阿拉斯加航空 (ALK) 2011 Q4 法說會逐字稿

Good morning.

My name is Steve, and I'll be your conference operator today.

At this time, I would like to welcome everyone to the Alaska Air Group Fourth Quarter and Full Year 2011 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, Steve.

Good morning, everybody, and thank you for joining us for Alaska Air Group's Fourth Quarter 2011 Earnings Call.

This morning, Alaska Air Group CEO, Bill Ayer, Air Group CFO, Brandon Pedersen, and Alaska Airlines President, Brad Tilden, will comment on our financial results, our operations and our outlook for 2012.

Other members of our senior management team are also here to help answer your questions.

Our discussion today will include forward-looking statements regarding future expectations, which may differ significantly from actual results.

Information on risk factors that could affect our business can be found in our SEC filings, available on our website.

We will refer often to some non-GAAP financial measures, such as adjusted earnings, or unit costs excluding fuel, so we've 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 profit of $64 million.

Excluding the impact of mark-to-market adjustments related to our fuel hedge portfolio, Air Group reported an adjusted net profit of $37.2 million or $1.02 per diluted share.

The result is compared to last year's adjusted net income of $47.4 million or $1.28 per share and the First Call consensus of $1.14 per share.

To provide some prospective, the $0.12 miss from consensus is about $4 million due to our low share count.

For the full year, Air Group reported a record adjusted net profit of $287 million compared to $263 million in 2010.

Earnings per share grew by nearly 10%, from $7.14 per share in 2010 to $7.83 per share in 2011, on an adjusted basis.

Additional information about our unit cost expectations, capacity plans, future fuel hedge positions, capital expenditures, and other items, can be found in our Investor Update, included in our form 8-K issued this morning and available on our website at alaskaair.com.

I would now like to turn the call over to Bill.

Thanks, Chris, and good morning, everybody.

Today we reported the best full-year adjusted profit in our history, surpassing the record set last year.

The full year result represents our eighth consecutive annual profit and our second consecutive year with return on invested capital above our 10% goal.

Although the quarterly profit was down from last year, it was the second best quarter -- second best fourth quarter in our history.

Our focus over the past decade on providing great customer service, improving our operations, engaging our employees, and generating a return for our shareholders has helped to move the Company to the top of the industry in many measures.

2011 was a very good year and one that resulted in many accomplishments and new records.

For example, we were awarded the J.D.

Power Customer Satisfaction Award for Traditional Network Carriers for the fourth straight year.

We posted record low factors at both airlines, and for the first time ever, we exceeded 80% for the Mainline operation in each month of the year, and we've now had 31 consecutive months of low tractor improvement.

For the second year in a row, Alaska was named the Most On-Time Airline among major North American carriers, by FlightStats.

Our people served a record number of passengers and by doing so, increased productivity by nearly 5% and earned $72 million in incentive pay, or approximately $4,000 on average, per frontline employee.

Alaska and Horizon became the first US airlines to operate multiple passenger flights using biofuels.

And Alaska won Seattle Business Magazine's 2011 Green Award in our category.

We just recently received the 2012 Joseph S.

Murphy Industry Service Award from Air Transport World magazine for our numerous environmental and corporate giving initiatives.

And finally, The Wall Street Journal named Alaska Airlines The Best Performing Carrier in the US, in its annual Middle Seat Analysis.

Horizon is included in much of this recognition, and I would be remiss if I didn't specifically call out the extraordinary improvement in both operational and financial results during 2011.

The major changes Horizon has made, including the transition to a single fleet of Q400s and the shift to a 100% capacity purchase model has helped drive this improvement.

All of these Air Group accomplishments were because of the hard work and dedication of our people, and I want to thank them for their focus on running a safe and on-time operation and for the excellent customer service they provide.

Our results recognize our efforts to ensure that all constituents -- customers, communities, employees, and investors find value in our Company.

Long term success requires this balance of stakeholder benefit, and our industry has a poor history of providing it on a sustained basis.

So the challenge now is to maintain our performance and build on this solid foundation.

We know that 2011's good results came from the initiatives that we've worked on over the past several years.

Success in this business can be fragile and our continued success will depend on the plans and initiatives that we're working on today.

Our future depends much more on what we do than on what happens to the economy, oil prices, or our competitors.

These factors are important, but a clear understanding among all 12,000 employees of what we can control will give us the best chance of sustaining this performance and becoming not just a great airline, but a great business.

Due to our conviction of controlling what we can control and good execution of initiatives over the past decade, I'm very confident about the future.

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

Thanks, Bill, and hello, everybody.

As Chris said, Air Group reported an adjusted net profit of $37.2 million this quarter, compared to a $47.4 million profit in 2010.

The fourth quarter profit brings the full year result to a record adjusted net profit of $287 million, compared to 2010's record of $263 million.

The 2011 results translate into an 11.7% return on invested capital, eclipsing both the 10.7% mark set in 2010 and our 10% after-tax goal.

I want to join Bill in congratulating all Alaska and Horizon employees for these outstanding results and a record year.

On a pre-tax basis, the fourth quarter was $18 million lower than the previous year.

The 2011 decline includes a $6 million impairment charge related to an MD-80 lease to another operator.

The remaining decline of $12 million resulted from an $83 million, or 34%, increase in our economic fuel bill, and a $23 million increase in our non-fuel operating costs, partially offset by the $86 million improvement in revenue and an $8 million decrease in non-operating expenses.

Again, on a pre-tax basis, full year adjusted earnings improved by $38 million.

Operating revenues were up $486 million, or nearly 13%, more than enough to overcome a $372 million, or 41% increase, in economic fuel costs, and an $86 million, or 3.5%, increase in non-fuel costs.

Our pre-tax margin was 10.7%, down slightly from the 11.1% margin in 2010.

Consolidated economic fuel price per gallon was $3.18 for the year, 34% higher than in 2010.

The impact of higher refining margins was significant, averaging $0.78 per gallon in 2011 versus $0.33 per gallon in 2010.

The steep price increase in crude and refining costs, combined with a 6% increase in consumption, drove fuel costs up to a record $1.3 billion for 2011.

Although our hedging contracts had a net cost to us in the fourth quarter, the program saved us over $21 million in 2011, bringing our total hedge savings to over $400 million since the program began a decade ago.

At our Investor Day last November, I described a modest adjustment to our hedging strategy to one where we would use out-of-the-money options for hedges that we were placing for 2013 and 2014, as a way to reduce our premium expense.

To stay with the insurance analogy that we often use, the move was designed to reduce premium costs by assuming a higher deductible, which we were safely able to do because of our very strong balance sheet.

With that same objective in mind, we recently modified our 2012 hedge portfolio.

For 2012, we are now 50% hedged at an average of $100 per barrel with a $9 per barrel average premium cost.

Prior to the change, we were 50% hedged at $92 per barrel, but had an average premium cost of $13.

This change allows us to reduce the premium expense that will come through the 2012 P&L by approximately $18 million, yet still protects us from significant spikes in oil prices.

Turning to incentive pay, as Bill said, Air Group employees will receive $72 million through our performance-based pay, or PBP program, and the operational performance rewards, or OPR program.

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

Like last year, we exceeded many of the goals set by our Board, including the profitability goal, which represents 70% of the PBP weighting.

As a result, the payout for most employees will be more than 6.5% of pay.

Alaska employees hit the monthly OPR customer satisfaction and on-time goals 11 out of 12 months, earning another $1,100 each, while Horizon employees hit the OPR targets nearly as often, earning $900 each.

We're proud of the fact that incentive pay over the last three years totals $240 million.

To give you an example of how that translates to a frontline employee, an Alaska employee making $35,000 per year will have received incentive payouts under the PBP and OPR programs of nearly $12,000 over that three-year period.

We know that $240 million is a lot of money, but we believe that generous, goals-based incentive programs do three things.

First, they help us hire and retain the best people.

Second, having goals that improve our operations and financial results aligns the interests of our employees, our customers, and ultimately, our shareholders.

And finally, we're able to share generously with employees when the Company is doing well, without imbedding fixed compensation into our cost structure that becomes a burden in times that our financial results are not as strong.

Turning to non-fuel costs, consolidated CASMex fuel was basically flat for the quarter, although slightly higher than even our more recent guidance.

Higher than expected maintenance costs at Horizon and medical costs and final incentive pay true-ups at both companies account for the difference.

Mainline unit costs increased by 1.8% to 7.89 cents on the 4.6% increase in Q4 capacity.

This was the first quarter-over-quarter increase in 2011, and was partly due to higher wages and benefits, planned and unplanned maintenance costs, and increases in other costs, combined with slower capacity growth.

Although the reasons are explainable, I'm disappointed in our cost performance for the quarter.

For the full year, Air Group's consolidated CASM, excluding fuel and fleet transition costs, declined by 3% on the nearly 7% increase in capacity.

Mainline ex fuel costs were down over 3% to 7.6 cents on the 8.5% capacity increase.

The mainline result was exactly inline with the full year guidance that we've been giving all year.

This was the second year in a row and the ninth time in the last 10 years that we have lowered unit costs.

We do have some cost pressures as we head into 2012, such as contractual wage increases, higher maintenance costs, IT investments in both infrastructure and innovation, and training costs.

We also expect pension expense to be $18 million higher this year because of meager asset returns in 2011 and a reduction in both the discount rate and the expected rate of return on planned assets.

In our Investor Update this morning, we guided to a 1% to 1.5% increase in ex fuel costs in the first quarter.

This follows a fourth quarter, where cost performance wasn't frankly all that great, and we're not happy with the two-quarter trend.

We know we need lower costs in order to offer low fares to our customers, improve our long-term competitive position, and continue to meet our return goals.

Highly productivity employees, better use of technology, keeping tight control over management headcount, and maintaining our low overhead mindset, while we increase capacity, should allow to us bring costs down further.

In fact, over the last few months, our divisional leaders have established more than 40 distinct three-year cost and productivity metrics that we'll be using to track progress against our long-term unit cost reduction goals.

For 2012, we expect consolidated ex fuel unit costs to be down for the third year in a row by approximately 1.5% and mainline costs to be down by approximately 1% on expected ASM growth of 6%.

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

This is, of course, over and above the $33 million that we contributed throughout the year under our normal funding policy, and brings our total DB contributions in the last three years to $427 million.

I want to stress that we had no required funding in any of those years and our contributions underscore our commitment to meeting our pension obligations.

As of the end of the year, we are 81% funded on a PBO basis, down from 85% at the end of 2010.

We plan to make cash contributions of approximately $35 million in 2012.

Although again, we'll have no requirement to do so.

And, as a reminder, we'll freeze the DB benefits for non-union employees as of January 1, 2014, and all of our plans are closed to new entrants.

Looking to the balance sheet; we ended the year with more than $1.1 billion in cash and short-term investments, equal to about 26% of revenues.

Because of the strong financial performance, we generated a record $680 million of operating cash flow, compared to $554 million last year.

Free cash flow was approximately $300 million this year, $70 million less than in 2010, even though our capital spending increased by $200 million.

Our strong results over the last three years have produced more than $1.5 billion of operating cash flow.

With that cash generated, we've been able to do a number of really good things.

Let me share some examples.

First, we've invested in the business.

We've purchased ten 737-800s and two Q400 aircraft, free and clear, that we've used to expand and strengthen the network.

Second, we've protected our Company from future shocks by lowering our leverage.

On balance sheet debt has come down by over $0.5 billion and the capitalized value of leases has declined by over $300 million.

Combined with higher equity from strong earnings, we have been able to reduce our debt-to-cap ratio, including leases, to 62%, down 19 points, from the end of 2008.

Third, we've rewarded our shareholders by repurchasing 3.6 million shares of our common stock for $148 million.

And since 2007, we've spent more than a $0.25 billion to acquire 8.4 million shares at an average cost of $31 a share.

And finally, although it's reflected in the operating cash flow number, it bears mentioning once again that we've contributed $427 million to our pension plans when none was required, and shared $240 million in incentive pay with our employees.

Finally, looking at the fleet, we expect to take delivery of three 737-800s in the first half of the year, fitted with the new Boeing Sky interior.

Then in the fourth quarter, we'll be introducing three new 737-900ERs into the fleet.

This will be a great airplane for us and improve our ability to grow capacity without a commensurate increase in costs.

By the end of 2014, we'll have at least 19 737-900ERs in the fleet.

With the current firm delivery schedule and planned non-aircraft spending, we expect CapEx to be approximately $425 million for 2012.

We'll also have to make a decision this spring on whether or not to exercise options for three 737s and two Q400s that would be delivered in 2013, so our CapEx may go up a bit depending on the direction we choose to go.

If the environment remains similar to what we're seeing today, we would once again expect to generate free cash flow in 2012 given that level of CapEx.

We plan to deploy that cash in a similarly balanced way.

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

Thanks, Brandon, and good morning, everyone.

We now have another year behind us, and as Bill and Brandon have said, it was a very good year.

We broke a number of records at both Alaska and Horizon.

Alaska had its most profitable year ever, reporting $444 million of adjusted pre-tax profit.

And Horizon posted an adjusted pre-tax profit of $22 million.

These equate to pre-tax margins of 10.3% and 5.7%, respectively.

A lot of the profit improvement has come from working to improve weaker months, our weaker days of the week, and our weaker flights.

We reduced our seasonality by scheduled reductions and redeployments and by better managing inventory between peak and off-peak days.

This is our second consecutive year where we've had an adjusted profit in all four quarters.

For the quarter, Alaska earned an adjusted pre-tax profit of $53 million versus $77 million in 2010.

Our margin was 5.1% versus 9% in 2010.

The four point decline in margin is due to revenues which did not increase enough to cover increases in capacity and higher fuel costs, and mainline unit costs ex fuel, which increased this quarter by 2% versus the decreases we saw in the first three quarters of the year.

By our calculations, roughly half of the margin decline is due to fuel/revenues and half is due to unit costs other than fuel.

Mainline passenger revenue increased by $72 million or 10%.

The revenue improvement was driven by a 4.6% increase in capacity and a 5.5% increase in passenger unit revenues.

The passenger unit revenue improvement was due to a 3.4% increase in yield and a 1.6 point improvement in load factor to 85.4%.

We believe this will be the highest load factor of the top 10 airlines for the second year in a row.

And as most of you know, this is a big change from where we were several years ago.

Sequentially, we saw mainline PRASM increases of 5%, 6.7% and 4.7% in October, November, and December.

We are generally pleased with our revenue performance, considering our capacity growth and the 2.3% increase in our average stage length, but there is an opportunity to do better as we deal with these very high fuel costs.

Some of what we're wrestling with is the shortfall, not in coupon revenue, but in Mileage Plan and ancillary revenue.

Alaska's regional business, which includes revenue from flights flown by Horizon, SkyWest and PenAir, less contractual payments to these carriers, reported a profit of $12.5 million for the quarter, versus $6.2 million in 2010.

PRASM for this business increased 9.3% on the 2.3% decline in capacity.

The Horizon operation turned in a profit of $5.1 million for the quarter, versus a loss of $1.2 million in 2010.

Both of these businesses have shown substantial improvement over the last several quarters.

And we owe our thanks to the folks involved, particularly at Horizon, but also in our marketing, planning, and revenue management departments, who together are engineering a transformation that covers the fleet, the cost structure, the brand, and the schedule.

For the fourth quarter, our mainline CASMex fuel was 7.89 cents up 1.8% from the prior year.

Costs are up due to the reasons Brandon mentioned.

We are not happy with the increase and we are focused on bringing unit costs down.

During the quarter, we finalized a five-year agreement with AMFA which covers our aircraft technicians.

Our technicians received a pay increase on the date of signing and increases in the four downline years.

As part of the discussions, we agreed on significant productivity increases.

In fact, we don't plan to increase our technician headcount as we add the next 15 aircraft.

This will help us improve our metric for technicians per aircraft, which is a good example of one of the three year metrics that Brandon referred to.

Improvement in this area will enable us to build upon our productivity increases of recent times, which for the Mainline business were 9.5% in 2010, and 4.6% in 2011.

One area where we have done especially well is operations.

Both Alaska and Horizon posted record on-time performances for the year, at 88.2% and 86.1%, respectively.

Alaska continues to hold the number one spot among the ten largest carriers for on-time performance in the last 12 months.

This operational record was impacted last week as we dealt with first, a snowstorm, and then freezing rain in the Pacific Northwest.

We canceled 33% of our flights last Wednesday and Thursday, and inconvenienced some 45,000 passengers.

Financially, we estimate the impact of the storm was about $3.5 million, with the majority of that being lost revenue.

Our people have shown what they're made of, not only for the way they handled this disruption, but also for the way they worked together as a team to produce the great operational results of 2010 and 2011.

As we look to 2012, we currently expect to grow mainline and consolidated capacity by about 6%.

The growth is mostly coming from annualizing our Hawaii schedule and from routes which have been announced, but not started.

When the announcements take effect, we'll have 24 daily round-trips to Hawaii in our winter peaks.

In our regional operation, we just announced expanded service in California, connecting San Diego to Santa Rosa, Fresno and Monterrey.

By quarter-end 2012, we expect consolidated capacity growth of 3.5% in Q1, 6% in Q2, 6% in Q3 and 7.5% in Q4.

We were very excited to be moving into our new home in Terminal 6 in LAX in just a couple of months.

This will be nicely finished space for our customers.

It will help them more easily connect with our alliance partners and it should streamline the customs and immigration process for our passengers coming in from Mexico.

We also just announced a reciprocal frequent flyer relationship with Emirates, which will facilitate traffic flows in a high-growth part of the world.

Emirates is starting non-stop service from Dubai to Seattle on March 1st.

We're also excited about our alaskaair.com business, which is really starting to grow.

Our team launched a completely redesigned website this past April and new mobile applications for the iPhone and Android phones this past fall.

Our customers are responding to the changes as their bookings through alaskaair.com increased from 51% of our total in December 2010, to 55% in December 2011.

For January, February, and March, our consolidated advanced book load factor is up 3.5 points, 3 points, and 1.5 points, respectively, compared to the same months in 2011.

All things considered, passenger demand looks reasonably strong, but we're constantly watching this.

As I close, I'd like to thank you all for your support of this Company over the last several years, as we're driving this transformation.

And I'd also like to thank our leadership team and our frontline employees.

We've got a lot more work to do.

The fourth quarter results point to some opportunities and we will be fully focused on this work.

But 2011 was a good year, and we want our people to know just how much we appreciate what they're doing.

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

Thanks, Brad.

2011 was an outstanding year and it took all 12,000 Air Group employees working together to achieve these results.

At this time, we are ready for your questions.

(Operator Instructions).

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

Your line is now open.

Hi guys, this is John Godyn filling in for Bill.

First, just a question on the demand environment.

It looks like the advanced book factors that you guys reported in December went up in the most recent disclosure.

Can you just give us a sense and elaborate on what you saw in the demand environment between December and now?

It seems like a lot of your peers are reporting strong RASM, so it's not a surprise, but maybe just some color on how the last month or so has evolved, would be helpful.

Hi, John, this is Andrew.

Probably the most significant change -- as we looked into the first quarter, which is traditionally a weaker one for us, is we had a very significant fare sale, with very compelling fares.

We often in January and February fly with some empty seats in our airplanes.

And we've seen very significant load factor builds in certain regions, especially in California.

So that would probably be the most significant reason you saw the change in that load factor trend.

Okay, thanks.

And just a question on your overlap with American.

Is there anything that you can tell us about AMR's competitive presence within your markets on the West coast?

And how important would AMR capacity cuts be?

We can calculate the overlap, but that doesn't always tell the story.

How do you feel when you face them as a competitor?

John, this is Andrew again.

A couple of things - as you know, American is a very important codeshare partner with us in the US.

And secondly, the overlap on the direct basis is about 6%, and probably on an indirect, about 9%.

To date we haven't seen any meaningful change in their capacity where we compete head-to-head, so we continue to watch that situation and go from there.

Okay, great, thanks a lot.

Your next question comes from the line of Hunter Keay with Wolfe Trahan.

Your line is now open.

Thank you, good morning.

So Brandon, let's talk about ROIC for a minute here.

As we think about the next leg up on continuing to drive ROIC up; is it a numerator thing or is it a denominator thing?

That's the end of my question.

Honestly, I think it's both.

We need to get better at using the capital that we have.

There is always opportunities to do more.

Our interest on the numerator has continued to grow this Business and do so profitably, and on the denominator side, I still think there's some opportunity to even bring that down a tiny bit.

I think the answer to your question is both.

Okay.

So maybe using some cash to deploy and maybe some early debt pre-payments in addition to scheduled stuff, things of that nature, if the opportunity comes up on the denominator side?

Yes, if I look at the denominator alone, we'll have earnings growth that moves equity up.

But if I think about debt, you mentioned that, we have $200 million of normal debt payments next year, so that will take some of the invested capital base out.

And to the extent there's an opportunity to do more than that, that would further that.

Okay, great, thanks.

And I would love to hear your thoughts on this, too, Andrew, on this Club 49 promotion that you announced about four months ago.

I'm curious how much of a revenue bad guy this will be for the elimination of bag fees.

I'm wondering if this is potentially an indicator of maybe some concerns that you might have over the long run about some competitive forces up in the Alaska business?

Jet blue is now flying to Anchorage.

Southwest, I think, has even alluded to some possibility of flying up there.

Is this a preemptive defensive move because of something like that?

Hey, Hunter, this is Joe Sprague.

I'll take a shot.

First off, Club 49 -- it's not surprising that it's been met with a lot of warm acceptance by our Alaskan customers.

We're watching the economics of it very closely.

The bag fee waiver is the primary benefit for folks in the program up there.

And that was about $2 million of foregone revenue in the fourth quarter.

That's about where we expected to be, so no big surprise there.

We're doing some weekly fare sales as well up there, which is actually generating a little positive revenue for us.

Yes, we're going to compete very aggressively in our core markets.

And Alaska, certainly, is our most core market.

We held our own quite well against some of the other competition that has come up there over the last several years.

But long-term, these are our customers that have always been with us and it was a move to try to recognize their long-term loyalty.

Okay, great, thanks a lot.

Your next question comes from the line of Ray Neidl from Maxim Group.

Your line is open.

Yes, the Club 49, if I was going go to Alaska, you would charge me for the bag though, right?

That's just for your best customers in Alaska, right?

Yes.

That's right.

Okay, I'll cancel my trip then.

Basically, I just want to clarify your pension.

It's still active for current employees, not active for new employee, so you're still funding that for certain labor groups.

Now, you are terminating it for everybody, is that what you said?

Yes, basically to recap.

This is Brandon.

All of the plans are closed to new entrants, but there is an active plan for the pilots and the non-union employees that started before 2003.

As I've mentioned, we've announced plans to freeze the benefits in that non-union plan starting January 1, 2014.

So for the foreseeable future we're going to still have service costs, we're going to have a funding obligation.

Because of our funded status, we don't, as I said, have any required funding, but we choose do that.

Okay, great, that clarifies it.

The other thing is seasonality.

Alaska used to be even more seasonable than any other airline, for obvious reasons, until you expanded your network.

It sounds like from what you said earlier, there still is a big seasonality factor there in the first quarter.

Is that a good assumption to make?

Ray, this is Andrew.

Actually, both Q1 and Q4, we still have heavy seasonality; with Q2 and Q3 being much stronger.

Every time we come into the quarter -- first quarter is getting better and more balanced, but we still have work to do there.

Okay, great, those are my questions.

Thanks.

Your next question comes from the line of Duane Pfennigwerth with Evercore Partners, your line is now open.

Good morning.

I was wondering if you could talk about customer willingness, acceptance to take higher fares, currently.

Is there anything that we should read into your larger advanced book load factors that you're changing something on the revenue management strategy and maybe yields are not as strong?

Hey, Duane, this is Andrew.

If I was to answer at a higher level; you've seen -- over the past couple of years we've focused heavily on traffic and making sure that we cover our fuel costs and get our return on invested capital.

As has been shared, our load factors are getting at record levels.

I will tell you that, as we move into 2012 and the first quarter, we're going to turn our attention more to the yield side of the business, recognizing that we have good strong traffic and the demand looks solid.

So that's what we're going to be working on to make sure that in 2012, we continue to have our revenues exceed fuel increases and also make sure we hit our return on invested capital.

Okay, I appreciate that.

Is it fair to say with the weather impact in the first quarter, that that's going to be difficult to do?

We're still analyzing that, but what I can tell you is that basically on the load factor side, the ASMs that didn't fly and the passengers that disappeared, they've about netted out in the first quarter.

It will be a little bit of a challenge just in January, but with a couple of days, we're going to continue to work through that problem and try to recover.

Okay.

So we should not look at your fourth quarter results -- I mean you guys have been growing earnings year-to-year for quite a while now.

And there's nothing we should take from your 4Q -- and even if I back out the impairment, earnings were down year-to-year.

What, if anything, does that suggest for 2012?

Duane, it's Brad.

We don't give guidance, particularly on revenues for the future.

But I think what we're trying to say is we looked at fourth quarter, we had a cost problem.

Brandon has given guidance for the first quarter of 2012; we're going to have costs up, year-over-year, again.

We're very unhappy to have cost increases in the fourth quarter of 2011 and the first quarter of 2012.

Our guidance is reductions in unit costs in Q2, Q3 and Q4.

On the revenue side - I think I would say that there's -- we feel pretty darn good about how revenues have performed for most of 2011.

But right now we're looking at this saying, these fuel costs are really high and we need to make sure we're doing everything we can to recover both -- like in this fourth quarter, the capacity increase, you have to make up for the higher capacity -- and our objective is to cover all of these higher fuel costs.

So that's what we're trying to do.

We have a very good history of doing that over the last several years.

The fourth quarter we slipped a little bit.

And the goal is to get back on and produce the same sort of stuff in 2012.

While we don't give guidance quarter by quarter, we're very confident in the Company's ability to do that over time.

I appreciate that response, thank you.

Is the implication in there, if you can't cover fuel, that the capacity plan must change?

To continue with it, the commitment is to cover the return on invested capital; so it's fuel, it's CASM.

If you look at our 2011 results, getting cost reductions -- cost other than fuel reductions, has been a big part of it.

The commitment is for us to cover our return on invested capital.

Going back to Hunter's question; if we can't do that on the numerator side, at some point you have to start looking at the denominator.

Thanks very much.

Duane, this is Bill.

You know our history on being pretty nimble with capacity adjustments, scheduled redeployments, and so forth.

So we're practiced at that, and if we needed to do more of that, we sure would.

Thanks for the answers.

Your next question comes from the line of Michael Linenberg with Deutsche bank.

Your line is now open.

Hey, good morning, guys.

A couple of questions here; the 737-900ERs, what's the configuration on that?

Is that an airplane that you could fly off of the West Coast to Hawaii year-round, without penalty, even in the high wind season?

Hi, Mike, it's Brandon.

I'll start on that one.

We'll configure the 900ER with 181 seats.

That compares to 157 currently on the 800.

So that's a significant addition into the number of seats .So that will be really good for costs on a per-passenger and on an ASM basis.

In terms of the flying to Hawaii, we could do that.

I'm going ask Ben on Andrew to jump in here, in terms of the seasonal restrictions, because there are some, particularly out of the Pacific Northwest.

This is Andrew.

We can fly that airplane to Honolulu and to Kona, and we can do it from the Bay area all year long.

There are some seasonal restrictions in the Pacific Northwest during the winter.

But a good six, seven plus months of the year, we can certainly send that to Hawaii.

Our plan right now is to fully equip our 900ERs ETOPS, make it possible to fly missions to Hawaii.

And we'll deploy that in the peak times where it makes sense, just as we blend it into the rest of our network.

Very good.

My second question, there's been a lot out there about AMR having a tough time in the LA market, lots of different analyses highlighting the extent of their losses and that they may need assistance there.

It was notable that in the last set of proposals that they put forth before their pilots, there was a carve-out to do a lot more with you guys on the West Coast.

I'm just curious -- I know there's restrictions there and some of the stuff is very arcane and it maybe even has do with the history of whether or not it was a previously flown route by American; but when I think about either one-way codeshares or dual codeshares, and I think about what you do for Delta and what you do for American -- how much lesser is the American codeshare or agreement than, say, what you're doing with Delta?

Is there a lot of potential upside with American on the West Coast if you could have something where the restrictions were unshackled, where there was just a lot more to do with them than what you do now?

Your thoughts on that?

I realize there may be some confidentiality elements here, but I'm really curious about the potential on the West Coast with you and American.

It's a complicated question, I suppose.

And we shared a little bit on the Investor Day.

The American agreement, which we all know has restrictions, especially as it relates to scope and that type of thing.

And really both Delta and American have a lot of code up and down the West Coast.

As far as it goes East to West, that would be something that we really can't do today and I'm not privy to any other discussions of some of the things that you have seen.

But that would be something that would be new facts for us and we would need to explore that.

Okay.

One quick last one here.

When I think of Allegiant and I think of you guys, two very different models doing two very different things; and yet, when you look at what they're doing on the West Coast, they started to fly out of an LA base and they just announced Oakland.

And it's interesting because a lot of the markets are more, I'd say, Pacific Northwest oriented.

I think about the Medfords, the Redmonds, Idaho Falls, Montana; it's a lot of markets off of the West Coast that if I didn't have the non-stop service on Allegiant, it would be very likely that I would take you guys to some of those markets.

I'm just curious -- again, different markets.

Is there anything out there or are you starting to see any -- and maybe this is with respect to Horizon, it's a bigger impact there.

Or is it still two very different products and they're having no impact?

What I would say is, obviously their biggest presence is in Bellingham to Las Vegas, and that's where they have decent frequencies.

The markets that you just mentioned, they're all just once and twice a week.

So really, at the end of the day, I think they're two different business models.

And of course, we keep an eye on them and obviously in the Las Vegas market especially.

But we have the Mileage Plan, the strength of that, we have daily service, three, four, five times a day, sometimes.

Where we are today is we watch that.

But right now, it's not materially impacting our results.

That's good to hear then.

Mike, Brandon here.

I just want to reiterate that we watch that very, very closely.

And we don't take anything for granted.

You have to give kudos to the folks at Allegiant because they have a neat business and make quite a bit of money.

But we're absolutely watching on what's going on with those markets.

I figured as much.

I think your movement into the Bellingham, Hawaii market about a year ago was clear evidence of that.

Thanks, great.

Appreciate it,

Your next question comes from the line of Helane Becker with Dahlman Rose.

Your line is now open.

Thanks very much, Operator.

Hey, everybody.

One question is, with respect to your interline agreements with some of the international airlines, and obviously, you've got the one with Emirates coming up; is there anyway you can say what percent of your traffic actually comes from those agreements?

And that they make sense to continue doing?

Or is it more publicity --?

Helane, maybe I'll start with the numbers and get Joe to give more beef on the background on why we do the international ones.

I think we've said in the past that our interline business overall is 13%, 14%, 15%, kind of in that general area as a percentage of our revenues.

And I think we've also said that, overall, the domestic things -- if you were to look at the volumes, are the lion's share of the interline agreements.

In terms of -- these international ones are very, very important.

Joe, do you want to talk about our strategy there?

And why we did the Emirates deal?

We continue to feel like our frequent flyer program, the Mileage Plan, has utility for our customers that far exceeds our relatively small size.

And the big reason is - as Brad alludes to is these international partnerships.

The Emirates deal that we announced this past week is an exciting one.

That is obviously a very fast growing airline, serving an important part of the world and has a really great product.

I believe we will be the first US domestic airline to do any sort of partnership with Emirates.

And so we feel really good about that.

They join a long list of other, well-respected international airlines; British, Air France, KLM, Iceland Air, et cetera, that we have partnerships with that really allow a lot of inventory for award redemption for our frequent flyers, for our Mileage Plan members, which makes the Alaska program that much more attractive.

We're excited about expanding that network of partner carriers.

Okay.

And then, I don't know if you said this; but can you give us any color at all on unit revenue growth for January?

Or maybe you haven't figured out how last week's storm affects the total business -- maybe you already answered that?

Helene, this is Andrew.

As you're probably aware, we don't give unit revenue guidance forward-looking.

We'll just, again, reiterate that we're seeing solid demand.

We're very happy with our traffic build, given our capacity increases.

And our goal, as we focus more on yield over the coming months, is to work to have our revenues exceed our increases in fuel costs.

Okay.

That's fine, I guess.

I'm sorry?

Helane, it's Brandon.

I want to answer your question, specifically, on the impact of the storm.

We did say in the prepared remarks that the impact was about $3.5 million.

With most of that, more than half of that, being a revenue impact, then there was a net cost, as well.

I wanted to make sure that you didn't go away without having that question answered.

Oh, okay.

That's helpful.

Can I just ask a balance sheet related question?

I think you said that you finished your share repurchase program in January and you talked a lot about generating free cash flow and so on.

How should we think about re-upping that program?

So if you exercise options for additional aircraft for delivery in 2013, would you not re-up the program?

Or does re-upping the program have nothing to do with what you're thinking about, in terms of CapEx?

I think those are two independent decisions.

In our Investor Update, we provided preliminary CapEx guidance for the year.

And I mentioned in the prepared remarks that if we exercise those options we would have CapEx grow a little bit beyond that -- it's probably, off of the top of my head, $50 million, $60 million of additional CapEx.

But based on what we're seeing today, we would have the question of, is there excess cash to deploy.

I tried to address that when I said we had plans to do that in a way that was similarly balanced to what we have been doing in the past.

Getting back to Hunter's question, we like the notion of working both the numerator and the denominator to improve the returns on invested capital.

I can't speak to what our Board is going to decide do.

But if you look at our history, over the course of last five years, we had repurchase programs going in 2007, 2008, 2009, 2010, and 2011.

So I'll leave you with that.

Thanks, have a nice day.

Your next question comes from the line of Savi Syth with Raymond James.

Your line is now open.

Hey, guys, thanks for taking my questions.

On the cost side, I know you're working on it and we're seeing the fourth quarter and the first quarter going up, and you've identified some of the things that should help bring it back down again.

How does that work as you go through the year?

Hi, Savi --what's that?

Sorry, I interrupted you.

No, I was wondering if it was more back-end loaded or how we should think about the progression?

I think that's fair to say - this is Brandon, by the way.

If we look at what's happening in the first quarter, we have a number of things that are front-end loaded if I look at things on a line items basis.

For example, I think about what's driving the growth in unit cost year-over-year.

If I just looked at what I might have needed to keep my costs flat, obviously, I have a big pension headwind coming through wages, that's part of it, although that's pretty stable throughout the year.

We have a big training investment in the first half of the year, that's driving some of it.

Then we have some IT spend that's loaded into the front of the year, as well.

That is driving the year-over-year increase in unit costs in the first quarter.

That combined, of course, with the fact that it's probably our lowest growth quarter of the year.

That's not to say, however, that we're relying on growth to bring down our unit costs.

So is it the IT spend and things that fall off than more in the third quarter and the fourth quarter?

Yes, there is some front-end loading that's driving Q1 up a little bit, then it will start to tail off a tiny bit as we get farther into the year.

What's generally the ASM variation from trough to peak?

It's mostly -- I'll start and maybe Andrew can jump in here.

It's mostly related to the build of Hawaii throughout the year.

As we think about the ASM growth numbers that Brad laid out, it was -- just off of the top of my head -- 3.5, 6, 6, 7.5.

It's really the growth of Hawaii on a year-over-year basis, as we start to -- the impact of that as we start to get later into the year.

Andrew, you have anything to add to that?

No, that's fine.

One last question.

On the regional partner side with Horizon or SkyWest, any thoughts on -- do you need to expand that?

Or do you have the right capacity now, and that should be relatively at current levels, going into the next few years?

As I think Brandon or Brad mentioned, there are some option considerations that we're going have to make later on this year.

But right now we're very happy with the deployment and the capacity that we have in our regional markets.

And as you heard earlier, the business is performing very well and we're going to make sure that that stays that way.

Great, thanks, guys.

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

Your line is now open.

Good morning.

Couple questions; one, if I looked at the implied capacity of your regionals in 2012, it looks like it's up 4% to 5%, and your fleet is flat.

So what's driving that?

Thanks, Glenn.

Actually what that is really a big credit to Glenn and his team at Horizon.

Where, literally, we're able to free up two aircraft with our improved reliability and getting through the CPA transition [unaudible].

So we'll have a couple of extra aircraft to deploy in the back end.

Which again, is no new invested capital, it's just new revenue coming into the business in the new markets that you've seen us recently announce as part of that.

So that extra capacity is back-end loaded?

Yes, starts in the middle of the year.

And second question I have is -- if I looked at your RASM relative to the industry, it lagged by about two points in the spring, three points in the summer, and looks like about four points in the fall; so why do you seem to be under performing by a growing amount as the year progressed?

I think the way I would answer is, is that I personally was not happy with the fourth quarter.

And the reality was about 17% of our capacity is in the state of Alaska and I put too many seats in that market and we had negative unit revenues, which hurt.

So we're going true that up and get that right, going forward.

Again, as we've said earlier, absent that, our unit revenues and our fares have been enough to cover the cost of fuel and our return on invested capital, and that's our guiding light.

Thank you very much.

Your next question comes from the line of Dan McKenzie with Rodman & Renshaw.

Your line is now open.

Good morning, guys.

Good morning.

My first question is just a quick housekeeping items.

I'm trying to tie the results this morning to your January 5th filing, where you called out a $6 million write-down of an MD-80.

I don't see mention of it in the earnings release, but it looks like it's included in the earnings table.

So I'm hoping you can clarify if it, in fact, was included.

Dan, it's Brandon.

Yes, it was absolutely included.

It was in other non-operating.

And we did not, as you pointed out, elect to call that out as a special item or an adjustment -- we consider that part of normal earnings.

Got it.

If I'm not mistaken, I think it was tied to AMR's Chapter 11 filing --I'm trying to reconcile here, because if we want to strip it out as one-time -- I'm trying to clarify if it was tied to AMR's Chapter 11 filing, cause that's one-time in nature.

And if the write-down is one time in nature -- first, I want to verify if it's correct.

And if it is, if we strip it out, it would seem like your earnings for the quarter would really be $2.18.

I want to make sure my math is correct.

$2.18?

we'll take it.

I'm sorry, $1.18.

It is related to one airplane, it's one MD-80 that we had leased to another operator, as I'll say.

And I guess it was $6 million.

So doing some rough math, that's about a dime -- $0.10, after tax.

Okay, very good.

By virtue of the fact that we had one MD-80 and it's now impaired, that will be a one-time item.

Very good, I appreciate that.

Brandon, if I could just come back to your comments earlier about using free cash flow in a similarly balanced way.

If I interpret that literally, it would suggest -- if you have $300 million in free cash flow this year, perhaps $75 million of that would go to share repurchases.

If I'm looking at the four constituencies that you've targeted your free cash flow for.

My question is; does it make sense to distribute that free cash flow evenly with the stock north of $70?

When the stock was at $30 or $50, it seemed like an easy decision.

If I could give you a friendly pushback in that area and get your thoughts.

Sure.

Thanks for the friendly pushback.

I don't think there's any suggestion there that we need to distribute that number, $300 million, to use your example, ratably among the constituents.

We've done -- I'll start with the pension funding -- we've done quite a bit of that, as I said in my comments.

And we're in an ultra low interest rate environment, and based on what happens -- we'll see what happens to funding levels.

But we don't have any commitment to fund that by another $100 million by next year.

Our planned funding is $33 million for 2012.

In terms of debt repayment, we have $200 million of planned maturities of long-term debt.

Whether we do more than that is yet to be seen.

Then on the repurchase side -- I think I'll go back to what I said to Helane, which is the Company has had an active share repurchase program in place since 2007.

I'm not promising that there's going to be one in 2012, because that is, of course, the Board's decision.

But we have a ton of confidence in this Company and it's not just what is the price today, $71, $72 a share, it's what do we think we can do over the next few years.

And that's more of the way we think about whether or not it's a "good deal" to repurchase share.

Understood.

Do you have a sense on the timing on when you would make your decisions on the uses of cash?

I think it's just fair to say that we'll make those decisions throughout the year, based on what we see in the environment, and what we do with the options, and what happens in the competitive environment.

There's so many things that go into those decisions, I think that's a dynamic process that runs the course of the year.

Terrific.

Thanks so much, appreciate the perspective.

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

Your line is now open.

Hi, thank you.

Just two quick questions.

I think you noted some weakness in ancillary, and if you could talk about if it has anything to do with -- if it's different than the Club 49 promotion?

Could you expand on that?

And what your plans are to move that higher, maybe in line with the industry, if that's the problem?

Then second, what the return on invested capital was for Horizon -- if you have that.

Steve, this is Joe, I'll take a shot at the ancillary, first.

I think, overall, ancillary was a bit less than what we had hoped.

A big driver there was bag fees.

Less related to Club 49 and more just in general, I think we're seeing a behavioral change with customers with respect to bag fees.

In the second half of the year, where we have a good clean comparison to 2010, when we had the higher first bag fee in place, we actually had a 6% decline in checked bags.

So that's something that we're concerned with and wrestling with and looking at what we can do about that.

Beyond bag fees, though, I would note that some other important areas of ancillary did perform pretty well for us on a year-over-year basis in 2011.

Notably, buy-on-board revenue from our Northern Bites meals-for-purchase program performed exceptionally well last year.

And on a year-over-year basis, our hotel and vacation sales were also up nicely.

And ROIC -- I apologize, Steve.

We've really changed the focus internally, where we're thinking about ROIC on an Air Group level, because it really is Air Group Capital.

That's the way we think about it.

In terms of Horizon level results; what we're really trying to do is trying to drive the specific companies to focus on pre-tax margin.

We talk a lot internally about the goal to have a 10% pre-tax margin -- in fact the need to have a 10% pre-tax margin.

We talk to our employees about this notion of keeping $0.10 for every dollar that we've collected.

Alaska's in pretty good shape on that front and Horizon is moving in the right direction.

If you look at Horizon's stand-alone results, and remember this has CPA revenues from Alaska minus actual costs that are typically borne by a CPA provider, Horizon's margin for the quarter was 5.7%.

So Horizon is still on to the journey up to the 10% goal.

But we focus more on pre-tax margin at the subsidiary level and ROIC at the consolidated level.

Okay, and then if I could just jump back to ancillary real quick; I think you have the 20-20-20 in place.

I'm wondering if there's any thought to changing that?

And do you think that would help?

Maybe you can comment on whether you think you get any revenue premiums based on your lower ancillary charges.

Steve, it's Brad.

I don't know that we would comment on what we do in the future.

What I would tell you is that we're wrestling with this issue.

We do want to get our revenues to a point where we're recovering these higher levels of fuel costs as well as our growth, and we need to push things a little bit to get to that point.

Bag fees are tough, because we know that if you increase the bag fees, the revenue goes up.

And we know that, as Joe just hinted at, customers don't love bag fees and their behavior changes.

We're going to look at the overall problem without a focus on any one particular area.

And I'm quite confident that we'll make a little bit of adjustment here, as we move forward.

Okay, thank you.

We have time for maybe one more question, Steve.

Okay, your last question comes from the line of Hunter Keay with Wolfe Trahan.

Your line is now open.

Thanks for taking my follow-up.

I'll be quick.

Did you guys mention anything about variable pay targets for 2012?

No.

The variable incentive, have you guys -- sorry, go ahead.

Hunter, it's Brandon, again, obviously.

We didn't give any guidance on variable pay targets for 2012.

Our mindset around variable pay is that it should be aligned with the business plan and we just wrapped that up, so we'll be announcing the targets internally.

What I will tell you is that at target, variable pay is right around $60 million on a consolidated basis and that's roughly -- and I'm getting some notes here -- that's roughly $50 million in the PBP plan and roughly $10 million in the OPR plan.

That's what I was looking for.

In terms of gross interest expense on a year-over-year basis, we've been trending down - fair to think that the fourth quarter gross interest expense is a reasonable run rate going through into next year?

We'll give some guidance in our next Investor Update on what we think non-op will be.

I can add some color on gross interest expense in another forum.

But Q4 is -- the non-up in Q4 is murky because there's the impairment charge related to the MD-80, and there is some capitalized interest true-ups that were in there and stuff.

So I'll provide more guidance at another time.

Your point is right on.

And it's fair to say that interest expense has come down nicely as a result of all of the debt that we've paid off over the last couple of years.

All right, thanks again, guys, appreciate it.

We have to wrap it up here in the interest of time.

Thanks everybody for joining us today and we look forward to talking with you again next quarter.

Take care.

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