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Executives

Shannon Albert - Managing Director IR

Bill Ayer - Chairman, President, CEO

Glenn Johnson - CFO

Brad Tilden - President

Jeff Pinneo - President and CEO

Andrew Harrison - VP Planning/Revenue Management

Steve Jarvis - VP Marketing

Caroline Boren - Managing Director, Corporate Communications

Analysts

Bill Greene - Morgan Stanley

Gary Chase - Barclays Capital

Mike Linenberg - Banc of America/Merrill Lynch

Helane Becker - Jesup & Lamont

Dan McKenzie - Next Generation Equity

Kevin Crissey - UBS

Steve O’Hara - Sidoti & Company

Megan Kuhn - Flight International

Alaska Air Group, Inc. (ALK) F4Q09 Earnings Call January 28, 2010 11:30 AM ET

Operator

Good morning. My name is Christie, and I will be your conference Operator today. At this time, I would like to welcome everyone to the Alaska Air Fourth Quarter and Full Year 2009 Earnings Conference Call. Today’s call is being recorded and will be accessible for future playback at www.alaskaair.com. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. I would now like to turn the call over to Alaska Air Group’s Managing Director of Investor Relations, Shannon Albert.

Shannon Albert

Thanks, Christie. Hello, everyone. And thank you for joining us for Alaska Air Group’s fourth quarter and year-end 2009 earnings call. During our call today Alaska Air Group’s CEO, Bill Ayer, will provide a company overview; CFO, Glenn Johnson will talk about Air Group’s financial position; and a President of our two operating subsidiary. Brad Tilden and Jeff Pinneo will comment on the financial and operational performance and future initiatives of Alaska and Horizon. Other members of the senior management team are also present to help answer your questions.

Today’s call will include forward-looking statements that may differ materially from actual results. Additional information on risk factors that could affect our business can be found in our periodic SEC filings available on our website.

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

This morning, Alaska Air Group reported a fourth quarter GAAP profit of $24.1 million. Excluding the impact of mark-to-market adjustments related to our fuel hedge portfolio, Air Group reported an adjusted net profit of $4.4 million or $0.12 per share, compared to a First Call mean estimate of $0.32 per share. This compares to last year’s adjusted profit of $16.4 million or $0.45 per share. Again, excluding unusual items, Air Group reported a full year profit of $88.7 million or $2.45 per share versus a profit of $4.4 million or $0.12 per share in 2008.

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

I will now turn the call over to Bill.

Bill Ayer

Thanks, Shannon. And good morning, everyone. We posted a modest fourth quarter profit and a full year result that is among the best in the industry. 2009 marks Alaska Air Group’s sixth consecutive year of adjusted profits and although we’re not yet where we need to be, we’re making great strides in spite of weak demand and volatile oil prices.

The past 12 months have certainly been a challenging time but we also see plenty of opportunity. And that’s why we’re focused on controlling what we can even in the face of substantial external forces.

During 2009, our key initiative was to optimize revenue. We reduced and redeployed capacity to better match demand and the new markets we entered are performing well. Both Alaska and Horizon had a strong year operationally thanks to our people.

Alaska led the 10 largest carriers in on-time performance in seven of 11 months and we expect that to be eight out of 12 when the December numbers come out. I might add that if Horizon were reporting to DOT they would have led the industry for the year.

Our customers enjoyed select travel experiences in 2009 as evidenced by our internal surveys and by Alaska’s number one ranking in customer service by J.D. Power for the second on a row.

During the year we reached agreements with several of our labor groups including Alaska’s pilots, mechanics and ramp employees, Horizon’s dispatchers and flight attendance at Alaska and Horizon. Those agreements provide for improve productivity and a common gain sharing formula in which the majority of Air Group employees now participate.

As is appropriate, our people share in the results when the company does well. For the year, Alaska and Horizon employees earned $76 million. We’re working together more than ever and having employees aligned around common goals through the same incentive plan means future execution should be even better.

While we made great progress over many years, it has taken longer than we planned to reach some of our goals. CASM ex-fuel is one of those and we’ll talk more about that in a moment. Specifically about our efforts to improve productivity and reduce overhead. The most difficult part of the year was having to furlough people and it’s especially tough during a time when jobs are scarce.

Our long-term strategy is based on simple principles that don’t change over time. As we look to the future, we will continue to pursue them with the goal of providing a high value product for customers, good careers for employees and a healthy return for investors.

Our conservative financial management has served us well. We intend to maintain a strong balance sheet and consistent fuel hedging program, which provide a buffer against uncertainty and the flexibility to take advantage of new opportunities.

We think our smaller size is also a strength, because we are smaller we can move more quickly, we’re closer to customers and there’s a greater sense of personal accountability among employees.

Like last year, our key initiative for 2010 is focused on improving the topline specifically the way we merchandise fares and ancillaries products and services, as well as, broader employee involvement in our marketing efforts.

The economic downturn has resulted in yet more structural change for the airline business and one of the industry lessons of the last couple of years is the importance of getting capacity right and we are committed to our discipline of keeping supply in line with demand.

Let me say in closing that nothing gives me more hope for the future than knowing that we have 13,000 hard working employees across Alaska and Horizon all pulling in the same direction and I want to thank them for their continued dedication.

With that, I’ll turn the call over to Glenn.

Glenn Johnson

Thanks, Bill. Good morning, everybody. As Shannon said, Air Group earned a fourth quarter 2009 adjusted net profit of $4.4 million versus a $16.4 million adjusted net profit in Q4 2008 and a full year adjusted net profit of $88.7 million. That means our full year adjusted result equates to a pre-tax margin of 4.4% and return on invested capital of 6% at the Air Group level.

Our quarterly results did fall short of First Call mean estimate by $0.20. That was driven primarily by our Alaska Airline subsidiary’s non-fuel cost being $10 million higher than the midpoint of our most recent guidance.

There were four main drivers for that increase. First, final adjustments to the incentive pay accruals. Second, higher than expected employee medical costs. Third, we wrote-off some costs associated with certain discontinued capital projects. And finally, higher costs associated with environmental remediation settlements, legal costs and winter operations.

I would note that to the extent that these costs have future impact, we have incorporated them into our guidance. So for the fourth quarter, for the first time this year, we showed a decline in our year-over-year pre-tax profits.

There were three main components to that decline. First, a $61 million increase in non-fuel operating costs, as in earlier quarters, this was driven by the increase in Alaska’s pension expense, a dramatic increase in incentive pay at both subsidiaries and higher pilot costs at Alaska Airlines.

Second, economic fuel costs were $25 million lower this year than last. I would note that this year-over-year decline in fuel cost is the smallest we’ve seen in any quarter of the year.

And third, Air Group revenues were up $19 million or 2.3% ahead of last year. That reflects the easier comps and is also the first quarter of the year where revenues have been up over the prior year.

For the full year, Air Group’s pre-tax profit improved $139 million. The most significant driver of that improvement was $460 million or 38% decline in economic fuel costs. Adjusted revenues fell $220 million or 6%, non-fuel expenses were up $77 million for the reasons we’ve talked about on our prior calls and non-operating expenses were up $24 million.

I want to spend the balance of my time talking about three areas. Our balance sheet, our incentive pay plans and our pensions. First, our balance sheet and cash position. At December 31, 2009, we had just under $1.2 billion of cash for about 35% of revenues, that’s up $115 million over last year-end. We generated $305 million of cash flow from operations and proceeds from new financings of just over $500 million this year.

I believe the fact that we were able to complete this level of new financing in this year, given the climate in the markets, demonstrates the competitive advantage that comes from our strong balance sheet and good collateral.

Offsetting the in-flows that I just talked about, we had capital spending of $440 million, debt repayments of $261 million and share repurchases of $24 million. As we drive towards our goal to deliver a 10% return on invested capital to our shareholders, we recognize that the current level of cash does create a headwind.

Assuming the relatively stable environment, we’re seeing today stays intact, we plan to reduce our cash balance during the 2010 and 2011 time period. Through debt repayments, pension funding, share repurchases or a combination thereof.

I would also remind you that we intend to pay cash for the new 737 deliveries in 2010. Longer term, I see our target for cash to revenue in the 25% to 30% range versus the 35% where we sit today. With debt-to-capitalization ratio including leases at something less than 70/30. We’re currently at 76/24 on debt-to-capitalization ratio.

Despite the goal to lower our cash balance, we’re still committed to a strong balance sheet with plenty of access to liquidity should we need it. To that end we’re working to renew and potentially expand our line of credit which expires in March this year.

Turning to CapEx, 2009 CapEx was lower than both 2008 and 2007, and we’re forecasting even lower for 2010. I’d remind you that we revised our delivery schedules with both Boeing and Bombardier earlier this year, so that we now have four 737s being delivered this year and three in 2011 and no new Q-400s in either year for Horizon. Our current CapEx forecast is $207 million in 2010. We do foresee a potential to generate free cash flow in 2010 with this level of CapEx.

Turning to our incentive plans, many investors have asked how the program works and about the associated expense. I think first it’s important to talk about how we thing about these plans.

First, we believe alignment is critical. All employees with the same goals, creates a virtual cycle and frankly disenfranchised employees have been a problem in our industry for a long time. Our job as management is to get value out of this investment we’re making with these programs.

Most Alaska and Horizon employees now participate in our performance based pay or as we call it PBP plan. The structure is such that the board sets annual targets during our annual planning process each fall for the coming year. The targets are designed to drive employee alignment and behavior in the following areas.

Safety, customers satisfaction and unit cost, each of which are weighted at 10% and profitability which is weighted at 70%. When we achieve the target set by the board the vast majority of our employees earn an incentive bonus equal to 5% of their pay. If we exceed the targets there is the opportunity to earn a maximum payout up to 10% of pay and if we miss the threshold levels set by the board there is no payout.

At target, from an Alaska Air Group perspective, our PBP program would pay $35 million per year. That compares to $58 million this year, which correlates to approximately 8% of pay since we were between the target and max levels set by the board for 2009.

In addition to PBP, we have a monthly program which we call operational rewards program or OPR, which covers every employee at both Alaska and Horizon regardless of position or level. It allows employees to earn up to $50 per month when we achieve customer satisfaction goals and $50 per month when we achieve on-time goals.

So in 2010, if we aggregate the PBP plan, the operational rewards program and the traditional profit sharing program which still covers a small group of our people, we’re budgeting incentive pay at $50 million, which would assume we achieved target levels. That compares to $76 million actual payout in 2009, where we exceeded target levels. So we’re anticipating in the neighborhood of a $25 million reduction in incentive pay for 2010 versus 2009.

I would also note that we recognize this year is higher than expected and at a 10% return on invested capital income level, if we were paying at target, incentive pay would represent about 15% of profits which we believe is a good investment in order to ensure that we have the alignment that I talked about.

And finally, turning to our pensions, first let me review our funding status. As we noted in the press release this morning in December we made an additional $100 million voluntary contribution, bringing our full year contribution for 2009 to $148 million and our total contributions since 2001 to $570 million for the plans. The extra $100 million contribution plus the portfolio gains in 2009 result in our plans being 77% funded at December 31, 2009 versus 59% funded the year earlier.

Our projected benefit obligation is $1.18 billion. The fair value of our plan assets is $900 million. Leaving our unfunded liability at just under $275 million at December 31, 2009, compared to a $445 million shortfall at the end of 2008.

Our current plan is to continue our historical practice of funding service cost, which would result in approximately $50 million of 2010 contributions. It’s important to note that our broad retirement strategy is to ensure that we offer retirement benefits that help employees achieve retirement security and ensure the company is cost competitive.

To that end, we want to ensure that we are continuing to review the plans we have been working since 2003 to close PBP plan to new entrants. We achieved that fully in 2009 which is a positive outcome but leaves a long tail of active employees who are still participating.

So over the next year or so, we’ll evaluate what we can do to provide retirement security for employees that is structured in a way that is affordable for the long-term and it reduces volatility and risk for both employees and the company.

With that, I’ll turn the call over to Brad and then Jeff to provide color on the individual experience.

Brad Tilden

Thanks, Glenn. And good morning, everyone. As Bill and Glenn have said, we’re wrapping up what was quite a good year for Alaska Airlines. I’ll take you through some the numbers but first I’d like to thank the 9,000 people who produced these results and our leaders who have been working hard on our transformation for many years now. We’re thrilled to be celebrating this performance with PBP and profit sharing payouts that are easily the best we’ve had in over a decade.

For the quarter, Alaska Airlines reported an adjusted pre-tax profit of $8.9 million, compared to a profit of $23.8 million in 2008. For the full year, our profit was $145.9 million versus $25.2 million in 2008.

The 2009 figure represents a pre-tax margin of 4.9%, which compares to a margin of slightly less than 1% in 2008. We have a good story with revenues but I would like to start with costs as they need our urgent attention. We ended the year with CASM ex-fuel of $8.26, up 10% from the prior year on the 4.4% decline in capacity and 2% over our initial guidance of $8.1.

The reason are the ones we mentioned already, a $45 million increase in pensions, a $46 million increase in incentive payments, a deal with our pilots that cost $23 million, the fact that we didn’t sell four airplanes as planned and contract extensions for three other groups.

But even though we can explain the increase, it’s disheartening to see costs go up after so much hard work over the last five years and we’re going to turn this trend around. We know that our future is dependent on being able to offer low fares and to offer low fares we have to have low costs and we have to do this while maintaining and industry leading operation and award winning customer service.

We’re going to redouble our focus on cost and help all of our folks understand the low overhead and high productivity are the two key drivers we’re going to use to provide customers great value, grow the company and create the right long-term future for our employees and investors.

Specifically, we’re going to continue with our program to reduce and control management headcount. We’ll continue reducing our real estate footprint and we’re going to increase productivity.

Our major divisions have set aggressive productivity targets for this year, and to help us achieve them we’re going to use daily metrics to track things like overtime, flight crew reserve utilization, reservations calls per employee and hours incurred per day for each aircraft in a maintenance check.

We’re pushing these metrics down to our front line supervisors much like we did when we improved the operation and asking our leaders to translate our need for lower CASM into understandable metrics and clear actions for each work group.

As we look to 2010, we’re firming up our previous estimate for full year CASM ex-fuel of $0.08. This is 3% lower than 2009 on a 2% increase in ASMs. This means our non-fuel costs are forecast to be $1.89 billion, down $20 million from 2009.

The big changes are a $28 million reduction retirement expense, a $20 million reduction in PBP expense, significant productivity improvements and a host of other factors which go both directions.

Note that the 2% increase in ASMs is entirely due to gauge and stage length as our fleet is actually coming down by two units.

Now turning back to revenues. Alaska’s main line passenger revenue was down $8 million or just over 1% for the quarter. The decline came on a 2.8% decline in passenger unit revenue, which was offset by 1.5% increase in capacity.

Looking at the individual months, passenger RASM declined by 4.7% in October, by 0.8% in November and by 3.2% in December. Our 2.8% quarterly decline once again compares very favorably with the domestic industry, which posted a decline of 6.9%.

For the year, our passenger unit revenues declined by 3.5%, compared to 11.5% for the industry. Because our unit revenue declines were more modest than those seen around the industry, it’s possible that our improvement in 2010 will be less than the others because we aren’t starting from such a low base.

The first bag fee once again contributed to our strong performance in the quarter. We collected $20 million for Alaska and $24 million for all of Air Group, bringing the Air Group total for the year to $47 million. We’ll see the benefit of the first bag fee continued through the first two quarters of 2010.

Operating PRASM was flat due to the passenger revenues we just discussed as well as a new agreement with our credit card issuer and changes to our mileage plan award levels.

As we look across our regions we were excited to see load factor increases in each of our regions outside the state of Alaska this quarter. We also saw a record load factor for the quarter and a record load factor which approached 80% for the year.

We’re beginning to see unit revenue improvements in southern Cal, the Bay Area and Arizona, Nevada on higher load factors while unit revenues in Hawaii, while encouraging, have softened a bit as we added capacity. Mexico remained weak despite our 15% reduction in capacity.

Alaska’s January and February advanced book load factors are both up six points and March is up three and half points. We stimulated bookings during this traditionally soft period with a very aggressive fare sale. We’re also seeing our booking curve lengthen somewhat and this is helping.

We believe the yield declines will largely offset load factor increases and we’ll see PRASM increases in the first quarter that are modest and due in part to the first bag fee.

At this point, I’ll turn the call over to Jeff.

Jeff Pinneo

Thanks, Brad. And good day, everybody. Horizon posted an adjusted pre-tax profit of $2.3 million for the quarter, compared to a profit of $3.2 million in 2008. For the full year, our $7.7 million adjusted profit marks a significant improvement over last year’s $10.4 million loss and while we’re certainly pleased to return to full year profitability our 1.2% adjusted pre-tax margin falls well short of the return on capital goals we’re focused on and committed to achieving.

2009 was a year of major change for Horizon with the retiming of our fleet transition plan, further reducing and reallocating capacity, decreasing personnel and transitioning many functions to shared services with Alaska.

One thing that remained consistent was the outstanding effort and dedication our people displayed in serving our customers throughout the year. As Bill mentioned, when the final tally is in, we believe that Horizon’s 86.1% performance will translate to a number one on time ranking among all main land U.S. Operators for 2009. This result is the product of their dedication and great teamwork and I simply can’t thank them enough.

For the quarter, our unit cost excluding fuel and transition charges increased 6.6%, on 4.6% capacity growth. Key drivers were the new flight attendant contract and inclusion of all non-union employees in the PBP plan which resulted in $3.8 million of additional expense during the quarter.

Since last year’s fourth quarter, we reduced our workforce by over 190 employees or 5.5%, which when combined with our 4.2% increase in passenger boardings, resulted in a 10.2% improvements in passengers per FTE.

Regarding our fleet, we took delivery of three Q-400s during the quarter, which will be utilized as replacement aircraft with no net additions in flying. We continue to actively market three CRJ-700 aircraft to offset these deliveries. Although we have taken a pause in our fleet transition, our long-term plan is still to move to a single type fleet of Q-400s.

Turning to revenue, our fourth quarter total revenue increased 4.8% or $7.8 million, while brand flying revenue was down slightly on a 4.3% decreases in capacity. Our capacity purchase flying increased to 41% of our total business in 2009 and was 44% in the fourth quarter.

Serving lower density markets with our 70 seat regional jets allows Air Group to better tailor capacity to market demand, preserves schedule frequency and optimize revenues. As the revenue we received from Alaska continues to move toward a more market based formula we are working to further decrease our costs to bring them more in line with our regional peers.

Looking ahead to 2010, we intend to enhance our competitiveness by continuing to improve productivity and cost efficiency in all that we do. Placing particular focus on our pilot costs and maintenance expenses. Our plan is to hold capacity flat and we’re forecasting a 2% decrease in CASM ex-fuel for the full year.

We’re pleased with how load factors have continued to respond to the schedule and pricing actions we’ve taken. Advanced book load factor is up five points for January, two points for February and flat for March. Like Alaska, we’re optimistic that strong loads will help improve overall RASM.

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

Bill Ayer

Thanks, Jeff. So all-in-all we’re pleased with the past year especially considering all the challenges. We’re continuing to improve our ability to make changes and sustain those changes. And we intend to apply what we’ve learned to improve our performance in 2010.

And with that, we’ll open it up to questions.

Shannon Albert

Christine, (inaudible).

Question-and-Answer Session

Operator

(Operator Instructions) First question comes from Bill Greene with Morgan Stanley.

Bill Greene - Morgan Stanley

Yeah. Hi, there. I’m wondering if you could talk a little about your target ROIC. If you think about how you’re going to get to that 10% threshold, what are some of the drivers? Is it a margin expansion story, are you going to have to reduce the capital base dramatically? How do you think about getting there?

Glenn Johnson

Thanks, Bill. This is Glenn. I think about that in a couple different ways. First of all, we do have kind of this excess level of cash that we built up this year to provide a cushion against the economic environment that we are seeing and so to the extent that we can either pay down debt with that cash that we’ve changed the formula, certainly we need to produce better net income also as part of that equation.

And we have some of the capital really both sides that is not fully deployed at this point in time, I think we talked about that in the past for on the Alaska side, for example, you’ll see that we are down about 8 -- 10 of an hour in terms of utilization across the fleet and so there is the capability to put more utilization out there with no additional invested capital and produce results with that, provided that the demand is there for it.

Bill Greene - Morgan Stanley

Okay. And when you think about the strategies you deployed in 2009, obviously you were quite successful in spite of the economic downturn. How unique do you think these strategies are? Could they be applied elsewhere in the industry or is it sort of something that’s more unique to what Alaska does and where you are?

Bill Ayer

This is Bill. Bill, I think, why, the one of the biggest things obviously in ‘09 was the network effort that we did and overall reducing capacity which anybody can do, obviously. But then importantly, figuring out where we can redeploy that excess capacity for better revenue, better profitability.

And so we have a loyal -- a relatively large base in Seattle, in the Pacific Northwest, a base of frequent fliers that like our product and service and as we go to new places, particularly from this base, from Seattle in particular is what we did in ‘09, those folks move and so even in the face of a declining overall demand picture, we’ve been successful in moving market share with these new routes. So I think that’s been probably the single biggest thing in ‘09 that led to these results.

Bill Greene - Morgan Stanley

So I don’t want to apology but it sounds like a lost that stuff is something you could replicate across others. It’s not something that’s wholly unique to your geography?

Brad Tilden

Yeah, Bill. I think, this is Brad. I think we are big believes that the most important thing the industry can do to help improve its profitability is get capacity right. So in general industry capacity does need to be aligned with demand. Alaska did have some unique opportunities in ‘09 as we took delivery of the 737, 800s with task capability and as we lost two competitors in Hawaii, we really grew our Hawaii business and we also added some flying into the mid continent and Transcons destinations that we weren’t in before.

So, I don’t, and maybe that what we did is, and I think as you know, we really brought down our capacity in southern Cal and the Bay Area, Arizona, Nevada, Mexico. So I’m not sure that redeployment is a strategy that could be done everywhere because in total capacity does need to be brought down to be in line with demand.

Bill Greene - Morgan Stanley

Yeah. I was just basically getting out, if you put your strategy on others, would it work and therefore, maybe M&A is a decent way to get your returns higher if you can actually -- that’s what I was trying getting at, trying to get you to say but, well?

Brad Tilden

Nice try.

Operator

Your next question comes from Gary Chase with Barclays Capital.

Gary Chase - Barclays Capital

Good morning, everybody.

Bill Ayer

Good morning, Gary.

Shannon Albert

Hi, Gary.

Gary Chase - Barclays Capital

Brad, when -- couple things I wanted to follow up on, I guess first, just quickly, you said yields would be offsetting to the load factor gains that you’re showing, at least in terms of book load factors. I’m just curious, I mean, if you look at that book load factor number you’re showing, it’s definitely in contrast to what others were doing.

So I’m just curious why it was that you decided to run the aggressive promotions when others are talking to the fact that they’re deciding to do less of that and in fact their book loads are down. You just not getting the close-ins that maybe some of the others are getting? Could you just elaborate a little bit more on why that was?

Brad Tilden

Absolutely, Gary. We’ll ask Andrew Harrison to do that for us.

Andrew Harrison

Hi, Gary. You know, one of the things is seasonality and Q1 is always a quarter that we actually drop in traffic, in fact, our load factors in January and February are very low 70% levels and so in December what we decided to do was we knew we had plenty of room on those airplanes so we decided to do early a very aggressive, $50, $75, $100 fare sale and we saw bookings increase Gary employee. Then we turned that off and as we rolled in, going into January and February, we continued to see our traffic build upon the basis that we’d done.

So overall we’re very pleased with the traffic that we brought in. As you mentioned, our yield is somewhat offsetting those load factors but at the end of the day we also have new ancillary revenue coming in, in the first quarter as well.

Brad Tilden

Gary, I’d like to jump on. I don’t think we’re really seeing core weakness. As we said in the prepared remarks, our advance -- our booking curve is pushing out. The last 12 weeks we look at it, our average year-over-year increase in bookings has been 15% and there were two weeks that were particularly strong, 32% and 42% when we did this very aggressive fare sale but we are seeing decent strength in the volumes.

And it hard to say exactly what you’re seeing but I do think part of our reality in 2010 might be that part of this volume comes at lower prices and that’s not a bad position for us, high load factor for our company and great value for customers.

Gary Chase - Barclays Capital

But, I guess, I mean, what I’m driving at is, I think, others are seeing that year-on-year gain and you suggested that RASM gains would be pretty muted. If you believe that there was a structural shift in the network that you implemented, I would think you would be able to sustain that and build on it as the industry rebounds.

So I’m just -- I’m trying to get my arms around whether or not your markets happen to behave a lot better in the downturn than others or whether there’s something that’s incrementally happening with Alaska that means you’re not participating in some of the upside that others seem to be seeing.

Glenn Johnson

Yeah. Then the other thing is that, as we are reluctant to talk a lot about RASMs until they’re kind of in the book and so you may -- there may be some natural conservatism or a little bit of we don’t really know what the prices for this first -- the prices yet for this first quarter traffic.

Gary Chase - Barclays Capital

Okay. And then, you know, Brad, you said something that I wanted to pick up on as well. You said, one of the reasons that the yields may be offsetting may be a function of the bag fees that you’ve implemented, which bags the question, you take a look at what’s going on with Southwest and I think you know we’ve asked this a number of times in the past whether or not they’re actually adding to total revenue.

No doubt they’re adding to other revenue but I’m curious for your perspective and based on the way you said that, do you think these are significantly additive to overall revenue or is it just moving it around on the P&L from passenger to other?

Steve Jarvis

Hi, Gary. This is Steve Jarvis. When we look at bag fees, we actually think about it first and foremost in terms of customer value. If you look at the economics of it does float straight to the bottom line unlike other things, like attempts at increases in fare, I mean, this is something we see brightly on the bottom line.

And so we do believe it has been incremental and we also believe that we’re providing a great value to customers. We did not follow the industry in raising that bag fee recently. Our first bag fee remains $15. I tell you we’re evaluating increasing it for agent assisted at the ticket counter, leaving it at $15 for self service.

] But what we’ve done uniquely in terms of delivering customer value behind that bag fee. One, leaving it at $15, unlike other carriers, we will interline and connect that bag obviously to the customer’s final destination and then we stand behind it was a very unique baggage service guarantee, I believe the only in the industry.

So I guess the answer to your question is we do believe it’s incremental and additive. You look at our margins and it’s hard to believe you could ever shift enough share or yield to make up for the $47 million we saw straight to the bottom line in first bag fees in 2009.

But we also believe we’re providing a good value to customers and that’s why we didn’t raise it. We want to stake out a real value position for our customers and we think we’re doing that.

Brad Tilden

And Gary again, our RASM performance was very good compared to the industry, down 3 versus the industry down 11. And also, I think in our markets you wouldn’t see the strength in bookings that we’ve seen for the last 12 weeks if a lot of folks were moving away from us because of the bag fee.

Gary Chase - Barclays Capital

Okay. Thanks, guys.

Operator

Your next question comes from Mike Linenberg with Banc of America/Merrill Lynch.

Mike Linenberg - Banc of America/Merrill Lynch

Hey, everybody. Good morning.

Bill Ayer

Good morning, Mike.

Shannon Albert

Hey, Mike.

Mike Linenberg - Banc of America/Merrill Lynch

Just two questions here. Glenn, when you were talking about the defined benefit pension plans and you may have said this and I may have missed it. What are you modeling in for pension expense if 2010 and what is the anticipated cash contribution?

Glenn Johnson

Let’s have (inaudible) answer the expense piece of it but the cash contribution, if we continue our historical practice of funding service cost which is our current intention would be a $50 million contribution.

Mike Linenberg - Banc of America/Merrill Lynch

Okay. So…

Glenn Johnson

Yeah. Hi, Mike. (inaudible). On the expense side we’re modeling retirement expense to be down $27 million.

Mike Linenberg - Banc of America/Merrill Lynch

Okay. So it would be down 27. What was it then as a base, what was it in 2009?

Glenn Johnson

It was 93.

Mike Linenberg - Banc of America/Merrill Lynch

Okay. Okay. That’s helpful there.

Glenn Johnson

And remember, Mike, that’s across the PBP or the pension plan, the DB plans, but offsetting with some higher 401-K expenses as a result of the movement of people out of the DB plans.

Mike Linenberg - Banc of America/Merrill Lynch

Oh! I see. So when you do your retirement expense, that’s both DB and DC.

Glenn Johnson

That’s everything.

Mike Linenberg - Banc of America/Merrill Lynch

Okay. That is helpful. And then did you also say, Glenn, did you also say there was going to be a potential savings by changing around something to do with the service cost or length of service, did I get that?

Glenn Johnson

No. I think my point there was that we’ve made good progress in terms of getting the plans close to new entrants. We still have people who participate in the plans who have a long tail, so to speak in the plans and over the next year or so we’ll be evaluating what we can do to make sure that the plans are well set up across all of our retirement options to provide retirement security for employees but ensure that we don’t have too much volatility or risk from the company’s perspective.

So nothing specific to report on that, just that we continue to look at the DB plans to determine how we can best structure those over the long-term.

Mike Linenberg - Banc of America/Merrill Lynch

Okay. That actually you just -- you sparked my follow-up which was you indicated that you’ve closed the DB plans to new entrants now. I know you did that with the pilots and I presume each of the recent contract agreements that have been put into place and I know there’s been a you slew of them. Did you -- you achieved that objective as well, is that the proper interpretation?

Glenn Johnson

Actually, we started in 2003, management, each of the other groups were closed prior to this and the pilots were the last group, so we achieved that with the agreement that we reached with the pilots this year.

Mike Linenberg - Banc of America/Merrill Lynch

Okay. Good. Like you said, it’s a long tail, but it -- overtime will get become less of a liability. Okay. Very good. Thank you.

Glenn Johnson

Thanks, Mike.

Operator

Your next question comes from Helane Becker with Jesup & Lamont.

Helane Becker - Jesup & Lamont

Good morning, everybody. Thank you very much for taking my question. Brad, I think you were commenting that the Hawaiian markets were under or were not doing as well as some of the other markets because of the add in capacity.

Have you thought about rejiggering that, pulling some of that capacity out and putting it into other markets that might be more receptive?

Andrew Harrison

Hi, Helane. This is Andrew. And…

Helane Becker - Jesup & Lamont

Hi, Andrew.

Andrew Harrison

We’ve been very happy with our Hawaii markets. I think we’re up about 68% in capacity in Q4. But we are serving out of the Pacific Northwest and the state of Alaska, we feel good about our markets and the islands and as you may be aware, that we’ve started a Bay Area growth there.

At the end of the day, we continue to watch them but we’re very happy with where we have capacity right now for our Hawaii franchise.

Helane Becker - Jesup & Lamont

Okay. And then can you just say what Mexico is going to be like in the first and second quarter on a year-on-year basis?

Andrew Harrison

As far as?

Helane Becker - Jesup & Lamont

Capacity.

Andrew Harrison

Capacity? Yeah. We -- let me just see here real quick.

Helane Becker - Jesup & Lamont

Because I know you took capacity out and then you added capacity back, so can you just remind us where you are?

Andrew Harrison

So what we did was we took out about 38% capacity when the situation got bad with H1N1 and all that sort of stuff. And we kept that through the summer and the fall and we came back to full capacity in the winter and then but just recently we’ve done a marginal cut of capacity there.

So the fourth quarter was down about 14% for Mexico and right now we’re continuing to project pre-swine flu cuts in 2010 but we continue to look at Mexico and as Brad mentioned, the traffic is there but the yields are very, very soft.

Helane Becker - Jesup & Lamont

Okay. Thank you very much.

Andrew Harrison

Thanks, Helane.

Operator

Your next question comes from Dan McKenzie with Next Generation Equity.

Dan McKenzie - Next Generation Equity

Hey. Good morning. Thanks, guys. My understanding is that Delta has exclusivity of Alaska’s feed over the Pacific and Delta has even said this is the case. But this is the airline industry so nothing evidently is ever easy and AMR of course is challenging me on this.

So just for the fun of it I tried to book an Alaska flight from Beijing in Tokyo from Seattle to see if I could be fed on a Delta flight but was unable. So doesn’t look like Alaska’s customers can feed through to Delta later this summer which leads me to believe Alaska is probably leaving some revenues on the table here. So, I guess, first, can you verify what the exclusivity is or isn’t and when can I fly Alaska to Asia?

Brad Tilden

Wow, Dan. You know, first of all, I think what we need to say is that these contracts are thick and complicated and there are lots of provisions in them and I think as you know, we had domestic alliance arrangements with Northwest, Delta, American and Continental and now due to a couple different things we have contracts with American and Delta. And we don’t comment on specific provisions but I would just tell you that there are lots of details in these agreements.

In terms of being able to fly on Alaska to Beijing, the way we think about these deals, that’s a level of complexity that we don’t aspire to offer our customers. In terms of the international itineraries we really want them to be able to travel from Beijing to (inaudible) or Yakima or [Ketchikem] and so they’re picking up code on our segments but we’re not trying to represent ourselves as holding up those itineraries for our customers.

We think that in terms of our niche and what we do well and kind of an attention on simplicity, that’s the part of the market that we want to be in here.

And I guess, the other thing I would just say while we’re talking about it is a huge aspect of these plans is the frequent flier side of things and we’re really happy to our customers get to accrue and redeem miles on American and Delta and we’re happy that Delta and American’s customers get to do that on

Bill Ayer

Dan, this is Bill. We’re really focused on the customer aspects of these co-shared marketing agreements. We really want it to work for our customers. As we look around the industry, we see a little too much of slap the code on the flight and start booking traffic without sometimes a close enough examination of does it really work for the customer.

So we’re spending times with both of our major partners here, Delta and American, looking at it from a customer’s perspective and making sure from the booking right on through to picking up your bag at the final destination that these things are really adding value for people and closing seams as we call it in the relationship between the two.

Dan McKenzie - Next Generation Equity

Yeah. I appreciate the response and the answer, I understand that. Just out of curiosity, if sometime down the road you change your thought process on this, do you have the IT capability to connect to Delta to offer these flights and the reason I ask that is it seems like the IT consultants are pretty good at the cutovers as we’ve seen at some other airlines?

Brad Tilden

Yeah. I don’t actually know the answer to that, Dan. I guess I would tell you that it really isn’t our strategy today so we haven’t spent a lot of energy developing that capacity. It would be worth thinking through the value of those international itineraries compared to the value that we might lift for a Seattle to [Ketchikem] segment. And there is a lot of complexity that you take on, we believe.

Dan McKenzie - Next Generation Equity

Understood. Okay. Well, thanks a lot. I appreciate that.

Brad Tilden

Yeah.

Operator

Your next question comes from Kevin Crissey with UBS.

Kevin Crissey - UBS

Thanks, guys. My question actually has been withdrawn but I’ll just thank you for spending so much attention on the return on invested capital and actually calculating it, I’m not convinced that many others have and I’ll probably follow up to make sure I’m calculating it the same way as you are after the call? Thank you.

Glenn Johnson

Thanks, Kevin. We’ve all got that stamped on our forehead around here. 10% ROIC we’re not there yet obviously, but we’re going to get there, I mean, making it prominent and talking about it in every budget review, every, certainly on the call, we’re going to keep talking about it and it’s really important. That’s how you make things happen.

Kevin Crissey - UBS

Now that I am on here why don’t I follow that up then with in your target, your target dollar figure falls. I’m going to go back and read the transcript on it. I assume you’re setting a higher benchmark in return on invested capital is one of those bench marks within your target, is that right?

Glenn Johnson

Are you referring now to the PBP program?

Kevin Crissey - UBS

Yeah.

Glenn Johnson

Okay. So, yeah, the -- I think what I said in the script is that at a 10% ROIC, we pay out about 15% in terms of employee incentive. So in the annual targets that the Board is setting, we clearly didn’t achieve the 10% ROIC this year with the target payout because we’re in the process of building up to the 10% ROIC as Bill said, that’s our long-term objective here.

Bill Ayer

So the target would be raised as we perform up to the 10% level and that’s that calculation.

Kevin Crissey - UBS

So it’s not that your dollar -- your dollar figure is going to get harder and harder to obtain is partly what I’m getting at I guess. The $50 million is off of an easier target than the $35 million would be.

Bill Ayer

That’s right. The dollar target for 2010 is higher than the dollar target in 2009.

Kevin Crissey - UBS

Okay.

Bill Ayer

These are relative terms. We’ll build a foundation here and the targets will be achievable, hopefully. The intent is that on average this thing ought to pay at target. The plan on a fairly consistent basis, you can never guarantee that, but that’s the idea. The Board sets the targets accordingly.

Kevin Crissey - UBS

Terrific.

Bill Ayer

It’s that whole cycle of we’ve got to be able to return the 10% ROIC to shareholders. We want to pay 5% target under the PBP to employees and we want to buy and deploy more airplanes to enhance the schedule utility for our customers and it all works together.

Kevin Crissey - UBS

Measuring it’s the first step and I applaud you for doing that.

Operator

(Operator Instructions). Your next question comes from Steve O’Hara with Sidoti & Company.

Steve O’Hara - Sidoti & Company

I was hoping if you could quickly touch on your success in Bellingham and how that’s going versus Allegiant there and also pressure on the Hawaiian market with some other capacity moving in and I apologize if you’ve already covered this stuff.

Andrew Harrison

This is Andrew, Steve. Well, I suppose Bellingham, there’s Bellingham, Vegas and there’s Bellingham, Seattle. Bellingham Seattle is a very important feeder market into our network.

To your point, we started Bellingham to Vegas where we run very, very high load factors and many folks like to come over the Canadian border and fly out of Bellingham so we’ve been happy with our expectations there and how that has performed and with our Hawaii markets, I think of top of mind, there’s actually been some reductions by other carriers out of the Pacific Northwest as it relates to the Hawaii markets as we have added.

Steve O’Hara - Sidoti & Company

Okay. Great. Thank you very much.

Operator

There are no further questions at this time. Presenters, I hand the conference back over to you for any comments or closing remarks.

Caroline Boren

Thanks again to the analysts participating on today’s call for your questions. This is Caroline Boren, I’m Managing Director of Corporate Communications. At this time we would like to open up the call to any questions from journalists participating. Christie, would you please remind our callers for the procedure for asking questions?

Operator

(Operator Instructions).

Bill Ayer

Sounds like we do not have a lot of takers.

Operator

Are you there, Christie? Yeah, ma’am. I am. You have a question from Megan Kuhn with Flight International.

Caroline Boren

Hello, Megan. Are you there?

`

Yes. Good morning. I wanted to get the latest status on Wi-Fi roll-out for the fleet. I know that last year there was talk of trying to get this to make it -- finalize a decision by the end of ‘09 for fleet-wide rollout in 2010. Was wondering when a decision is likely and is 2010 fleet-wide rollout still the goal or what’s going on?

Steve Jarvis

Hi, Megan. This is Steve Jarvis. We are still working towards a 2010 deployment of the fleet. The update on that, since the last call, we mentioned last time that we’ve been evaluating both options, the satellite option and the air to ground option from air cell.

Between last quarter’s call and this one, we have concluded a successful test on our 700 we learned a lot about operating a system, about customer satisfaction and a lot about uptake from customers at care just price points and stage lengths so we’re actually evaluating both options with all of that learning now. It impacts our decisions on capital we want to invest, how much risk we want to take and routes that are important to fly the system on.

What we do know is customers want it. They told us they want it. They showed us that they want it when we’ve flown it. We are committed to deploying the fleet an and working on a decision currently. I can tell you that it’s our plan to deploy especially the 800 fleet for the longer haul and trans con business routes in 2010.

Megan Kuhn - Flight International

So in terms of the fleet-wide for both the 800s and 700s, still both fleet types for 2010?

Steve Jarvis

We’re working on -- obviously we need to make a decision on our partner and then we’re working on the schedule. We will prioritize the 800s so our hope is to have that fleet done in 2010. We would like to have the entire fleet done but at this point in time, the decision needs to come first and then we’ll start working as fast as we can to get aircraft deployed.

And the speed of that deployment also plays into this decision as well, how much out of service time and all of the impacts on the airplanes of the deployment itself. So can’t promise you the whole fleet in 2010 but that’s our goal.

Megan Kuhn - Flight International

Okay. Thank you.

Operator

Again, to ask a question, please press star one on your telephone key pad. There are no further questions at this time.

Bill Ayer

Okay. Thanks everybody for joining us and we will talk to you next quarter. Take care.

Operator

Thank you for participating in today’s conference call. This call will be available for replay beginning at 2:30 p.m. Eastern Time through 11:59 p.m. Eastern Standard Time on February 28, 2010. The conference ID number for the replay is 38145247. Again, the conference ID number for the replay is 38145247. The number to dial for the replay is 1-800-642-1687 or 1-706-645-9291. Also, the call will be accessible for future playback at www.alaskaair.com. You may now disconnect.

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Source: Alaska Air Group, Inc. F4Q09 Earnings Conference Call
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