Alaska Air Group, Inc. Q4 2007 Earnings Call Transcript

Alaska Air Group Inc. (ALK)

Q4 2007 Earnings Call

January 24, 2008 11:30 am ET

Executives

Bill Ayer - Chairman, President, CEO

Brad Tilden - Exec VP, Finance and CFO

Jeff Pinneo - President & CEO, Horizon Air Industries

Shannon Alberts - Managing Director, Investor Relations

Gregg Saretsky - Exec VP, Flight and Marketing

John Shaefer - SVP, Finance and Treasurer

Brandon Pedersen - VP, Finance and Controller

Glenn Johnson - Exec VP, Airport Services and M&E

Caroline Boren - Managing Director of Corporate Communications

Analysts

Raymond Neidl - Calyon Securities

Christopher Cuomo - Goldman Sachs

Jamie Baker - JPMorgan Chase

Mike Linenberg - Merrill Lynch

Frank Boroch - Bear Stearns

Peter Jacobs - Ragen Mackenzie

Daniel Mckenzie - Credit Suisse

Robert Toomey - E.K.Riley Investments

Elizabeth Gillespie - Associated Press

Susanna Ray - Bloomberg

John Crawley - Reuters

Presentation

Operator

Good morning. My name is Lupita, and I will be your conference operator today. At this time, I would like to welcome everyone to the Alaska Air Group fourth quarter 2007 Earnings Call. 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)

Now, I will turn the call over to Ms. Shannon Alberts, managing director, Investor Relations. Please go ahead, ma’am.

Shannon Alberts

Thanks you Lupita. Hello everyone, and thank you for joining us today for Alaska Air Group’s fourth quarter and full year 2007 conference call. Alaska Air Group chairman and CEO Bill Ayers, CFO Brad Tilden, and Horizon Air CEO Jeff Pinneo, will provide an overview of the quarter, after which we’ll be happy to take 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 actually results. Additional information on risk factors that could affect our business can be found in our periodic SEC filings. Our presentation includes some non-GAAP financial measures, and we’ve provided a reconciliation between the most directly comparable GAAP and non-GAAP measures in our earnings release, which can be found on our website, at alaskaair.com.

As we reported earlier this morning, in the fourth quarter 2007, Alaska Air Group earned GAAP net income of $7.4 million, or $0.19 per diluted share, versus a net loss of $11.6 million, or $0.29 per share last year. We should note that the 2006 GAAP results included a favorable adjustment to the restructuring reserve, and both quarters included mark-to-market fuel hedge adjustments. After adjusting for these items, Air Group reported a fourth quarter net loss of $17.9 million, or $0.46 per share, which compares to a first column mean loss estimate of $0.32 per share, and to a 2006 loss of $0.08 per share. For the full year, again adjusting for the unusual items in each year, Air Group’s net income was $92.3 million, or $2.28 per share, versus $137.7 million, or $3.45 per share in 2006.

Our fourth quarter results included $3.75 million adjustments that resulted from our recent decision not to capitalize the investment we’ve made in Row 44, our technology partner with whom we’re developing onboard broadband connectivity, given their early stage nature. As a result, it was not included in our most recent guidance. The adjustment was $2.3 million after tax, or $0.06 per share. Please see pages 9-10 of our earnings release for a reconciliation of our GAAP and our adjusted results, as well as additional information about expected capacity changes, unit costs, fuel hedge positions, capital expenditures, and fleet count.

Now I’ll turn the call over to Bill Ayer.

Bill Ayer

Thanks Shannon, and good morning everyone. We’re continuing to make good overall progress on our transformation, but our adjusted results for the fourth quarter and full year fell short of our plan and lagged our 2006 performance. Now the primary reason was the significant rise in the price of fuel, combined with our inability to recoup the added cost through higher fares in the current competitive and economic environment. And in addition, Horizon had a difficult 2007, and our capacity purchase market performance did not meet our expectations. Jeff and his team, along with our planning group, are hard at work to improve these results.

We face several challenges in 2008, including fuel costs, the economy and some new competition, but as we start a new year, I think it’s helpful to put these challenges in the context of what we’ve already achieved. We have many things going for us. Two great brands, loyal customers, a strong balance sheet, a strategic plan that recognizes the needs of all of our stakeholders, progress towards simplified fleets at both carriers, and employees at Alaska Airlines and Horizon Air who are the best in the business.

As evidence that our plan is working, for the four quarters ended September 30, Alaska Airlines had the second best pre-tax margin in the industry, and we expect to again make a strong showing for the full year 2007, once other carrier’s results are all in. These results reflect the fact that Alaska Airlines achieved mainline CASM ex-fuel of $0.075, which is at the low end of the guidance range that we gave you last January. We’ve achieved meaningful CASM decreases in five of the last six years. These unit cost reductions are saving us $298 million per year, based on the ASMs that we flew in 2007. It’s hard to imagine that we’d be here today, had we not made these reductions. And I really want to thank our people who have worked hard to achieve these savings.

On last quarter’s call, Alaska’s VP Finance, Brandon Pederson explained how we calculate our cost to capital, and return on invested capital, or ROIC. And for the full year 2007, adjusting for the unusual items, Air Group’s ROIC was 6.1%. Now that’s well below our target of 10%, so while we’re pleased with our performance relative to the industry, we know that we have more work ahead to improve our absolute performance.

We understand that it’s critical for capital providers to earn a reasonable return on their investments over time, and our strategic plan is built on this premise, and of course we’ll keep you apprised of our progress on future calls. In keeping with this goal, our board of directors approved a share repurchase program last September, and to date we’ve repurchased almost 80% of the $100 million authorized.

We also have a conviction about the necessary relationship between profitability and growth. And that is, that growth only makes sense when profits support it. Brad will talk more about our 2008 capacity plan in a minute, and it’s important to note that over the coming years, our Boeing order and lease agreements provide a lot of flexibility to regulate our growth.

Let me talk about some of the specific initiatives that give us confidence about our future. In 2008, our most important objective is to improve our Seattle operation, which will help our system-wide performance. A better operation builds customer loyalty and lowers our costs. We’ve recently made some organizational changes aimed at improving performance.

Our decision in 2006 to move Alaska to a single fleet type will become a reality by the end of this year. And there’s no more impactful initiative for achieving simplicity, standardization and long term cost savings. This represents the culmination of three years of work by our planning and operations teams, and Horizon is also in the midst of simplifying its fleet, and Jeff will talk more about that in a moment.

Our new fuel-efficient 737-800s provide a long term fuel hedge, which has become even more important, given current fuel prices. A combination of our fuel hedging program, a fuel-efficient fleet, direct flying, using RNP flight guidance technology, and winglets on next-gen aircraft, give us a sustained competitive advantage, and significantly reduced emissions.

We have several initiatives aimed at improving our customers’ experience. In addition to the simplified pricing structure already in place, we’re increasing our real estate productivity through our “Airport of the Future” check-in process. We’re working with Row 44 to be the first U.S airline to launch satellite-based, in-flight Internet connectivity, and we’ve recently enhanced alaskaair.com, to make it easier for our customers to find mileage plan awards space, and to make online ticket changes. We’ve also just announced more convenient schedules in some of our Seattle to California markets, and Brad will provide more detail on those in just a moment.

And speaking of markets, during the fourth quarter, we initiated service to Honolulu from Seattle and Anchorage, as well as service directly to Kauai from Seattle. This move was received with great fanfare by customers and employees alike, and demand in these new markets is strong and the trends look good.

Well, 2008’s going to be a challenging year with continued high oil prices, a likely softer economy, and increased competition in some of our markets. Our healthy balance sheet, a young single fleet at Alaska, and solid brand reputations at both carriers, put us in an excellent position to compete in this difficult environment. We have a good understanding of what’s needed strategically, and we have the right plan, and the right people, to succeed.

So with that, I’ll turn the call over to Brad.

Brad Tilden

Thanks Bill, and good morning everyone. Excluding the unusual items, Alaska Airlines reported an adjusted pre-tax loss for the quarter of $18.8 million, compared to a loss of $1.9 million in 2006. For the full year, Alaska reported an adjusted pre-tax profit of $172.7 million, down from $200.5 million in 2006. Our full year results equates to a mainline profit margin of 7% versus 7.4% in 2006.

Mainline passenger revenue increased 7.4% this quarter, on a 4.6% increase in capacity, and a 2.7% increase in passenger RASM. The quarterly PRASM increase was driven by a 1.3% increase in yield, and a 1 point improvement in load factor.

Regionally, we saw unit revenue strength in Alaska, Canada, and in our trans-con markets, but continued softness in Mexico. Our 2.7% unit revenue increase was lower than the industry’s 5.9% increase. As you know, we’ve increased the amount of long haul flying that we’re doing, and in fact, almost all our capacity increases for the quarter is represented by about six new long haul flights, two trans-cons out of Portland, three new Hawaii flights, and increases in our Seattle-Cancun service. We calculate that these long haul flights depressed our system yield and RASM figures by about 2.5 points. If you adjust for this, our numbers would have been much closer to the industry average. We expect to see this effect through the next three quarters as we annualize flying recently added.

Although we’ve seen some modest yield increases, I think everyone in the industry recognizes that domestic fares are not high enough to cover fuel at $90 per barrel. We recently calculated that a one-way fare for our average 1,100 mile market needs to increase by $15 to cover the increase in raw fuel costs since May. Our revenue management folks have been working diligently to realize fare increases, but to date, we’ve had mixed results.

Our [advance book load] factors are strong and have been bolstered by very solid Hawaii bookings. January and February are up 3 points, while March is up a bit more than that due to the early Easter break. Our yields for the first couple of weeks of January are down by 0.5%.

You way have seen that we recently re-aligned our schedule between Seattle and six California cities to make our service even more convenient for business travelers, and to improve our operational reliability and efficiency. We’re moving to hourly service between Seattle and Los Angeles, with southbound departures leaving on the hour, and northbound departures leaving on the half hour. For service between Seattle and our three Bay Area airports, as well as Orange County and San Diego, we’ve also timed our departures to leave on the hour or half hour, with flights scheduled in two-hour intervals. With these changes, Air Group will offer 78 flights each weekday between Seattle and California this summer, versus 74 last year.

We started 2008 with 14 MD-80s, all of which will be retired this year, seven before the summer starts, and seven in the fall. The [inaudible] date for two of these aircraft has been advanced by almost 12 months, given the high fuel prices we’re seeing. We also plan to retire two 737-400s in October. We’re looking at the fall schedule now to see if there are further opportunities to pare on profitable flying, and perhaps retire some of the MD-80s a couple of months sooner than currently planned.

These 16 retirements will be offset by the addition of 17 737-800s. The higher seat count and utilization of these airplanes will result in an increase in our mainline capacity of about 3%, but a decrease in our departures of about 1.5%. It’s fair to say that we’re all very excited about having a single fleet of modern, larger gauge, fuel-efficient 737s by late fall.

For the year, Air Group’s economic fuel expense approached $1 billion, a number that would have been unimaginable just a few years ago. The fourth quarter was no different with economic fuel costs of $261 million, up $62 million from 2006. Our fourth quarter fuel expense was positively impacted by $29 million of hedge benefit. We believe we have the second best hedge book in the industry with 42% of our 2008 consumption hedged at $69 per barrel.

To provide some perspective on the impact of Alaska's fleet modernization, we flew 4% more seat miles in 2007 than in 2006 and burned exactly the same amount of fuel. At current raw prices, of about $2.80 per gallon, this equals annual savings of $40 million. This represents only one year of a multiyear transition, and it is an annuity that we will enjoy for many years.

Our cost efforts have been helped by a number of technology firsts. As we told you last quarter, we unveiled the first part of our airport of the future in Seattle in October and we look forward to opening the next two parts in February and June. We had our first 50% month on alaskaair.com in October and we now regularly check-in more than 65% of our customers at our kiosks and over the web.

Looking at 2008 we expect our CASM ex-fuel to be about flat at approximately $0.075 per ASM. This number could change modestly as a result of our fall schedule review.

We expect costs to be flat rather than decline because we're seeing pressure in wages, contracted services and maintenance as we enter a period where we'll have significant airframe overhaul work on our 737-400 fleet and engine work on our older, next generation aircraft. Fortunately we'll continue to realize the benefit of our fleet transition which should hold maintenance cost increases to about 5%.

We also expect to see a 14% increase in depreciation as a result of the new 737-800s. For the first quarter we're currently forecasting mainline CASM ex-fuel of $0.078, again about flat compared to the first quarter of 2007.

I'll close with a few comments about our capacity purchase flying, the majority of which is covered under an agreement between Alaska and Horizon. Revenues in these markets fell short of costs by $8.8 million during the quarter, bringing the full year deficit to $21 million. The markets included are both flow markets which provide connecting traffic to Alaska and local, or harmonization markets where Horizon's regional jets were used to maximize returns or minimize losses for Air Group and allow Alaska to deploy its larger jets on other routes.

Generally speaking, revenues in the flow markets are close to costs. The revenues in many of the harmonization markets fall short of costs. We are evaluating several alternatives to improve the performance of these markets including reducing the size of the CRJ fleet, moving some of this flying to the Q400 fleet and having a portion of the harmonization flying done by a third party with larger, more efficient units.

To give you a sense of scale, we have twenty long term CRJ-700s and approximately 12 of these are deployed in capacity purchase markets. At this point, I'll turn the call over to Jeff to walk you through the Horizon's results.

Jeff Pinneo

Great, thanks Brad and good day everybody. Horizon Air reported an adjusted pre-tax loss for the quarter of $11.2 million, compared to a loss of $500,000 in fourth quarter of 2006. For the full year, we reported an adjusted pre-tax loss of $19.5 million compared to a profit of $23.2 million in 2006.

Contributing to the losses in both the quarter and the full year were extraordinary costs associated with our fleet simplification, record high fuel prices and a highly competitive fare environment in many of our brand markets. Adding to the burden was an increase in planned engine overhaul activity that added about $16 million in expense over the prior year as well as the challenge of integrating several CRJ-700s back into our native network on their return from Frontier jet express service.

While we knew going into the year we'd encountered many such headwinds, we're clearly not satisfied with these results and have a sense of urgency about making the changes needed to turn our performance around to achieve adequate levels of return. We believe the major changes we made in 2007 to our fleet, our fare structure and our business model were appropriate and necessary to lay the right groundwork for our future success. We remain focused on improving our cost performance and on further developing markets to improve profitability.

As we shifted capacity away from the low CASM, low RASM Frontier flying to higher RASM and CASM flying for Alaska and our own brand, we began to report changes in capacity, load factor, yield and RASM by line of business to provide more transparency. You’ll find information about our product mix changes in our lines of business section of the press release.

Our total revenues for the fourth quarter were higher by 14.5% or about $23 million on 10.3% growth in system capacity. Approximately half of the revenue increase came from our brand flying which with ASM growth of 30% produced a load factor that was four points lower than in the prior year period. This combined with a 7.7% yield decline to lower our RASM by 13.7% which was offset to a large degree by our 13.4% decline in brand CASM ex-fuel.

The growth in our brand flying was driven by up-gauging from Q200s to Q400s and by redeploying some of our returning Frontier CRJs to longer haul competitive markets.

ASMs dedicated to our Alaska capacity purchase flying increased 40% also as a result of up-gauging and integrating CRJs. Some of these assignments served to free Alaska jets to pursue the expansions Brad just mentioned. Currently, 61% of our capacity is assigned to brand with the remainder dedicated to Alaska CPA.

On the expense side of the quarter, the $30 million increase in adjusted operating costs represents and 18.9% jump over last year's fourth quarter. Nearly $18 million of this increase was in fuel, most of which was rate related but a portion of which stemmed from increased consumption associated with our migration away from Frontier flying. You may recall that fuel and some other expenses were covered by Frontier and that arrangement.

We also incurred $3.5 million in additional Q200 fleet transition costs and $4 million in non-fuel expenses associated with moving CRJ flying from Frontier to Horizon. Despite the product mix changes and charges associated with the Q200s, our CASM ex-fuel was lower by almost 1% and down by 3.2% if you exclude the fleet transition charges. This was a bit better than the guidance on our last 8-K.

During the quarter we saw good progress on a number of major initiatives launched earlier in the year. As you'll note from the table in the press release, fleet simplification was a key activity driver for us in 2007. All up, we transitioned 11 Q200s out of the fleet and took in 13 new Q400s in addition to reintegrating the 9 CRJ-700s that had been assigned to Frontier. Over the next year and a half, we plan to transition our remaining 17 Q200s and make way for the remaining 15 Q400s that we have on firm order.

These fleet changes allowed us to simplify and lower our fare structures in the third quarter to stimulate local traffic and expand our ability to accommodate feed for our Alaska and our other partners. We expected RASM would decline but the CASM would decline even more leading to higher unit profitability on capacity growth. In general, the early returns are promising. Some markets responded immediately while others are taking more time in promotional investment. We continue to monitor each market's response and have been actively adjusting fare levels, schedules and capacity where appropriate to maximize market profitability.

Also during the quarter we received approval to begin operating in Mexico which we put to work in the LA - Loreto market last week.

In 2008 we expect our overall capacity to decrease by about 4% as a result of six planned Q200 retirements and the return of one CRJ on a short term lease. However, the year-over-year changes in mix will drive capacity increases in both our brand and CPA lines of business. Accordingly, we've already taken steps to further trim and redeploy capacity to maximize profitability within our network including reductions in Boise and Spokane patterns to support AAG network missions out of Portland.

2008 promises to be a much quieter year in terms of operational change. Engine overhaul activity and Q200 retirement charges are estimated to decrease by $20 million and $6 million respectively. Another non-recurring item was the estimated $5 million revenue loss associated with the Q400 landing gear inspections in September of last year.

Still, our goal remains achieving and sustaining returns that appropriately compensate our investors and that fund our future. Our 2008 plan reflects the urgency and importance of that commitment with numerous major cost reducing and revenue optimizing initiatives underway in all divisions.

On the expense side, we're focusing on areas where expenditures are high and improvements are highly leveraged across the organization, applying lean process improvement, technology applications and best practice benchmarking to drive costs down and productivity up.

On the revenue side, our efforts will add rigor to our revenue management processes and marketing efforts, targeting markets specific RASM improvements. These efforts to improve passenger revenues are supplemented by plans to grow cargo and contract service revenues.

Looking further down the road, we're mindful of the challenges but confident in our plan, our people, and the groundwork we're laying for the future. The investments we’re making to simplify our fleet will position us to be more competitive in this new era of high oil prices and customer demand for value. As we continue to track the performance of the Q400 fleet type as a replacement for Q200s we believe the Q400 also has the potential to improve the economics of much of the flying we're currently doing with the CRJ-700s, particularly in the current environment of high fuel costs and downward pressure on yields.

Early indications are compelling with the emerging thesis being that the economic benefits to Horizon of further fleet simplification moving from a mixed  fleet of CRJ-700s and Q400s to a single type Q400 fleet may outweigh the .benefits of flexibility that our current mix supports. Accordingly,  we're actively investigating the pros and cons of a single fleet concept in coordination with the broader AAG capacity planning efforts that Brad referenced earlier.

For the first quarter we're forecasting a 1% increase in ASMs with CASM ex-fuel of $0.156 up 1% versus 2007's first quarter. This expected unit cost increase is a result of the product mix shift I described earlier offset by a reduction in engine overhaul activity, and by the improved economics of the Q400s versus the Q200s they are replacing.

Now, let me turn the call back to Brad who will take you through the Air Group balance sheet. Brad.

Brad Tilden

Thanks Jeff. Air Group entered the quarter with $823 million in cash and short term investments, down about a $190 million from our balance at the end of 2006. We generated $482 million of cash flow from operations during 2007 and had proceeds from new financings of approximately $280 million, both of which were offset by capital spending of $770 million and debt repayments of $130 million.

Almost all of the capital spending this year was related to advance deposits and delivery payments for the 14 737-800s and 13 Q400s we took delivery of. We currently expect our capital expenditures to be $570 million in 2008 and the good news is that by the end of this year, our $2 billion fleet transition will be complete and our required capital spending will decrease materially.

During the year we made contributions to our defined benefit pension plans totaling $52 million, bringing our contributions since 9-11 to $368 million.

On a PBO basis, which is the most conservative measure, we are now funded at approximately 86%, up from 80% in 2006 and 65% in 2002. On an ABO basis, we are approximately 97% funded.

Through December 31 we repurchased 2.6 million shares of our stock for $63 million and through yesterday we had repurchased 3.3 million shares or approximately $80 million. These repurchases were made at an average price of $24.06 per share.

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

Shannon Alberts

Thanks Brad. We're happy to address questions from analysts at this time.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Ray Neidl.

Raymond Neidl - Calyon Securities

Good afternoon. Basically, I think you said that demand in most of your sectors still looks like it's pretty strong going into the first quarter. Mexico was weak. I'm just wondering what your seeing as far as the competition looks on the west coast, particularly in the key Los Angeles market?

Brad Tilden

Yeah Ray, this is Brad, maybe I'll start and see if Gregg wants to chime in. I think the basic point you're making is the right point. Demand does look fairly good for us as we look forward, I think, advances are up by three points in January and February and a bit more than that in March. Regionally there's strength in Alaska, in our trans-con markets in Canada, in Vegas, in Phoenix and there is some weakness in Mexico as you point out.

If we talk about competition, there are both increases and decreases. Out of Seattle I think everyone is aware that Virgin is going to start four Los Angeles flights this spring, three in April and one more in May, and three San Francisco flights. And there are some other modest increases. Southwest has got a couple of frequencies into San Jose and Sacramento and they've got new service into Denver. Those are year-over-year comps.

I think it's important to point out there are a lot of decreases as well. Into LAX out of Seattle, United has got one less flight. They have one less flight into San Francisco. In Denver, both United and Frontier are dropping a flight. Our competitors are dropping a couple of flights into Chicago. Vegas has a flight down, Dallas has a flight down, you get the picture. So there is an increase in capacity into San Francisco and LA. These are very, very important markets to the company that we are going to defend. But I think, apart from that, I think the picture is not particularly bad.

Gregg, is there anything you can add to that?

Gregg Saretsky

No, I think it’s worthwhile repeating the fact 25% of our capacity is to and from California and the Pacific Northwest and so as Brad said these are important markets for us to defend and we’re going to do that aggressively.

And yet we only have to look back at history and see the mistakes that were made at in Atlanta, perhaps a decade ago when one airline didn’t do much to defend its turf when a second carrier entered. And we’re not going to allow history repeat itself here in Seattle.

Raymond Neidl - Calyon Securities

OK, great. And regarding Horizon, it seems like it’s still being a heavy drag on the company even though you’re making major adjustments. Is there any thought of doing something maybe more radical? I know you don’t want to sell off because it’s part of the Alaska Air Group. But have you ever thought of selling part of it off to say like a sky west to give it greater economics of scale and maybe give it a little better chance of competing across the whole spectrum.

Bill Ayer

Yeah Ray. This is Bill. We really haven’t. I mean our focus here is as you said, Horizon is an integral part. It’s a strategic part of Air Group and the relationship with Alaska is really important both from a flow traffic perspective as well as these harmonization markets. And the focus is on making all that work. And that’s got 100% of our attention.

Raymond Neidl - Calyon Securities

Okay.

Jeff Pinneo

And this is Jeff, Ray. I think it’s really important to point out that as strategic as the arrangement is, it’s incumbent on Horizon to be a competitive partner in the whole process here too. So all of the efforts that we cited and are supported by short term blocking and tackling work, continuous improvement on cost efficiencies, and then the structural stuff we talked about should aid that as well. A huge effort in maintenance and engineering is going on this year as well, that’s partially related to simplification and lean. But all in all, that’s where our attention is focused.

Raymond Neidl - Calyon Securities

Great. And Brad did you give us a fuel cost estimate by quarter?

Brad Tilden

You might ask Jay Schaefer to handle that. I guess, maybe as we do that, are you looking for historically, Jay, or are you looking for the future, or Ray?

Raymond Neidl - Calyon Securities

The future.

Jay Schaefer

That’s a hard one.

Raymond Neidl - Calyon Securities

I know.

Jay Schaefer

You know, Ray, we have the same [ford] curve you have so I won’t give it to you by quarter. I’ll give you what we put in our forecast, which is $87 a barrel. That will be wrong. I just don’t know whether it will be high or low. But, let me give you our fuel hedge positions by quarter, and then maybe you can work from there. We’re 50% hedged for Q1 at almost $67, $66 a barrel;    Q2, 50% hedged at $72 a barrel; Q3, 30%, excuse me, 33% hedged at $68 a barrel; and Q4, 34% hedged at $68 a barrel.

Raymond Neidl - Calyon Securities

Ok. Thank you.

Brad Tilden

Ray, in terms of our crude assumption for our plan for whatever it’s worth, we’ve assumed $95 a barrel in the first quarter going down by $5 a barrel each quarter after that. So - 95, 90, 85, 80 and that gets to the $87 figure Jay mentioned.

Operator

You next question comes from the line of Christopher Cuomo with Goldman Sachs

Christopher Cuomo - Goldman Sachs

Hello everybody. I just wanted to have a cost question here. First could you just remind us of your goal, your 7.25 mainline CASM ex-fuel goal. What’s your timing around that and how confident do you feel in sort of meeting that goal.

Brad Tilden

Yeah, Chris, maybe I’ll start. Maybe we can get Glen Johnson to chime in here, but, I guess, we look at this as what is going to be required for this company to be successful and have an answer to all of our competitors, and we’ve started, five or six years ago, when our costs were $.0873 and we put a goal out of $.0725 and nothing has happened to change our belief that we need to get to $.0725. And in fact we still think that we probably need to get lower than that. So we just kind of start with that requirement and then, we didn’t file for bankruptcy. So the idea of defaulting on our pension plans or, you know we took charges to our P&L. when we got out of the MD-80 fleet.

It’s kind of the way we are doing fleet transitions, so the improvements that we’re getting come from procurement efforts or efficiency or better real estate utilization, that sort of thing. So maybe directionally, the 725 is still a goal. As we said the goal for 2008 is flat and we can talk about why that is. We’re not giving a specific time frame for 725. But that’s,  maybe that’s a little bit of a big picture sense of where we need to go.

Glenn, maybe you can chime in on some of the things that, the opportunities we have in front of us to work on to get cost down.

Glenn Johnson

Sure. I’d be happy to Brad. So, I guess we look at this from kind of a couple different perspectives and on the CASM ex-fuel, and I’ll talk about fuel in a second, but, there’s really two major focuses; kind of our supply chain management efforts and then our lean manufacturing principles. And just a reminder; We’ve been on this lean journey for a couple of years here where we really are trying to remove waste in any form from; time, effort, dollars, material. And that’s a journey that we’ve been on.

We have now specialists in every division, really working on those projects. So some of the areas that we are going to be specifically focused on this year to be looking for lean efficiencies would be in our engine maintenance agreements; our power by the hour agreements; our ground service handling contracts; our real estate footprint; our efficiency of real estate usage both from a square foot usage as well as rates and with particular focus on our Seattle and Portland hubs, where we think we have particular opportunity; air frame overhaul efficiencies from a cost perspective; our operational improvements that Bill mentioned in terms of improving our operations with a real focus on Seattle.

We think we’ll bring costs in the areas of passenger remuneration and employee overtime. There are significant benefits to be realized if we complete our single fleet transition both from the pilot efficiencies in training and reserves in the fuel line clearly because of the MDs being out and the more efficient 800s replacing those. And then we continued to leverage technology in terms of our “Airport of the Future” that Bill mentioned, a 40% improvement in our throughput of customers at Seattle, and Alaskasir.com improvements as well.

Bill Ayer

And Chris, I might just add that our initial plan back in late ‘06 had growth around 6%. We are now planning 3% growth for this year, and that puts some pressure on CASM obviously.

And the other really big picture thing that I think Brad said was that once we decided we weren’t going to do this via bankruptcy, that by definition means it takes longer to get the costs down and in some respects I think it’s harder. But hopefully we’re doing it more with our people working together to find these savings and make process changes and it’s longer than any of us would like, for sure, in terms of realizing the CASM reductions. But we’re on a steady path. We’ve got a very nice trend line and we intend to keep moving down that trend line on CASM.

Christopher Cuomo - Goldman Sachs

Well I appreciate the detailed answer. Then let me just throw one out on a popular topic of consolidation. If we were to assume that Alaska is not directly involved in consolidation, just curious how you believe your airline is positioned. What are the challenges? What are the opportunities presented to you, if the US airline industry were to consolidate?

Bill Ayer

Chris, Bill again. I think everybody knows our position on consolidation which is for us we think our best future is to remain independent. Wet think that’s best for all of our stakeholders and particularly for the state of Alaska where we have a mission that is beyond just economics there. It really is a community mission to provide service, passenger and cargo service, to a lot of communities that otherwise wouldn’t have it. And we all feel like that’s pretty darn important and probably wouldn’t be continued if we were bought by a big carrier.

But we also understand that we have to perform. Otherwise somebody else might make that decision about our remaining independent. Having said that, the world may very well be changing here and we need to follow what’s happening closely and keep track of events.

So that’s, in terms of positioning for other people making changes, I think we feel pretty good about that. I think that to the extent there are domestic, and industry wide, I think we’re also of the belief, as most of you are, that some consolidation could be healthy for this industry to the extent that it results in less capacity.

And that’s, capacity is sort of the root of all evil here, that too much capacity is a fundamental problem with this industry and has been for a long time. So we’re in favor of some industry movement. We just don’t think it’s right for us. And we do think we’re well positioned with our partnerships that we have, our alliances that we have with some of the big carriers and the extent that they may be re-looking at their networks both domestically and internationally. There might be some opportunities for us in that.

Christopher Cuomo - Goldman Sachs

Thank you for your time.

Operator

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

Jamie Baker - JPMorgan Chase

Hey, good morning. You know, Bill I appreciate the 10% ROIC target. I’ve actually been trying to pin down many of your competitors as to what sort of returns they target and how they measure that progress, but I haven’t had much luck in that regard. I’m not going to hold you to this number, but do you have a plan, and maybe it’s not the plan that’s in front of you, right now, but a plan that nonetheless gets you somewhere close to this return, in an $85 soft, $85 oil soft economy type environment?

Bill Ayer

It’s a good question and we’re certainly, I think the first thing to say is we’ve recognized the need to strive for 10%, and so we’ve got a lot of pressure coming to work everyday to keep working both the cost and revenue side of the equation.  So I think that’s really important, I feel really good about the fact that our team understands the importance of that goal.  Then you get to the how do you execute on that, how do you actually get there and what are the things you can do? And we don’t have all the answers right now.  We’re certainly trying to work both sides of this, as hard as we can.

We are frustrated with the yield side and the prospect of a softening economy in ’08, yield improvements are going to be tough.  And we’ve got to continue to work on that; we’ve got to understand the segmentation of our market’s business and leisure traffic and bucket mix and all of that and how can we get an extra dollar or two in various markets.  At the same time we’ve got some new competitive incursions and we’re going to take those very seriously and to grace point it back, you don’t just pretend that somebody isn’t there when they are, and we’re not going to let that happen. 

So, that all adds up to saying, ’08, I think when we talk about ’08 we talk about let’s have good relative performance to the industry.  But certainly as you go out beyond ’08 we understand that we need to have not only good relative performance but good absolute performance and make progress against this 10% goal.  We don’t know exactly how we’re going to get there, but we’re intent on doing it and we’re going to find a way.

Jamie Baker - JPMorgan Chase

Okay, well I appreciate that, and as a follow-up to the earlier consolidation question, you know the deals that are being popularly discussed today are of a magnitude that are of a magnitude that are almost certain to result in at least in my opinion, BOJ mandated divestitures.  So I’m not asking you about your participation in sort of a deal making perspective, you already answered that question thoroughly, but with a stronger balance sheet than most, should we assume that you are both capable and interested in stepping up to the plate if sufficiently lucrative assets are put up for sale?  

Bill Ayer

We’re going to stay awake here, and if there’s opportunities, like over our 75-year history there have been opportunities, we’re going to look at those things and do things that are in the best interest of our long-term, for all of our stakeholders.

Jamie Baker - JPMorgan Chase

I appreciate the clarity, thank you very much.

Operator

Your next question comes from the line of Mike Linenberg with Merrill Lynch.

Mike Linenberg - Merrill Lynch

Good morning all.  I guess two questions.  Brad, when you were going through the forward book you indicated that advance bookings were running up, call it three points, but largely due to Hawaii.  I’m curious if you were to strip out Hawaii what does that number look like?  And maybe as a corollary to that you did indicate that yields were running down 0.5% so presumably the Hawaiian service, while it’s adding to bookings, it’s also pressuring yields. So if you could just pull that piece out.

Brad Tilden

Sure, bookings, Mike, are okay.  Hawaii books earlier than the rest of our market, so Hawaii is changing the nature of our booking curve.  So I guess we wouldn’t right now, if we were up three, three and more than three for March, we wouldn’t currently forecast that we would end up that good.  Hawaii books early. 

But if you look around, I think I already mentioned this, we see strength in the Alaska long haul, we see strength in both Phoenix and Vegas, we see strength in the trans-cons, and candidly we don’t see big negatives anywhere in terms of our markets, in terms of the bookings.  On the yield side, I think you make a fair point; the yield on a 2,500-mile stage length flight is considerably lower than our system average, so the long haul flights do put downward pressure on yields.

Mike Linenberg - Merrill Lynch

Okay, and then just my second question, you spent some time highlighting a lot of the macro issues and it’s coming up on a lot of these calls.  You are growing at a decent clip in the first quarter, although it looks like a lot of this new long haul stuff kicking in; it wasn’t in place a year ago and so as you move through the year your supply does come down.  You did hit several times, I think Brad and Bill, that you were going to look toward the fall maybe as an opportunity to pare further. 

I just want to explore that a little more, is the proper interpretation that basically the schedule for the most part is set in stone for the next 6-9 months and that’s largely a function of the fact that you have a lot of airplanes coming in and it would be more difficult for the sizeable amount of airplanes that are also going out, maybe to accelerate that.  I mean, what sort of flexibility, such that if things really slowed, that, forget about the fall, you could address it within the next couple months.  Call it a March-April timeframe.

Brad Tilden

One thing to keep in mind, Mike, is that we are more seasonal than most of the airlines out there, even in a pretty lousy year, which I don’t think that we’re currently seeing for 2008, our company does very well in the summer months, so I’m not sure that we think it’s profitable to talk about a lot of capacity reductions for the summer months, which are really our bread and butter months.  So that’s one of the things that pushes us to the fall. The other thing is that we do have the seven MD-80s that will fly through the summer and that they currently are scheduled the be phased out of our fleet, on a pro-rata basis, September, October, November, December.  So, if you had wanted to make a capacity reduction, that’s an easy place to look, those seven, instead of doing a scale down through the fall, to do them a little bit earlier.  That’s maybe the main thing we’re thinking about at this point.

Mike Linenberg - Merrill Lynch

Okay, very good, thank you.

Operator

Your next question comes from the line of Frank Boroch with Bear Stearns.

Frank Boroch - Bear Stearns

Morning everyone.  Bill, I know in the past you’ve talked about, you’ve given your outlook on profitability and factoring in some of the cost guidance and new competitive incursions and changes, it looks as though ’08 could be another down earnings year for Alaska, second in a row.  What is your early read, how would you want to comment on that, and do you think that’s unreasonable to, that that could happen.

Bill Ayer

We don’t obviously give earnings guidance per se; we’ve given you pieces of the puzzle and some of the color around it.  We’re just all focused every day on doing what we can to run a great airline and optimize revenue and keep downward pressure on cost, and I think that’s all the guidance we should give you right now.

Frank Boroch - Bear Stearns

Brad, in the CASM ex-fuel guidance, does that assume any changes to labor contracts?

Brad Tilden

We don’t, Frank, we don’t normally get into details like that in terms of the CASM guidance that we provide.

Frank Boroch - Bear Stearns

So we should assume it’s a steady state, current contracts?

Bill Ayer

Bottom line is we don’t normally give guidance in terms of assumptions like that, that underline the guidance.

Frank Boroch - Bear Stearns

Okay, a lot of the other airlines do talk about that.  I think in the second quarter of ’08 you have a new policy change on the mileage expiration for the frequent flier plan, do you expect that to have a RASM benefit in 2Q?

Bill Ayer

I’ll get Brandon Pedersen, our controller to address that.

Brandon Pedersen

You know that, the expiration change will take place in April, and at this point we expect that probably 3-4% of our miles could expire, there are some initiatives underway to make sure that we reach out to customers and try to re-engage them, so that may change.  If we do expire that number of miles, there would be a benefit that comes through in RASM, although that might be coupled with a change in our breakage assumptions.  So we’re really not sure of the net effect, we’re kind of looking at that right now.

Frank Boroch - Bear Stearns

Okay, great, thanks.

Operator

Peter Jacobs with Ragen Mackenzie has the next question.

Peter Jacobs - Ragen Mackenzie

Thank you, good morning gentleman.  Brad and Bill, when I think about the fuel costs or the cost guidance ex-fuel for 2008, I guess I’m a little surprised and a little disappointed that there won’t be continued progress made on that front.  And the take away from the last couple calls has been, at least in my interpretation, is that progress could probably still be made there in 2008, so perhaps if you go through the three items that you talked about in terms of wages, maintenance, and contract and services and help me understand if there’s been anything now that’s come to light as you’re looking at 2008 that maybe wasn’t there mid-year 2007, that has put the breaks on progress on that front, please.

Brad Tilden

Sure, maybe I’ll start and then see if Brandon or someone wants to jump in here and help Peter, but if we look at wages, you saw a significant reduction this year in the invariable incentive pay that we would probably budget that at more of a targeted level as we look forward.  On the wage line itself there isn’t major changes in terms of our assumptions, but many of our people do get step increases and some of our benefit lines are having increases, so there’s increases that aren’t really material to the wage and benefit line, but they  do match CASM up a little bit. 

Contract services, we are doing some, essentially all of our growth is outside of Seattle where we don’t handle ourselves, so that’s pushing the contract services line up a little bit.  Maintenance, the 737-400s are entering, I think our folks in maintenance have done a terrific job managing those costs down over the last several years and we’re much more competitive today than we were a few years ago.

But we are looking at a year next year where there is kind of an unusually high level of overhaul work with our 737-400 fleet, and also engine overhaul work with our older 737 next-gens, and then finally depreciation, I mentioned that it’s up 14%, that’s $20 million, or almost 10 basis points of CASM.  So those are the increases.  I think that the big thing is we look at it and say “Well, why isn’t that going down?” it’s probably not those increases; it’s just the lack of other decreases that are funding it.  So Glenn got to some of that stuff that we’re going to be looking at. 

We’ll be looking at the procurement, at the supply chain, what can we do with engine agreements, what can we do with airport costs.  And another big thing to talk about is a primary focus for our company in 2008 is on improving our operating numbers, so improving our completion rate, improving our baggage rate, improving our on-time arrival rate.  And so we are making investments across the board in that and I guess our view  is that it’s short-term investment and long-term payoffs.  So, I think all of us can see the payoff of those improvements down the road, but we’re not budgeting them in 2008.

Peter Jacobs - Ragen Mackenzie

Okay, two other quick questions.  First, raw fuel prices that you’re seeing at the airport now?

Jay Schaefer

This is Jay.  So, if we assume sort of $87-90 a barrel that, with hedging, would put us at about $2.53-2.55 a gallon.

Peter Jacobs - Ragen Mackenzie

Do you have a raw number Jay?

Jay Schaefer

Yes, 2.72.

Peter Jacobs - Ragen Mackenzie

Okay, 2.72, thank you.  And then for Jeff, when I look at the higher fuel consumption per ASM at Horizon, which you did speak about in your prepared presentation, is that a good rate to think about going forward now?

Jeff Pinneo

Well, we’re going to continue to have some year over year shifts and mix as we get to the point where the Frontier experience is completely behind us, Peter, so by the end of the year we’ll be there.  But the difference is of course is we purchase and consume the fuel on our books for brand and CPA versus what we do for Frontier.  You’ll see you have to do the math on both rate and volume and the volume part of that will continue to peter out through the year.

Peter Jacobs - Ragen Mackenzie

But the fuel burn per ASM, are you saying that could continue, then, to step up as we go through the year?

Jeff Pinneo

Fuel burn per mainlining attempt for Horizon should continue to come down as we introduce more Q-400s in place of the 200s.  We’re looking at this last year at the 4% efficiency gain on fuel CASM and we expect that to continue going forward.

Peter Jacobs - Ragen Mackenzie

I might have to take that offline with Shannon or you.  I’m showing that the fuel consumption per ASM was up about 16% year over year and I’m just curious on just how that would move forward for the entire operation.

Brad Tilden

Hey Peter, just to be clear on that, we didn’t, when those airplanes were flying for Frontier we didn’t buy the fuel, we didn’t show the gallons and [the come back], the mix changes, so we’re buying the fuel and showing the gallons for those airplanes.  The ’08 plan, all the airplanes are flying for us, in ’07 they weren’t.

Peter Jacobs - Ragen Mackenzie

The question I was driving at is the rate that we saw in the fourth quarter is that the appropriate rate to be using in 2008 or could it continue to step up until the transition is completely done?

Jeff Pinneo

That’s the right answer Peter.  We had Frontier flying going through November 28th, so fourth quarter was affected by that.

Peter Jacobs - Ragen Mackenzie

Thank you.  That’s all I have.

Operator

Your next question comes from the line of Dan Mckenzie with Credit Suisse.

Daniel Mckenzie - Credit Suisse

Hi, good morning. I’m wondering what your thoughts, maybe this is for Brad, I’m wondering what your thoughts are about how much passengers would be willing to pay for onboard Internet service and then related to that, what that could potentially mean for Alaska, and of course any timing.

Gregg Saretsky

Dan, this is Gregg Saretsky, maybe I’ll take that, since Row 44 is a project that my team is working on.  We’re going to test what [pray] sensitivity is to that type of a feature.  We’re hoping for a first aircraft sometime in Q2 and we’re going to look at a variety of different pricing models, ranging from a per use to a subscriptions model, and we’ll how the numbers work best for us.

Daniel Mckenzie - Credit Suisse

Okay, and then I guess separately, it sounds like there are a number of potential changes here at Horizon. I’m wondering if you can provide some perspective with respect to timing for any decision about cutting RJs or outsourcing [flying], and then related to that, whether labor input would be required for any change?

Brad Tilden

Dan, I think we probably want to stick largely to what we said in our prepared remarks there. What we basically said is that we’re looking at that flying and we’re not satisfied with the returns, we’re looking at the idea of moving, helping Horizon move to a single fleet, and we’re going to do an analysis. And that analysis is going to take all these things into consideration, alternatives, what they would look like, all the issues, the financial issues. And I think probably what we would say is that you should expect to hear more from us about this. We’ll at least give you an update on next quarter’s conference call.

Daniel Mckenzie - Credit Suisse

I see, okay. That’s it, thanks very much.

Shannon Alberts

Okay, we have time for one more question, and then Alaska’s Managing Director of Corporate Communications, Caroline Boren, will conduct the media portion of the call.

Operator

Your next question comes from the line of Robert Toomey with E.K.Riley Investments.

Robert Toomey - E.K.Riley Investments

Hi good morning, a number of my questions of been answered. Just a follow-up to that last question, for Jeff really, you spent some time talking about the initiatives that you’re taking at Horizon to improve your operations, and I know you can’t go into a great amount of detail, more than what you said earlier, but can you tell us your relative level of confidence of how much you think you’re going to accomplish in ’08. I mean, should ’08 be significantly better, or materially better operationally than ’07?

Jeff Pinneo

You mean in terms of our operation costs, Rob?

Robert Toomey - E.K.Riley Investments

In terms of your overall performance, really bottom-line performance.

Jeff Pinneo

Yeah, I think the answer is yes, for a couple reasons. First of all, I cited the timing issues, the engine overhaul activity that’s going to subside by about $20 million, the related benefits of moving [inaudible] fleet, and stripping out inventory, getting simplicity on that front. That is going to drive it as well. As we move toward a two fleet type operation, we’re starting to get a better line of sight to the overhead reduction benefits that accompany that, in terms of inventory and training programs, pilot bidding cycles, etc. So we’re confident that’s going to materialize as well.

In the look though, we’ve recognized, particularly in maintenance and engineering, that we have relatively high costs related to a complicated three fleet type support operations. We do an excellent job, our people are terrific, but spread across 65 airplanes, three fleet types, it drives a lot of cost that we’ll take care of as we further simplify. So we have a lot of confidence on that front. The challenge on the [inaudible] basis, of course, is to produce on a declining ASM base. We’re coming down 4% overall this year, even though there’s significant changes on brand and CPA because of the returning Frontier aircraft. So our budget for this year has many, many stretch elements in it, to keep to even a flat CASM, because of that decline. Every division’s participating, they’re all stretching hard and working very hard, and I think most of my confidence lies around the great work that’s happening, process wise, with a view to the future toward greater simplicity.

Robert Toomey - E.K.Riley Investments

Great, and one other question. Other expense with 63 million in the quarter, that was higher than what I had modeled, and up quite a bit from the fourth quarter. Was there anything in that, or can you explain what’s in that number, and is there anything that was of a little more non-recurring type nature in that 63 million?

Brandon Pedersen

Yeah, Bob, this is Brandon. Let me get oriented her for just a second. So you’re looking at other expense on the Alaska side, I guess I didn’t quite follow what you were asking.

Robert Toomey - E.K.Riley Investments

I guess it’s consolidated, if you look at the top, the consolidated number. I believe it shows 63, and that’s up quite a bit from last year, and quite a bit more than I was modeling. And up quite a bit from Q3. Just wondering if there was anything in there of a non-recurring nature, or why was it up so much.

Brandon Pedersen

You know, it really was a hodgepodge of things. It was…

Robert Toomey - E.K.Riley Investments

Did I say income, I meant expense. I meant other expense. 

Brandon Pedersen

You know, I’m looking at the detail, it really was a whole bunch of stuff. One of the inflationary pressures that we’ve been seeing all year is in the area of crew hotel costs. That was up 15%, that’s been, as I said, something all year. We had a number of consultants working on various projects. Those expenses were up $2.5 million a year.

We’ve seen some cost increases in property taxes, as we bring on new 800s, but offsetting that there’s been some nice declines in liability insurance and a couple of other things, so it really is a whole host of things. Some of them were one time in nature, some of them are ongoing.

Robert Toomey - E.K.Riley Investments

Okay, and one last quick question if I can. You mentioned that the competitive situation, in I think Los Angeles was more difficult, can you kind of give us an update on what Delta has been doing in the LA and Mexico market?

Gregg Saretsky

Bob, this is Gregg Saretsky, they have been actually pulling back, they’ve taken a number of their services out of LA from daily to a couple of times weekly, I’m thinking specifically in La Paz, Loreto, and Manzanillo from Los Angeles. Their capacity has been shrinking year over year.

Robert Toomey - E.K.Riley Investments

It’s been shrinking.

Gregg Saretsky

Yes

Robert Toomey - E.K.Riley Investments

Okay, thank you. 

Caroline Boren

All right, this is Caroline Boren, we now have time for questions from any journalists participating today. Lupita, would you please remind our callers of the procedure for asking questions?

Operator

[Operator Instructions] Your first question comes from the line of Elizabeth Gillespie with the Associated Press.

Elizabeth Gillespie - Associated Press

Hello, this is a question for Brad or Bill. Brad, you mentioned that a $15 fare increase would be needed to basically cover your costs. I'm wondering if you can describe what kind of resistance you're seeing from passengers. Can you quantify how much of a fare increase prompted a drop-off in ticket purchases? I'm just wondering how you are trying to get to the point where you can start to recoup some of those costs.

Bill Ayer

Sure Liz. I might start, maybe we can get Greg to chime in here as well. The first thing I would say is that this is an industry issue, it's not just an Alaska Air Group issue, and $15 is pretty significant on a fare of roughly $140. That's pretty material, and it will be difficult without either significant capacity reductions or a very strong economy.

In terms of what we are seeing, we’ve been working this really hard. In terms of some of the things we've done we've been working the structural fares, we've been poking around trying to get fares that we think are - I mean, we want to keep the value proposition the company has but recapture the higher fuel. So, if you look we do have $20 increases we've got through in the Seattle-Anchorage market. In Intra-Alaska we've got through $5 or $10 increases. Some of the trans-con markets we've got increases in the $10 to $20 range. Other markets, where there's really intense competition we've had less success getting through increases.

So, I guess we think that we have the same problem that every other airline has that when fuel - our fuel bill's gone from $300 million a few years ago to what will likely be over $1 billion next year. So the fares have to go up but for that to happen, for the industry I think we either need a strong economy or fewer seats flying around. Gregg, do you want to add to that?

Gregg Saretsky

Yeah, all I'd say is that we're seeing demand staying pretty strong and what corporate accounts are telling us is that they expect their travel in 2008 to continue at levels equal to what they were doing in '07 but there is pressure on them to buy down, to shop in advance and take in advantage of lower fares. And so getting an increase in a marketplace where our biggest corporate customers are telling us they're buying down our fare structure is what actually moves us in the wrong direction.

Elizabeth Gillespie - Associated Press

And one more question if I could. Mexico has been such an important market for you. Can you describe why you think it was soft this quarter and what changes you are making to improve performance in the coming quarters?

Gregg Saretsky

Yeah, Mexico is soft only because we have a case of supply exceeding demand. Last year the bilateral between the United States and Mexico was liberalized and we had new competition entering every single market that was available under that bilateral liberalization.

Now what we're seeing is some of those new services that were added were not successful. Frontier is suspending service from Los Angeles to Los Cabos and Delta has been pulling back off the west coast and Mexico as well. It remains to be seen what happens as a result of some of those bilaterals being vacated. I think there are other airlines that are queuing up to take advantage of that. So, the situation of excess capacity will likely endure for the foreseeable future.

Elizabeth Gillespie - Associated Press

Thanks.

Bill Ayer

Elizabeth, maybe just onto that fare increase question, this notion of fares need to go up $15 to cover the increase in the price of crude, that $15 assumes that it all has to made up on the revenue side and one point that we would make, and I think Continental Airlines made this point as well, is that when we replace an MD-80 with a 737-800, our fuel cost per passenger goes down by $15. Obviously we can't do that for 115 airplanes, but in terms of where the company is positioned, it's not like we have to make up all of these problems on the fare side. There are other things that we can do to help our profitability.

Operator

Your next question comes from the line of Susanna Ray with Bloomberg.

Caroline Boren

Hi Susanna.

Susanna Ray - Bloomberg

Hi there, I know you guys have said all along that you prefer to stay independent but most CEOs have said they were at least considering consolidation or studying partner possibilities, or language like that. Are you guys in the mix anywhere? Or are you truly just staying out of the fray and watching it all?

Bill Ayer

Yeah Susanna, Bill again. I'll just reiterate what I said earlier, I think, which in our long held position on this is that we think our best future is as an independent carrier and we think there's a great viable position for us given the nature of our network and especially the state of Alaskan markets. But also, the world is changing and we've just got to stay up to speed on what's happening around us. But we think that's our best path.

The other thing is we've looked at mergers in the past. Maybe it would be different in the future and we hope it would for the industry's sake but the actual integration of two companies, two airlines is very, very difficult. It's difficult from a technical standpoint with systems. For example, systems that need to talk to each other so the combined networks operate well for customers. It's also proven to be very difficult from a labor relations standpoint and the integration of pilots in particular in seniority lists. I think if you are staying abreast of what's going on at US Air you see an example today of how difficult this is.

And so, typically I think some of the planned synergies, the planned economic benefits of these mergers, in the past anyway haven’t been realized because of the difficulty in actually getting it done. So, we watched that and we say that's difficult but moreover we think we have a good path remaining independent, but it does require that we continue to execute our plan and that's where our focus is.

Susanna Ray - Bloomberg

Okay, and you kind of looked at benefits that you would see if there was consolidation elsewhere in the industry. Could you, maybe expand upon that? More so than just bringing down capacity which obviously would help everyone.

Bill Ayer

Well, there are just so many different combinations and possibilities, I really can't speculate but we are an opportunistic carrier, and when there are opportunities in the marketplace we have a history of trying to take advantage of those, where it works for us, where it works for everybody involved, customers, employees, and shareholders. And so, we're going to just continue to watch and where there are opportunities, if there are any, either in markets or whatever, we'll be evaluating those things.

It's not as though we have blinders on here and we don't want to hear about what's going on around us. We understand and we're part of the industry and we need to be aware of what's happening and if that does produce opportunities for us then we'll be looking at that.

Susanna Ray - Bloomberg

Okay, and then just, lastly, a different topic. If you  could just explain for me in sort of a layman's summary, if you are using less fuel and getting all these savings from the new planes and your hedging is second best in the industry and fares are up and all of that, can you just briefly describe why the adjusted loss widened by so much?

Bill Ayer

Susanna, the fuel increases are, I mean I just would reiterate, the fuel increases are huge this industry has sustained over the last four or five years. We've gone from fuel, if you go back a few years ago, fuel at $25 a barrel, for our company $300 million, to economic fuel that pushed $1 billion this year. So that's why we're talking about fare increases and that's why we're talking about the efficiency of our fleet, and all of that.

I think we really do believe that this company is as well positioned as anyone to deal with this price environment, but these increases are just very, very big. Jay, do you have some more?

Jay Schaefer

Well, I was just going to - for the fourth quarter in particular and I think that's what you are asking about. For Q4 of 2006 on average a barrel of oil was $60. This is all raw. And in Q4 of '07 it was $90 so that's $30 per barrel increase and for Alaska Air Group that was again, unhedged, an $81 million increase in expense. And so even with the great hedge position and fuel efficient planes, it's very difficult to completely overcome that kind of a headwind.

Bill Ayer

That's in the quarter.

Jay Schaefer

That's just for the quarter.

Susanna Ray - Bloomberg

Okay.

Operator

Your next question comes from the line of John Crawley with Reuters.

John Crawley - Reuters

Hi, Bill and everybody. The potential for divested assets was mentioned earlier and you said you'd stay awake on that one. But I don’t know if you can add any more perspective on what kind of assets might make sense for you. What could you swallow without changing your plans?

Bill Ayer

Yeah, we don't have anything specific there John.  There's just so many possibilities. The basic point is that there may be opportunities, don't know what those would be at all but if anything makes sense for us, again and if it works for our customers and employees and our shareholders then we would be interested. Whatever it is, well this is totally undefined in this conversation. I don’t know what it is but we're just not saying no to everything in this environment. We're saying we're going to be sensible and we're going to look, if there are opportunities that would work for us long term then we would be, of course, evaluating those things. Any company would.

John Crawley - Reuters

Okay thank you.

Operator

[Operator instructions]

Caroline Boren

If there are no more questions we can wrap up.

Bill Ayer

Why don't we do that? Thanks everybody for their participation and we will talk with you all next quarter. Take care.

Operator

This concludes today's conference call. You may now disconnect.

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