阿拉斯加航空 (ALK) 2010 Q4 法說會逐字稿

Please stand by for real time transcript.

Good morning, My name is Christie and I will be your conference operator today.

At this time, I would like to welcome everyone to the Alaska Air Group fourth quarter and full year 2010 earnings conference call.

Today's call is being recorded and will be accessible for future playback at www.alaskaair.com.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session for analysts and journalists.

(Operator Instructions)Thank you.

I would now like to turn the call over to Alaska Air Group's Managing Director of Investor Relations, Chris Berry.

Thanks, Christie.

Hi everybody and thank you for joining us for Alaska Air Group's fourth quarter and full year 2010 earnings call.

Today, Alaska Air Group's CEO, Bill Ayer, Air Group's CFO Brandon Pedersen, and Alaska Airlines President Brad Tilden will share their thoughts on our record financial results, the operating environment, and our future initiatives.

Other members of the senior management team are also present to help answer your questions.

Today's call will include forward-looking statements that may differ materially from actual results.

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

Our discussion today includes some non-GAAP financial measures and we provided a reconciliation between the most directly comparable GAAP and non-GAAP measures in our earnings release.

This morning, Alaska Air Group reported a fourth quarter GAAP net profit of $64.8 million.

Excluding the impact of mark to market adjustments in connection with our fuel hedges, Air Group reported an adjusted net profit of $47.4 million, or $1.28 per share.

This compares to a First Call mean estimate of $1.02 per share and to last years adjusted net profit of $4.4 million, or $0.12 per share.

For the full year, Air Group reported a record adjusted net profit of $262.6 million, or $7.14 per share, compared to $88.7 million, or $2.45 per share for 2009 and our previous record of $4.88 per share in 1999.

Additional information about planned capacity, expected unit costs, fuel hedge positions, capital expenditures and fleet count can be found in our investor update included in our Form 8-K issued this morning and available on our web site at alaskaair.com.

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

Thanks, Chris and good morning everybody.Today we reported the best fourth quarter and the best full year results in our history.

It is a fitting end to a year in which Alaska earned its third executive JD Power award for highest in customer satisfaction, was named a top performing airline by Aviation Week, had record load factors, and achieved outstanding operational performance resulting in being named best in on-time arrival performance among North American airlines from flightstats.com.

At the heart of these results are the 12,000 hard working Alaska and Horizon employees who care about the Company and provide outstanding service to our customers.

Working together, we produce great results and I want to thank and congratulate the entire team.

This year marks our seventh consecutive year of adjusted profits.

We also exceeded our 10% return on invested capital goal, a significant milestone in the transformation plan that we embarked on back in 2003.

In that plan, we envisioned a virtuous cycle that starts with engaged employees who deliver excellent customer service, leading ultimately to sustained financial success.

That success in turn allows us to grow our business.

In that vain, today we announced an order for 15 new Boeing 737-800 and 900ER aircraft to be delivered in late 2012 through 2014.

When we embarked on our 2010 plan, it wasn't just about creating sustainable financial performance, although that was very important because we realized that investors had largely been left out of the equation in this industry.

We set forth a number of ambitious objectives that define a great company, not just a great airline.

So, let me share some accomplishments with you.

First, safety.

We aim to be consistently recognized as having best in class safety practices and oversight.

We've been early adopters of every important flight deck technology over the last two decades.

We pioneered RNP technology in the mid-90s and now have RNP procedures at 25 airports.

In fact, Alaska's extensive track record of innovation and flight safety technology was one of the reasons Air Transport World named Alaska the winner of its 2011 airline technology leadership award.

In addition, Alaska and Horizon have received the diamond award for maintenance excellence from the FAA for many years and have developed robust vendor oversight programs.

Second, we've restructured our network so that we're more balanced seasonally and much less dependent on the state of Alaska and our traditional routes up and down the West Coast.

In 2003, when we established the 2010 plan, Hawaii was simply a question mark.

But now it represents about 15% of Alaska's system, placing us a close second to United in daily West Coast departures to the Islands.

Third, we have successfully negotiated long-term contracts with all of our major work groups that provide market-based compensation.

Most recently, we reached agreements with Horizon's pilots and mechanics, as well as a three-year tentative agreement with Alaska's IAM representative group, which includes customer service and reservation agents among others.

We've closed all of our defined benefit plans to new entrants, replacing those plans with generous defined contribution plans and improved the security of the defined benefit plans by contributing nearly $700 million since 2003.

Fourth, all of our employees participate in common incentive plans with the same goals.

And Air Group employees this year earned $92 million through these plans, the highest ever.

That equates to more than one month's pay for everyone and is consistent with our vision of sharing our success broadly with employees.

Fifth is fleet.

We set a goal to have a single fleet of efficient Boeing 737 aircraft and we achieved that back in 2008.

Horizon will complete its transition to an all Q400 fleet by June of this year.

Next is growth.

While we're fully supportive of industry efforts to balance supply with demand, we believe that the most efficient operators should grow more than the industry average.

In contrast to flat domestic industry capacity since 2003, Air Group's ASMs have grown by 18%.

With the fleet order announced today, we'll have the option to grow at a rate of 3% to 6% annually for many years, assuming economic conditions and fuel prices support that level of growth.

And just to be clear, we won't grow at these rates if conditions don't permit.

And finally, cost.

We've reduced Alaska's non-fuel unit cost from 8.73 cents in 2001 to 7.85 cents in 2010.

While difficult, we know we're not done since our view is that we're permanently in a low fare environment.

With Alaska making good progress, we've turned our attention to improving Horizon's financial performance.

In 2011, we'll see two major changes.

First, our plan to transition to an all Q400 fleet is becoming a reality as we expect to be out of the remaining 13 RJs by June of this year.

And second, effective this month, we move to an industry standard CPA model whereby Alaska is purchasing all of Horizon's capacity.

We've also decided to phase out the Horizon external brand and put the Alaska Eskimo on the tail.

That was a difficult decision because we recognize the strength of the Horizon brand in the Pacific Northwest and employees pride in that 30-year-old brand.

However, this change is an important part of our efforts to bring our two companies closer together while keeping the operating certificates separate.

Our team at Horizon continues to manage these changes and I want to thank them for their hard work during the past year.

As we look at the current environment, we're encouraged by the demand trends, despite slow overall economic growth.

Our biggest concern is oil prices.

On that front, we believe that we're well positioned to deal with the rising cost of fuel because we have the most fuel efficient airplanes in their class and arguably, the best fuel hedging program in the industry.

Also, because our smaller size allows us to be more nimble, we were able to quickly adjust capacity as conditions dictate.

Our size has been and remains a source of competitive advantage.

To sum it up, we believe that the changes we've made over the past several years have fundamentally improved the economics of our business while balancing the interest of all of our stakeholders.

Secure careers for employees where they share in the Company's success through generous incentive plans, award-winning service and low fares for customers and sustained profitability and long-term returns for our shareholders.

And with that, I'll turn the call over to Brandon.

Thanks, Bill.

Hello, everyone.

As Chris said, Air Group reported a record fourth quarter adjusted net profit of $47.4 million, compared to a $4.4 million profit in 2009.

The full year was also a record.

With adjusted net profit rising to $262 million, compared to an $89 million profit in 2009.

I join Bill in congratulating all Alaska and Horizon employees on these outstanding results.

Our full year results translate to a record 11.1% adjusted pre-tax margin, which brings our 2010 return on invested capital to 10.7% which is an after-tax number by the way.

Eclipsing our 10% goal and our estimated 8% weighted average cost of capital.

I might also note that this is the first time since 1999 that we have reported an adjusted profit in all four quarters, a direct result of the important changes we've made to reduce the seasonality of our business.

For the fourth quarter, our pre-tax results improved by $65 million, revenues grew by $112 million or 13% on an 8% increase in capacity and a 5% increase in unit revenues.

The revenue increase was offset by a $42 million increase in our economic fuel costs and flat non-fuel costs.

For the year, Air Group revenues increased by $433 million or nearly 13%, but those gains were offset by a $150 million increase in our economic fuel cost.

Our raw fuel costs increased by $213 million or 31%, and we had a net hedge benefit this year of $3.3 million.

With the increasing price of oil and the higher cost of hedging, we're often asked if our practice of using all caps to hedge fuel price still makes sense given the higher cost of options.

We absolutely believe it does.

Our goal is to manage volatility and ensure the Company against balance sheet threatening spikes in oil prices.

We're currently hedged at $86 a barrel for 50% of our planned consumption in 2011.

The premium cost on those caps is about $11 a barrel, meaning we're in the money at $97 crude.

With some analysts predicting oil prices to reach $100 or more, we feel good about our level of protection.

Our non-fuel costs were basically flat year-over-year even though we increased capacity by 5%.

We're very pleased with our non-fuel cost performance this year and want to acknowledge the impressive job that our managers and front line employees around the Company have done to manage costs by increasing productivity and keeping overhead in check.

Brad will give you some statistics on productivity, but it is notable that we reduced overhead by $11 million in 2010 on top of the $17 million reduction in 2009.

Turning to incentive pay, we're proud to be able to share more than $90 million with our employees through our performance-based pay, or PBP program, and the operational performance rewards program, or OPR.

Under the PBP program, the vast majority of our employees have a target bonus equal to 5% of pay.

However, in 2010, we exceeded the goal set by our Board in nearly all categories.

So, the payout for most employees is roughly 185% of target or more than 9% of pay.

As Bill said, this is in excess of a month's pay, which is unprecedented in the industry today.

Alaska employees also hit the monthly OPR customer satisfaction and on-time goals 12 out of 12 months, earning another $1,200 each.

While Horizon employees hit the OPR targets nearly as often, earning $1,050 each.

Turning to the balance sheet, we closed the quarter with $1.2 billion in cash and short-term investments or 32% of revenues, which should place us near or at the top of the industry.

We generated $520 million of operating cash flow in 2010, compared to just over $300 million last year.

Operating cash flow was offset by relatively modest capital expenditures of $180 million, resulting in free cash flow of $340 million for the year, a record for us.

We prepaid $169 million of long-term debt in 2010 and another $26 million earlier this month.

We also expect to prepay $25 million next week, bringing the total pre payments to $220 million.

A deleveraged balance sheet combined with strong earnings resulted in a debt to cap ratio of 67% at the end of the year -- the lowest leverage level since 1999.

And finally, we repurchased 1 million shares of our common stock this year for $45 million, bringing our total repurchases since 2007 to just over 7 million shares.

The current $50 million authorization expires in June and we have about $30 million still remaining.

I want to spend a minute talking about our fleet changes.

As Bill mentioned, we've added 15 new Boeing 737 deliveries to the fleet plan, 13 of which will be 900ER deliveries in 2013 and 2014.

There is a table in the press release that shows the ins and the outs over the next several years.

On the Horizon side, we expect to dispose of the final 13 RJs this year.

Eight will be subleased to another operator and back filled with an equivalent number of Q400s.

Brad will provide more color on the remaining five RJs in a moment, but the net result will be a reduction in the number of Horizon airplanes to 48 by midyear.

With these changes, we expect our 2011 CapEx to be approximately $385 million.

This includes the three 737 deliveries in the first quarter that we will pay for with cash on hand, and the eight replacement Q400s I just mentioned, which will likely be financed because of the attractive rates available to us.

Looking out a bit farther, we expect 2012 CapEx to be approximately $370 million, although I want to reiterate that this is a very preliminary estimate.

While it is not CapEx per se, we expect to fund approximately $100 million to $125 million of the remodel costs at LAX terminal 6 this year, the majority of which will be reimbursed by the airport authority or the TSA no later than upon completion of the project.

We look forward to moving into our new home at Los Angeles in 2012.

If the environment remains similar to what we're seeing today, we expect to generate free cash flow again in 2011.

As I said last quarter, this remains an important goal for us and will allow us to continue to strengthen the balance sheet.

Turning to pensions, we're pleased to announce that for the second consecutive year, we've contributed $100 million to our defined benefit pension plans in December.

This is in addition to the $45 million that we contributed throughout the year under our normal funding policy.

It is also important to note that we had no required funding in 2010.

Our funded status now stands at 85% on a PBO basis, up from 77% at the end of 2009.

In 2011, we expect pension expense to be approximately $50 million, roughly flat compared to 2010.

We plan to make cash contributions of approximately $35 million in 2011 although again, we have no requirement to do so.

Before turning it over to Brad, I wanted to touch on Horizon's results.

Horizon posted about break even pre-tax results for the quarter, similar to last year.

For the full year, Horizon posted an adjusted pre-tax profit of $22.8 million, compared to a $7.7 million profit in 2009.

The 2010 results include signing bonuses resulting from new contracts with pilots and mechanics, and the 2009 results include nearly $9 million of Q200 exit charges that were not treated as special, making the comp a bit difficult.

But on a more apples to apples basis, Horizon's results improved by roughly $10 million, although we're still not at a point of earning appropriate returns in the business, reinforcing the need to make the changes that we've initiated.

As we exit the CRJ fleet in 2011, we expect to record fleet transition charges of up to $3 million per airplane as they leave the operating fleet.

And finally, as we transition to an all CPA model, the results of the individual subsidiaries become less meaningful.

As a result, you can expect our disclosure in the future to be more focused on the consolidated results.

However, we'll continue to provide statistical and financial information for the Alaska main line business.

This moves us to a reporting format that is more consistent with what others in the industry are doing.

The guidance in today's investor update reflects that change.

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

Thanks, Brandon.

Good morning, everyone.

This was another great quarter for Alaska Airlines.

We reported an adjusted pre-tax profit of $77.3 million, compared to $8.9 million in the fourth quarter of 2009.

For the full year, our adjusted pre-tax profit was a record $404.9 million, which represents a record margin of 11.8% and a 178% improvement over last year.

As Bill and Brandon have noted, we're performing well on virtually all fronts and producing results that are a testament to the hard work that our people have put in over the past few years.

We've made fundamental changes that have not been easy, but the perseverance, dedication and willingness of our people to work through these issues and to implement the structural changes outside of bankruptcy is unique in this industry and something we are really proud of.

Things are never perfect, but we believe this team is more aligned than those at other airlines and more able to respond to changes in our industry quickly and effectively.

One area that demonstrates the outstanding efforts of our people is our on-time performance.

For all of 2010, Alaska reported an 87.5% on-time arrival rate, representing an all-time high and an increase of 4.6 points over 2009.

This is the best performance among the top ten airlines resulting in recognition from FlightStats as Bill mentioned.

The fundamental changes we've made had an objective of positioning us for sustainable profitability and growth, and the aircraft order announced today will allow us to do just that.

The 737-900ER with its common flight deck, pilot training, and maintenance procedures will be a great addition to our 737 fleet.

Depending on its ultimate configuration, the 900ER will have between 21 and 27 more seats and lower unit cost than the 737-800, without a significant increase in capital.

The 900ER will be a perfect fit for our transcon, high traffic West Coast and midcon markets and will be the most fuel efficient narrow body aircraft available on a per seat basis.

The 900ER is at least 6% more fuel efficient than the smaller 737-800 and is 8% more fuel efficient than an Airbus A-321 on a 1,500 mile stage link.

With an additional 13,000 pounds of gross weight capability, the 900ER will reach many more markets than our current 900s.

The airplane order gives us the opportunity to grow modestly and ramp up growth if economic conditions permits.

The table in our press release shows potential ASM and block hour growth for the next several years.

Because of our growth, we now expect to recall the rest of our furloughed pilots by April 1, of 2012.

This means that we will have offered a recall to all of our furloughed employees somewhere in our system by that date.

As Brandon said, with Horizon's transition to an all Q400 fleet, we were left with five aircraft lines of West Coast flying that are not well suited for our Q400 or a 737.

So, today, we're also announcing an agreement with Skywest Airlines for capacity purchase flying.

Under this arrangement, Skywest will lease or sublease the last five RJs in the fleet.

We expect this to start in May and we expect that Skywest will primarily be flying the RJs in longer stage link city pairs between the Pacific Northwest and California.

We're also examining the marriage of using Q400s on select flights in the state of Alaska.

This would be new for us, but it is consistent with the actions we've taken in the lower 48 to harmonize flying between the two carriers so that the right airplane is serving the right market.

The fact that the Q400s will have the Alaska livery will make this transition easier if we elect to go this route.

The fundamental reason for considering this change is to lower our operating cost in lighter traffic city pairs and to pass the benefit of those lower costs on to our customers through lower fares.

Should we decide to move forward, this change would not take place before the end of the year and it would likely involve two or three airplanes.

Mainline passenger revenue increased by $100 million or 17%.

On a 10% increase in mainline capacity, passenger unit revenues increased 6.3%.

The present increase was driven by a 3.6 point increase in load factor to 83.8% and a 1.8% increase in yields.

I might note that our load factor of 83.8% was the highest among the largest ten domestic airlines, which is a first for us as a major airline in any quarter let alone the fourth quarter.

Mainline PRASM growth was consistent throughout the quarter, increasing by 5.6% in October, 6.6% in November and by 6.8% in December.

December was particularly noteworthy because of the nearly 11% increase in capacity.

Our December PRASM increase was 1.4 points better than the industry's.

Unit revenues increased in every one of our regions.

With Mexico and trans con doing particularly well.

We launched several new Hawaii flights in the fourth quarter and started our Sacramento and San Jose to Guadalajara flights.

In this quarter, we launched Bellingham to Honolulu service on January 7, and we will start Oakland and San Jose to Kauai service in March.

We're obviously very pleased with our results in Hawaii and these markets have helped boost winter traffic and further reduced seasonality.

Currently, our mainline advance book load factor for January is up about 2 points and February and March are both up about 0.5 point.

Fourth quarter main line CASM ex fuel was 7.75 cents, down 9% from 2009.

We extended the full year with -- we ended the full year with main line CASM of 7.85 cents, down 5% from 2009 and well below our original guidance of 8 cents.The cost reduction was driven by higher than planned capacity and excellent cost control, especially in the area of productivity.

As a pre-deregulation airline, we know we're burdened by relatively high wage rates and legacy benefits such as our defined benefit pension plans.

Productivity is our most effective tool for keeping our costs competitive.

Alaska's productivity increased by 9.5% to 159 passengers per FTE per month in 2010.

These productivity gains have come from significant changes in the way we staff our business.

We recognize that some of these changes have been difficult for our front line employees and we want to thank them for helping us make this work and helping to produce these excellent results.

We know our customers want low fares and in order to provide low fares, we need to have low costs.

Looking forward, we expect 2011 mainline unit costs to be down approximately 3% from 2010, which would put mainline CASM ex fuel at 7.6 cents.

For the quarter, we're anticipating mainline non-fuel costs of between 7.9 cents and 8 cents, or about 5% to 6% lower than the first quarter of 2010.

First quarter capacity is increasing 13% as we annualize utilization improvements implemented in the Fall of 2010.

For the second, third and fourth quarters, we expect main line ASMs to grow 10%, 6% and 5% respectively resulting in full year, mainline ASM growth of between 8% and 9%, which is unchanged from the guidance we provided last quarter.

Just to be clear, this first and second quarter growth is largely the extension of flying we added in the second half of 2010.

At this point, I would like to turn the call back to Bill.

Thanks, Brad.

2010 was a record year in nearly every regard and reflects the efforts of the past decade, as much as the last 12 months.

I want to once again thank our people for being open to new ideas and working together to deliver outstanding customer service and operational performance.

And though it has been difficult at times because of our collective perseverance and the structural changes we've made, our future is as bright as it is has ever been.

At this time, Christie, we're ready to take questions.

(Operator Instructions)As a reminder ladies and gentlemen, everyone is allowed to ask one question and one follow-up question.

Your first question comes from Hunter Keay with Stifel Nicolaus.

Thanks.

Can you hear me?

Hi, Hunter.

Hi, how are you?

Good morning.

Curious about some of this Mexicana stuff.

How much of the capacity growth is in markets where you're back filling Mexicana after it looked like they were going to shut down permanently, and how does their announcement that they are going to restart operations again impact some of those capacity decisions?

Hi, Hunter.

This is Andrew.

As it relates to Mexicana, that did create some opportunity for us.

And in fact, part of our growth in the first quarter of this year, 11% of our total growth is going to be in Mexico.

We found that the ASMs we put back into Mexico through Mexico City and Guadalajara have done very well.

With the news of maybe Mexicana starting up again, we watch that very closely but at this time, we're very happy with the capacity changes we've made in Mexico.

Was that 11 points of growth or was that 11% of the incremental growth?

So, the first quarter say 13% growth, about 1.5 points of that is Mexico.

Hunter, this is Brad.

We've added service to LA, Mexico City, maybe last fall, Andrew.

More recently, we've added San Jose and Sacramento to Guadalajara, both which would of been -- those are opportunities created by the Mexicana bankruptcy.

We've also added San Diego to Puerto Vallarta service, Andrew, and San Jose to Cabo, which Mexicana would not have been in those markets.

Overall, Mexico is probably on an annual basis in 2011 about 8% of our total capacity.

All right then.

That's helpful.

Thanks.

And second one on the -- a little more on the 900ERs, I would like to flush out more color there.

You mentioned some trans con stuff.

I appreciate that.

Have you thought about anything that would prohibit you guys from exploring something south of Mexico?

Maybe there into deeper central or South America?

I think some exposure, particularly to Brazil would probably jive pretty well given their GDP growth rates with your ASM growth.

Any thoughts there?

Hunter, right now, as it relates to the 900ER, we're very focused about incorporating that into our current network and really using the economic power of its CASM in our high density markets and to be able to serve some of the trans con markets with very high traffic that we could well do with some extra seats.

That's our focus right now.

Hi, Hunter, it is Brandon.

One thing I would add to that is, you've seen most of our growth over the last few years really be out of our cities where we have point of sales strength.

I don't see us deviating from that here in the near term.

Thanks.

That's very helpful.

Thank you very much guys.

Thanks, Hunter.

Your next question comes from the line of Bill Greene with Morgan Stanley.

Hi.

I'm wondering if we can talk a little bit about -- I realize the outlook for capacity from you guys really hasn't changed much, but I think there is a broad sense that, that's been the case so far this earnings season.

We've not really had any airlines sort of reacting to fuel prices.

And admittedly, your results suggest that you probably have a bit better justification for some of the growth.

But nonetheless, the industry still seems to be growing at a rate that I would argue is a bit faster than I think folks would have thought given the run up in fuel.

When you last had and faced a run up in fuel, what was the thought process that went into deciding whether or not you should adjust capacity?

Because I realize there is probably not a fuel price specifically, but there's got to be some sort of attributes of what that environment looks like where you would go and adjust the capacity.

Hi, Bill, good morning.

It is Brandon.

I'll start and I think Andrew will jump in here.

We actually have thought a lot about this question over the last few weeks as we've seen fuel prices run up.

The way we think about it is we think about the kinds of structural changes that we've made to our business since 2003 and how that positions us to what might be short-term spikes in oil prices.

I think longer term, the industry responds.

Short term, the kinds of structural changes that we've made that we think better position us to handle those kind of changes.

The other is we look at the fuel efficiency of our fleet, which will only get better with the 900ER, the strength of our hedge positions in terms of insulating us from the shocks and then we really go to what's our advantage versus other guys other than that.

And that is our smaller size and our ability to move quickly.

I think you've seen lots of examples of how we've changed and redeployed capacity over the last couple of years, particularly in response to the fuel run up in 2008.

And we would absolutely do those kinds of things again to the extent the situation warranted it.

At $86 a barrel oil, I'm not sure we're there.

Andrew?

Bill, just to give you some numbers here, in the fourth quarter of 2008 when things began to implode, if you compare that to the fourth quarter of 2010, we've actually grown our ASMs 10%.

Load factor is up 8.6 points.

Departures are flat and our unit passenger revenues are up 9%.

So, we feel very confident that if we're struck again by another significant change in the economic environment, we'll be nimble and we will redeploy our fleet and react appropriately.

Ok.

Just as a follow-up, if you look out across the competitive landscape there, is there anything that stands out as something you have got to keep an eye on and sort of watch whether it is looking at sort of Virgin America's plans to grow the fleet, or is there anything out there that kind of stands out that you've kind of got your eye on that you're sort of watching closely to make sure you have the right strategy for?

Bill, this is Bill Ayer.

We're slightly paranoid here.

(Laughter) We look at all sorts of things.

The things you mentioned are all things that are on our radar.

But the best we can do is control what we can control and you've seen evidence of that over the last several years.

Bringing our cost down to structural things that Brandon talked about and then taking advantage of our smaller size to be nimble and understand customers, understand competitive mindset and respond appropriately to continue to have a successful outcome.

So, given the fact that sort of in both answers here, the size of the Company sounded like a strategic advantage, does that suggest there is an upper limit to growth?

In other words, you might lose the agility?

No, Bill.

It is Brandon.

I think we're a long way from losing the agility.

We're still 3% of the business and we compete against airlines that are multiples of our size.

So, we're a very small company here.

We have a big revenue number, but we think and act like a small company.

I think we're quite a few years away from that changing.

I think it is at least as much how you behave as to what the employee head count is.

We are embarked on some efforts right now to really work together with our folks to understand the employee point of view, and understand customers and we're going to feel even smaller.

Even if we do grow the head count a little bit over time, I think we can maintain this for a long, long time.

Okay, great.

That's very helpful.

Thank you.

Your next question comes from Duane Pfennigwerth with Raymond James.

Hi, guys.

Good morning.

Good morning, Duane.

Wanted to ask you some questions on your regional business.

First, on the five 700s that are going to go to Skywest, what's the term on that agreement?

Duane, this is Andrew.

It is -- five, six years.

Basically, the term with Skywest matches our remaining lease obligations for the airplanes.

Okay, that's great.

And then, at this point, I think you have visibility into the fact that you're going to lose the other eight or get rid of the other eight.

What's going to happen to those eight 700s?

That the last eight are just going to go to another regional operator through lease or sublease.

Do you think it is likely they show up at another operator here?

They will definitely show up with another operator in the US, yes.

Okay.

And then just on your CPA, can you talk about is there a target margin for Horizon in that CPA?

Can you talk about the structure of it a bit?

Duane, what I think we would say about the structure is it is a fully industry standard structure with rates for aircraft, and maintenance, and pilots, and flight attendants and so forth.

In terms of the margin, it does have a margin not unlike the other deals that you see in the industry, but our thinking is that we're not going to disclose that margin at this point in time.

Okay.

That's fair enough.

But moving to that industry standard, does that help you think about perhaps selling that business down the road?

No.

This is Bill, Duane.

We think Horizon continues to fit in the Air Group picture here.

It fills an important niche in terms of our ability to serve the Pacific Northwest.

This point of sale idea is really important to us.

We view that not just to Seattle or Anchorage or Portland, but really the whole Pacific Northwest in its entirety, and Horizon airplanes and that we control the flying of those airplanes.

And we have oversight on the safety and the whole thing, we think is a real asset for Air Group and that's our intent to work with through the changes we've discussed here and improve the competitiveness and financial viability of that entity and have it contribute even more significantly in the future.

Okay, guys, thanks very much.

Thanks, Duane.

Your next question comes from Ray Neidl with Maxim Group.

Good morning.

Hi, Ray.

Just to get back to Horizon here, you went over pretty well but just some general things is, you're changing the name.

Operating margins were down.

I guess that's going to change with the Q400.

You're keeping a separate operating certificate.

I guess that means you're keeping separate union agreements and what do you think the growth might be there?

Hi, Ray, this is Glenn.

I'll start out with a couple of observations and let the others chime in.

We're adopting the Alaska external brands.

We're repainting the airplanes and putting Alaska Airlines external marks on that, keeping the Horizon name on the airplane also.

So, we're remaining independent company, separate operating certificates and as you say, all the union agreements remain as they are.

The focus for Horizon really becomes producing efficient, safe ASMs on behalf of Alaska.

And we still have a lot of work to do on the Horizon side in terms of getting our costs down.

We returned a 5% return on invested capital on the Horizon side of the business for 2010.

So, we're only about halfway to our target of a 10% in line with the Air Group target.

Hi, Ray, Brandon here.

I don't think you would see us grow Horizon until we're at a point where we're achieving appropriate returns in that business.

Okay, great.

That makes sense.

And then the second one is just a very general question that I have.

You're doing a good job out of free cash flow and cleaning up your balance sheet.

You're down to 67% debt to cap.

What's your goal?

What would be the optimum level of debt to capitalization?

I've heard some airlines say 60%.

Others think that maybe going below that would get you a higher multiple.

Do you have any opinion on that?

Yes, Brandon here.

I don't know if I have an opinion necessarily about the multiple, but in terms of the right leverage ratio, I think something that starts with a six is probably appropriate for us.

I think that balances the cost of debt and equity capital nicely, while still not putting shareholders at risk.

Lower leverage I guess is better and so absent any other good use of cash, my vote would be to pay down more debt.

I'm not sure we're at that point.

If we have free cash flow, we have a lot of flexibility to do a lot of different things and debt pre-payments or continuing debt pre-payments would be certainly an option to us.

I don't see us necessarily headed toward the 50s as a goal.

Okay, great.

Congratulations on the quarter.

Thank you.

Thanks, Ray.

Your next question comes from the line of Dan McKenzie with Hudson Securities.

Hi, good morning, everybody.

Hi, Dan.

I appreciate your fleet commentary and I understand the new planes are more fuel efficient, but in light of the order, what flexibility do you have to park planes or shed aircraft if needed?

If you needed, could you keep the fleet plan flat say in 2012 and 2013?

Hi, Dan, maybe I'll jump in.

See if Brandon wants to follow.

This is Brad.

We own the vast majority of our airplanes, including some 737-400s.

We always have the possibility of selling airplanes or parking airplanes or reducing utilization of the airplanes that we have.

So, that flexibility exists.

If we were to see something that caused us to want to pull in capacity, that's what we would do.

One point I might make is if we were to see fuel prices run to 120, 130, we were seeing a need to get prices up, we would get prices up and if those increased prices reduced demand, what we would do is what we did in 2008, we would do a market by market review.

We would get the seats right in each market.

That algebra is what worked so well for this Company over the last 24 months.

We would do that again.

What was available to us in 2008 is we could take some of these airplanes and put them into new markets like Hawaii or St Louis or Houston.

We would probably look to do that again.

But if that failed and that wasn't available to us, we would look at either selling an airplane or reducing utilization in the current fleet.

Okay, good.

I appreciate that.

I guess as a second question here, Alaska has had a real nice west coast niche for the past 20 years, but the industry is changing particularly with Southwest becoming stronger.

So, I guess my question is first, is the west coast niche enough looking ahead and then longer term, what strategic weaknesses in your view likely need to be addressed ahead?

Dan, this is Andrew.

I'll take a shot at that.

Obviously, we've been in the west coast a long time.

Very important to us.

Southwest is a really impressive airline and competitor.

We've been going head to head with them for many, many years.

We'll continue to do so.

Overall right now, we're very much to the points this morning looking at two things.

Not only just the network, but when you see fourth quarter CASM EX of 9% reductions, productivity up nearly 11%.

As we continue those into 2011, we don't know what other opportunities are ahead of us.

As we get our costs down, get our fares down, continue to build our Hawaii presence and strengthen the Pacific Northwest, we're just excited about potential opportunities.

That's where we are right now.

Okay.

Thanks.

Your next question comes from Helane Becker with Dahlman Rose .

Helane?

Helane, your line is open.

Hello.

Can you hear me?

There you are.

Oh, there you go.

Okay, thanks.

So, I have, of course, two questions.

The first question is what about paying the -- the idea of paying a dividend.

I know you returned capital by buying back stock, but have you talked amongst the Board members or has the Board talked about instituting a dividend?

And the second question is does the pilot contract permit the extended range aircraft or do you have to do a modification on the contract?

Helane, it is Brandon.

I'll start with the dividend question.

Yes, our Board has talked about it.

At this point, we prefer the share repurchase route.

We are very comfortable with the changes that we've made in the business and feel confident that the changes are going to produce sustainable profits.

But we want to put some track record underneath us before we give it a lot more serious consideration.

I think a repurchase accomplishes the same objective and we don't get ourselves into a position of starting a dividend and then being forced to turn it off because of the volatile nature of the industry.

But ideally, some day, we might have a more thorough discussion about that.

As far as the pilot contract goes, I'm going to let Ben Minicucci, our COO, answer that question.

Hi, Helane, it's Ben Minicucci, operations.

No, our existing ALPA agreement allows us to fly the 900ER with no changes.

Okay.

Great.

Thank you very much.

Thanks, Helane.

Your next question comes from Gary Chase with Barclays Capital.

Good morning, everybody.

Wanted to see -- I apologize if I missed this in the prepared remarks, but Brad, I know you discussed the book load factors for January.

Did you mention anything on what you're seeing in terms of yield trends as we roll into the new year?

We didn't, Gary, but I'll ask Andrew to cover that.

Thanks, Brad.

Gary, as you probably know, we normally don't give that guidance.

But I will -- just a couple of remarks on the fly overs.

In the last six weeks, we've been able to pass on between $7 and $15 in fare increases in the lower 48 and Hawaii.

The last ten weeks, percentage increase in traffic every single week has been higher than our ASM growth that we're looking at.

We were very happy with the growth that we had in Q4 and the highest growth markets, which were Hawaii and Mexico, had the highest unit revenue increases.

So, we feel strength there and just from a business, our fourth quarter first class cabin, we increased our seats 5% in the fourth quarter.

Our paid first class was up 23%.

So, as we go into the first quarter, we feel good about the loads.

We had a wonderful sale in November.

That helped fill our airplanes as we go into the first quarter.

And so I think you should see, without my crystal ball here, continued strength in the first few months of this year.

Okay.

And then, if I could ask a more strategic question and it kind of follows up on the way that you've answered some prior questions about the smaller size and the ability to be nimble.

I'm wondering if I read between the lines, if you think there is a major unexploited network opportunity that you might be able to turn a lot of these assets towards an -- in an adverse environment and is there maybe some potential that you would look to dial up the growth if we don't have a bad outcome on fuel or if the revenue environment continues to improve.

It just feels like the way you're answering these questions, the confidence you're reflecting and your ability to adapt suggests that maybe you're eyeing a larger growth opportunity than maybe we've been thinking.

Gary, this is Bill.

We're just -- we're comfortable with where we are.

And this idea of some modest amount of growth based on the profits that we've generated in this ROIC target and hoping to continue to build on that, got the right kind of airplane, we think we've got the market opportunities out there, we think we have the right product for our customers, and most importantly, we think the employee side of the business is working really well.

Productivity is very encouraging.

So, there is nothing really more to it than that.

Kind of an incremental approach to some growth and taking advantage of opportunities.

It has worked well.

We're going to continue on that path.

Gary, this is Brad.

There have been a lot of questions on growth today.

Might just make it really clear.

There are three airplanes coming to Alaska mainline this year and three airplanes coming next year.

That's what's happening in the next 24 months.

Okay.

Guys, thank you.

Thanks, Gary.

Your next question comes from Michael Linenberg with Deutsche Bank.

Good morning, guys.

Just a couple of questions.

The 10.7% ROIC, Brandon that you mentioned, is that on Air Group or is that just on Alaska, the main line?

Air Group.

Okay.

And then when you were talking about how you would like your debt to cap to have a six in front of it.

Maybe you said this and maybe I missed it.

Are you shooting for an investment grade rating or is that less important to you?

Maybe you don't get the credit in the market place on your borrowing costs.

What are your thoughts on maybe moving toward investment grade?

We don't necessarily have an explicit goal to be investment grade and I'm not sure how much it would lower our borrowing cost.

We've got great collateral and I think what you see happening is lenders make lending decisions more based on their own internal credit evaluations as opposed to an S&P or a Moody's rating.

So, I'm not sure it gets us a ton, although there are some optics that go with that and there would be nothing wrong with having more than one investment grade airline in the US.

So, I guess that's a long-winded way of saying it would be great, but we're very comfortable with where we are on our balance sheet.

I think you'll continue to see our leverage go down and if we get there, that's fabulous.

Jay?

Do you want to add more to that?

No, I think the only thing I would point out as well is last year, we paid off the last of our public debt and so we actually don't even have any requirement for a Moody's or S&P debt rating.

So, as we improve our financial performance, we'll evaluate whether that's an even useful metric for us to have in the public space.

Okay, great.

Just my last question to Andrew, you talked about the revenue trends and where book load factors are headed, what -- just the competitive backdrop.

What are you seeing?

You have a decent amount of capacity coming into markets like Hawaii and I realize some of it is the annualization.

Mexico as well.

It looks like a lot of other carriers are adding service into Mexico.

When you look at your network, where are the pluses, where are the minuses in head to head competition.

Any color on that would be great.

Thanks.

Hi, Michael.

Excuse me, I think in general, if we look over the next two quarters, that's probably the safest place to be.

We're seeing really competitive seats.

Markets on an overall basis actually coming down.

Maybe 2%, 3%, 4%.

Really, that's, as you mentioned, a lot of seats out of the west coast to Mexico and even though folks are filling them back in, we're still down overall.

There has been some adjustments in Hawaii, so we are seeing in the Pacific Northwest, seats are also down there just a little bit.

So, overall the competitive landscape is still obviously very strong, but we're not seeing a whole lot of growth.

We do have a little bit of growth in Vegas and Phoenix and some of those as the economy picks up.

But overall, fairly stable.

Okay.

Very good.

Thanks.

Thanks everyone.

Your next question comes from Glenn Engel with Bank of America Merrill Lynch.

Good morning and congratulations.

Thanks, Glenn.

Couple of things, one, what level of incentive pay do you have in your cost outlook in 2011?

Glenn, it is Brandon.

I'll take that question.

We don't disclose the actual amount that we budgeted, but what I will say is that at target, our incentive plans would pay roughly $55 million.

So, the actual amount that we budget or the targets we set each year are aligned with the business plan and our long-term financial goal and it is going to be pretty close to that number.

So, do the targets then go up if you were in the same amount in 2011 as 2010, would your incentive pay be the same or would it be less?

Well, we do -- we do change the targets every year and the targets for this year will be more difficult than the targets we set in 2010.

Second, when you started the fourth quarter, the book load factor, actually, I thought was down slightly.

Yet the loads ended up 3 to 4 points.

So, was that unusual?

What really happened?

Glenn, I think just recalling back to last quarter, but we had -- we were fairly confident that the traffic would come and just recently, with some of the demand strength we've been holding out a little bit on the load factor.

We were very pleased how the fourth quarter came in.

A lot of the traffic, we actually had a movement from the business class down to the lower class.

But overall, the yields were up and so as we go into the first quarter, again, we're mindful of where the strength is, but making sure we've got good loads.

Advance book loads have increased as we've gotten closer to the travel dates the last few months, Glenn.

And finally, can you go through distribution, one, how your own web site is doing its percent of sales and how that's trended over time and two, what are your strategies to reduce distribution costs?

Sure, Glenn.

This is Joe Sprague from marketing.

First, we ended 2010 with alaskaair.com share at 48%.

Our other direct channel through our call centers was about 11%.

That's up from 35% five years ago in 2005.

So, nice trend there.

We would like to see that trend continue.

Obviously there is lots of activity in the airline distribution area right now.

We're tracking this activity very closely.

Our view is that distribution costs are certainly an area that should be reduced.

Over the last 25 years, ATA stats show that the industry has had an operating profit at $1 - $2 per passenger.

And a pre tax loss of $2 or $3 per passenger.

And against this backdrop, airlines are paying GDS fees of $3.50 to $4 per segment.

So, the economics are clearly out of whack.

And from the customers perspective, we believe they can learn more about us and have more relevant content offered to them when they come shop at alaskaair.com.

This is where we would like to see more and more folks shopping for air travel on Alaska Airlines.

We're not ready to make any big changes in terms of our distribution mix right now, but again we're monitoring the situation very closely.

Your next question comes from the line of Steve O'Hara with Sidoti & Company.

Hi, good morning.

Can you just talk a little bit about the amount of cash on your balance sheet and does that change your -- the amount of equity you put into the aircraft rather than in the past?

Steve, this is Jay.

So, our cash position ended the year roughly at about $1.2 billion.

As you know, we generated great cash flow from Ops last year.

Had free cash flow.

Our current thinking is for the -- well, we know for a fact that the deliveries that will take this year we'll pay cash for.

And Brandon talked about what's the right mix between debt to equity over the long-term, but our sense is we want to pay cash for airplanes that have good asset values.

We'll likely finance the Q400s.

We have good rates on those.

So, we'll try to do a mix.

But certainly, we're generating good cash flow to pay for the capital spending.

Steve, Brandon, one interesting fact.

We did not borrow any money in 2010 and the only borrowing that we would do in 2011 is for the Q400s and that's because there's EDC financing available to us at a very attractive rate.

Okay, thank you.

And then second, maybe if you touched on this, apologize.

In terms of the aircraft order, you talk about some of the -- when you make the decision, some of the inputs into the model when you decide to purchase the plane, what type of fuel levels are you expecting out at that point?

Sure.

I'll take that one.

First, I rely on promises from Andrew that he can make money flying these things.

(Laughter) I mean, it is -- it is a very detailed calculation as you might imagine.

We don't spend this kind of money without doing a very thorough business case.

We've talked a lot for many years about our commitment to return on invested capital and our cost of capital, and those work themselves into the equation.

We look at the opportunities for where we can fly these things and then we do scenario modeling at current fuel costs, and do some sensitivity one way or another on that as well.

All of that penciled out before we made the decision to buy these 15 airplanes.

Okay.

And then on the 10% return invested capital goal, I mean, what's the new goal?

You kind of met that.

Is that something that you expect to be an on-going goal?

Would you expect to raise that going forward and how does that impact your employee agreements?

Well, the 10% return on invested capital goal is intended to be a long-term goal over the business cycle.

So, that goal remains unchanged.

We've said a couple of times now that when times are good, we should appropriately be doing better than 10% because inevitably, there will be times when we don't do as well as 10%, but the long-term goal is and remains 10%.

Now, as far as employee agreements go, there really is no link between ROIC and our various employee agreements.

All of our employee agreements now, we're assuming that the COPS group ratifies will include participation in the performance-based pay plan.

And that obviously is a plan that has both operational and financial metrics and one of those metrics will be around -- or is and continues to be around profit and our profit goal continues to have 10% as being a long-term objective.

Okay.

Thank you very much.

Your next question comes from the line of Aubrey Cohen with Seattle P.I.

Hi.

I wanted to ask in light of, particularly in light of Virgin America's order for the Airbus 320 Neo and Boeing's continued insistence apparently that their customers aren't clamoring for a re-engined 737, what your view as an all 737 operator with Alaska Airlines is on that?

We like the airplane a lot.

We like the 737, we like the family of airplanes.

We like the commonality, the fuel burn, the fuel efficiency, the flexibility and the seating.

And we're big fans of this 900ER, the more we looked at it, the more we liked it.

We think it is going to fit in our network really well, especially as we've driven load factors up and the peaking we still have in the summer time in particular.

With respect to this question about re-engining I don't think we have a position on it.

We're interested in Boeing's continued analysis of that.

We are interested in watching the landscape with Airbus.

Fuel savings is really important.

Fuel efficiency is really, really important.

We're getting more of that and part of that equation is the size of the airplane as well.

It is efficiency on a per passenger, per seat basis.

So, we're getting all we can with the way we operate the airplane and the winglets that we put on over the years and so forth.

We like the airplanes a lot that Boeing produces, we're interested to see what they might come up with next.

If what they come up with is a replacement aircraft that would enter service, later around 2020, does that potentially something that works for you guys?

We would have to look at it and see the specifics, but potentially, sure.

Okay.

As a separate follow-up question, you talked about phasing out the Horizon brands.

Obviously you're not doing that immediately, you're just taking some steps towards that.

When do you see that brand completely going away?

Hi, Aubrey.

This is Glenn Johnson over at Horizon.

It will take us several months at least to go through that transition.

We have to paint all of the airplanes, then we'll be changing airport signage and so forth.

So, I would expect to see that take 12 plus months probably by the time we get all of that done with the new airplanes coming in and having to repaint existing airplanes.

Great.

Thanks.

I'm sorry, who answered my question on the 737?

This is Bill.

All right, thank you.

Your final question comes from the line of Tom Banse with KUOW Radio.

Thanks, good morning.

I just have a quick follow-up on the question of the airline ticket distribution.

I'm curious how soon Alaska Air Group's contracts with the major GDS purveyors expire and if, at that point, you would publicly join American Airlines' fight to get better treatment?

Tom, this is Joe.

Our agreements with the Global Distribution Systems, they're not all up on the same date but they're all up this year during 2011.

We're, obviously as I said, watching this very closely and we'll be having the right kinds of conversations with the GDSs about what they charge.

Thank you.

Well, let me once again congratulate all of our employees for a terrific year and to our audience, we like to thank you for joining us today and we look forward to talking with you again next quarter.

Take care, everybody.

Thank you for participating in today's conference call.

(Operator Instructions)