阿拉斯加航空 (ALK) 2019 Q4 法說會逐字稿

Good morning.

My name is Catherine, 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 Earnings Release Conference Call.

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

(Operator Instructions) I would now like to turn the call over to Alaska Air Group's Director, Investor Relations, Emily Halverson.

Thanks, Catherine.

Good afternoon, and thank you for joining us for our fourth quarter and full year 2019 earnings call.

In today's prepared remarks, you'll hear updates from Brad, Ben, Andrew, Brandon and Shane Tackett.

Several other members of our management team are also on hand to answer your questions during the Q&A portion of the call.

This afternoon, Alaska Air Group reported fourth quarter net income of $181 million on both a GAAP and adjusted basis, with the latter, excluding merger-related costs and mark-to-market fuel hedging adjustments.

Air Group's adjusted earnings per share were $1.46, $0.05 ahead of the First Call consensus.

These results compare to adjusted net income of $93 million and adjusted earnings per share of $0.75 in the fourth quarter of 2018.

Our fourth quarter adjusted pretax margin expanded 470 basis points to 10.9%.

This marks the fourth quarter of sequential improvement in our margin expansion.

For the full year 2019, Air Group reported record revenues of $8.8 billion, adjusted net income of $798 million and adjusted earnings per share of $6.42.

Pretax margin was 12%, with adjusted operating cash flow of $1.8 billion and adjusted free cash flow of $1.1 billion.

Our debt-to-capitalization ratio declined to 41%, and our return on invested capital was 12.2%.

As a reminder, our comments today will include forward-looking statements on our expected future performance, which may differ materially from actual results.

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

On today's call, we refer to certain non-GAAP financial measures, such as adjusted earnings and unit costs, excluding fuel, and as usual, we've provided a reconciliation between the most directly comparable GAAP and non-GAAP measures in today's earnings release.

And now I'll turn the call over to Brad for his opening remarks.

Thank you, Emily, and good afternoon, everybody.

As we've discussed on the last couple of calls, we feel that 2019 marked a turning point for us as we got through the bulk of our Virgin America integration and began to see the returns on that investment.

And more importantly, as we focused our energy on running a fantastic airline and on executing initiatives, which we designed to strengthen our long-term competitive advantage.

As Emily shared, today, we reported that our 2019 adjusted pretax income grew by 43% to nearly $1.1 billion, and our adjusted pretax margin expanded 3.1 points to 12%.

Our operating cash flow was exceptional, as it grew 37% to $1.8 billion.

Our free cash flow of $1.1 billion and our net income to free cash flow conversion of about 140% were also very strong.

We've now paid down 75% of the $2 billion we borrowed to buy Virgin America.

And as Emily said, our debt-to-cap ratio is now down to 41%.

These results deliver terrific value for our owners.

In 2019, our ROIC grew 280 basis points to 12.2%, and our earnings per share for the full year grew 44%, which is the highest growth rate of any airline that's reported so far.

Of this value, we returned $250 million to shareholders in 2019 through dividends and share repurchases.

Brandon will talk in a moment about our capital return plans for 2020, which will include the $0.10 increase in our annual dividend, which we announced today.

We've made progress on many fronts, but we're especially pleased with our momentum on commercial initiatives designed to improve the guest experience and drive revenue gains.

For both the fourth quarter and the full year, we expect our unit revenue growth will be the best in the industry.

I want to congratulate Andrew and his team for this exceptional performance, and I want to thank our front-line employees for operating safely and reliably and for operating -- and for offering genuine and caring service to our customers.

These things are sometimes overlooked.

But I think we all know that no airline nor any business for that matter, can deliver on value creation opportunities if the underlying product is not inherently good.

It's not just the leaders of Alaska that believe we have outstanding people.

J.D. Power, Condé Nast, Newsweek, and U.S. News & All -- U.S. News & World Report, all spoke up in 2019 to validate our views.

Tomorrow, over $130 million in annual performance-based pay bonuses will go out to all Alaska and Horizon employees.

This is the tenth year that our program, which focuses all of us on safety, low cost, remarkable service and financial performance will pay out.

And the average over those 10 years is about an extra month of pay per year.

Even with these results, we've got work to do.

At our 2018 Investor Day, we shared our road map detailing plans to return pretax margins to the range of 13% to 15% over the cycle by improving performance in the controllable parts of our operation.

This is our #1 financial priority in 2020.

And as I close, I want to take a minute to recognize that this will be Brandon's last earnings call.

Brandon has been with Alaska for 16 years and has served as our CFO for almost 10 of those years.

As you know, Brandon is an exceptional CFO.

And he's been recognized as one of the best CFOs in the industry because of his financial abilities and because of the clarity with which he communicates our plan to you, the investment community, as well as to our employees.

We will miss Brandon dearly.

And all of us at Alaska wish him and his wife Janet the very best in retirement.

Shane Tackett will be Alaska's new CFO effective March 3. Many of you know Shane well, and we're excited to see him step into this role.

Shane has been with Alaska for nearly 20 years and has led financial planning and analysis, e-commerce, revenue management and labor relations.

He has a terrific understanding of our business and of how we work with people to continue to grow and nurture Alaska.

We're confident in his leadership, and we're anxious to see the imprint he leaves on Alaska in his new role as CFO.

Last week, the leadership team and I returned from 2 weeks on the road for employee meetings in 7 cities across our network.

The goal of these meetings was to share our strategy for 2025.

And we found employees throughout the operation were energized about the road ahead.

This industry can be challenging, but our people know what it takes to win: a relentless focus on safety and on-time operation, truly remarkable service and a low fare, low cost, high-efficiency financial profile.

We continue to do these things well and we'll continue to grow.

You'll hear more about this from others today.

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

Thanks, Brad, and good afternoon, everyone.

At our Investor Day in the fall of 2018, we laid out a road map to achieving our goal of 13% to 15% pretax margins and a series of revenue and cost initiatives that would move us closer to that goal.

Building on that momentum, we've been working on our strategic plan for the last 6 months that sets the vision for Alaska for the next 5 years.

The plan builds on our strengths and addresses key areas of opportunities for our company to thrive in a consolidated and increasingly competitive industry.

The plan is comprehensive and for obvious reasons, we won't share specific details, but at a high level, it is focused on 3 areas:

The first is growth, which includes how we build our network in hubs, how we unlock the value proposition of our brand in California, how we build the best-in-class merchandisers, how we become the best-in-class merchandisers and how we drive guest and employee-facing innovation.

Second is people, which addresses how we continue to nurture our fantastic culture, how we build excellent labor relations and how we develop best leaders in the industry.

And third is our business model, which builds on our strong safety culture and operational excellence.

Our path of being leaders in sustainability and our focus on creating a robust financial engine that allows us to generate appropriate financial returns over the long term.

Alaska always has been and will continue to be a growth airline.

Since 2000, we've grown at a rate that outpaced industry 3:1.

We were able to do this because of our durable, competitive advantages.

We're safe.

We run a good operation.

Our people provide remarkable service.

And we have low-cost so we can offer our guests low fares.

Building these muscles has required enormous discipline.

Over the last 10 years, we've demonstrated our ability to be at or near the top of the industry in each of these areas.

We know that preserving these competitive advantages is key to the continued profitable growth, but we're seeing increasing congestion in our largest hubs that is challenging us.

Gary Beck, our new Chief Operating Officer and his leadership team will be laser-focused on operational excellence, and changing processes so we can continue to operate in our congested hubs with a low-cost, high productivity mindset.

Recently, we began building another muscle that is key to our future as a growth airline, building our commercial advantage through improved merchandising and demand generation.

We saw the impact these efforts had on our performance in 2019 and believe there is additional opportunity to improve in these areas.

Andrew will be sharing more about these plans in a bit.

Finally, our business model.

You know that we are committed to achieving a 13% to 15% pretax margin, and that remains unchanged.

Additionally, we've been working on concrete goals around capital allocation, specifically related to free cash flow generation and returns of capital.

You hear us talk often about the value we create for our guests and employees and our Board has always been supportive of this.

They've challenged us to also model the same clarity in our long-term commitments to owners.

So we've created a document that we hope to share with investors this spring that provides insights on our management philosophy, and that covers the financial targets that we should be held accountable to.

The working title of this document is called the owner's manual.

We plan to share more about it at our annual shareholder meeting on [May 7] (corrected by company after the call).

If you don't typically dial-in for that, I suggest that you do so this year.

Before I hand it over to Andrew, I'd like to mention several achievements during the quarter.

First, we completed our busiest holiday travel season ever.

Our fantastic people helped over 11 million guests get to their destinations this quarter, that both Christmas and New Year's falling midweek, demand was higher than usual as evidenced by elevated load factors and yield throughout 2 holiday weeks.

And despite a rough Christmas week operationally, our people provided excellent service to our guests and I want to thank them for their efforts over a busy couple of weeks.

Second, with the recent ratification of a joint collective bargain agreement with our Airbus and Boeing aircraft technicians, all work groups across the company are integrated completing a significant milestone in under 3 years after the merger with Virgin America.

Third, Horizon delivered one of the best financial and operational performances in its history in 2019, with its lowest unit cost ever.

Gary Beck and the entire team at Horizon have led a remarkable transformation.

Congratulations to them.

And looking forward, I'm eager to see how new Horizon President, Joe Sprague and the team build on this success, including continued cost management and moving even more to best-in-class E175 operational performance.

As I reflect on my almost 16 years with Alaska, I know that our success has been fueled by our fantastic people, many of whom have been here for decades, building our brand and the special connection we have with our guests.

Our culture and focus on kindness is truly unique, and we will continue to nurture that even as we continue to grow.

Our employee meetings over 7 cities in the last 2 weeks, we're inspiring and energizing and that gives me confidence we can execute this ambitious plan.

And now over to Andrew.

Thanks, Ben, and good afternoon, everyone.

To echo what you've heard from others, the commercial business ended the year on a very strong note.

Our total revenue grew 7.9% in the fourth quarter on just 3.5% capacity increase.

This translates to unit revenue growth of 4.2%, which we believe will exceed the industry by over 350 basis points.

Both leisure and business demand was solid this quarter, I'm pleased to report that New York and California transcon performance were both among the top 3 TRASM improvement stories for Alaska.

Our teams have worked hard this year to recover from the challenges we faced early in 2019 and have made a positive impact turning those markets around.

This is a testament to what we know to be true, putting the right aircraft in the right markets when combined with Alaska's high-quality product and service is a win for both our guests and Alaska Airlines.

An important contributor to our revenue growth has been our premium product.

You may recall that prior to 2017, our mainline fleet was segmented into just 2 classes.

First and main cabin, with the regional fleet only main cabin.

At that time, premium product revenues comprised just 7% of all revenues, with 70% of revenues generated by main cabin seats.

Today, First Class and Premium Class represent 22% of our total revenues.

This mix will grow as we complete the reconfiguration of the Airbus to bring the premium product mix in line with the rest of the fleet.

On the regional side of our business, we also see solid demand for premium seating on the Embraer 175s.

We're intentional about how we manage our premium product business.

Our goal is to keep our premium cabins affordable, provide generous benefits to our loyalty members while competing effectively against our peers.

In the fourth quarter, First Class revenue was up 19% on 13.6% more seats.

Premium Class revenues were up 16% on 14.5% more seats.

This momentum will continue into 2020 as we complete the remainder of the retrofit and focus on more effective merchandising of our premium cabin.

RASM from our premium products was 54% higher than generated by our main cabin and a 6-point improvement from the fourth quarter of 2018.

On the loyalty front, we once again saw double-digit percentage growth in our revenues this quarter.

Revenues include mileage plan commissions on our credit card as well as redemption revenues included in passenger revenue.

This quarter's performance caps off 3 incredible years of growth in our loyalty program since the acquisition.

I'd also like to note that this quarter's results concluded 4 consecutive quarters of year-over-year RASM growth and a strong close to the year.

Total revenues in 2019 grew 6.3% to $8.8 billion on 2% capacity growth.

RASM for the full year is up 4.2%, more than 200 basis points over industry.

And additionally, this represents approximately 50 basis points over expectations we've shared with you at our Investor Day in the fall of 2018 and represents our highest full year relative RASM increase since 2011.

We started talking to you about an inflection at the beginning of 2019, and we are pleased that our results this year demonstrate that we achieved it.

As Ben mentioned, it is imperative that we carry the momentum we've built in 2019 forward.

And we will be squarely focused on building strength in the areas of merchandising, demand generation and innovation.

To improve the execution of revenue initiatives and the guest experience, my organization has recently undergone a structural realignment to better anticipate and serve the needs and desires of our guests.

The drivers of our revenue have fundamentally changed over the past decade, where they were once predominantly driven by main cabin ticket sales, we now manage a fully segmented cabin that houses numerous billion-dollar segments, including First Class, Premium Class, Saver Fares and loyalty revenue.

A new organizational structure better reflects how we do business today and will improve both the guest experience and our revenue performance.

The company has long been a leader in merchandising and technology.

A key enhancement to the commercial organization was appointing Charu Jain as Senior VP of Merchandising and Innovation.

This new division will also include responsibilities over distribution and e-commerce.

Charu, who has previously Alaska's CIO brings deep technology experience.

She'll be working with all our leaders to not only drive merchandising, but innovation that will be squarely anchored in revenue generation, improving the guest experience and developing tools for our employees so we can deliver our products and service with excellence.

We are very confident that Charu's leadership will drive us to regain a top position in these disciplines.

Also on the technology front, the implementation of our new revenue management system is well underway.

This project is a multi-year investment, which will bring advanced forecasting capabilities, along with revenue and network optimization support.

We plan to complete the first phase in the back half of 2020.

While the incremental revenue delivered in the first year is small at around $20 million, the capability it supports will unlock more significant revenue potential in the years to follow.

As I shared on our last call, our 2020 revenue includes the carryover of 2019 revenue initiatives and synergies of approximately $125 million.

This will be concentrated in the first half of the year.

Half of this represents synergies, such as cross fleeting, and the other half revenue initiatives such as the annualization of Saver Fare and other ancillary price changes.

Additionally, the focus we're putting on merchandising, demand generation and innovation is expected to drive additional revenue growth with most of the opportunities skewing to the second half of the year as some of the larger initiatives require the activation of new technology.

We will be updating you on the progress of our 2020 initiatives through our quarterly revenue guides.

This afternoon, we established our first quarter guidance ranges.

Capacity growth will be approximately 4% and unit revenue is expected to grow between 0.5 point and 3.5 percentage.

While Q1 is the weakest seasonal period in the industry, we've seen indications of strength in the early weeks of the quarter relative to last year.

To date, pricing has been stable.

And structural changes to our network in January and February to better match our network to demand patterns is resulting in some nice load factor increases, and we expect to outperform industry unit revenues this quarter.

2019 was a strong year accompanied by great momentum, delivering margin improvement through higher RASM and a better guest experience remains the commercial team's #1 priority as we enter 2020.

We've demonstrated our ability to identify and execute against high-quality, self-help measures in 2019 and are confident that the additional opportunities we have identified will be similarly successful in 2020.

And with that, I'll turn it over to Brandon and Shane.

Okay.

Thanks, Andrew.

Good afternoon, everybody.

As part of our transition, you're going to hear from both Shane and me today as we walk through our Q4 and full year performance and talk about 2020.

We were pleased with our fourth quarter results.

Net income and earnings per share both nearly doubled.

Our 10.9% pretax margin was 470 basis points better than last year on the strength of unit revenues, solid execution against our cost plan, again, and a modest decline in fuel prices.

This was our fourth consecutive quarter of margin improvement and the largest.

For the full year, adjusted pretax margin was 12%, a 3.1-point improvement over last year and meaningful progress on our path to 13% to 15% margin.

Profits increased because our teams executed well on the initiatives we laid out at our 2018 Investor Day.

Our fourth quarter unit costs increased 0.7% on 3.5% increase in capacity.

We weren't happy with the result.

We did have a modest reduction in capacity given December's weather and some related costs, but we also saw some late adjustments to employee benefit accruals, including high dollar adjustments to pilot disability accruals and large medical claims that came into the last couple of weeks of the year.

Brad mentioned our performance-based pay program, and I thought it might be useful to connect our year-end benefits related adjustments to the PBP payouts earned by our people.

These late adjustments reduced the payout of an employee making $50,000 a year by $275.

We need to improve the structure of these programs to better manage these costs prospectively.

Overall, our full year cost performance was solid.

Our teams across the company, both in operational roles and support roles, did a nice job developing aggressive plans and then hitting them.

It's notable that our full year CASM increased only 2 -- excuse me, 2.3% on 2% ASM growth.

You might recall that our initial guidance for 2019 was for 2% to 2.5% unit cost growth.

We achieved that while absorbing $48 million of costs associated with the new collective bargaining agreements with our IAM and AMFA represented employees, not in the original guide.

Productivity was good, but we still have lots of opportunity to get back to peak performance.

Overhead was down 3.5% or $25 million year-over-year helped by the outstanding work of our supply chain team and their very successful initiative to improve terms with our business partners and the steps we took to rightsize our corporate staff.

In fact, there's more work underway to simplify reporting structures and make us more agile.

Now over to Shane.

Thank you, Brandon, and good afternoon, everybody.

My remarks today will touch on both capacity and cost guidance for 2020.

And then briefly on our fleet plan and owner's manual.

Regarding capacity, it remains our intent to grow between 3% and 4% this year.

This does assume a midyear MAX return to service, which, given Boeing's press release last week and the likely requirement for sim-based training for MAX pilots is still uncertain.

Regarding cost guidance, we believe unit costs will be up about 2% for 2020, excluding the impact of a new agreement with Alaska's pilots.

I would also note that 2% excludes any impact to capacity due to the MAX delivery timing as well as any costs associated with potentially required training related to returning the MAX to service.

We'll continue to update both our capacity and cost guidance as we gain more certainty about the timing of the 10 MAX aircraft we are scheduled to receive this year.

To discuss costs a little further, we just wrapped our annual budget process.

And although I'm happy that we have a plan that will again grow our pretax margin, we continue to have opportunity on our cost structure.

As you know, during integration, we intentionally de-prioritized, to a modest degree, our cost focus.

That is now behind us, and we know that our long-term health is secured only with the ability to offer low fares and high-value to our guests.

And that to offer low fares, we need to be relentless again in our focus on efficiency and low cost.

While goals are aggressive for 2020 in light of a few large headwinds, we are committed to demonstrating our continued focus on cost discipline in the quarters and years ahead.

For Q1 specifically, we expect unit cost to increase roughly 3% on the 4% ASM growth that Andrew mentioned.

Another important area of focus is our long-term fleet plan.

We have an opportunity to replace 61 A319 and A320 aircraft with larger gauge, more efficient assets, either MAX 9s and 10s or Airbus 321neos.

All of which would give us the ability to generate more revenue while lowering unit costs.

The economics of up-gauging over the next several years are compelling, and we are looking forward to finalizing plans to do this as one of our main 2020 objectives.

The ultimate timing of a fleet transition will be balanced to smooth incremental training costs, especially if moving to a single fleet, and will also be done in a manner that ensures we can meet our free cash flow and capital return goals.

We'll have more on this topic in the quarters to come.

Lastly, Ben talked to you about our owner's manual, which is something we are excited to share more about later this spring.

Alaska, led by Brandon in these past 10-plus years, has established a history of balanced and consistent capital allocation, balance sheet health and cash flow generation that has served the company, our guests, our employees and our owners well.

The owner's manual will serve to build on this history by documenting and memorializing goals in several areas, including free cash flow generation, leverage, returns to shareholders, ROIC and pretax margins.

It also discusses the factors that have driven and will drive our continued success, including the way we serve customers, how we offer value to and create loyalty with guests.

And the critical importance of operating with excellence and being a great place to build a career for our people.

As Ben said, we will share this in May at our Shareholder Meeting.

And with that, one last volley, back over to Brandon.

Thanks, Shane.

Turning to the balance sheet.

We ended the quarter with $1.5 billion in cash and marketable securities.

We produced a record $1.8 billion of operating cash flow before pension funding while net CapEx was approximately $700 million, resulting in $1.1 billion of free cash flow, a $760 million improvement over last year.

Free cash flow conversion was exceptional at approximately 140%.

CapEx was lower-than-planned because of MAX delivery delays, but planned CapEx was also low because of the intentional constraints we put on CapEx 2 years ago in order to improve our ability to generate free cash flow.

Our #1 capital allocation priority for 2019 was to re-deleverage our balance sheet.

We paid off more than $600 million of balance sheet debt and have now paid off $1.5 billion or 75% of the amount we borrowed to acquire Virgin America.

We closed the quarter with a debt-to-cap ratio of 41%, and with the trailing 12-month net debt-to-EBITDA ratio of 0.9x.

We also made a $65 million contribution to our defined benefit pension plans, which are now 86% funded.

Last quarter, I mentioned that our treasury team was working hard not only to prepay debt, but to restructure the debt that remains to take advantage of the low rate environment.

They've done a great job.

We have $1.5 billion of balance sheet debt remaining, 79% of that is fixed, and the overall portfolio rate is currently 3%.

Current maturities average only $250 million per year over the next 3 years.

Rounding out our fortress balance sheet, our 113 unencumbered mainline and E175 aircraft and $400 million of undrawn lines of credit.

On the capital return side, I hope you all saw that we once again increased the dividend this time by $0.10 per share or 7%, signaling our Board's confidence that we're on the right track and our current expectation that 2020 profit will eclipse that of 2019.

Given that our leverage is basically where we want it, we're poised to increase returns to shareholders with the going-in assumption that share repurchases will increase by more than 3x to $250 million this year.

When combined with the higher dividend, we expect to return $430 million to our owners this year, the second highest amount in our history.

Before we go to Q&A, I thought I might offer some closing thoughts through a more personal lens.

First, you've heard about our competitive advantages.

They are real and durable, but the secret sauce of this company is our people.

Sure, that might sound cliché, and I know investors can't model it, but it's actually the truth.

Not just the way they connect with our guests, but how resilient and determined they are across all corners of this special company, despite our 87 year history of being the underdog.

Second, I couldn't be more enthusiastic about our new CFO.

There is nobody here better than Shane at understanding the profit drivers of our business.

And finally, we have an awesome strategic plan.

That's exactly the right plan for where Alaska is today.

And we have an exceptional group of leaders, especially those around this table that I have been incredibly lucky to work with, who will make it come to life.

It's going to be fun to watch.

And with that, let's go to questions.

(Operator Instructions) And your first question comes from the line of Catherine O'Brien with Goldman Sachs.

I think I'd be remiss to not start off by saying congratulations, Brandon, on your retirement, but I'm sure you know that you'll be missed by all.

And then from there, I guess, I'll start off with the cost question.

So just on your 2020 cost outlook, so thinking back, this year's unit costs were up 2.3% on 2% capacity growth, which, as you just highlighted, includes about 100 basis points of labor headwind from new agreements you reached in this year?

And then in 2020, you're expecting unit cost to increase to similar around on what could be 150 basis points more capacity.

Can you just help us walk through any headwinds you're facing this year?

Or any big cost tailwinds (inaudible) from 2019 to help explain that pickup in unit costs?

Yes, Catie, this is Shane.

I'll take that.

And just to reiterate, I do think we had a really good year in 2019.

If you recall at Investor Day in 2018, we laid out a multi-year sort of road map that articulated $160 million of cost savings that we were going to go after over the next couple of years.

I think we did really well on a number of those, selling related expenses, constraining overhead, which was down $40 million.

Brandon mentioned the supply chain work that was done this year.

And so that's all really good.

We do have more work to do on the productivity side of the business, asset utilization side of the business.

In order to get those unlocked, we need to be able to grow more and to do that, we just need more stability in our fleet plan, and we need to unlock some of the constraints in the way of growing, which include crew training.

And again, just sort of knowing which aircraft we're going to have over the next year or 2.

There are a couple of headwind areas, principally airport related costs.

This is a place we used to be super efficient at.

It was maybe 3% or 4% of the cost structure.

It's 7% or 8% now, and I think it's going to be elevated for a while as aging infrastructure at airports does need to be upgraded and we understand and support that.

And then we do have a big maintenance sort of driven expense item this year, both on the Airbus and the Boeing side, a lot of the Airbus related costs are related to beginning to account for lease returns that begin in earnest next year.

Okay, great.

Maybe just one quick follow-up on that one.

So on the lease returns, do you have any sense of -- or could you give us some color on like what portion of the CASM mix that's driving this year?

Yes, Catie, I think we do know that, but I don't think we're giving that level of detail out today on the call.

Got it.

And maybe just one more on the MAX.

So a couple of your peers were negatively impacted by lost capacity due to grounding of the MAX in 2019, have reached agreements with Boeing, that should reduce CapEx going forward.

Could we see downside to your $750 million CapEx forecast, not only just from the timing shift, but also from a potential reduction in purchase price if the MAX remains out of service through later this year.

Catie, it's Nat Pieper.

We're talking with Boeing, as I think every other airline is on the planet right now with potential delivery schedules.

As you know, we were supposed to have 3 airplanes last year and take 7 more in 2020.

It's part of our longer-term fleet strategy and looking at growth and replacement going forward, and there's just going to be more to come on that.

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

Just a little bit of slightly different side of the coin to Catie's question on CASMex.

I think, Shane, you mentioned that your -- the plan is to expand pretax margin.

So kind of curious on the revenue side.

It seems like there's some confidence that maybe you'd outperform the industry -- you'll be able to continue outperform in the industry.

I'm not quite clear on kind of all the drivers there and what gives you confidence as with everybody having these various revenue initiatives.

And I was just wondering if you could talk a little bit more about that?

Hi, Savi, it's Andrew.

I think a lot of things that we've had an opportunity to do that we're going to continue to see.

The first thing is, as I shared in my prepared remarks, we do have carryover synergies and initiatives that are quite significant.

And most of the other carriers had their basic economy in already and of course, the synergies from cross fleeting and other things.

So that's a benefit that's going to come through.

The other thing is that we are really hitting our stride now.

We're squarely focused on running our core business.

The network team is doing a magnificent job at getting seasonal schedules tighter, more efficient, more productive, working with the ops groups.

And we are now moving away from integration and squarely focused on getting our revenue initiatives in more quickly and doing a much better job of it.

Overall, from what I'm seeing in the first quarter, we feel really good about how all those things are working together on the revenue momentum front.

Makes sense.

And then, Brandon, if I might ask you a question as Brad pointed out.

You've been doing this for -- leading Alaska for 16 years, and I think longer being a part of Alaska.

Just wondering, over this time, kind of what you think consider to be advantages that Alaska have today that you didn't see when you kind of joined?

And maybe what are the challenges that you see today that are different than maybe kind of 10, 15 years ago?

That's Savi.

That's an interesting question, just off the cuff.

What I would say is, we're way more disciplined than we were 16 years ago.

And that just comes from us maturing as a company and getting a better leadership team and focusing more on process.

That cuts across the operation and how we think about our service and also think cuts across the finance part of the business as well.

In terms of challenges going forward, I think it's just continuing to grow profitably in an industry where 4 carriers have 85% market share.

But I'm confident, as I said, that we've got a mix of competitive advantages, some tangible and some intangibles that will allow us to do this going forward, and I'm really optimistic about the company's future.

Your next question comes from the line of Joe Caiado with Crédit Suisse.

Congrats again, Brandon and Shane.

Congrats to Kyle, Sangita, lots of congratulations to go around over there.

As you work on putting together your 5-year plan, how was the uncertainty around the MAX impacted that process internally.

Have you had to delay certain decisions or could it even be seen as an opportunity as you revisit your delivery schedule with Boeing?

Shane, you talked about -- you're thinking about upgauging, might this actually afford you more flexibility in terms of fleet or CapEx planning as you think about putting together that 5-year plan?

Joe, it's Nat Pieper, again.

I think what we've been focused on is really defining our fleet requirements for the next 5 to 10 years, covering our replacement needs and covering growth.

Shane mentioned the 61 A319s and 320s that we currently operate.

And those are the airplanes that are the primary candidates for replacement.

We're looking at the MAX 9 and the MAX 10, looking at the A321neo and there's going to be upgauge benefits for us with that, better cost performance, better revenue performance.

Boeing's challenges with the MAX did cause us to rework the sequencing of events and some of our timing.

But we're confident that over the next 6 to 9 months, we're going to come with a good decision for Alaska.

Later this quarter, we're going to start the acquisition process.

We'll work it through the summer, and we're confident we'll come up with an answer in third quarter, fourth quarter of this year.

Appreciate that.

And then maybe just a quick question.

On this owner's manual, understand more details to come at the annual meeting, we certainly look forward to that.

But just can you describe the document a little bit more in its intended purpose.

Is that something that would be accompanied by formal changes to the proxy and management compensation structure?

Is it more sort of a philosophical document or guidepost for management.

Just how should investors think about that document?

Joe, this is Chris Berry.

It really is more the latter.

I mean, it's a pretty comprehensive document, but it shares our competitive advantages, our management philosophy, our style.

And then really sets up these guideposts for long-term financial performance.

And so you'll see that laid out in the owner's manual.

We'll spend more time with you all after we made those announcements to share more of the detail on the sausage making, but that's generally how it's laid out.

Chris gave a great answer.

I might just sort of maybe add some perspective from the Board.

Our Board of Directors got very interested in this process.

We had 2 or 3 investors come and speak with the board 18 months or 24 months ago.

And the basic idea was we feel like we do articulate how we bring value to our communities, to our customers, to our employees, and they really nudged us to say get more articulate about what the deal is for people that own the business.

And I think we've had a lot of fun putting the manual together.

I think -- I hope, as we put it out there, I hope you will give us feedback, but it's -- the idea is that we don't want our stock to be a trading vehicle.

We don't want it as a shareholder roster to be filled with short-term investors.

We want this to be a fantastic place for you to invest over decades, and we want to be part of getting more respect for the industry, getting people that invest in the airline space to have a mindset when they invest that it's going to be a great long-term investment.

So that -- this is sort of us taking a stab at putting -- making some commitments.

We know that we've done well when we've made public commitments about what we want to do.

So as Ben and Chris have said, we'll roll this out in May, but we're anxious to get your feedback to it and then have it get better as we move along.

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

Brandon, congratulations.

Given your comments, Ben, on hub congestion and Shane, some of the comments you made about rising airport costs.

So what's the company view on this proposed second airport in the SeaTac region?

Hunter, you're talking Paine Field.

No.

I'm talking about the proposed -- didn't the City Council talk about, there was going to be some proposals going to be debated at some point in 2022, about building a second airport in the region just completely from scratch.

Yes, this is a great chance for Diana Birkett Rakow to jump in, and she's been working on this, Hunter.

And Diana, why don't you share our thoughts.

Sure.

Thanks, Hunter, you've been reading some good Washington state news.

So the legislature passed a bill last year to set up a governor commission to -- governor commissioned board to look at potential options for growing capacity across the region.

That could be at Paine Field, that could be at another airport in the region and asked for a recommendation to the governor by January 1, 2022.

Shane Jones, who is our Vice President of Airports is on that commission, along with many others and we're very interested in the results.

We certainly know that we have fantastic growth in this region, and we have constrained airport space, and we want to make sure that we can continue to grow.

What's your view on it?

Do you want it to happen?

Or I mean what's your company view?

Yes, we do want it to happen.

We're really glad that the commission was set up.

We don't have a bias yet as to where that capacity increase occurs.

Obviously, there's some underway at SeaTac, but we need more than that.

And we're anxious to get through the evaluation to make sure we do have a thoughtful answer about where.

And it -- more maybe 1 location, at maybe more than 1 location at the end.

Okay, great.

And then second question, Andrew, you talked about sort of the revenue initiates and network initiatives.

It looks like seasonality is kind of creeping back into the P&L a little bit.

And that means bad margins in 1Q and really good margins in 3Q.

You guys kind of got away from that a few years ago, and the balance was something you talked about.

As you make network changes to sort of return to areas of strength, does it also reintroduce a little bit of sort of quarter-to-quarter seasonal imbalance in your annual earnings results.

Is that something you're trying to manage?

Yes, that's been squarely on my team's radar.

In fact, just to be frank, watching January and February of this quarter, very, very closely because we made some very significant network moves.

And what I'm seeing right now is very decent load factor increases accompanied by yield increases.

So I think going forward, our job will still be in the first and the fourth quarter, but the first quarter is really our biggest challenge.

And I think as we move the network around, as we upgauge, as we do a lot of other stuff, I think we'll get this a little more in line.

But first quarter is probably going to be always the weakest.

Our next question comes from the line of Michael Linenberg with Deutsche Bank.

And just to kind of echo the sentiment of everyone else, Brandon, it's been a great run.

So on that note, I'm going to ask a pension question, but you can deflect over.

One more pension question, right?

But I don't know if you may have mentioned it earlier, but do we see in 2020, do we see a benefit in the non-op from maybe better-than-expected returns in your pension in 2019?

Yes, definitely.

The non-op portion will be a small favorable improvement year-over-year.

Okay, great.

And then just my second question, and maybe this is more to Andrew.

When we think about you talk about growth, and I sense that it's all about margin growth and earnings growth, but we also look at sort of where your supply growth is relative to the industry.

And the 3% to 4% number if we were to go back 12-plus months pre MAX, was that where the planning was for 2020, maybe 2021?

Or is that maybe even a bit on the low side because you had some pretty meaningful network changes.

It does seem like you've pulled back some transcons and some longer hauls.

That 3%, 4%, how has that changed maybe post MAX is what I'm asking?

Yes, that's a good question.

I think -- well, for '19, we were more deliberate about slowing our growth as we tried to get the integration behind us.

I would say for 2020, our growth is lower than we would like, just to be honest.

The MAX for sure has pushed on that a little bit, but also we're working through this multi-fleet and crew and all the rest.

But at the end of the day, as we've shared, it's 4% to 6% growth.

And I'm looking forward to getting through some of these decisions and challenges so that we can move this forward.

Okay, great.

And just one just last word of Brandon.

I presumably you picked the March week, the first week of March because that's when S&P upgrades you to investment grade, right?

We should assume that.

Bless you, Man.

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

And Brandon, I will echo everybody else's comments, we'll miss working with you.

Shane we're looking forward to working with you.

And Brandon, I'm looking forward to seeing what your next chapter is going to look like.

So 2 questions.

One is, are you doing any accruals for prospective contracts like for the pilot contract?

Or is that an after the fact item?

No, it's an after the fact item for us.

Okay.

And then my next question is kind of unrelated to some of the things you've talked about so far.

With -- I know you guys have a lot of codeshare agreements and interline agreements with various international airlines, especially ones in Asia and China.

And I'm wondering if you're seeing any declines in passenger transfers between your airline and those airlines?

Or if it's way too soon with what's going on in China?

Helane, it's Andrew.

We've looked at it.

The international connectivity to and from especially China and some Asia is a very small number for us.

And so as we look at our growth and traffic right now, it has not been impacted at this time because of this.

Okay.

And then just one other question.

On transcon, do you have to rethink your decision not to have lie-flat seats as you grow that business?

Or are you not going to grow that business going forward?

Yes, thanks, Helane.

Actually, that's a fair question, but I have been extremely encouraged by what's happened in the transcon business, how we've restructured our pricing and the product and the loyalty growth that we've seen.

So right now, the product that we have on board is working very well for us, and I still see upside even going forward.

So for me right now, lie-flat seats is not something that I'm consider -- that we're looking at.

Your next question comes from the line of Joseph DeNardi with Stifel.

Brandon, congrats.

I felt like some of the commentary around the fleet transition and the capital that could go with that was a little bit cryptic.

So could you just maybe provide a little bit more clarity around maybe how capital-intensive the business could get over that period or what your commitments in terms of returning cash to shareholders would be through that.

Joe, it's Shane.

Yes, we're not sort of in a position to have a lot of precision around that.

Just because we don't know what this deal might look like or deals might look like as we go out and look at acquiring aircraft.

But certainly, replacing 61 aircraft over a period of time is going to require some capital.

A lot of those, as you know, are leased today.

There's a chance that we could replace some of those with leases.

But our goal is to sort of get the best value and the best deal for Alaska as we go through this process with the manufacturers.

And we'll say more about this when we roll out the owners manual, but also be very committed to returns to shareholders, assuming we have a good profitability, which is what we're planning to have over the next several years.

And Joe, it's Brandon.

Maybe just to follow-up.

It's not intended to be cryptic at all.

It's really just the uncertainty around the timing and what we actually do that will drive Capex for the year.

But just to reiterate what Shane said, that's really one of the purposes of the owner's manual is to allow some guidelines to make sure that we're meeting our commitments on balance sheet strength and free cash flow generation.

Okay.

And then, Brad, I think either you or Brandon have mentioned how much of the Virgin debt you've paid down about 73x over the past 12 months.

So it's clearly something that you think is important.

Can you just help us understand what we should interpret that as?

Like what happens when all of the debt is paid down.

Why is that so important in your view?

Yes, well, we -- it was -- we've never done M&A before.

If I recall, we paid $2.6 billion of the equity value for Virgin America.

We financed $2 billion or $2.1 billion of that with debt.

And Brandon, you can audit me as we go here.

But that was different.

And we are super proud of a very conservative balance sheet and conservative financial profile, and it was important to us to get the balance sheet back to what investors think of what we -- how we think of ourselves as quickly as we could.

So we are really proud to have off 75%, $2 billion, and now 74x where mentioned that.

I think the other reason that's important is all of this and some of the messaging we're trying to do today.

All of this positions us to move forward now.

It's -- as you go through every you always learn things, but these are big things.

There's all kinds of systems and brands and loyalty and single certificate reservations.

There's so much stuff that needs to be done.

And for a while, you are actually really held into that space.

But what we're trying to say is that's behind us now.

We're no more looking through the rearview mirror.

We're looking forward.

We're -- what are the things that make Alaska great.

What are the things that make it great for investors and customers, investors -- sorry, investors, customers, employees.

And let's look all eyes through the front windshield, moving forward, continuing to make a great airline even better.

So that's what we're -- that's the messaging we're trying to do.

I'm not sure how well we've done it, but that is our mindset.

Your next question comes from the line of Jamie Baker with JPMorgan.

Question on 2-week roadshow that Brad spoke enthusiastically about in the prepared remarks.

Presumably, the mood amongst rank at time was positive.

But could you identify the typical areas of dissatisfaction?

Jamie, it's Ben.

I'm thinking back.

We did so many road shows across all our big hubs.

There were a lot of questions related to some internal things, internal systems that we needed to operate better within the company.

So it's -- and this will be stuff that bores you guys, but timekeeping systems and scheduling systems.

But I would say, overall, what was really good for me, my big takeaway is they were really energized about the vision and the plan over the next 5 years.

There was growth.

And the big thing, yes, one of the biggest things was that the Virgin America questions weren't there anymore.

People were jelling as one team.

I had just felt for the first time in 3 years doing all these roadshows that -- I felt like the airline was one.

And that was so inspiring.

And again, we did all our big stations, it was a lot of fun.

Okay.

That's helpful.

Second, when I think back pre-merger Alaska went through a phase of innovation.

I think you were the first with self-printing bag tags.

I remember an experiment with RFID key chains that would check customers in when they enter the terminals.

Obviously, that's reaching back before smartphones.

It's not going to impact my 2020 model or anything.

But was that just a phase, I mean I'm wondering if the 13% to 15% margins also includes once again, pushing the envelope in terms of technology.

And I'm thinking more about what the customer experience is not so much distribution.

Is this also a mandate for Charu's area?

Jamie, this is Andrew.

It absolutely is.

And I think if you just look at the airline industry today, it's not as much about networks anymore, obviously, for the big guys, they fly everywhere.

It's about the guest.

It's about the interaction of the guest.

It's about making it easy and bringing that all together.

And I think on the innovation front, we got distracted by the integration.

And I think what I'm really excited about is organizationally, and I think it's okay to say, too, we also have an audit -- excuse me, we have a subcommittee of the board now that's focused on innovation that Charu and I are accountable to.

So I think you're going to see some real momentum here.

You're right.

2020 it will be started but the next few years is a big focus for us.

Your next question comes from the line of Duane Pfennigwerth with Evercore.

Not much more to add at this point.

Best wishes Brandon on the next chapter.

Not sure if you'd be willing to talk about it, but do you have a noncompete?

And if you do, how long does it last?

It last 15 years.

We're actually not willing to talk about it because it's not focused on Air Group going forward.

Fair enough.

On free cash flow, great to hear you're stepping back up the buyback in 2020.

Just checking the math a little bit because if you truly are done re-deleveraging, it feels like it could be substantially bigger than what you've outlined.

So should we think about this as a starting point?

Or are you looking to build cash for now?

Duane, maybe I'll take that one.

Yes, we're not looking to build cash.

We ended the year with $1.5 billion.

That's probably about where we see it ending next year as well.

You are absolutely right with the math that you are doing.

There will be more, but it's all dependent on what we end up doing with the fleet decision.

That's why we started at $250 million, but we're going to be flexible on that, and we have capacity under our existing repurchase program to do more than $400 million.

So we'll wait and see.

And then if I could sneak one last one in for Andrew.

Sorry for the baseball analogy.

What inning would you say you're in with respect to the Premium revenue push both in inventory availability and your ability to merchandise it?

Yes, I'd say we're sort of in the final innings as far as putting the inventory on the shelf.

We took 25 175s and all the conversions.

We're now turning over to up-selling and all the rest of it.

And we've got ways to go there to do a better job there.

Your next question comes from the line of Brandon Oglenski with Barclays.

This is actually Matt Wisniewski on for Brandon.

First, congrats Brandon.

But I just had one quick question.

I wanted to just think about -- to get some additional color on how we should be thinking about growth this year.

Last year was focused on regional, this year was a shift towards the mainline, whether that's new markets?

And then in the case of the MAX not returning, what levers potentially could you pull to potentially mitigate the impact, whether it's utilization or anything else?

Yes.

But basically -- I'm sorry, I got distracted on n (inaudible).

Regionally -- geographically -- where we're going to be if MAX doesn't come.

How do we grow?

The growth is 100% mainline.

The regional is shrinking just a little bit and then we do have some levers to pull, whether it's paint lines, mud lines or some other things that we really don't want to, but if we needed to, we might be able to squeeze some more out.

Possibly Airbus lease extensions as well.

Your next question comes from the line of Myles Walton with UBS.

I was wondering in the context of the 3% to 4% capacity growth you're looking for in 2020, kind of what you're looking for from the regional versus the mainline?

And also, in the context of your fleet planning decision, how intertwined is the exercise of the options on the 175s to the decisions on the mainline side?

And did they kind of have to happen in sequence.

Just on the growth, as I just shared, it's all mainline this year, regional is flat to down.

Yes.

And on the question about the options for E175s, we've done a bunch of regional growth recently.

We're going to focus on mainline fleet plan over the next several months.

And then by the end of the year, Myles, we do plan to make some decisions about what we want to do with the regional fleet over a 5- to 10-year period as well.

And you guys have that kind of unique advantage of having, in the past, operate the single fleet and then going to get the complexity of the second type, and I know in the prepared remarks, you hinted at the evaluation of that single fleet benefit.

Can you maybe lay out economically what you've seen as the complexity cost of the dual fleets?

And maybe what that is as a put if you decide to maintain a dual fleet?

Myles, I might not provide a specific number.

We do -- we have looked at it.

There are clearly some hard costs associated with just crew and some maintenance provisioning and those sorts of things, some training.

There are a lot of soft costs that sort of get lost, that it's hard to quantify around just schedule efficiency and making sure you have the right planes and the right cities on every single flight, and it gets more complicated during the regular ops, but it's not insignificant.

And so if we maintain a dual fleet, we'll just need to make sure we can get the revenue out of the aircraft.

Your next question comes from the line of Darryl Genovesi with Vertical Research.

Andrew, as a follow-up to Savi's, the 2019 RASM outperformance of the industry really just reversed the underperformance that you saw in 2018 despite the synergies and commercial initiatives.

So just wanted to ask you, when you say you will be similarly -- you think you'll be similarly successful you think that you have enough in the toolbox to actually outperform domestic industry RASM in 2020, particularly starting in the second quarter when the prior year comps start to get more difficult?

Yes.

Again, I'm only going to comment on the first quarter.

But I think what I would share is that we have some good initiatives and some good momentum here to continue to grow our unit revenues over the course of every quarter this year.

Okay.

And then, Brandon, I apologize in advance because the overall body of work speaks for itself.

But Shane, without completely front-running the Investor Day message, what do you think Brandon might have done a little differently over the last 10 years.

Brandon was a -- particular stickler for not allowing us to enjoy box lunches, but expected us to work at the same time, but I'll probably adopt that.

It was a good message of frugality.

Okay.

And then Brandon, now that Shane has completed the airing of grievances, in a harmless way as possible, how sympathetic to his situation where you're feeling when you came up with this 2% CASM ex guide.

Honestly, I'm really -- not to dodge the question, I actually do love the discipline we have in the 2020 budget, and I know everybody aligned around just really getting back to a place where we reinforce that competitive advantage we have, that is the cost advantage.

And I don't know what you thought of the headline 2% number.

We've got some uncertainty with respect to capacity.

But I'll tell you that we are really focused on making sure that this place rocks when it comes to cost performance.

Operator, we have time for one more question here.

Okay.

And your last question comes from the line of Dan McKenzie with Buckingham Research.

Congrats, Brandon and Shane, nicely done, echoing everybody else here of course.

So I guess a couple of questions.

Andrew or Shane, I wondered if you can elaborate a bit more on how you plan to integrate the MAXs into the fleet once they come.

So specifically, once you get the green light from Boeing, how much time are you building in for filling the plane before they go into service.

So like a 1-month booking window, 2 months and I'm just -- I guess, what my question is getting at is could the shorter booking window weigh on system revenue.

And are the new revenue initiatives that you kind of outlined intended to offset some of those challenges.

Yes, Dan.

We've got pilots that are available to fly.

I think at the end of the day, what I would say is, is that we're going to start this thing off.

We're just going to flight up and down the West Coast.

But we will have enough flexibility, given the number that we're getting to be able to weave these into the schedule.

Maybe first is spares and then building the revenue production over a period, depending on the market, 60 to 90 days.

Andrew, I think it's true.

We're going to sell as if we plan to lift the capacity 1 way or the other.

So we're not going to shorten the booking window where we intend to deploy the MAXs.

Yes.

I see.

Okay, very good.

And then the reference on the premium revenue in the prepared remarks.

What is the planned growth in premium seats this year?

And where are you at in the premium seating reconfiguration of the Virgin fleet?

So we're -- the growth is going to slow significantly.

We've got about 20 units to convert of which the front cabin goes from 8 seats to 12 seats.

But at the end of the day, we're now really down the opportunity is.

Now we've got all the premium costs out there, all the 175s out there and all the conversions, that's really the upsell and growing that nicely.

And I think that if my understanding is correct.

I think Dan McKenzie was our last question for the quarter.

Thanks, everybody, for tuning in.

Thanks for being a part of this, and we look forward to talking with you after the first quarter earnings, and we -- as Ben said, I hope many of you can join our shareholder call where we talk more about the owner's manual.

Thanks very much.

Thank you for participating in today's conference call.

This call will be available for future playback at alaskaair.com.

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