed at the plans over the last 5 years, even though none was required and the plan restructuring that we've done.
As a reminder, all of our defined benefit plans are closed to new entrants and the management DB plan will be frozen on January 1, 2014. We've also had some help from strong investment income and the recent increase in interest rates.
As a result of all these factors, we expect a reduction in pension expense next year that could be $40 million or more. That's a very preliminary number, but lower pension costs will offset some of the cost pressures I talked about earlier.
Finally, I hope to see you all at our Investor Conference on November 14 in New York. If you haven't registered yet and you would like to, please let Chris know.
With that, we'd now like to open it up to Q&A. Chris?
Chris Berry
Alright Megan, go ahead and prompt for questions. Thank you.
Operator
[Operator Instructions] Your first question comes from the line of Duane Pfennigwerth with Evercore.
Duane Pfennigwerth - Evercore Partners Inc., Research Division
I'm just wondering, it feels like State of Alaska, probably a little bit better but clearly, some more competition in the fourth quarter along the West Coast. How much do you think competition cost you or incremental competition cost you in the third quarter?
And how do you view it sort of fourth quarter, first quarter, it is it getting worse? Is it getting better?
Is it about the same?
Andrew Harrison
It's Andrew. The competitive pressures from other airlines peaked at about 10% growth in the third quarter.
As we see it, it's about 7% growth in the fourth quarter, and then about 8% in the first quarter. So it's reducing.
At the end of the day, we've seen good strengthening of our development markets and we feel very good about our lower capacity in both the fourth quarter and the first quarter to help offset these adds.
Duane Pfennigwerth - Evercore Partners Inc., Research Division
And you mentioned some favorable cost items in 2014. I may have missed it, how should we be thinking about sort of your total x fuel cost looking into next year?
Brandon S. Pedersen
It's Brandon. We haven't given guidance yet on 2014 x fuel cost, you can expect more at Investor Day.
I did make the comment that as the growth slows, it will be more difficult to bring down unit cost. We are totally focused on it.
We're in the midst of the budget season right now. We've have a long track record of bringing down unit cost.
We recognized its importance. We're trying to balance that with some of the normal inflationary pressures we're dealing with, plus our decision to continue to make strategic investments into IT and perhaps, the brand as we move into 2014.
Operator
Your next question comes from the line of Hunter Keay with Wolfe Trahan.
Hunter K. Keay - Wolfe Research, LLC
For the brand, Brandon?
Brandon S. Pedersen
Brands Brandon, yes.
Hunter K. Keay - Wolfe Research, LLC
What do you meant by that?
Brandon S. Pedersen
Yes, well, Hunter, as you know, we've had a project ongoing by about 1 year, 1.5 years now, to see if there were ways that we could make our brand more energetic and compelling, particularly to folks outside of the Pacific Northwest. We are early in that process, but we're making good headway.
I'll let Joe talk about it more. We may end up spending some money on that in 2014.
We haven't quantified that. As I said, we're early on in the process, but it may cost us something to make changes to the brand.
Hunter K. Keay - Wolfe Research, LLC
Well, that's fine. We can talk about it later.
But my question was, first of all, I love the commentary on the buyback acceleration potentially, but why, just to play devil's advocate for a second, why would you wait for a pullback if your stock if so cheap? You know it, I know it, everyone knows your stock is undervalued, so the stock chart doesn't necessarily mean that the stock is appropriately priced or whatever.
So why would you not accelerate the buyback now anyway, given what your stock trades in relation to the returns that you're generating?
Brandon S. Pedersen
We may very well do that.
Hunter K. Keay - Wolfe Research, LLC
Wonderful. And in terms of the TRASM gap to PRASM in the third quarter, it was a little bit bigger than I thought and my beloved change fees and bag fees don't even kick in until next week.
So should we expect that gap between TRASM and PRASM to continue to accelerate into the first quarter of next year?
Brandon S. Pedersen
Hunter, it's Brandon again. We don't give a lot of guidance on PRASM or RASM numbers I think you hit on an important topic which is the change fees do kick in later this year and we'll really start to see that in the first quarter.
Our total revenue number includes some other things like cargo, which has been relatively flat. We did see some growth in the quarter, but relatively flat when compared to overall capacity growth.
So it's a complicated question. The other thing and we did mention it into our prepared remarks is that PRASM included $8 million of retro associated with the new bank deal that won't carryover, that's a one-time deal.
Operator
Your next question comes from the line of John Godyn, Morgan Stanley.
John D. Godyn - Morgan Stanley, Research Division
Brandon, I was hoping a follow-up on one of the cost comments earlier. I can appreciate not giving sort of a point estimate for guidance in 2014, but we've heard this commentary in the past where you highlight a whole long list of cost pressures and then once that guidance comes out, we're still seeing down CASM x fuel year-over-year, you mentioned a good guy with a pension expense here.
Just in broad strokes, are we still -- I mean, is the management ideology still in the world where we think we can improve the CASM x fuel cost structure year-over-year? Are there still opportunities to do that as we look out the next few years?
Brandon S. Pedersen
Yes. I think the management -- our head is totally in continuing to reduce cost as we look forward.
As you said, we're not ready to give a specific estimate, but we do think that there's continued opportunity to improve productivity, for example. And while it may slow next year, longer-term, we do think it's important for us to be able to continue to drive down cost to get our cost structure closer to the low-cost carriers.
John D. Godyn - Morgan Stanley, Research Division
Okay, great. That's very helpful.
And then just on ancillary revenues, kind of big picture, we've seen you guys do some very thoughtful ancillaries recently and they're very powerful in a sense that they're not the types that necessarily drive a substitution effect with yields or PRASM or how we think about it. Can you just kind of speak to the ancillary strategy bigger picture?
Are there more of these types of opportunities down the line that you guys are investigating?
Joseph A. Sprague
John, this is Joe Sprague from marketing. I think at a high level, the first thing as you point out, we're wanting to implement and do so successfully with our new bag fee and change fee increases that will go into effect next week.
Overall, I think we're actually pleased with, even before those changes take effect, how ancillaries are performing this year. For the quarter, our ancillaries per passenger were at $11.94 and that was up from $11.78 in the same period last year.
And bag fees was a big contributor to that, so they're performing better even before the new increase goes into effect. And we've also seen some great progress with our buy on board food program as well.
So I think high level, are there other things we can do? You bet, and we absolutely look at those all the time.
And as we get these current changes implemented, we'll continue to focus on that.
Operator
Your next question comes from the line of Savi Syth with Raymond James.
Savanthi Syth - Raymond James & Associates, Inc., Research Division
Just a quick question on the topic that's been discussed much. But just with Delta's action, I was just wondering, is the positive aspects of Delta having a lot more international and therefore, needing a lot more feed from you over -- is that business overshadowing the negative impact it's having from a competitive standpoint?
Andrew Harrison
Savi, it's Andrew. Yes, Delta is continuing to grow its international presence.
And as we have 55% of the seat share in Seattle, we obviously, bring a lot of that traffic into Seattle. But as Brad eloquently put in his opening remarks, we'll work together where there's benefit as we work with them on the international growth.
And then where there is competition, and we work there, head-to-head competition, then we'll vigorously defend our core markets.
Savanthi Syth - Raymond James & Associates, Inc., Research Division
Got it. And then just -- have you taken any kind of moves in the near term in relation to that?
Andrew Harrison
As far as the competitive, we have. We have increased our market presence in both Seattle-LA Seattle-Las Vegas, Seattle-San Francisco.
So we absolutely have and working to vigorously defend that. We also -- Joe's team did a double miles earning elite on qualifying status on those markets as well.
Savanthi Syth - Raymond James & Associates, Inc., Research Division
And one last question, just on the West Coast market. So the pressure that you saw in the summer, is that continuing into the fall as well?
Andrew Harrison
The specific pressure that goes on into the fall, Savi, is not so much in the State of Alaska, but more up and down the West Coast, the Seattle-LAs, Seattle-Vegases, Seattle-San Francisco.
Savanthi Syth - Raymond James & Associates, Inc., Research Division
So that continues to the same magnitude?
Andrew Harrison
If not, a little bit more.
Operator
Your next question comes from the line of Helane Becker with Cowen.
Helane R. Becker - Cowen and Company, LLC, Research Division
I actually wanted to know one kind of housekeeping item, or maybe 2. Landing fees were up 16% and so there's a two-part question.
One is the drivers for that, and two is, with all the new capacity going into Seattle, I know that's it historically been a high cost airport for you, does that help that line item slow growth? I probably asked that backwards.
Does that help in terms of lower cost increases going forward?
Brandon S. Pedersen
Helane, it's Brandon. Maybe I'll start with the first part and then Ben can help with the second part.
On the landing fee increase, much of that increase is related to the increase that we saw at Seattle or you might be back -- remember back at the end of the second quarter, we told you that the Port of Seattle had imposed rates on us in the absence of a lease agreement that go back to January 1 and we're still accruing at that higher rate. So if you carve that out, the increase is basically a volume-related increase, as well as just what I would consider more normalized increases at other locations.
As I mentioned, we did sign a new lease with the port and once enough airlines are able to sign that, we're hopeful that, that will be reflected in 2013 as a favorable adjustment because the new lease has rates that are lower than those imposed. In terms of the growth in Seattle and how that might help us, Ben, do you want to talk about that?
Benito Minicucci
Helane, what I could tell you just about cost is that year -- I mean, before resolution rates, rates are increasing. So it's a volume and rate equation that's causing our rates to go up.
So even with increased capacity, we'll still see higher cost for ourselves in Seattle.
Unknown Executive
More volume theoretically helps. I don't think it's going to actually help, Helane.
Brandon S. Pedersen
Did that help?
Helane R. Becker - Cowen and Company, LLC, Research Division
All right, so -- yes, that's fine. I don't have a problem with that.
And then my other question is, with respect to fuel hedging, given -- I know you guys believe in it and so on, but any talk to changing the amount you hedged going forward, maybe with fuel cost coming down?
Mark Eliasen
This is Mark. We have quite satisfied with our program.
It's worked for us, as you know, for 13 years. We have made some adjustments with the deductibles but overall, we're happy with the program, and I think we're going to stay the course.
Brandon S. Pedersen
[indiscernible] let [indiscernible] to remind [indiscernible] on the call -- this is Brad, we had gone from hedging 50% of our fuel with basically half the money call options to 50% and starting 3 years out, to 50% of our capacity with 20% out of the money call options starting what, Mark? 12 or 18 months out?
Mark Eliasen
Yes. Well, we're at 6 months.
Yes.
Bradley D. Tilden
6 Month. So our -- Helane, our premium expense, that -- it may not sound like that's a material change in sort of the premium money that we're spending to hedge.
And that's happened over the last 18 months or something.
Mark Eliasen
Yes, that's right. And the premium should go down from about $45 million so far year-to-date, down to about $20 million to $25 million a year.
Operator
Your next question comes from the line of David Fintzen with Barclays.
David E. Fintzen - Barclays Capital, Research Division
A question, I think Brad, you kind of referenced this in your opening comments but I'm just curious how Southern California and some of the new flying you added about a year ago is developing, particularly, some of those transcons. And then how San Diego, et cetera, kind of fits into your growth plans going forward?
Bradley D. Tilden
We'll ask Andrew to give some color on that.
Andrew Harrison
David, we're seeing continued improvement in our transcon markets. We just recently moved our San Diego-Orlando to a daytime flight from a redeye and we're seeing very nice unit revenue increases moving out.
As far as San Diego goes in general, we just look for opportunistic things to do there. We have a decent presence there.
We've served that market for a long, long time. And again, a lot of new markets but they're basically developing in line where we expect but it will take them a few years to mature.
David E. Fintzen - Barclays Capital, Research Division
Okay. And just -- did I understand the comments -- the 5-ish percent was a 14 ASM growth?
Was that -- -- I think it was in Brandon's comments.
Brandon S. Pedersen
Yes, it's actually that Q4 number and basically the 2014 number as we see it today. And I made the point in the prepared remarks but it's worth mentioning again that a lot of that comes from the gauge of the 900 ERs that are coming in, as well as the additional row of seats that we'll be adding to the 800s and 900s.
So unit growth or airplane growth, maybe is a better way to say it, on the main line side, were only up 2 units next year.
David E. Fintzen - Barclays Capital, Research Division
Okay. And so just remind us, I think you have said this before, the added seats, what does that translate into the ASMs?
Is that a full point?
Andrew Harrison
Yes, about a point in 2014 and a point in 2015, just because we'll be working through much of '14 to get that project done.
Operator
Your next question comes from the line of Michael Linenberg with Deutsche Bank.
Michael Linenberg - Deutsche Bank AG, Research Division
Two questions here. Just back on the pension expense, I think you indicated that it was going to be down, it could be down, I mean, rough estimate's $40 million.
What is the base?
Brandon S. Pedersen
What is the base in courier pension expense? It's right around $50 million.
Michael Linenberg - Deutsche Bank AG, Research Division
Wow, so that could fall like 80%. Okay.
Brandon S. Pedersen
Yes, and the accounting rules require us to snap the line as of December 31 and that sets the bar going forward. So that is a preliminary number.
But based on what we see today, we're encouraged that our costs are going to go down a lot in that area.
Michael Linenberg - Deutsche Bank AG, Research Division
Okay, very good. And then just my second question, when you look at the new flights that Delta's putting in and you're adding additional flights, are those markets that you currently codeshare on or are you not codesharing on them now?
Can you talk about that?
Bradley D. Tilden
This is Brad. I might chat about the Delta relationship for a bit.
First of all, the new flights that Delta's putting in into some of our North-Southwest markets are markets that we will not be code sharing on. And a lot of folks have asked question about Delta and I guess one of the things that I want folks to know that we're trying to do here is take the emotion out of this process and make the best decisions that we possibly can.
I would think that as we move forward, there are going to be places where it's going to be in our interest to work with Delta and we're going to support them, they're growing internationally by itself, that should be a good thing for both of us, and so we're going to work with them to grow the connections between the 2 airlines. And then there are places where they are growing in North-South markets that have been long-term core markets for Alaska Air Group.
And in those markets, we will compete and we'll defend what we've built over the next years. But we got a long-standing relationship with these folks.
We had a lot of competition North-South and the West Coast over the years. It will be a little complicated, but that's the world we're moving into and I think it's going to be okay.
Michael Linenberg - Deutsche Bank AG, Research Division
Is there -- just as a follow-up, is there -- I mean, there's a lot of players in these markets. I mean, is there the possibility that maybe someone else besides you or Delta or even United may end up actually scaling back supply?
And is there anything out in the forward schedule data that maybe suggests that there are some pullbacks, maybe by some who are being hurt disproportionately from this?
Bradley D. Tilden
Mike and Andrew has talked forward schedules, in particular, but to your first question, I would say absolutely. If you look at just the way the West Coast makeup has gone over 5, 10, 15, 20 years, it's changing all of the time in terms of who's doing what flying.
And I think net-net, Alaska's been a winner in all of those moves for a long, long time now. But absolutely, markets, new capacity comes in and someone told maybe that new capacity comes out again or somebody else comes out but, absolutely.
I would not expect somebody makes announcement that it wouldn't be right, I don't think to say okay, that's the permanent structure of the market. People are moving all the time and the water will sort of find its level again at some point here.
Andrew, do you want to talk? Is there any data that we see in forward schedule?
Andrew Harrison
Nothing significant. We've seen Virgin move out of Portland-LA and put that into San Francisco.
We've seen some winter capacity reductions. But on the whole, we haven't seen any changes yet.
Operator
Your next question comes from the line of Jamie Baker with JPMorgan.
Jamie N. Baker - JP Morgan Chase & Co, Research Division
The relationships between airlines, well, big airlines and their regional partners are pretty well disclosed in terms of breakage policies. There's typically a notification period limits on how many aircraft you can roll out per year.
There might be some early out provisions related to work stoppages or operational metrics, but the details are out there. But this is not the case with codeshare relationships.
Who really wears the pants in those agreements? Or put differently, if one of your partners simply decided to call it quits, how easily can they do so?
Can they just walk away at a moment's notice? And the same applies to you, to Alaska, of course, unilaterally deciding, call it quits?
Bradley D. Tilden
Jamie it's Brad. This is as you say, it's a codeshare relationship, it's got marketing, it's got other features to it.
The basic relationship is the long-term agreement. And I don't think we said publicly and probably not going to say now exactly what the duration is.
But it is a long-term agreement that does contain certain contractual minimums. So that's the nature of the deal.
As I said in the last question, I mean, our thinking now, I mean, our -- as you know, Jamie, our alliance structure has changed a lot over the 20-year history of this company. And if it needs to change, it will change.
Our thinking now is to sort of keep the emotion out of this thing, deal with the facts that are in front of us, deal with what we see happening in the marketplace and make decisions at every juncture that are in the best, long-term interest of Alaska Air Group. So that's how we're thinking about it.
Jamie N. Baker - JP Morgan Chase & Co, Research Division
And would you be willing to quantify as a percentage of your total codeshare business, and whether you want to answer this in passengers or preferably revenue -- well, actually, preferably profitability, the component that AMR makes up?
Bradley D. Tilden
Yes. Do you mean Delta or AMR?
Jamie N. Baker - JP Morgan Chase & Co, Research Division
AMR.
Bradley D. Tilden
Okay. I don't -- here's what I'll tell you, Jamie, interline revenues in total are about 13% of our revenues.
About 4% of that comes -- is enabled by Delta, either through codeshare or miles or interline agreements. American would be a little less than that.
Operator
Your next question comes from the line of Glenn Engel with Bank of America.
Glenn D. Engel - BofA Merrill Lynch, Research Division
The Seattle, if you get a new airport agreements, how much is that worth? And would that be another good guy for 2014?
Brandon S. Pedersen
Glenn, it's Brandon. Yes, it would be a good guy for us in the fourth quarter and into 2014.
I'd say the 2013 impact could be in the neighborhood of $8 million, and that's probably a fair representation of the benefit that we see going into '14 as well.
Glenn D. Engel - BofA Merrill Lynch, Research Division
So the higher cost guidance in the fourth quarter is Seattle now being included in the higher incentive pay?
Brandon S. Pedersen
The higher cost trends in the fourth quarter is incentive pay and it includes the existing rate structure. If we are able to get this thing pushed over the goal line in the fourth quarter, it would be a favorable -- it has a favorable impact to Q4 costs.
Glenn D. Engel - BofA Merrill Lynch, Research Division
And Brad, not to beat a dead horse on this Delta issue, but it does seem like you're subsidizing a competitor by codesharing with them on these international flights, making him stronger in a market he's going against you. Why don't you want it to make it more painful for Delta to not dump on you?
Bradley D. Tilden
Glenn, it's Brad. Good question.
I think what I'd say is that we're looking at this closely. We are studying it.
There's all sort of things, actions that Alaska could take. It's just probably not in our interest to talk a lot on a quarterly conference call about what those actions might be.
I think the best thing for us to do is to look at this and make whatever decisions we make and execute those decisions in the market.
Operator
[Operator Instructions] Your next question comes from the line of Dan McKenzie with Buckingham Research.
Daniel McKenzie - The Buckingham Research Group Incorporated
One quick clarification. I think I heard you say the new ancillary revenues were enough to offset the competitive capacity from Delta, but did you say that you thought it would be enough to offset the anticipated cost pressures as well, heading into next year?
Brandon S. Pedersen
Dan, it's Brandon. No, we did not say that directly.
What we said was the impact of the new ancillary structure plus the new seats, plus the modified agreement, they would all work together to offset or certainly at least, mitigate some of the impact we're seeing from competitive capacity incursions, as well as cost pressures in other areas.
Daniel McKenzie - The Buckingham Research Group Incorporated
Got it, okay. And then I guess Brandon, while I have you here, for purposes of evaluating the return of capital, can you remind us, are you using a gross CapEx number?
Or if it's a net CapEx number, what are the adjustments that you're making to that gross number, exactly? And I guess, related to that, does the corporate finance map suggest that it could make some sense to add a small amount of debt to the balance sheet for potential share buybacks?
Brandon S. Pedersen
There's 2 questions there so I'll try to take them one by one. One is just your question about gross CapEx versus net CapEx.
All of our CapEx numbers are gross, we really don't have a lot of proceeds coming in from the sales of any assets, certainly nothing material and so it's all gross, to answer the question. On the corporate finance math question, we get the whole cost of capital question and how if we raise more debt, it would theoretically reduce our cost to capital.
We're definitely mindful of that. We do that calculation.
The history of the airline industry though, and I've said this in prior calls, is that there's been way too much debt. So we really like where we're at, kind of in this 40% to 50% range.
Not saying that we would always be there necessarily, but maybe it's a long winded way of answering your question to say that we are looking at that, we may raise debt just to manage the capital structure. We wouldn't keep that cash just in the checking account and so you can do the math from there.
Operator
Your next question comes from the line of Steve O'Hara with Sidoti & Company.
Stephen O'Hara - Sidoti & Company, LLC
I was curious, in terms of the $150 million or so from the change fees and credit card, I mean, it seems I guess around $5 a share in terms of -- or I'm sorry, $5 a passenger in terms of ancillary. I mean, am I close on that?
And I mean, it seems like it does a pretty good job of kind of vaulting you guys higher and I think -- I don't know if you mentioned this yet, but maybe you could talk about if you've seen any customer reaction in terms of the change/bag fees and maybe it's hard to determine given kind of what's going on competitively.
Brandon S. Pedersen
Steve, it's Brandon and I'll start -- or I'll start and then give it to Joe. Just in terms of how we measure ancillaries, the impact of the seats, that would come through passenger revenue, even the mileage plan or this affinity card deal, that gets split between passenger revenue and other revenue.
We don't count that in our ancillary numbers, just the modifications to the bag fee policy and the change fee policy would get included in ancillary revenues. So that's just kind of how we think about it and how we do the math.
Joe, you want to take part 2?
Joseph A. Sprague
On the bag fees, in terms of customer reactions, it's a good question, Steve. We're going from $20 to $25 for each of the first 3 bags.
We've always felt we had a good value proposition, if there is such a thing when it comes to bag fees because of number one, our simplicity, relatively low rate structure. In both cases, we believe we're maintaining that with $25 for each of the first 3 bags.
And then we still have the industry's only baggage service guarantee, which gives customers truly something of value in exchange for checking their bag with us.
Stephen O'Hara - Sidoti & Company, LLC
Okay. And then I guess maybe as a follow-up, I mean, you guys talked about being on the forefront of technology.
I mean, can you just maybe give us a preview of what you see down the road that maybe would cut cost or drive for further ancillary revenue?
Benito Minicucci
Steve, it' Ben Minicucci. So we have -- I think in the last quarter, we announced Vice President of Innovation and Technology that has put a team together that's going to drive a lot of innovation into our operation and into our company.
So at Investor Day, we're going to give you a preview of what that looks like. But we have definitely, a pretty set goal by 2017, of being the most hassle-free airline of the world and we're on track to be there.
Joseph A. Sprague
Steve, it's Joe, again. I might just add, Ben's exactly right.
One area that's been particularly encouraging, we'll talk more about this Investor Day, is our efforts with our mobile apps. We think we have the industry's leading mobile apps.
We just had our millionth download of the mobile app and importantly, how it affects sort of productivity and make our whole operation more efficient. We're now just under 10% of all check-ins happening via our mobile apps, so that's good.
And if I can just correct one thing, I said to you Steve, on the bag fees, our first 3 are $25, $25 and $75, still a good value proposition and simple to understand for customers.
Operator
Your next question comes from the line of Steve Wilhelm [ph] with Petersound [ph] Business.
Unknown Analyst
One of the questions just went away so I just had 2. One is I've heard that this redesign might include shedding the Eskimo motif.
I wondered if you could discuss that or say where that might be leading? And then one more after that.
Joseph A. Sprague
Steve, this is Joe. As Brandon mentioned earlier in the call, we're at a relatively early phase of taking a fresh look at our brand.
Our particular goal is to make certain that our brand expression is more consistent across all different touch points. There may be some possible changes to the design.
We're not ready to talk about that just yet. I would just say the Eskimo is a beloved part of our brand expression and something that customers and employees resonate and relate to very closely.
Unknown Analyst
Okay. And then secondly, I know that you touched on this before, but in terms of the Delta competition, there's sort of this discussion that this might lead to a merger acquisition at some point because things are different now.
Can you sort of refresh where you're at in terms of that?
Bradley D. Tilden
Sure, Steve, this is Brad. I guess what I would tell you is that we are very happy with our strategy.
We've proven over the years that us being independent has been a good ownership structure for our customers, for our communities, for our employees, and most importantly, for our owners. So we like our strategy a lot and our plan is to continue executing it.
Operator
Your next question comes from the line of Tom Banse with KUOW Public Radio.
Tom Banse
I had just one last question on the Delta competition. I'm wondering if do you think there's anything materially different from Delta attacking your West Coast core routes, compared to Alaska's earlier expansions to Delta's hubs, like Salt Lake, Atlanta and Minneapolis?
Andrew Harrison
This is Andrew. I don't think so.
Tom Banse
Is there any aspect of payback here?
Andrew Harrison
I'm not going to answer that question. What I will tell you though, is that part of the relationship we enjoy is that we connect into each other's hubs and connect our traffic beyond each other's hubs and that will continue to evolve over time and there will be adjustments made down the road.
But as Brad has very well said, we are going to focus on our instrument panel and what we need to do we'll do and guide through this to make sure that things work for the best of Air Group's shareholders, customers and employees.
Tom Banse
And then just last 1 question in terms about the past history and the present. Were your expansions into what you might call Delta's core territory friendlier than what's just happened here on the West Coast?
Bradley D. Tilden
Tom, it's Brad. I don't know that it makes a lot of sense for us to talk about that.
I mean, competition is the nature of the industry. It's been this way for 80 years and it will continue to be.
People do go into each other's markets. Our deal is just to deal with the facts that we have in front of us.
Operator
Your next question comes from the line of Glenn Farley with KING Television.
Glenn Farley
My question really goes to fleet planning. We were looking at the -- you guys never owned 757s before, but there has been some sort of increasing buzz within the industry about bringing something with those performance characteristics back.
And with your route structure now, with your 737, 800s, and 900s, do you feel like in -- I know you're getting maxes going forward, do you feel like you're sort of pushing the envelope there? Could you see getting a larger airplane, a longer range airplane than what those the 9 max and the 900 offer?
Brandon S. Pedersen
Glenn, it's Brandon. We have worked really, really hard to get both the fleets in Alaska and Horizon down to a single fleet type within even the 737 family.
As you well know, there's a number of different variations. The 900 ER is a big plane and that's a super, super plane for us right now.
So we have no plans to move to a larger airplane at this time.
Operator
And there are no further questions at this time. I'll turn the call back over to Brad Tilden.
Bradley D. Tilden
Thanks very much, Megan, and thanks, everybody, for joining us. We look forward to -- we do look forward to seeing you all in New York on November 14 for our Investor Day.
Operator
Thank you for participating in today's conference call. This will be available for replay beginning at 1:30 p.m.
Eastern Time today through 11:59 p.m. Eastern Time on November 24, 2013.
Conference ID number for the replay will be 37718015. The number to dial for the replay is 1 (800) 585-8367 or (404) 537-3406.
Also, the call will be available for future playback at www.alaskaair.com. You may now disconnect.