阿拉斯加航空 (ALK) 2006 Q4 法說會逐字稿

At this time, I would like to welcome everyone to the Alaska Air Group quarterly earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder, today's conference is being recorded for future play back at www.alaskaair.com.

Thank you.

At this time, I would like to turn the conference over to Shannon Alberts, Managing Director of Investor Relations.

Thanks.

Hi, everyone, and thank you, for joining us for Alaska Air Group's fourth quarter 2006 conference call today.

Speaking today will be Chairman and CEO, Bill Ayer, CFO, Brad Tilden, Horizon Air's CEO, Jeff Pinneo.

Also, here to answer your questions are Alaska's Executive Vice President of Marketing and Planning, Gregg Saretsky, Executive Vice President of Operations, Kevin Finan, Senior VP Customer Service, Glenn Johnson, Air Group Vice President.

Finance and Controller, Brandon Pedersen, Horizon Air VP Finance, Rudi Schmidt, Air Group Treasurer, Jay Schaefer, and Alaska's Managing Director of Corporate Communications, Caroline Boren.

Our agenda includes a management overview.

After which, we'll be happy to take questions from analysts then from the news media.

This call does include forward-looking statements and these statements may differ materially from our actual results.

Additional information on risk factors that could affect our business can be found in our periodic SEC filings.

Our presentation includes non-GAAP financial measures and we have provided a reconciliation between the most directly comparable GAAP and non-GAAP measures in our earnings release which can be found on our web site at Alaskaair.com.

As we reported early this morning, Alaska Air Group reported a net loss of $11.6 million or $0.29 per share in the fourth quarter 2006 versus a net loss of $33 million or $1.15 per share in 2005.

There are two items that affect the 2006 fourth quarter comparison with 2005.

The first is fuel hedge mark to market adjustments and the second is a favorable change to a restructuring charge originally recorded in the third quarter of 2006.

After adjusting for these items, Air Group reported a net loss of $3.4 million or $0.08 per share for the fourth quarter of 2006, compared to a Q4 2005 net profit of $600,000 or $0.02 per share.

And a Q4 2006 break-even first call mean estimate.

The fourth quarter was also negatively impacted by a $4.6 million depreciation charge associated with our MD-80s that Brad will talk a little bit more about later.

As a consequence, our results came in a bit lower than our most recent guidance, although we had cautioned in our 8K that the impact of this item had not yet been finalized.

For the full year, that brings Alaska Air Group's net loss to $52.6 million or $1.39 per share compared to a net loss of $5.9 million after the change in our maintenance accounting policy or a loss of $0.01per share in 2005.

Adjusting for the significant fleet transition costs, restructuring charges and mark to market fuel hedging gains and losses.

Alaska Air Group's net income was $137.7 million or $3.46 per share compared to net income of $55 million or $1.78 per share in 2005.

Please see pages 8-10 of our adjusted -- of our earnings release for more details on the reconciliation of our GAAP and adjusted results.

With that, I'll turn the call over to Bill.

Thanks, Shannon.

And hello, everybody.

In spite of a slight loss for the fourth quarter, we're pleased to report full year adjusted net earnings of $137.7 million, which represents our fifth consecutive year of steady profitability improvement in our largest adjusted profit ever.

To provide perspective on our progress, back in 2001 we posted an $88 million adjusted net loss.

We decreased the loss to $68 million in 2002.

Then again to a loss of $31 million in 2003.

In 2004, we made our way back into the black eking out a $5 million adjusted net profit, followed by a $55 million profit in 2005 and finally almost $138 million here in 2006.

The steady improvement is the result of countless efforts by many people at both Alaska and Horizon.

And I couldn't be more proud of the job they're doing.

Alaska Air Group's 2006 total revenue exceeded the $3 billion mark for the first time, representing growth of over 12%.

Alaska Airlines adjusted pretax was 7.4%.

And many of you know that our long-term goal was to achieve a 10% average pretax profit margin.

To do that, we have to provide customers a more compelling value than the competition and that means offering a preferred product at attractive prices.

That also means we have to have low costs.

And we're making really good progress on that front.

You may recall that at Alaska airlines, we began to lower costs beginning in 2001 when we were at $0.0873 per ASM, excluding fuel.

In it 2002, we decreased by 2.4% to $0.0852, then we went down another 2.2% in 2003 to $0.0833.

In 2004, we dropped 5% for a full year CASM of $0.0792.

In 2005, we had a bit of a hiccup as we reduced the schedule to respond to operational issues and ended that year at $0.0801.

And this year, we shaved off another 2.5% for full year 2006 CASM up $0.0781 excluding fuel.

That five-year effort has resulted in an aggregate decrease of 10.5% or more than $210 million in annual savings thus far.

This kind of steady progress gives me confidence in our ability to continue to improve our competitive position by enabling us to offer a very good value to customers and to do so profitably.

During our annual officer planning session, we set a 2007 CASMX fuel goal in the range of $0.075 to $0.076 for Alaska airlines and we identified a number of initiatives to achieve that.

Besides a modest increase in ASMs, our strategy for reaching that goal includes: continuing our fleet transition, which is now less than 24 months away from completion.

And by the way, we estimate a total CASMX fuel benefit of $0.003 when the transition is fully complete.

I think we're beginning to realize a small part of the savings in the form of better fuel efficiency and lower maintenance cost as we phase out the MD-80s from our fleet.

At the same time, Alaska and Horizon are implementing several changes that will make the airport experience easier, faster and less stressful for our customers.

By the end of 2007, we plan to implement our state-of-the-art Airport of the Future check in process at Seattle and in Juneau.

This patented design is already in place in Anchorage and has cut check in time for passengers in half.

This change will not only make more effective use of our airport space, but it supports our long-term growth plan for Seattle.

Other customer-friendly changes to watch for during 2007 include simplified ticket reissues and refunds that can be handled entirely on-line through Alaskaair.com or through our call centers.

One-way mileage plan awards, which will make finding and booking flights easier for our frequent fliers.

And consistent information at all flight information displays and customer touch points.

I want to take a minute to thank our employees for their extra effort during the record wind storm that struck Seattle in mid-December, just as the peak holiday travel was beginning to ramp up, as well as during two other snowstorms so far this winter.

Although Alaska's 2006 average on-time performance of 73.2% has improved over 2005, we're still about two points under the industry average, and we're working hard not only to close the gap, but to surpass the average.

We do face some unique challenges due to the terrain and weather conditions over parts of our system, but we're nonetheless committed to provide consistently dependable service.

It is what our customers expect and our employees deserve.

We're excited to be less than 24 months away from having a single type fleet in Alaska and we're looking forward to the return of nine CRJs to Horizon's native network this year.

These aircraft will increase our ability to match aircraft capacity with demand and replacing our aging 737-200 fleet with modified 737-400 [ INDISCERNIBLE ] will help us carry out our commitment of passenger and cargo service to the communities we serve up in the state of Alaska.

To recap our fleet changes in Alaska, in 2006, we took delivery of 12 new Boeing 737-800s and retired three MD-80s and five 737-200s.

In addition, we exercised options for 11 additional 737-800s.

Bringing our firm deliveries to 14 in 2007 and to 12 in 2008.

We started out with 35 firm positions back in June of 2005 and since then, we've exercised every option we've had available.

We're currently at 54 deliveries and firm orders and counting.

Jeff will tell you a little bit more about Horizon's fleet activity in just a minute.

During the year, we initiated service between Los Angeles and La Paz, Mexico, and from San Francisco to Cancun.

We also added new nonstop service between Seattle and Cancun and from Portland to Los Cabos and Puerto Vallarta.

Combine with added service to existing routes, this represents an ASM increase of about 20% in our Mexico markets.

We recently announced service from Portland to Boston and Orlando beginning in September.

And this is consistent with our strategy to provide more nonstop service out of our key cities on the west coast.

And In March, Horizon will begin service from the wine country of Sonoma County to both Los Angeles and Seattle.

Far from being a commodity, this is first and foremost a people business.

It's all about taking care of customers and that's why our employees are our greatest competitive advantage.

When our company prospers, employees should share in the fruits of their efforts.

This year, Alaska and Horizon employees will receive a total of $36.8 million in incentive pay.

And that's one expense that I hope gets bigger every year, because a significant payout means we're successfully executing our plan.

We're looking forward to celebrating Alaska's 75th anniversary this year, just as we celebrated Horizon's 25th last year.

We have a number of special activities planned to commemorate the anniversary, including the roll-out in February of a new 737-800 painted in an historical livery that was chosen by our employees.

As we celebrate this milestone, I'm reminded again of the legacy of perseverance and determination that comes from our roots in the great land of Alaska.

These traits will serve us well as we chart our course for the future.

At this point, I'll turn the call over to Brad.

Thanks, Bill.

Good morning, everyone.

Excluding the two special items that Shannon talked about, Alaska Airlines reported a pre-tax loss for the quarter of $1.9 million compared to a pre-tax profit of $500,000 in 2005.

Our total revenues increased by $45 million.

Our economic fuel cost increased by $27 million, and our adjusted nonfuel operating expenses increased by $25 million.

For the full year Alaska reported an adjusted pre-tax profit of $200.5 million, compared to $85.8 million in 2005.

While this adjusted pre-tax profit is a record for us, the company is quite a bit larger than we were in 1998 and 1999, the last years when we had profits of this magnitude, and the 2006 figure represents a pre-tax margin of 7.4% versus margins of 11% to 12% in 1998 and 1999.

We believe the 2006 margin does indicate that we're making very solid progress with respect to our plan and performing very well in comparison to our peers, although we haven't yet hit our 10% goal.

Our passenger revenue for the quarter increased 8.4% on a 4.7% increase in passenger RASM and a 3.6% increase in capacity.

The PRASM gain was driven entirely by a 4.8% increase in yield, as our low factor declined by 2/10 of a point.

Our PRASM increase was slightly less than the 5.5% increase for the mainline domestic carriers, however, our increase came on a capacity increase of 3.6% while the industries came on a capacity decrease of 2.5%.

Additionally, while our unit revenue gains have been a bit less than the industry's for the last few quarters, we led the industry for several quarters before that.

Our unit revenues have increased gradually over the last three years and we believe these increases have been appropriate as they've helped us recoup the very significant run up in fuel prices.

Looking at how our various regions performed during the quarter, yields were mixed with most of our regions showing relatively strong increases, while others such as California saw only modest gains.

Yields look like they're up about 4% in the first few weeks of January.

With respect to advanced book load factors, January is down about two points, while February and March look flat at this stage.

We expect January's load factors will be impacted by the severe weather we experienced in the Pacific northwest earlier this month.

Turning now to expenses, operating expenses excluding special item and including fuel on economic basis were up $52 million or 9% in the fourth quarter with half that increase coming from fuel and half coming from other areas.

Our economic fuel cost for the quarter was $172 million compared to $145 million last year.

Alaska gains from subtle hedges from $8.0 million compared to $27.4 million in the fourth quarter of last year bringing our full year hedge benefit to $87 million for Alaska and $101 million for Air Group.

With oil prices having declined recently, Air Group's hedge portfolio is now worth $69 million, including the premiums that we've capitalized.

At this point, 45% of expected 2007 consumption is capped at $58 per barrel and 19% of 2008 is capped at just under $60 per barrel.

The recent reduction in crude oil prices is obviously great news for Alaska Air Group.

If the forward curve were to remain at current levels, our raw fuel prices would be lower than those we experienced in 2006, but a curve price that we anticipate almost no hedging benefit in 2007.

Clearly we think declining fuel prices are good thing, but our 2007 hedges aren't at the same price as 2006's were.

To see a reconciliation between raw, economic and GAAP fuel costs, please refer to pages eight and nine of our earnings release.

Nonfuel operating expenses for the quarter increased by $25 million or 5.7% on to 3.6% increase in capacity, resulting in overall unit cost of $0.0806, which is up 2% from the $0.079 we reported last year.

As you know, this unit cost increase compares to decreases we had for the first three quarters of the year.

If we look at our P&L, we see that many have decreases or minimal increases.

The drivers of the unit cost increase are the following four items.

First, wages and benefits which were up by $17 million or 10% on a 6.1% increase in FTEs, a $4.3 million increase in group medical cost.

And that swing is due in part to a $2 million favorable accrual adjustment last year and a $1 million unfavorable adjustment this year and a $4.2 million dollar increase in defined benefit pension cost.

Second, variable incentive pay, which was up by $2.6 million or 33% due to our financial performance as well as payouts on some of the nonfinancial measures in our plans.

Third, we saw smaller increases in other expenses due to two favorable accrual adjustments '05 that we didn't see in it 2006 and increased passenger remuneration cost in 2006.

And perhaps most importantly, the fact that our ASMs were 4% lower in the fourth quarter than our original plan.

The unfortunate reality is it is difficult for us to pull all of the related costs out of our system as we reduce ASMs, particularly when the reductions come close in as was the case to a portion of this shortfall.

This is why it is very important we produce the ASMs that we plan.

Finally, while this doesn't affect our year-over-year comparisons, as Shannon said, our fourth quarter costs were higher than our guidance because we recorded an additional $4.6 million of depreciation expense on our MD-80 fleet at the end of December as we decided not to proceed with the sale lease back transaction on the fleet.

While we did need to book this additional depreciation, the good news is that the depreciation expense we'll book in 2007 is slightly lower than the rent expense we would have booked under the contemplated sale lease back transaction .

For 2007, we developed an aggressive plan that will help us continue to drive our transformation and improve our competitiveness.

The plan has a number of initiatives that are designed to improve our value proposition for customers, improve our operation and reduce or cost.

Bill mentioned the move to a single fleet, changes in our refunds and reissues and our plan to implement our Airport of the Future check in process in Seattle and Juneau.

In addition to these, I would like to go through a few other things we're planning.

First, we have an effort to increase our airport space utilization.

Our goal is to improve utilization from about five turns per gate at our largest airports to date to six turns by the end of '07 and eight turns by the end of 2008.

Second, we recently negotiated new agreements with most of our GDS providers that will reduce our distribution cost.

While we're on the topic of distribution, I might note that we passed a historic milestone in when we exceeded $1 billion in sales over last year in one year.

Third, we anticipate a reduction in credit card commissions as a result of a new agreement that we have in place and initiatives we have in process to increase the penetration of the Alaskan Airlines Visa card.

Fourth, we've got a project to reduce our corporate overhead by $3 million by the end of 2007 and stay within a nonunion head count cap of 1,675 positions.

And finally, we anticipate somewhat significant reductions in our defined pension plan cost and aviation insurance cost in 2007.

Of course we'll have some headwinds ahead of us including the recent unprecedented rate hike at LAX, which will increase cost there by over $7 million per year, as well as continued inflationary pressure in other parts of our business.

Capacity for the full year in 2007 is expected to increase by 4.5%.

By quarter, we're planning increases of 2.5% to 3% in the first quarter. 4.5% in the second quarter. 3.5% in the second quarter and 7% in the fourth quarter.

If we achieve our plan as Bill said, we'll reach full year CASM X fuel of between $0.075 for mainline flying, a reduction of between 2% and 3%.

For the first quarter 2007, we expect our main line CASM X fuel to be between $0.08 and $0.081 of 1% to 2% over the first quarter of 2006, because of increases in airport costs, other operating expenses and wages and benefits without commensurate increases in ASMs.

For the remaining quarters, we're expecting unit cost to be down by an average of about 4% and this reduction is currently weighted toward the quarters where we have greater capacity increases.

A final note on the look of the income statement.

We're going to change the financial statement presentation of the flying that Horizon does for Alaska to make this arrangement look more like a traditional capacity purchase deal.

We expect that Alaska will record the passenger revenue and regional flying expense for the markets that Horizon flies at Alaska's request, and Horizon will record contract revenue under the capacity purchase arrangement.

At the same time, Alaska will reclassify the amount we pay to a third airline for the Dutch Harbor flying that's currently recorded in contract services.

We're working through the final details now.

We plan to make a white paper available on our website in early February that explains more about what we're doing and what the impact will be on each company's financials.

Since these are intercompany items only, there won't be any P&L impact on Air Group.

To wrap up, we're bullish about 2007's profit potential.

As you know, in this business, revenues are hard to predict, but we're hoping to annualize some of the RASM improvements we've seen in 2006 and we're planning for further reductions in our unit cost X fuel.

If we provide a preferred level of fuel and deliver on our cost goals, we should see our five-year trend of improving earnings continue into 2007.

At this point, I'll turn the call over to Jeff to walk you through Horizon's results.

Thank you, Brad.

And good day, everybody.

I'm very happy to report we closed our our 25th anniversary year with adjusted pre-tax earnings of $23.2 million.

Our second best year ever, and our fourth executive year of improved earnings since the events of 9-11.

Our traffic growth of 8.7% outpaced our capacity increase of 6.8%, producing a new annual record load factor of 7.1%.

This represents great progress against our long-term plan and is a testament to the skill and hard work of Horizon's people in laying the ground work for providing greater value to our customers.

For the quarter, we posted an an adjusted pre-tax loss of a $.5 million.

This compares to a $400,000 profit during the same period last year.

This result came on traffic growth of 4.3% and a 13% increase in revenue, offset by a 14% increase in operating expenses.

Our CASM X fuel for the quarter came in at $0.147.

For the full year $0.142.

Both figures are in line with the guidance we provided last quarter.

Unit revenues were up 7.1% overall and 5.4% on the native network.

The slight decline in our operating results for the quarter was due principally to a higher level of scheduled maintenance activities and higher fuel prices, both of which I'll touch on in more detail in just a moment.

On the revenue side, growth in our native network revenues accounted for all of the improvement in the quarter as Frontier JetExpress revenues were flat on 4.3% less capacity, a result of Denver weather-related cancellations in December.

Our native network load factor was up by half a point.

Our yields were higher by 5.2%.

A figure that gained momentum during the quarter.

System wide, our yields improved 7.6%.

As we've commented before, the Frontier JetExpress yield is not related directly to traffic or customer pricing.

Yield performance has generally held steady into the current quarter.

Turning to expenses, the major contributors to our 14% or $20 million increase were, as in prior quarters: fuel, maintenance and wages.

Economic fuel was higher by $4.9 million or 22% on 8% more gallons and a 14% increase on price.

For the year, our fuel cost increase was $24 million or 29% on 6% more gallons and a 22% increase in price.

Our ops team implemented a number of fuel-saving initiatives this past year that have resulted in reduced cost and they're continuing to work on additional measures this year.

Maintenance was higher by $11.7 million for the quarter and $30.6 million for the year due to a higher number of scheduled heavy tanks and engine overalls.

Specifically, we had six more tanks and seven more engine overalls than we did in the same period last year.

For 2007, we're forecasting a slightly higher rate of planned overall activity which will result in a further increase in costs before the event cycle begins to decline in 2008.

This will coincide with the arrival of new 2-400s that will further reduce our maintenance costs going forward.

Wages and benefits were $3.9 million higher on a 3.8% increase in FTE and a 3.2% increase in the average wage.

Now, one component of this that I'm happy to see increase as Bill mentioned earlier is our variable incentive pay, which was higher by $600,000 as a result of our people achieving certain financial and operational goals during the period.

Our 401(k) matching expense was higher by $260,000 as more of our employees chose to participate in our defined contribution plan.

Finally, I'm pleased to report that we reached agreement with the city and county of Denver to waive their claim for $2.3 million in Frontier sales tax that I reported on in the last call and which was reversed in the first quarter.

As I mentioned before, it was a challenging December in Denver for our Frontier JetExpress operation.

In all, we cancelled 158 JetExpress flights during the peak holiday travel period.

Through it all, our Denver team never backed down from the challenge.

They responded with professionalism and dedication to the extremely adverse circumstances and we're all very grateful for their efforts.

Meanwhile, on our native network, where a brief crippling snowstorm and winter storm slammed into the region, our on-time performance and scheduled reliability were down only slightly from prior year, but at levels that are not acceptable in the long run.

Our baggage handling performance also slid due to weather, high loads and weight restricted aircraft.

Addressing these challenges and restoring what had for many months been industry-leading performance is among our highest priorities.

Through it all, our people have continued to perform exceptionally well, improved the refining processes and improving productivity another 2.3% for the quarter and 1.7% for the year.

With respect to our fleet, we have three major initiatives planned for this year.

First, we've just begun the return of the 9CRJ700s we had dedicated to JetExpress.

The first two have returned and are being deployed into new harmonization missions in west coast markets beginning next week.

Remaining seven will return between September and December.

Second, we're taking delivery of 13 new Q400s from Bombardier, at a rate of six in both the first and second quarters, and one in the third quarter.

And finally, to make room for the Q400s, we're subleasing 16 of our 28Q200s to Commute Air and delivering 11 to them this year.

We delivered our first one to them in early January.

From there, they'll receive one per month beginning in March.

As each Q200 is subleased, we'll be booking a charge that equates to the difference between our remaining lease obligation and the sublease amount.

On average, this will run approximately $1.5 million per aircraft.

We're not planning to classify these as special charges and we will provide transparency to them in future regulatory filings and on these calls.

We've provided additional detail in our press release [indiscernible] as of the end of each quarter.

Looking ahead for 2007, we're forecasting a 10.5% increase in ASMs and a CASMX fuel of $0.142.

Excluding the Commute Air charges that I talked about, our CASMX fuel target is $0.137, which represents a 5% reduction from the $0.142 we achieved in 2006 and reflects the economics of new Q400s, improved productivity and lower distribution and insurance costs.

Our ASM guidance by quarter is as follows.

For the first quarter, 3.6% .

The second quarter, 10.2%.

The third quarter, 18.4%.

And the fourth quarter, 9.4%.

Now, for an update on the Air Group balance sheet, I'll turn it back over to you, Brad.

Thanks, Jeff.

Air Group ended the year with $1.014 billion in cash and short-term investments compared to $983 million at the end of 2005.

This puts our ratio of cash to revenues at 30%, which we believe to be among the best in the industry.

The increase is due to strong cash flows from operations of approximately $460 million.

Proceeds from new debt of $391 million.

Both of which were offset by capital spending of $620 million.

MD80 lease buy outs of $70 million and debt repayments of $186 million.

As reported earlier in the quarter, we made a voluntary contribution of $50 million in December to our four defined benefit pension plans combined with $72 million in voluntary contributions made earlier in the year.

We strengthen our defined benefit plans by nearly $12 million in 2006.

On an PBO basis, we're now funded at approximately 80% and an ABO basis we're funded at approximately 87%.

We believe our funded status is among the best in the industry.

We currently expect our capital expenditures to be $680 million in 2007, and approximately $450 million in 2008, with nearly 90% of related aircraft.

Our debt to capitalization adjusted for operating leases was 72% as of December 31st, and improved a bit from the 73% we reported at the end of 2005, but up from 69% at the end of the third quarter.

Our shareholders equity was negatively impacted by $61 million from the adoption of the new pension and retiree medical accounting rules and by $19 million from the adoption of SEC staff accounting bulletin number 108.

At this point, I'll turn the call back to Shannon.

Thanks, Brad.

We're happen to address your questions at this time.

First from the analysts then we'll take any questions our journalists might have.

Luanna, would you please go ahead and assemble the roster.

[OPERATOR INSTRUCTIONS] Your first question comes from Robert Barry of Goldman Sachs.

Hi, guys.

Good afternoon.

Good morning.

I guess two questions.

One is on the ASM guidance for Horizon, I guess it is.

Pretty significant growth rates, I guess not that surprising given the aircraft coming back but any thoughts on how you're going to deploy the planes and especially how we should think about yields given you've seen the deteriorating revenue environment?

Yes, Robert.

This is Jeff.

First of all, there an awful lot of activity as you've noted.

We've got I think somewhere around 40 airplane movements in and out through the course of a year between all three fleet types.

As you can see, it peaks a bit in the third quarter here.

Which is a happy circumstance relative to seasonal demand.

So our -- is to field as much as of that capacity, keep the factories running during the busy money season during that time and then continue to transition down to a lower fleet level by the end of the year.

The yield environment as far as deployments, each of the airplanes that are coming in have already been specifically assigned.

The RJs specifically to harmonization missions early in the year followed by a -- I guess you would call it a little bit of musical chairs of RJs replacing Q400s that are replacing Q200s that are going out.

So by the end of the year, we'll have a more rationalized situation actually continuing into '08.

And through all of that, while early indications are that the yield environment is holding stable, we understand that with all of this additional capacity, we're going to have to be more aggressive promotionally in filling the extra seats.

And that's a good thing, because most of the markets that we're putting the extra capacity into are underserved.

They're critical backyard markets.

We're going to be serious about defending them.

Ad the hope is we'll improve revenue and profitability at the same time as providing a better customer value proposition in the process.

So, all in all, we think all of the moving parts work very positively.

It will come down to execution.

As you can see, it's going to be a complicated year.

And Robert, this is Bill.

We've had a really good experience from an Air Group perspective with this harmonization notion.

And it is looking at the Air Group fleet with all of the airplanes and putting the right airplane in the right market.

And so we have a number of RJs flying from the Pacific northwest to California both northern and southern California principally out of Portland to the Bay Area and the LA area, and that's allowed us to maintain frequency and right size the capacity and greatly improve our profitability on some of those routes.

Should be more of the same in the future.

Given the -- I guess what you described as the musical chairs, is there likely some added up-front cost of all of that just added complexity, maybe some -- I don't know, retraining on different, slightly different fleet types that's built into your -- into your CASM guidance?

Yes, it is, Robert.

And you're right about that.

There is a lot of training activity.

There's costs associated with airplanes coming in and going out, as well.

And all of that has been factored into the plan, in the CASM guidance.

And just one last quick one.

Any update on your plans to begin service to Hawaii?

Let's let Gregg talk about some new markets a little bit.

Yes, we had our 2007 plan contemplated additional -- one additional service in our network.

But we haven't yet decided what that city is going to be or exactly when it might start.

Ok.

We'll stay tuned.

Thank you.

Thanks, Robert.

Your next question comes from Ray Neidl of Calyon Securities.

Yes.

Looking at some of the guidance you've been given, and it looks like during this year, you expect to see cost savings step up after the first quarter.

I'm just wondering if anything specific is happening in that period that is causing this progress.

Hi, Ray, is your question more about the first quarter or about the second -- what we'll be doing in the second, third and fourth quarters?

Second, third and fourth quarters.

Yes.

We've got a whole host of issues underway.

Part of the first quarter, we have been doing some early out programs.

And we're in a kind of position now where we've got people, we're maybe higher with staffing than we'll be in the second, third and fourth quarter.

I think we talked about some of the things that we've got going for next year.

We've got this continuation of the move to a single fleet type.

I think if you look at Alaska Airlines, our maintenance costs were actually down $30 million this year, as we're beginning to see that.

We expect that continuing next year.

We've had, thanks to Jay Schaefer and the risk management team, a very substantial reduction in the aviation insurance.

We talked about some of the things, distribution costs, GVSs, credit cards and so forth.

Customer check in stuff planned, moving into the Airport of the Future at Sea-Tac and so forth.

There's lots of stuff.

We think there's lots of leverage as we just begin to move to this single fleet type and further simplify our business, and I guess we've also got some outright cost reductions that are making us feel optimistic.

Anyway, that's the detail we have.

We gave some of that in script.

I could try to address further if you had further questions.

Yes.

Well, I have a Horizon question here.

With the ExpressJet now, going into the west coast, point-to-point markets, I'm just wondering what kind of effect you think that might have on Horizon.

They've had pretty much of an open playing field in expanding into some of the smaller lucrative markets in the Pacific northwest.

Is ExpressJet going to be tough competition and kind of preclude you from expanding as fast as you had previously planned to in future years?

Hi, Ray, this is Jeff.

Well, as I think you know, we live under the presumption that we're constantly under scrutiny and potentially under attack competitively.

And so we're not surprised at these actions.

Particularly with ExpressJet.

As you know, they've been in a situation with a lot of excess capacity for a little over a year now, looking for a good home and the strategy doesn't surprise us that way.

As it relates to where our confidence lies, I think we've executed this plan and refined it over a long period of time.

We have got tremendous brand awareness and equity, strong, loyal following, mileage plan participation, etc.

All of which I think gives us good, critical mass to defend existing markets and continue to project our good story going forward.

That's really our plan.

Nothing has really changed here.

It is change of names and situations, but we take it all very seriously and we're -- especially focused on protecting and defending the markets we built over the last 25 years.

Ok, good, thank you.

Your next question comes from Mike Linenberg of Merrill Lynch.

Yes, good morning, everyone.

Good morning.

A couple of questions on just the cost side.

Brad, as you walked through, you talked about the gate turns going from 5 to 6 to 8.

Now is that a function of adding more flights in the airports?

Is that a function of getting out of some of your gates?

What's going to drive that number?

I think both things, Mike is the quick answer to the question.

We've got five or six airport where is we have a significant number of gates.

If you take Sea-Tac as an example, I think we have 26 gates today.

We're returning to -- so we're going down to 24.

But we would love to return more gates to the airport at Sea-Tac.

As well as, as we add growth and add new cities, the notion would be to try to focus that growth and to try to get economies of scale.

So, focus that growth in the cities where we're already large and we have opportunities to increase our gate utilization.

Ok.

Then you indicated that one of the savings items in 2007 was savings on the pension side, and I presume that's the new legislation being able to take advantage of that.

You told us what the contribution was in '06.

I believe it was $122 million.

What does the number look like in '07?

What actually runs through the income statement?

What is the cash contribution versus the expense just for modeling purposes?

Yes, we are actually not affected by the legislation.

Our FAS 87 pension cost, we anticipate right now will go down from $82 million in 2006 to $68 million next year.

That's because of two things.

One our discount rate is decreased from 5.75 -- it has increased from 5.5% to 5.75%.

And secondly, just the asset performance, there are lower actuary losses that have to be amortized into the 2007 expense.

That's what's driving the reduction that FAS 87 expense that we book.

Basically, our funding philosophy with our defined benefit plans the last five or six years has basically been to put in at a minimum what the actuaries would call the normal cost, or the FAS 87 service cost, whichever is higher, so that we at least don't get worse with respect to our funded status.

And on top of that, if we have a good year, we would top it up.

You saw in 2006, we did put $50 million incrementally in.

I think you should think of that normal cost or service cost of being roughly $50 million or something like that.

Ok.

And then just one quick last one.

As you laid out your fleet plan in your press release nicely.

I see the MD-80s move down.

Those airplanes, do those airplanes have a home?

Do you have a buyer for those airplanes?

I would ask Jay Schaefer, our Treasurer.

He has been directly involved in this, to address that.

Yes.

Mike, as we mentioned earlier, we looked at a sale leaseback transaction that we ultimately decided not to execute.

And so we have three airplanes that have come out of service that we still own and are parked, and we are actively working with a few parties on the sales of those, very optimistic that we will have sales on those three executed soon.

And we're going to continue to work the remaining fleet.

We'll still consider an advance purchase, but our sense is we'll have no issues selling those as they come out of service going forward.

Ok.

Thank you very much.

All right.

Your next question comes from David Strine of Bear, Stearns.

Thanks.

Good morning.

Good morning, David.

Quick follow-up on Mike's question.

What did you say the cash contribution was for '07 expected for pension?

Roughly $50 million. $50 for cash.

Okay.

And Capex is still around $.5 billion?

You know, I think we just said $680 million next year.

That's true.

Then for the first quarter for Alaska, in terms of what you're seeing on demand, last year obviously thought RASMs were decelerated as the year progressed, as you were lacking on some of the bigger capacity cuts in the industry.

When you look at your bookings now and the first quarter, do you see a continuation of that unit revenue deceleration in terms of your growth rate, or is it starting to steady out?

Hi, David, this is Gregg Saretsky.

We did see steady declines month over month as you went through the fourth quarter, and sort of see that same trend continuing into the first quarter.

But remember, in addition, we're comparing to a prior year period where our RASM, our unit revenue was up 10% to 12% in first quarter '06.

So, much more difficult comps.

All of that said, we are expecting unit revenues to be roughly flat to up slightly for this fiscal quarter.

Okay.

And that's it for Alaska group.

Any difference at Horizon?

I'm sorry.

That's at Alaska.

Any difference in Horizon?

It is pretty similar, David.

We're seeing flat to slightly up load factors and pretty steady yield pictures.

Thanks a bunch.

Yes, David.

Your next question comes from Kevin Crissey of UBS.

Good morning, everybody.

Good morning.

Can you -- maybe I missed the rationale, but could you go over the rationale for reclassifying the regional flying?

Sure, Kevin.

Horizon has become a very big company.

And so I think part of it is that recognizing Horizon's size and recognizing the importance of this feed, this will be probably in excess of $200 million that Horizon flies at the request of Alaska.

I think we felt -- this is not viewed as a big deal within Alaska Air Group, but we felt it was appropriate to kind of put the accounting and the financial reporting kind of in line with processes that have been here for some time.

And that would be the give the revenues and associated expense to move that over to the people that have responsibility for those markets.

So, that kind of is the thinking about it.

It is a little more transparent, it's a little bit better of alignment of those markets with people that have responsibility for managing them.

But as we said before, it all eliminates in consolidation and shouldn't affect the big picture too much.

Ok, thank you.

Second question, more of I guess -- would be your fuel price assumption, did you say what your actual fuel price assumption was for your -- in your CASM guidance?

We'll ask Jay to take that again.

Right now, for 2007, we're looking at $1.88 per gallon.

Okay.

Economic.

Right, right.

Okay.

Kevin, our normal thinking around that is we would just take the forward curve and we would add $0.45 cents for the crack spread and taxes, Jay.

$0.45 for the crack and about $0.13 for taxes.

Okay.

Great.

And your CASM X fuel just to confirm, that includes the variable pay as well?

It does.

Okay.

Thank you very much.

Your next question comes from Helane Becker of Benchmark.

Thank you very much, operator.

Hi, everybody.

Hi, Helane.

So, this is my question.

I noticed that your airport costs, like landing fees and other stuff, weren't up as much as I would have thought they are given what I'm hearing from a lot of the airports in terms of what they're doing with fees and facility costs.

Maybe could you talk a little bit about how that's going?

I know Seattle has been one of the more expensive airports to operate in, but some of the others are starting to catch up.

So, could you talk about what you're doing to get those costs down?

Or address that issue?

Sure, Helane.

So, we're I guess at Alaska airlines at $158 million for 2006 for the fourth quarter, we were up, you're right, 3.3%.

We did get a surprise from LAX that amounted to about $1.5 million that we booked in the fourth quarter.

I think a little bit of what you're seeing Helane, is just these airport costs kind of move in relation to when the airports are doing capital projects and when those capital projects get completed and kind of rolled into the rate basin.

If we look at this line, it wasn't that many years ago when it was $50, $60 or $70 million.

So, it has been moving up for many, many years now.

Maybe we just have a little bit of a holiday here, but as we look forward, we're very concerned.

Most of the airports where we're in still have significant capital spending programs that have still not been rolled into the rate basin.

That's why it is so important that we pursue the initiatives to get better utilization of our gates, better utilization of the counterspace and so forth.

Okay.

And then I think you have labor negotiations that are --

We do, Helane.

This is Bill.

We have long-term deals with every group.

We are just began negotiations with ALPA.

We call this as a follow-up from the two-year arbitration that happened and the amendable data on the contract is made first.

We're getting a good, early start.

We really just started earlier this month.

And we have an aggressive schedule.

They're negotiating three days a week, I think.

We're optimist as always that we can we can reach a collaborative agreement just as quickly as possible, that recognizes the financial realities of our industry.

We're moving forward and hope to have a good conclusion to this soon.

Okay, great.

Then my last question is, you used to put in here and I didn't see it in my press release, a chart that showed your fuel hedging.

Is that going to be in the -- are you going to put something out with that, or did I miss it in my press release?

You know, it certainly is in the 8Ks.

I don't remember us putting it in the actual press releases.

It will be in the 8Ks as we've done in the past.

I think that we did share that we're 45% hedged for 2007 at -- what's the number, Jay?

$58.

At $58 a barrel.

We'll give you detail in the 8K.

Okay.

Thank you.

You're welcome.

Helane, this is Bill.

I might add one other thing on the airport cost subject.

I think you're aware that LAX has imposed significant and differential increases on carriers.

Right.

We're one of the differential carriers that's going up more than others.

And we don't think it is fair.

We think it is discriminatory.

And we plan to pursue that.

Okay.

Yes, I think there are a few airlines that are talking about pursuing that.

Right.

Okay, thank you.

Thanks, Helane.

Your next question comes from Dan McKenzie of Credit Suisse.

Hi.

Good morning.

Just a quick follow-up to Kevin's question as it relates to the capacity purchase arrangement at Horizon.

I guess one investor perception is that potentially Alaska could readying Horizon to potentially spin off or to sell.

Any comment or color you can provide on that potential monitorization of Horizon?

No.

That's not the plan, Dan.

Horizon is extremely strategic, extremely important to Alaska Air Group.

If you looked at us in Seattle, for example, if you looked at Alaska Airlines by ourselves, it is 35%, 36%, 37% of the airport.

Yes, Horizon, we're close to 50%.

We understand that you could maybe get that through a contractual agreement.

We don't think that's the same as having a wholly owned entity.

So, the only interest here is lining up the management metrics a little bit to set us up for optimal execution.

Okay.

One question I've been getting from both actually the media and investors is the possibility of some airlines going private in the future.

And I'm looking at the market cap for you folks. $1.6 billion to $1.7 billion.

Really, given the strength of your balance sheet, that doesn't even qualify as an LBO.

That's like a mini LBO given the kind of debt you guys could raise and the cash flow that you're generating.

Any kind of perspective you could provide on I guess, pros and cons of being public and perhaps you folks are better off being private?

I don't know, Dan.

I guess the one thing we do get, and you just wrote a research report on us which we appreciate you picking up coverage and so forth.

We do get the pressures that exist on public companies.

I guess we think that those the same pressures would exist on us if we were a private entity.

With all of the consolidation stuff tells us is this company has to perform.

And as we look at all of this and kind of look at the industry environment, it doesn't really change a lot.

The right answer for Alaska Air Group is for us to execute the plan to continue to improve the customer value proposition.

Get our operation performing better and get our costs down and profits up and have that reflected in the stock price and then we won't have the questions to deal with.

So, that is the strategy.

That's what we're working with very, very hard.

Okay, great.

Thanks so much.

We have time for one more question and then Alaska's Managing Director of Corporate Communications, Caroline Boren will conduct the media portion of the call.

Go ahead, Luanna.

Your next question comes from Gary Chase of Lehman Brothers.

Good morning, guys.

Just a couple of quick questions for you.

First, just a knit for Brad.

The reclassification of Horizon is not going to affect the group DNL, is it?

It's going to affect Airlines Inc., right?

Exactly right.

Okay.

Second question is you kind of went through a number of initiatives that you've got in place on the cost side, and I'm curious if -- were you intending to convey those were incremental to the guidance you've given on CASM, or was that sort of how you're going to drive the reduction you're forecasting during 2007?

How should we think about that?

I think it is how we're going to drive what we've talked about for 2007.

We're not trying to say that we're incremental guidance for '07.

But I think as we have talked about several times, we have said that we think for this company to do everything it wants to do over the future, our cost needs to come down from $0.075.

We've talked with you about the notion of our costs getting below $0.07.

And so, some of the initiatives, things like the airport space utilization go from 2006 to 2007 to 2008 and beyond.

So, I think we're trying to give you a sense of what we're working on to get beyond the $0.075, $0.076 in 2007 to lower numbers in 2008 and beyond.

Okay, so your comments were sort of reflecting the things you're doing to drive the reduction.

Your forecasting and presumably those are the types of things you think are going to move you closer to that subseven goal down the road.

That's exactly right.

It wasn't intended to be upside.

That's right.

Okay.

Question also on -- I can't remember whether it was Brad or Greg who talked about annualization of the RASM gains.

I'm curious about two things.

One, as we think about stage length and the impact of that phenomenon this year, how significant is the change there, if at all, and when you talked about annualization of some of the RASM gains, could you just elaborate a little bit on what you were intending there?

From our perspective, I guess things started to pick up sort of second and third quarter for Alaska last year.

Is that what you're driving at?

Stand by.

If your final question was is stage line impacting our yield, then I guess I would say the stage length has grown about 2%.

If anything, that should put pressure down on the yields and the fact that they haven't gone down, I guess reflects that we've effectively managed to grow stage length without it negatively impacting in our revenues.

And we expect that to be much the same in 2007.

[ INDISCERNIBLE ] I talked earlier about the possibility of adding one city pair and if we did that it would be later in the year and probably wouldn't have material impact on our overall stage length.

So, we should be thinking up two for the year, Greg?

Stage length?

Yes.

A little bit.

Then with respect to unit revenues, last year first quarter as I go through the months, January, February, March, we were up at Alaska 10.4, 14.3 and 10.1 over same period 2005.

And the industry was up about that.

A little bit more actually.

So, as we look at our year-over-year comps, those are difficult numbers to try and double up again.

So, our unit revenue performance, we're expecting to be roughly flat.

Maybe up slightly.

Okay.

Does is -- when you were talking about annualization, do things get tougher in the third quarter, third and fourth?

Is that -- Maybe you said annualization and I just misinterpreted what you were saying.

I thought you said you think you're capturing some of the annualization benefit in the first quarter.

Was that not what you were trying to convey?

Well, that trend is going to continue throughout the year, because as I looked at second quarter last year, unit revenues were also up in the 10% range.

And then third quarter they're up in the 5% range.

So, there is a declining trend, which as that gets annualized, you get closer to closer to being flat year over year.

That's what we're expecting is that positive unit revenue performance in first quarter will start to flatten out as you move through the year.

Okay, guys.

Thanks a lot.

Great.That concludes the analyst portion of the call.