Alaska Air Group Inc. Q4 2008 Earnings Call Transcript

| About: Alaska Air (ALK)

Alaska Air Group Inc. (NYSE:ALK)

Q4 2008 Earnings Call

January 29, 2009 11:30 am ET

Executives

Shannon Alberts – Managing Director of Investor Relations

William S. Ayer – Chairman, Chief Executive Officer

Bradley D. Tilden – Chief Financial Officer

Jeffrey D. Pinneo – Chief Executive Officer of Horizon Air Industries, Inc.

Caroline Boren

[Jay]

Analysts

Michael Linenberg – Merrill Lynch

William Green – Morgan Stanley

Raymond Neidl – Calyon Securities

Peter Jacobs – Ragen Mackenzie

Helane Becker – Jesup & Lamont Securities Corporation

[Megan Koon] – [Flight International]

(Operator Instructions) At this time, I would like to welcome everyone to the Alaska Air Group 2008 Fourth Quarter Earnings Call.

(Operator Instructions) At this time, it is my pleasure to turn the conference over to the Managing Director of Investor Relations, Shannon Alberts, please go ahead.

Shannon Alberts

Thank you for joining us for Alaska Air Group's Fourth Quarter 2008 Conference Call. Alaska Air Group Chairman and CEO Bill Ayer, CFO Glenn Johnson, Alaska President Brad Tilden, and Horizon Air President and CEO Jeff Pinneo, will provide an overview of the quarter. After which, we'll be happy to address questions from analysts, and then from journalists. Other members of the senior management team are also present to help answer your questions.

Today's call will include forward-looking statements that may differ materially from actual results. Additional information on the risk factors that could affect our business can be found in our periodic SEC filings available on our website. Our presentation includes some non-GAAP financial measures, and we've provided reconciliation between the most directly comparable GAAP and non-GAAP measures in our earnings release.

This morning, Alaska Air Group reported a GAAP loss of $75.2 million for the fourth quarter. Excluding the impact of mark-to-market adjustments for fuel and charges associated with the write-up of premiums for hedges that we replaced, are transition out of CRJ Aircraft and severance, Air Group reported an adjusted net profit of $16.4 million, or $0.45 per share.

This compares to a first-call mean loss of $0.04 per share, and to an adjusted net loss of $17.9 million, or $0.46 per share, last year. Again, excluding special items, Air Group was slightly better than breakeven for the year, posting a small profit of $4.4 million, or $0.12 per share, compared to a profit of $91.6 million, or $2.26 per share in 2007.

Additional information about expected capacity changes, unit costs, field hedge positions, capital expenditures and fleet count, can be found in our investor updates, which is included in our Form 8-K, available on our Investor website at www.alaskaair.com. Now I will turn the call over to Bill Ayer.

William S. Ayer

Before I give you my perspective on the quarter and full year, I want to mention our recent reorganization. Brad Tilden, who previously served as our CFO, was promoted to President of Alaska Airlines.

We have a new CFO, Glenn Johnson, who is a 26-year Alaska and Horizon veteran. And, Benito Minicucci was promoted to Chief Operating Officer of Alaska, and he's reporting to Brad. With Glenn's help, my focus will be on Air Group performance.

And, I'll be working with Brad at Alaska and Jeff at Horizon, as we strive to achieve the required return on invested capital, over the long term. And, I couldn't be more pleased to have proven leaders of their caliber in these new roles.

Today, I'll begin our discussion with an overview of the quarter and the year. Glenn will then discuss Air Group's hedging strategy and balance sheet, followed by Brad and Jeff who will provide perspective on Alaska's and Horizon's performance.

The industry experienced unprecedented volatility during 2008, with extraordinary summer fuel prices, given way to depressed passenger demand, in the wake of today's economic meltdown. In the face of these realities, we eked out a small-adjusted, full-year profit, and are pleased to be one of two major airlines to do so.

In fact, this is our fifth consecutive year of profitability on an adjusted bases. While we had planned for a better result, considering where fuel prices were, things would have been much worse had we not made so much progress over the years, on reducing non-fuel costs, strengthening the network, and improving our operation.

The most important factor of all has been our people taking really good care of customers. We're proud of the fact that we paid $12.5 million in operational performance bonuses to our people, an increase of $3.6 million over last year, tied to improved performance.

2008 marked several milestones for Alaska Air Group. One, we achieved our goal of a single 737 fleet type at Alaska and at Horizon, we are down to two aircraft types, and on our way to a single Q400 fleet.

Two, we've responded to last summer's stratosphere oil prices, by reducing and reallocating capacity, a move that will serve us well, as we navigate the current economic storm. Three, we've significantly improved our operation in Seattle, through some new processes and better accountability. And, we are extending these processes to the rest of our system.

And, fourth, we reached a long-term agreement with the new Delta that will be great for our customers and will support our future growth. Delta is now the largest airline in the world, and we're pleased that they chose us to be their preferred west coast partner.

Of course, this is in addition to several other of our important alliance partners, including American Airlines, which together, will give our customers access to a global network and outstanding frequent-flier benefits.

The year ended in a dramatic way, with a series of storms in December that crippled much of our core Pacific-Northwest operation, during the peak holiday travel period. The storms disrupted travel for many of our customers, and we apologize for any inconvenience that resulted.

I also want to recognize the extraordinary effort of so many Alaska and Horizon employees, who braved the elements to get into work, or cancelled their own vacations to help out. The difficult circumstances of the storm reminded me again of what a privilege it is to lead a group of people who have such a strong commitment to our customers and, I want to publicly thank all of our employees for their efforts.

During 2008, we moved our business forward, through better planning and execution of goals. We will apply the lessons we've learned to achieve our key initiative for 2009, which is to optimize revenue in this difficult economy.

It's also imperative that we sustain the operational improvements that we achieved in 2008. More generally, in 2009, we'll continue to pursue the basic tenants of our 20/10 vision, which include a high-value product for customers, good careers for our employees and a reasonable return for investors.

The most significant risk to airline profitability in 2009 and beyond continues to be the uncertainty of customer demand and the volatility of fuel prices. Our conservative financial management, which includes maintaining a strong balance sheet and a consistent fuel-hedging program, provides a buffer against that uncertainty, and gives us the flexibility to take advantage of opportunities to improve our bottom line.

If I had to sum up the principles that we've been adhering to, and that will guide our future decisions. They would sound a lot like something your parents or grandparents probably taught you. Don't buy things you can't afford, don't borrow money you can't pay back, don't agree to things you don't understand, and finally, if it doesn't seem right, it probably isn't. And, with that, I'll turn the call over to Glenn.

Glenn S. Johnson

I'm thrilled to be speaking with you this morning, and I'm really looking forward to my new role. As Shannon said, Air Group reported an adjusted net profit of $16.4 million for the quarter, compared to a loss of $17.9 million last year, a swing of more than $34 million after tax and $56 million on a pre-tax basis.

As is our usual practice, our adjusted figures state fuel on an economic basis and exclude fleet transition, severance and hedge restructuring charges. It's gratifying to see that kind of quarter-over-quarter improvement, particularly given the events of the past year.

However, for the 12 months just ended, Air Group generated a return of just 3.5%, on its $3.5 billion base in capital deployed, well short of our 10% ROIC goal. Consolidated revenues for the fourth quarter were boosted by more than $8 million in late December, as a result of the favorable settlement of a loss-revenue claim, and additional proceeds from our affinity card partner.

But, the quarter's results are really a cost story, both fuel and non-fuel. During the quarter, we saw a decline of $58 million, or more than 9% in consolidated, non-fuel operating costs. Our people at both companies did an excellent job managing capacity-related costs, and Horizon's maintenance costs continued to show dramatic year-over-year improvement, because of the timing of events and process improvements that they've made.

Our economic fuel cost declined by $32 million in the quarter, despite a net hedge cost of $6.7 million in 2008, versus a net hedge benefit of $28.9 million in 2007. That $6.7 million hedge cost represents the original premium expense paid for hedges that settled during the period.

Hedging has continued to receive a lot of attention in the past couple of months, as fuel prices have tumbled. Last quarter, our Treasurer J. Schaefer said it best when he described our hedge program as an insurance policy that helps us manage the volatility of rising fuel prices, while allowing us to enjoy most of the benefit of falling fuel prices.

Most of our portfolio consists of call options or CAPS where our only out-of-pocket cost is the premium that we pay upfront. CAPS make up about 93% of our current portfolio, although we drove a small number of caller instruments, where we are exposed to future cash outlaying, if the price drops below a predefined floor.

And, December 31, when oil was at about $45 per barrel, we were exposed to future cash outlays of approximately $24 million, but we had no collateral held by counterparties. All of our color instruments expire in 2009. As you might have seen in our recent investor updates we’ve been aggressively restructuring our hedge portfolio to take advantage of lower fuel prices.

We’ve been able to reduce our 2009 average strike price from $103 per barrel at the end of the third quarter to $76 today for 50% of our planned consumptions. And just to clarify we’re not locked in at that price, that’s the most we’ll pay. We’ll also have improved, but we have also improved our 2010 protection.

Terminating old hedges did not come without a cost however. We sold existing hedges for which we originally paid $56 million and received proceeds of $6 million resulting in a net economic impact of about $50 million, we then spent $38 million on the replacement hedges. Notwithstanding the costs, we believe that restructuring our hedge portfolio was a wise use of Air Group resources and consistent with our stated objective of managing volatility.

Turning to the Air Group balance sheet we closed the quarter with cash and short-term investments of $1.08 billion, about flat with the end of third quarter and up by more than $250 million compared to the $823 million at the end of 2007.

That puts our cash at 29% of revenues, which we believe is the strongest position in the industry. On the other hand, the substantial increase in debt, the pension charged to equity of $198 million and the gap loss puts our debt to total capitalization ratio at just over 81% significantly higher than last year’s 70%.

We generated $164 million of operating cash flow during the year, down from $482 million last year. The decline was due to lower profitability, higher hedge premiums and slower advance bookings. In addition to the $164 million of operating cash flow, we had proceeds from new financings of $884 million and a return of $80 million in pre delivery payments from Boeing to reflect the change in timing of deliveries for total cash inflows of $964 million.

These were offset by capital expenditures of $482 million, debt repayment of $343 million and share repurchases very early in the year of $49 million. We expect our 2009 capital spending to be up $455 million of which $405 million relates to aircraft and $50 million to non-aircraft spending.

These figures are before any cash proceeds that would be realized from the potential sale of up to four Boeing 737 700 aircraft, which we are planning to sell in an effort to better match fleet size with our lower capacity.

We have debt financing commitments in place for all of our firm Q400 deliveries and we’re working right now on a number of options to finance our 737 800 deliveries. At this point we expect to finance at least three and possibly up to six airplanes using sale re-SPEC financing in the first half of 2009.

This will drive up Alaska’s non-fuel unit costs slightly since all of the ownership costs are reflected in the rent line when an airplane is leased, as opposed to being split between depreciation and interest cost when an airplane is financed with debt.

And finally turning to pensions, our pension assets were affected by the dramatic drop in the stock market, declining nearly 30% during 2008 to $650 million and increasing our unfunded amount by approximately $300 million to $445 million under funded.

At the end of 2008 our funded status had fallen to 59% on a PBO basis, which is the most conservative measure. The decline in the portfolio value and increase in the unfunded amount will result in a very significant increase in our pension expense in 2009, more than doubling from $48 million in 2008 to $99 million in 2009.

On a unit basis this will increase Alaska’s CASM by more than two tenths of a cent. During the year we contributed $52 million to our divine benefit plans, bringing our post 9/11 funding to $420 million. We have no required funding in 2009 but our historical practice has been to fund the service cost, and our current plan is to continue with this funding formula throughout 2009.

Of course we’ll be mindful of our liquidity as we evaluate each month’s contribution. However assuming we make this estimated $45 million contribution, the plans would still be under funded by $400 million which underscores how vulnerable these plans are to external forces, now over to Brad.

Bradley D. Tilden

For the quarter, Alaska Airlines reported an adjusted pre-tax profit of $23.8 million compared to a loss of $18.8 million in 2007. And for the full year Alaska’s profit was $25.2 million versus a profit of $171.7 million in 2007. The 2008 profit represents a pre-tax margin of slightly less than 1% compared to a margin of 5.5% in 2007.

While we’re pleased to report profits for both the quarter and the year, particularly given the environment, we acknowledge that our results are far from satisfactory. Alaska’s passenger revenue for the fourth quarter was down 1.7% to $603 million, our revenue with the result of a 7.1% reduction capacity and a 5.9% increase in passenger unit revenues.

Sequentially, passenger RASM improved by 6.6% in October, was flat in November, and increased by 10.9% in December. Fourth quarter results included the one-time proceeds of $4 million from our affinity card partner that Glenn referred to earlier. Without this benefit, our RASM increase would have been 5.2% for the quarter.

Now our capacity reduction of 7.1% was significantly less than the industries reduction of 11.9% but our RASM performance exceeded the industries by a point and a half. We believe we’ve made the right cuts in the right markets, and we also believe our growth in the markets such as Hawaii and the Twin Cities has brought important new revenue into our network as demand in our core markets declined.

Recently we saw strength in Alaska, Hawaii and the Trans-Conts where we both grew and saw RASM improvement. We also saw RASM improvement in Mexico and Canada as a result of capacity reductions both by us and our competitors. And finally we were able to hold our unit revenues about flat in California, Arizona and Nevada where our scheduled reductions were most pronounced.

Revenue flown under our capacity purchase agreements decline by 7% for the quarter on an 18% reduction in capacity resulting in strong RASM increase of 13.7% we continue to be encouraged by the success of our ancillary revenue initiatives such as the fee for checking a second bag and the increases in our reservations and change fees.

Together these grew by more than $6 million or 35% during the quarter. Looking forward we don’t anticipate the unit revenue trend that we saw in December. We expect our January load factor to be up about two points and yields to be down resulting in [PRASMS] that’s about even with last year.

Alaska’s advanced load factor for February is down a point and for March is down three points, with the latest to this year. Our visibility is not good beyond March but as you would expect there are obvious signs of weakness in demand.

Turing now to cost our CASM ex fuel for the quarter was $0.78 at the low end of our most recent guidance and well below the initial fourth quarter guidance we issued in October. This means we had CASM ex fuel of $0.749 for the year below our planned range of $0.075 to $0.076 despite a significant reduction in planned capacity.

I really want to thank our people who did a great job of meeting their plan and managing down their cost as we reduced the schedule. As we look to 2009, we’re forecasting non-fuel unit cost of $0.81 per ASM on a 8% decline in capacity and a 12% decline in departures.

This forecast is very disappointing given the progress we’ve made over the last seven years, and is worth taking a couple of minutes to walk you through the reasons for the increase. When we decided to cut Alaska’s capacity by 8%, we set a goal of reducing our costs by two thirds of the capacity decrease or about 5.5%.

Given our size, that amounts to about $100 million of reductions and combined with capacity cut that would have given us a unit cost increase of about 2.5%. Almost all of our divisions met that goal and some exceeded it. However, there are four things that our offsetting the decreases our divisions produced. First as Glenn indicated earlier our pension cost will go up dramatically from $48 million in 2008 to $99 million this year.

Second instead of an $8 million decline in maintenance costs we expect an increase of $10 million due to the timing of planned maintenance events and the start of engine power by the hour agreements on our 737-700 and 900 aircraft,

Third because of the way we're choosing to finance aircraft, rent expense will contain $10 million in 2009 that would have been reported as interest expense had we used debt financing. And finally we're budgeting $15 million more for incentive pay-offs in 2009 than we had in 2008.

These items total $95 million essentially offsetting the reductions we achieved. This means that absolute cost in 2009 will be relatively unchanged from 2008 and our unit costs will increase by about 8% to $0.081 again this is our guidance and we will of course try to improve upon this number as we move forward into 2009. I might also note that our capacity number could change as we get more clarity on the economic picture and a better sense for demand in our markets.

On the operations front Alaska's on-time performance improved by six points for the year from 72.4% in 2007 to 78.3% in 2008. This was accomplished despite the storm that hampered our operations for a number of days in December. One side benefit to these very good results was a $5.9 million or 42% reduction in passenger remuneration costs.

We ended the year with 110 aircraft, down five from the end of 2007. Our plan however was to end the year with 115 aircraft flat with 2007 but the Boeing machinist strike pushed five aircraft into 2009. We've previously announced that we are attempting to sell four 737-700s. If we're successful we'll end the year with 112 aircraft, up two from 2008 and down three from 2007 at this point I'll turn the call over to Jeff.

Jeffrey D. Pinneo

I'm pleased to report that Horizon posted an adjusted pre-tax profit of $3.2 million for the quarter. While modest in scale it represents a $14.4 million improvement over Q4 '07 and was achieved in a period of steep economic decline and Arctic-like weather in December that crippled operations at several of our airports.

Our full-year adjusted loss of $10.4 million was a significant improvement over last year's $19.6 million loss yet it remains far short of our goal and is a disappointment for all our people who worked so hard to produce a positive outcome this year.

The big driver in this picture was a precipitous drop in demand leading to a 21.1% reduction in capacity. Our fourth quarter revenues were down 10% on a 22.4% decline in traffic which matched the 21.1% reduction in capacity.

Our system yield was up 15.5% which helped drive the system RASM improvement of 14%. Ancillary revenue played a larger role this year increasing $1.5 million for the quarter. As in previous quarters, line of business mix was a modest factor in the year-over-year comparison as we are no longer flying low RASM, low CASM missions for Frontier.

On the expense side our CASM mix fuel increased by only 2.9% on the 21% decline in capacity. As at Alaska our people did a great job bringing down non-fuel costs by $27.3 million or 18%. This was on top of the $6.5 million decline in economic fuel costs.

Shifting the focus to operations record December snow storms in the Pacific Northwest made for an extremely challenging holiday season. In the face of this our team posted a 75.5% DOT on-time rating for the quarter a slight decline over last year's 76.2%. For the full year our performance improved 2.4 points at 83.9%.

As previously announced we ended scheduled service of our 37-seat Q200 fleet on October 25th. We currently have six Q200s remaining in the fleet and we anticipate their successful re-marketing during the first quarter. All our attention will then be focused on finding new homes for our CRJ-700 fleet two of which we sub-leased during the quarter leaving 18 that we continue to operate during the transition.

While we are engaging interested parties the economic down turn and its impacts on aircraft financing and customer demand have undoubtedly slowed the re-marketing process. In the event we fall short of our re-marketing goals we'll be working with Bombardier to re-time our remaining Q400 deliveries to ensure that our capacity remains aligned with market conditions.

The capacity reduction in fleet simplification efforts outlined are two of several initiatives focused on producing returns sufficient to justify the capital investments we've made in Horizon's assets. We recognize that current returns are not adequate and as economic conditions evolve we will continue to work these and all other levers as needed to generate the returns our employees and shareholders expect and deserve.

As we reduce capacity once again this coming year in anticipation of demand softness we must continue the good work of 2008 in further reducing costs proportionately throughout the rest of our business.

Our success in managing non-fuel costs last year produced a full year CASM X fuel that was actually down slightly from the prior years despite a 9% capacity decline.

Productivity continues to be a central theme in our story. Our 2008 rate of 166 passengers per FTE represents an 8.3% gain over the prior year and is the product of continual improvements in 25 of the last 28 quarters. This is a tribute to the skill, hard work and sacrifice of Horizon people in every quarter.

As we move into 2009 we expect that the combination of increased scheduled maintenance and further reduced capacity will modestly increase our unit costs yet I'm confident that the resilience and adaptability evident in many aspects of our recent performance will continue to serve us well as we face the challenges and opportunities in the coming year.

For the full-year 2009 we're forecasting CASM X fuel of $0.154 to $0.155 6% to 7% higher than in 2008 on about a 9% reduction in capacity. This stems from an increase in planned maintenance activity mitigated by forecast reductions in wages and benefits, aircraft rent and fleet transition expenses.

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

William Ayer

So there you have the details of what is a solid fourth quarter considering the environment. On the positive side our revenue performance outpaced the industry and so far we've done a good job of adjusting our schedule to match demand.

Our cost performance was very good for both the quarter and the full year as we ended up beating our full year guidance even with capacity well below planned levels. Our fuel hedges benefitted us significantly during the first three quarters and in the fourth quarter when fuel prices collapsed the nature of our hedge instruments allowed us to enjoy the lower market prices.

On the other side of the coin the economy is in bad shape and it's pretty clear that airlines, like virtually all other businesses, are going to be under significant revenue pressure for the foreseeable future.

We held on to our sound cash position but this was largely through taking on a lot of debt during the year more than $500 million. This debt along with the reduction in equity due to both our GAAP losses and a large pension-funding charge has pushed our adjusted debt to capitalization above 80% for the first time in many years.

Additionally the decline in the funding levels of our pension plans creates costs and liquidity headwinds for this year and beyond.

While the outlook for the economy is extremely uncertain our competitive position remains strong. We're optimistic that we're going to weather this storm and be ready for new opportunities when conditions improve.

And now we're ready for your questions, Shannon.

Shannon Alberts

At this time we'd like to invite questions from analysts. [Lori], would you please assemble the roster?

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Michael Linenberg – Merrill Lynch.

Michael Linenberg – Merrill Lynch

Two questions first, Bill, you had talked about the Delta relationship and you also highlighted the fact that in the past Alaska has multiple partners. Going forward should we anticipate that the extent of the various agreements that you have with other carriers – will they remain in place or will there be potential restrictions?

Could we see dual co-chairs in some markets, Delta and another carrier? And then just as part of this question maybe a stab on incremental revenue that you could potentially get from this now that you have the preferred carrier partner status with Delta?

William Ayer

Maybe I'll just start on the first part of that and really it's just I think the recognition on our part and our partner's part that these things have been good for all of us. And from our standpoint these alliances have given us a just a broader network of kind of a virtual network globally. And that's been a really important competitive tool for us as we continue to grow our network at Alaskan Horizon.

So as long as they work for both parties that's the thing that keeps them going into the future and that's our hope right now. And on the revenue side...

Bradley D. Tilden

Mike, its Brad, we haven't closed revenue to these things. But I guess I would say the nature of our network, that connecting traffic is important. I think it's important to know that we had an alliance relationship with both Delta and Northwest before. And so what we have now is an expanded relation with the new Delta, and we're very excited about that. But, as Bill said, we're also excited about our other alliance relationships, and we're optimistic that this is going to be good for us and help us grow, and bring more passengers into our network in the future.

William S. Ayer

The other focus we have, Mike, is on customers. And I think the world is full of co-chairs, and some of them work really well for customers, and some of them don't. Some of them are just kind of window dressing with a code on a reservation screen, and with our partners, we work really hard on making sure these things really deliver value for customers. So we work closely to build schedules that connect. We look at the hub airports and make sure there's enough connect time for customers that baggage follows the customer and makes the connection, that the miles get credited correctly, and so forth.

So there's a real operational focus in working groups at both companies here, to make sure these things work for the customers. At the end of the day, it's the customers that get to decide whether these things are adding value or not, and whether they're successful.

Michael Linenberg – Merrill Lynch

Okay, good. And then just my second question on baggage fees – I believe you charge for the second, not the first. Obviously, there's sort of a value proposition argument there on one hand, but then a lot of carriers that you have decent overlap with, like Southwest and Virgin America, do not charge. Is that the primary reason why you want to be competitive with your primary competitors, or do you see an opportunity there?

Bradley D. Tilden

Mike, it's a great question. I guess the way we think about this at a very high level is that at the end of the day, our customers are going to decide how they want to be charged for the services we provide. And we feel like we're in a pretty good spot right now. And, as you said, we do charge for the second bag, but not the first, we do have some change fees and some fees for calling in to res and so forth.

We feel like we're in a pretty good position. The thing we're trying to do right now is make some noise about the fact that we don't charge for the first bag and I guess the economic case is that we're hoping that we get more loyalty and more business because of our position on this issue. But this is something we'll watch carefully as we move down the road, and try to make the right adjustments.

Operator

Our next question comes from William Green – Morgan Stanley.

William Green – Morgan Stanley

I'm wondering if you can talk a little bit about – you made some comments about capacity, and how you could flex it up or down as it relates to your profitability. So I guess the question is can we bookend a little bit how much flexibility you have on the upside or the downside, and in what time frame? And then also, what kind of metrics do you watch to determine whether to make a change to the outlook?

Bradley D. Tilden

Hey, Bill, it's Brad again. I don't know that we have absolute numbers to give you that respond to your question. But I think we might be able to talk with you a little bit in terms of how we think about this.

When we saw the high fuel prices last summer, and then the economic weakness, we made an initial kind of estimate of what kind of capacity reductions we needed to make. And what we are saying today, I think, is we feel really good about those adjustments that were made. We feel like the RASM performance, and the financial performance, is showing that we got it about right.

We use kind of the terminology around here [planned new check act a lot], in terms of just continuous [iterations], keep looking, and keep making adjustments. We don't like to shrink the network, but we do want to have the right size network for the demand that we have in our market.

So, to me, three or four months out, that's about the latest that you want to be making significant changes. If they're really material changes, you have to be farther out than that. On the other hand, like the State of Alaska business this summer, we will be watching very carefully for the next few months to see how it books up. And we'll have 21 flights, I think, a day this summer. So we could make a late adjustment to – by late, I mean the last month or two – to a flight or two.

Not a great answer to your question, but I think the biggest point is we want to be flexible, we want to watch demand carefully, and we do want to continually make the adjustments to size our network to the demand that we see out there.

William S. Ayer

And Brad, I think we all agree that this is a time to be cautious with capacity. The economy, I think everybody thinks the economy is still going south, it hasn't turned the corner yet. And we have been impressed with the effect that we've seen from these capacity reductions. If you look at our numbers, you see that our load factor has been constant or maybe even up a little bit, and RASM has certainly responded to these things.

I mean, our bias is to continue down this path, and just kind of see where demand is, and be cautious about adding capacity too quickly, until we have some really strong signals. And you do lock in you can't just turn on a dime, here. If you try to move too quickly, it runs your costs up so we're going to look out into the future and be cautious, and try to make prudent decisions.

William Green – Morgan Stanley

And yet, your margins are actually – at least the outlook for them – is improving quite nicely, given the drop in fuel. So I guess I'm just trying to get a sense for the profitability level whereby you say, okay, you know what, it's okay to put a little bit more out there, in terms of capacity.

Bradley D. Tilden

Yes it's a good point, you can't just look at RASM, with fuel costs having moved as much as they have. I think, a couple quarters ago we were talking about our fuel cost per passenger on a trans-con flight, and it was way north of a hundred bucks, and now it's about $50. So we can live with a little lower RASM in this environment and still have good financial performance.

William Green – Morgan Stanley

All right, let me turn a question to cash flow. You, I think, will have better cash flows in 2009 than you did in 2008, and yet you've also got some cash flow headwinds, as you mentioned, on the pension side and whatnot. But you were willing to do a buyback earlier last year so can you talk a little bit about how you rank, sort of, priorities for use of cash?

Bradley D. Tilden

Sure, Bill, I think, in this environment, the number one thing is to basically keep this franchise sound and keep us here to kind of fight another day, and kind of manage our way through this financial crisis and economic crisis that we're all dealing with.

After that, you would begin to think about things like capital spending and debt repayment, and maybe way down the list at this stage, share repurchases. But I think, right now, the big focus is really on just maintaining what we have and securing what we have. In terms of capital spending, we're not particularly bullish at the moment. You don't see us, whatever – talking to Boeing about additional firm commitments and that sort of thing. The mindset is maybe just kind of hold on here and get a little time under our belt, and see if we can navigate our way through this thing, get the performance up, and then look at growth.

Operator

Our next question today comes from Raymond Neidl – Calyon Securities.

Raymond Neidl – Calyon Securities Inc.

Well, congratulations on the fourth quarter, it's very good. Usually the fourth quarter and the first quarter are the worst quarters for Alaska, for obvious reasons, you're more seasonal than other airlines. It looks like you made great improvements at Horizon and it looks like you've got a lot of your costs down in the fourth quarter. I mean, for the first quarter, do you think you can do the same thing do you think you produce eke out a profit?

Glenn Johnson

Well, as you know, Ray – this is Glenn – we don't provide profit forecasts and I think we've talked here on the call about our concerns about the revenue picture, going forward. And while we have had positive movement on the absolute cost side, the reduction in capacity is going to put pressure on the CASM piece of it. Probably the most positive element, going forward into the first quarter, is the lower fuel costs that we're seeing.

Raymond Neidl – Calyon Securities Inc.

Okay, and secondly – I thought I'd try, anyway. The second thing, though, a little bit more specific, is you did talk quite a bit about your pensions your defined benefit pensions and the potential liabilities out there. It looks like there's not too many airlines left, or even that many companies in America left, with defined benefit programs. And even though 401(k)s can be just as expensive, you do have an additional potential liability by being responsible for the funding.

Going forward, can a small company like Alaska, a small airline like Alaska, afford to keep that program up, or is there something you do voluntarily with the employees to convert over to a 401(k) profit sharing type of program?

Glenn Johnson

Having said that, we have an obligation to the people that have been in these plans up to this point. We intend to fulfill those obligations and we have an ongoing obligation until we move the remaining folks over into enhanced 401(k)s.

Raymond Neidl – Calyon Securities Inc.

And when did that program convert to 401(k) for new employees?

Glenn Johnson

Yes, it's been at different points in time, with the management group I believe went first, then some of the other labor groups throughout various labor negotiations over the last five years or so.

Operator

Your next question comes from Peter Jacobs – Ragen Mackenzie.

Peter Jacobs – Ragen Mackenzie

Good morning everybody. A couple questions, first, on the purchase capacity, I noticed in the fourth quarter that you matched your purchased capacity revenues with expenses and that has not happened over the last couple of years, except in the third quarter.

So, is there anything different about either the revenue model there that you're employing or just in terms of the expense of purchasing that capacity in that we should think about it a little bit different going forward or was there some kind of anomaly happening in the fourth quarter.

William Ayer

Peter, the goal is for that line of business to make money. So that is the high level objective. I think what you saw happen in the fourth quarter is more aggressive capacity reductions. We trimmed flights that were not working. I think that we disclosed that capacity was down 18%, but revenue was only down 7%, so the unit revenues were up 14%. So you adjust – combine those schedule adjustments with lower fuel costs and we got the result that you saw. And we're hopeful that we're going to see more of that in the future.

Peter Jacobs – Ragen Mackenzie

Would it be considered a positive if you could just keep that at a break even standpoint as opposed to losing money there, or do you actually really want to make money off of that purchased capacity program?

Glenn Johnson

This is Glenn again. Our objective is for all three of the entities to be profitable. And contribute to the ROIC goals that we've set.

Peter Jacobs – Ragen Mackenzie

Okay. Second question, what price are you paying for raw fuel now at Sea-Tac? Can you give us that number?

[Jay]

Yes, Peter, this is Jay. Raw, unhedged about $1.61.

Peter Jacobs – Ragen Mackenzie

Okay, great thanks. Lastly, I may be getting into a little bit more of a sensitive subject, could you give us an update on the negotiations with both the Alaska Airline Pilot Union and the Horizon Air Pilot Union?

Bradley D. Tilden

Peter this is Brad. Maybe I'll start with Alaska and we'll get Jeff to talk about Horizon. You know when Bill put me into this new role, one of the first things he and I agreed on is that a number one priority is to try and get an agreement with our pilot group. So that's what we're going to be trying to do. It's a hard deal. There's been big adjustments through the arbitration that our folks have suffered and at the same time the industry has changed by just a huge amount over the last six or eight years.

But we are in mediation, there is a mediator involved. I know our union group is working really hard on trying to get an agreement. We're doing the same. And I guess we plug away, and I am personally very optimistic that we're going to get something done. It is important that we get a deal that works for everyone over the long run so that's what we're trying to accomplish here.

Peter Jacobs – Ragen Mackenzie

Are there any areas where you're on the same page as the Pilot Union that you can share with us? And also are there any areas that are sticky points that you're pretty far apart that you could share with us so we can get a sense of what the issues are out there?

Glenn Johnson

We all have a very vested interest in this place being around for a long time, so I think we're all on the same page in that regard. In terms of the detail of the different parts of the negotiation, I think it's best to leave that conversation for the negotiating table.

Peter Jacobs – Ragen Mackenzie

Okay, fair enough. And then Jeff, can you add some little color around the Horizon Air please?

Jeffrey D. Pinneo

Yes, I sure can, Peter. As you know the contract that we had in place for five years was amendable about a year ago September, and we've been in negotiations for about two years right now.

It was a tall order to face given the contract we had in place at that time was signed just five days before 9/11. It was built on status of the industry at that point and left us through the post 9/11 period with the highest pilot costs in our sector. To the groups' credit, they came together in acknowledgment of that, really focused on what we needed to be aligned on to the principles that Brad mentioned.

About a year ago, decided to engage in a different approach to negotiations. They've all participated in a process of learning interest-based tools and applying them to the process, and I'm really pleased with the progress that they've made through the application of those tools this last year. They continue to meet, they've made excellent progress in spite of the big challenges that they face and I'm confident it's going to produce a good outcome here soon.

Peter Jacobs – Ragen Mackenzie

Okay, I appreciate the update. That's all I have.

Operator

Our next question comes from Helane Becker – Jesup & Lamont.

Helane Becker – Jesup & Lamont Securities Corporation

Hi everybody. Just two things, on one of the big issues for Seattle for a long time was that the airport costs were higher than some of the other airports that your peer group operates from. And then over the years as you grew there, the costs sort of came into line. Can you just talk about how that is those costs are now given all the capacity adjustments that you're making on a cost per passenger basis?

Glenn Johnson

Sure, Helane. This is Glenn. Let me start on that and Brad can jump in on this as well -- Brad and Jeff. I guess I would just say first of all that we're working really hard with Sea-Tac primarily, but across our system with all of our airports to bring the costs down.

It is clearly a big line item for us, and while we're sensitive to the fact that they have to make long-term decisions, we still need them to partner with us on how to bring immediate costs down. We've had – I would characterize it as good luck – with those discussions with Sea-Tac. We've had very collaborative, productive discussions on how to get their capital programs lined up with what we want to have happen and bring the cost down as a result.

But there's more work to do to get – particularly Sea-Tac's costs down where we think they need to be. And then similarly with our other larger airports up and down the west coast in particular, we've got to focus on bringing down the cost and then we've also got an equal focus on our efficient use of space. So we're reducing gates at Sea-Tac, at Portland, and other areas so that our utilization of space is more efficient. Brad, anything to –

Bradley Tilden

No.

William Ayer

I might just add one thing, Glenn, that's the efficiency of the airport from an air traffic standpoint. We've got a third runway out here now; it was a very expensive runway, but now we have it. And so we're working with the FAA to make that sure we can take full advantage of our airborne technology for fewer delays, for closer spacing of airplanes.

We get a lot of rain and low clouds up here as you know, and so a lot of times before we had the third runway we had some arrival delays because of the weather. We're trying to make sure we can mitigate that as much as possible and in particular take advantage of our position with all the technology we have, the satellite technology and the airplanes of both companies really, Horizon and Alaska.

Helane Becker– Jesup & Lamont Securities Corporation

Right. Aren't your planes among the most advanced in being able to land in fog and so on?

William Ayer

That's right, exactly right.

Helane Becker – Jesup & Lamont Securities Corporation

Okay. And then the other question I had, I think Hawaii's service started some time in the last year. Has shaped up to be the way you thought it would be?

Glenn Johnson

You know Helane, Hawaii has been a really fun success story for this company. We did start I think October 12th Seattle-Honolulu and we've slowly added since then. Now we fly four Hawaiian destinations from Seattle and two from Anchorage. And I think by all accounts those markets are doing terrific for first year markets.

Operator

(Operator Instructions). At this time we have no further questions from analysts.

Shannon Alberts

Okay, then I think we'll turn the call over to Alaska's Managing Director of Corporate Communications [Caroline Boren] to conduct the media portion of the call.

Caroline Boren

Thanks, Shannon. At this time we welcome questions from journalists participating in today's call. [Lori], would you please remind our callers of the procedure for asking questions?

Operator

(Operator Instructions). We'll take our first question from [Megan Koon] – [Flight International.]

[Megan Koon] – [Flight International]

Hi, good morning. I was wondering if you could talk a bit about the status of the Row 44 Trial, if that's happening in the first quarter?

Glenn Johnson

Sure, [Megan.] This is Glenn again. There is a trial going on, we flew the system on one of our airplanes before the Christmas holidays, and then needed to put the aircraft back in service to sustain our schedule during Christmas. We're planning to outfit a second airplane here shortly and Southwest which is also customer of Row 44 is currently in the testing process as well. So we're very excited about the technology.

As you probably know, it's satellite based technology, so it's superior to the ground base technology that some other folks are using. It will give us coverage to Alaska to Hawaii and to Mexico, as well as across the continuous U.S. So we're looking forward to getting that out there. It's another one of these things that Bill in terms of providing what customers want and demand these days and we think it's going to be a big hit.

[Megan Koon] – [Flight International]

And now during the initial trial before the holidays, was that with customers on board?

Glenn Johnson

No, that was simply test aircraft trials.

[Megan Koon] – [Flight International]

Do you know soon on the second aircraft will be outfitted with the technology?

Glenn Johnson

I believe we're planning that in that in the first portion of February, depending on aircraft availability. To get that outfitted and tested, again in test configuration and then with passengers testing.

[Megan Koon] – [Flight International]

And so the test configuration will happen first and then passenger testing would begin after that?

Glenn Johnson

Correct.

Operator

(Operator Instructions). At this time there are no further questions.

Glenn Johnson

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

Operator

Thank you very much ladies and gentlemen for joining today's Alaska Air conference call. This concludes your conference. You may now disconnect.

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