Alaska Air Group, Inc. Q1 FY2022 Earnings Call

Good morning. My name is Charlie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Alaska Air Group's 2022 First Quarter Earnings Release Conference Call. Today's call is being recorded and will be accessible for future playback at alaskaair.com. I would now like to turn the call over to Alaska Air Group's Vice President of Finance, Emily Halverson.

Thank you, operator, and good morning. Thank you for joining us for our First Quarter 2022 Earnings Call. This morning, we issued our earnings release, which is available at investor.alaskaair.com. On today's call, you'll hear updates from Ben, Andrew, and Shane. Several others of our management team are also on the line to answer your questions during the Q&A portion of the call. This morning, Air Group reported a first quarter GAAP net loss of $143 million. Excluding special items and mark-to-market fuel hedge adjustments, Air Group reported an adjusted net loss of $167 million. As a reminder, our comments today will include forward-looking statements about future performance, which may differ materially from our actual results. Information on risk factors that could affect our business can be found in our SEC filings. We will also refer to certain non-GAAP measures, such as adjusted earnings and unit costs, excluding fuel. And as usual, we've provided a reconciliation between the most directly comparable GAAP and non-GAAP measures in today's earnings release. Over to you, Ben.

Thanks, Emily, and good morning, everyone. Despite a slow start to the year in January and February, March results were very strong. In March, we recorded Air Group's highest ever cash sales, 13% above our prior best month. For the first time since the pandemic began, March revenues exceeded their 2019 comparison. This was driven by strength in both leisure and business demand with leisure currently more than 100% recovered, and business demand now at 70% of 2019. As demand strength has carried into the second quarter and throughout the summer, we issued guidance today indicating that we expect to deliver double-digit percentage increases in both unit revenues and yields versus 2019. The second quarter guidance reflects line of sight to a double-digit pretax margin for the quarter. Given we expect to deliver profits in Q2 and for the remainder of the year, we are reiterating our full year pretax margin guidance of 6% to 9% for 2022, even with the higher fuel prices we are experiencing today. To provide more context about our expectations, I want to speak to you today about three topics: what Air Group is doing well, where we are experiencing challenges, and why our team is optimistic about our future. I'll start with what we're doing well. While scaling capacity back rapidly has proved challenging, I'm proud of all the work being done at the company today. Our people have persevered through a lot these past two years. Every day, I ask our people to focus on what we can control and where we need to do better. But I also want to say thank you to every one of our employees, from leaders to our frontline. It is because of their hard work that Alaska was recognized as the 2022 Airline of the Year by Air Transport World. It's an incredible affirmation of the hard work and results this team has produced in a very challenging environment. We are also progressing on many aspects of our long-term strategy extremely well, including our oneworld and West Coast International Alliance partnerships that continue to strengthen and provide more value to our guests and to our results. Our new long-term materially enhanced co-brand agreement with our partner, Bank of America, being recognized as one of the 100 Most Influential Companies by Time Magazine for our climate efforts underscored by our commitment to net-zero by 2040. Returning our balance sheet to within our target leverage range and continuing to post financial results that we believe will lead the industry this year. As we discussed extensively at Investor Day in late March, positioning Alaska to outperform the industry over the next several years given our cost profile and tangible commercial roadmap to grow revenue by $400 million. Moving on to where we are experiencing challenges. We have faced more operational disruptions than is acceptable as we scale our business back with the primary issue being staffing levels. We have been successful attracting new people to Alaska. We have hired 2,600 employees to date in 2022 with many of our work groups progressing as we expected against staffing plans. However, throughput in our pilot training department fell short of our plan at the end of the quarter, and our teams are now working to accelerate throughput and to get us back on track for the year. For this reason, coupled with our commitment to accelerate the exit of the Airbus 320 fleet, plus persistent high oil prices, we have reduced our planned capacity growth by a modest amount in the short term, and now expect full year capacity to be flat to down 3% versus 2019. Alaska at its core is a company that is rooted in operational excellence and the productive and efficient use of our resources. Returning to our historic levels of excellence in these areas is the primary focus of our teams going forward. Despite these challenges, I have full confidence that we have a phenomenal future ahead of us because of our people, our culture, and our business model. The key elements are now in place to build a solid foundation for profitable growth. We have deepened our expansive network and global connections from the West Coast. We've reshaped our network over the past few years, seizing profitable flying opportunities as the pandemic shifted the competitive landscape. We are deepening the spokes of our network with efficient, low-risk growth primarily in existing markets. And we continue to build our global presence via oneworld benefiting from international recovery as our global partners launch new nonstop flights and restart service. We have accelerated our move to a single fleet to drive cost savings and operational efficiency. This week, we welcomed our 20th MAX aircraft into the fleet. Last month, we announced plans to retire our Q400 aircraft and move our regional operation to a single fleet of modern E175 regional jets. The economics are clear and compelling and executing the strategy as quickly as possible is a top priority. We're leveraging our compelling product, brand and powerful loyalty program to strengthen our performance. Our renewed credit card agreement with Bank of America expands the value of our program and speaks to the incredible partnership we have and the potential to grow the program further. Finally, we're delivering on our resilient business model supported by our competitive advantages, including a low-cost, high productivity mindset, operational excellence and a remarkable service and culture of care. We have a track record of delivering industry-leading pretax margins. On top of this, we have restored our balance sheet to pre-pandemic strength, and continue to focus on our commitment to sustainability. Together, our business model and the initiatives we have undertaken will enhance our ability to produce superior results even in volatile times. As we navigate the remainder of the year, I've asked my team to prioritize three critical work streams. First, to pursue our transition to a single mainline fleet by no later than early 2023. We know and understand the benefits this brings for our company and the faster we get there, the better. Second, to deliver on the $400 million in commercial initiatives we outlined at Investor Day. And third, to return Air Group to operational excellence for our people and guests. Air Group has done well for over 90 years because we are committed to learning from and adapting to our ever-changing environment. It is no small feat that we grew our airline 32% over the same period in 2021, and we have the ability to deliver future growth plans with our commitment to excellence. We will adjust our plans where needed to ensure safety, quality, and our long-term success while also meeting our financial commitments in the near term, including our 6% to 9% pretax margin this year. I'm very excited for the bright future we have ahead of us. And with that, I'll turn it over to Andrew.

Thanks, Ben, and good morning, everyone. Today, I'll provide a recap of our Q1 results and trends with a specific focus on March, which is indicative of what we see going forward. I'll also touch on our Q2 guidance along with longer-term commercial drivers. Total first quarter revenues came in at $1.7 billion. That's nearly $1 billion more than the first quarter of last year and down just 10% versus the same period in 2019 on 11% less capacity. This marks continued sequential improvement in our revenues, up 5 points from the fourth quarter of last year. That said, the most exciting aspect of Q1 was just how remarkable the return in demand has been from February. We went from bookings down 40% versus 2019 in early January to above 2019 levels by the end of February. We have now settled into booking levels in line with our capacity, but at very strong yields. Our load factors followed this booking trend and continue to strengthen as case counts declined and people returned to travel. January's load factor was 69%, February improved to 75%, and March came in at over 85%. That's one point stronger than 2019. This positive progression contributed to our March revenues exceeding 2019 levels by 1.5%, even though capacity was down 8% versus 2019. Let me give you three main contributors to these results. First, the return in corporate demand. We've continued to see strength in leisure demand, but overall demand has also been buoyed by the return of business travel. Corporate travel has been improving at a rate of 2 to 3 points for some time now. Today, we are down just 30% in corporate bookings when compared to 2019. Strong yields. In the first quarter, yield was up 3.5% versus 2019, but March was up 9%. We expect to continue to see yields improve through Q2 as spring break travel hits in full, strong summer bookings maintain their trajectory, and corporate travel continues to recover. And our premium product outperformance. Q1 was another strong premium product quarter, but March was exceptional. First-class revenues were up 19%, with paid load up 15 points versus 2019. And for the first time ever, our regional fleet posted a paid first-class load factor on par with mainline with a 22-point improvement from 2019. Additionally, premium class revenues across our network were up 8.6%, with paid load up 9.7 points. Moving to Q2 guidance. With the continuation of strong bookings, I'm confident in our Q2 capacity setup and planned return to growth in the back half of the year. In Q2, we expect total revenues to be up 5% to 8% on capacity that will be down 6% to 9% versus 2019, resulting, as Ben said, in double-digit yields, double-digit unit revenues, and double-digit pretax margins for the quarter. While I've shared our near-term outlook and what sets us up to produce solid financial results this year, more importantly, Air Group is configured to grow profitably over the longer term, driven by revenue initiatives. As outlined at Investor Day, we have identified $400 million in incremental revenue that will build through 2025, driven by three categories: product and loyalty, fleet and network. First, product and loyalty. This represents $195 million, driven primarily by our renewed credit card deal with Bank of America. Our loyalty program continues to be a very strong performer with cash remuneration from the bank up 34% versus the first quarter of 2019. This new agreement offers a powerful source of continued cash flow growth, and I expect it will remain a resilient revenue source as we continue to grow the airline. Second, fleet accounts for about $70 million of the $400 million, representing the revenue opportunity from up-gauging and incremental premium mix. Demand for premium products has outperformed throughout the recovery. And with our longer average stage length than all of our major competitors, our increasing premium mix will be well suited for our network as well as our financial performance. And then finally, network and alliances. That will drive about $135 million in incremental revenue. Our growth will be highly efficient over the next few years, 90%, which will be driven by frequency, gauge, and stage length in existing markets. With the Pacific Northwest restored to 2019 levels of flying and California to be restored by year's end, we have the full breadth of our network back in play. Now we can prioritize building depth across our network with 70% of growth in the Pacific Northwest and 30% in California. We are focused on lower risk growth, competing where we can win and adding value to our network. Building on our own network, our alliance partnerships exponentially expand our reach and enable seamless global travel for our guests, which in turn only further strengthens the value proposition of our loyalty program. As business and international travel return, we are set to leverage our West Coast hubs as gateways to the rest of the world. This global access for our guests only continues to grow as partners add new and returning service off the West Coast, such as Seattle-Helsinki, Portland-London, and San Francisco-Madrid. As Seattle continues to grow as a destination and gateway, we're excited to begin the first phase of our terminal transformation this spring. The renovations will modernize the guest experience and double capacity throughput, making it a more smooth and seamless experience. What I hope you take away and what I am most excited about for the future is that the foundation for profitable growth is in place for Alaska, and we are well positioned to capitalize on the return of travel demand. And with that, I'll pass it to Shane.

Thanks, Andrew, and good morning, everyone. While losses are not ever the goal, the $167 million adjusted net loss for the quarter was a reasonable result given the Omicron backdrop we operated in. We are, of course, encouraged by our financial performance in the month of March where we turned to profit and by the strength of demand we are seeing this spring and summer. As you heard from both Ben and Andrew, we expect Q2 to perform at double-digit pretax margins and have reiterated our full year margin range of 6% to 9% even with higher oil prices. So while we will be focused on restoring operational excellence and ensuring our teams have the resources they need to do so, I remain excited about our position in the industry and about the initiatives we are executing on to set ourselves up for strong performance over the long term. Let me start with the near-term focus we are placing on ensuring we have the required staffing to run a more reliable operation. Our teams have done a solid job delivering absolute costs in line with our plans and targets, and our people have been resilient and consistently delivered care to our guests. However, we have been challenged in stepping up capacity as quickly as we would like to. As Ben mentioned, we've reduced our full year capacity by approximately 3.5 points at the midpoint to flat to down 3% versus 2019. This is primarily driven by staffing that is short of our plan, and simply put, we are going to fix that problem before we kick growth into a higher gear. Our CASMex guidance directly reflects this capacity change, and we now expect full year CASMex to be up 6% to 8%. For the second quarter, CASMex is expected to be up 16% to 19% on capacity down 6% to 9% versus 2019. The reduction in capacity adds approximately 8 points to CASMex in the quarter. Also, we expect fuel prices for the second quarter to be between $3.25 and $3.30 per gallon, up 40% from the beginning of the year, inclusive of hedge benefits. At current prices, our hedging program is expected to provide a net benefit of approximately $200 million for the full year. Reflecting on Q1, we were profitable in March and produced first quarter results in line with our guidance. Our non-fuel costs totaled $1.5 billion, inclusive of approximately $35 million in lease return costs and $36 million in incentive pay accruals for our employees. Beginning in Q2, lease return costs will be reflected as special as we accelerate our fleet transition. CASMex was up 17% versus first quarter 2019, coming in slightly better than our latest guide. Our balance sheet and liquidity remained healthy, and we ended the quarter with $3.3 billion in total liquidity, inclusive of on-hand cash and undrawn lines of credit. Our Q1 cash flows from operations were approximately $285 million, driven by the strong booking trends that began in February. We continue to feel comfortable with our liquidity position and our ability to generate positive cash flows on a sustained basis as our business returns to normal, which together will support cash payments for the 55 mainline aircraft deliveries we have scheduled through 2023. We ended the quarter with a debt-to-cap ratio of 50% within our target range and among the best in the industry. For the rest of 2022, our contractual debt repayments are roughly $200 million, with $52 million due in the second quarter. We expect our debt-to-cap to decline within our target range over the remainder of the year. During our Investor Day in late March, we guided full year pretax margins to between 6% and 9%. And as we've indicated, we are not changing this expectation today. Demand has remained strong. Our capacity modifications will be focused on our least profitable flying. And with oil prices where they are currently, capacity reductions can drive better margins in the near term even though they pressure near-term unit costs. Our profit guidance also includes expected continued accruals towards incentive bonuses for our employees. This year, we have returned our performance-based pay program focus back to the achievement of profitability goals, a shift from the focus on cash flow generation in 2021. This year, 70% of our bonus program will be tied to pretax profitability, while 30% remains linked to other important goals, including ESG, safety, and unit costs. We've also built-in goals related to outperforming the industry on pretax margin, which is ultimately what we are focused on achieving over the long term. And over the long term, I believe we have the right structure and business model in place. We have a strong balance sheet. We have a solid fleet plan and fleet order with Boeing. Our network position has improved coming out of the pandemic, and our growth will be primarily focused in geographies of strength. We have a solid $400 million commercial roadmap that is already in motion with the recently signed co-brand agreement extension and with the fleet up-gauging, which is underway. And we have line of sight to improving unit costs relative to the industry. It is this combination of initiatives that should enable us to continue to improve our relative position versus industry peers as we progress through the next few years. And with that, let's go to your questions.

Your first caller is Jamie Baker of JPMorgan.

So recognizing that the government has gotten involved in the past when the industry has required some form of assistance. Is that something that we should start thinking about vis-a-vis the pilot shortage? I'm thinking about the 1,500-hour rule. Maybe making, I don't know, low-cost government loans available for flight school. Like I guess another way of asking the question is whether you think the pilot shortage is severe enough or will become severe enough that the solution may not entirely be in the hands of the industry. You might need some outside help, if you will.

Jamie, that's a great question. One person who has been doing a lot of work for us is Joe Sprague on the regional side. As you know, that's how you first see the fax open up. So Joe, do you want to jump in here?

Jamie, it's Joe. It's an interesting question and certainly, there are a few issues hitting the entire industry right now more strongly than the pilot situation. The trade groups in D.C. have been focused on how we can boost financial aid for new student starts for flight training. That's an important piece at the very beginning of the pipeline and something that will help not only produce a greater supply of pilots but also help with improving the diversity of the pilot workforce as well. So we're certainly supportive of those efforts. Beyond that, it is something that will take a bit of time, but there are really strong training programs in place at Horizon and Alaska, and we feel comfortable about being able to produce pilots over the next several months and several years.

Jamie, we have a pilot development program that we have 500 pilots in that program right now that have signed up with some financial assistance. We've teamed up with a school in Hillsboro, Oregon, that's going to train 200 pilots a year for Horizon with pathways. So I think your question addresses potential industry initiatives that may address some structural things. And I think, as you're seeing, all airlines are taking destiny into their own hands to create a pipeline into their regional and mainline fleets, but you bring up a great point. I think this is going to be one of the biggest constraints for the industry going forward.

Interesting. All right. And second, just on the premium emphasis at Alaska, one question I get from clients is whether you're inadvertently creating a vacuum that ultra-low-cost carriers can backfill. I certainly have my own answer to that question. But how would you answer that, if posed by a current shareholder?

Jamie, I didn’t quite catch the first word of your question that was important. What was your first sentence?

Yes. Sorry about that. The premium strategy, chasing premium demand, which is something Alaska clearly is doing, does that create a vacancy sign, if you will, in markets for ultra-low-cost carriers to backfill, which in turn potentially hurts you down the road, possibly? I have my own views on this topic, but it's a question that I've gotten quite a bit as it relates to your premium strategy. How do you respond to the question?

Yes. It's interesting to note that we are indeed seeing demand for the premium cabin, with more people willing to pay for access. Additionally, there is strong interest in our saver or basic fare options. As we outlined on Investor Day, our focus is on catering to premium travelers, regular flyers, and those looking for budget-friendly fares. With the expansion of our fleet, we aim to provide more seats and create additional space. This aligns perfectly with our fleet and product strategy.

Your next caller is Helane Becker of Cowen.

Can you provide details on business travel by group and geography? Are there improvements in California and the West Coast overall, especially in California? Also, are tech companies starting to return, considering they were among the first to adopt remote work and seem to be hesitant to come back?

Yes. Thanks, Helane. It's actually quite fascinating to watch. And you're exactly right. I think the small, medium business is back to full strength, and they have been for a little bit. What I've literally seen in the last two weeks is a staggering increase in the flying for the large tech companies. Some of the big ones have come back at the end of March and early April, where their traffic was down 80-plus percent. Just in the last week, one of the largest high-tech companies was only down 25%. So I think we're going to be a little lagged on Alaska on the West Coast because of the high tech, as you say, but I see that coming in quite strongly. So that's where we stand.

Okay. My other question is for Ben. You're discussing the need to hire pilots amid a significant pilot shortage. We just heard United mention their forecast for the industry to hire 13,000 pilots, while our prediction is between 10,000 and 12,000 for the year. I'm curious about why pilots would choose to work for Alaska Airlines instead of American, Delta, or United, all of whom are hiring at least 200 pilots each month.

That's an excellent question. Regarding the pilot supply issue, pilots have choices about what and where they want to fly. We've always prided ourselves on having a distinct brand in the industry. Even though we are a large company, we maintain a close-knit culture. Being based on the West Coast allows us to fly across the country with a robust network. I believe there is significant appeal in who we are and how we operate. Currently, our plan is to hire 600 mainline pilots and a few hundred regional pilots. We are on track with the regional hiring, which is great. For the mainline, we've made progress, having hired 300 net pilots so far this year. However, this is putting considerable pressure on our training systems, and we are actively working on efficient ways to train pilots and get them operational.

Your next caller is Scott Group of Wolfe Research.

So the guidance implies a pretty massive inflection in capacity growth relative second quarter and the second half of the year. So is that just the pilot situation getting better for you? Is that aircraft? And then maybe just talk about what you think the exit rate will be on capacity exiting the year and your confidence in getting there?

Scott, it's Shane. Thanks for the question. Yes, it does imply a pretty significant upturn in capacity and growth above 2019 in the back half of the year. I think it really does assume that we get back to where we want to be on the pilot throughput in the training house. The one thing I'll just say is we're committed to this exit of the Airbus fleet on a very expedited basis. And as we begin to do that, we may continue to move capacity around a bit. I don't think we have a strong appetite to, for example, hire a new pilot onto the Airbus aircraft, have them fly it for one month and then put them back into training to transition. So as that comes into the window, we're just going to look to optimize the transition of that fleet off the business and over to the MAX. So there'll probably be some more changes. It's hard to predict what's going to happen in Q4 right now, but that's where we stand.

Okay. I wanted to ask about the fuel hedges. I understand you hedge oil and not the track spreads. Given the current jet prices, should we assume the guidance you provided for the second quarter will also apply for the rest of the year if jet prices remain stable? Additionally, will you reconsider your hedging strategy to better cover track spreads?

I'll take the second one first. It's Nat Pieper. Our hedge program is really consistent with the way we've run our company for 90 years, financially conservative, and frankly, it's on autopilot. As we talked about at Investor Day, buying calls 20% out of the money, 18 months in advance, 10% strips and just continuing to layer them on. As Shane mentioned in his script, we value the 2022 remaining order book at $200 million for a hedging benefit. It's basically 50% at $78 for the remainder of the year, 50% at $71 for the quarter.

Your next caller is Duane Pfennigwerth with Evercore ISI.

Just with respect to your loyalty card extension, can you talk about how ratable that is versus amounts paid upfront? Oftentimes, when we see these things in the industry, there'll be kind of a heavy weighting in the first part of the agreement, maybe the first quarter or two, and then it tails off. Can you talk about how this was designed and agreed to?

Duane, it's Shane. In terms of the cash, I think the cash you're going to see right away, I think that's something that we saw in the first quarter. We saw a very strong increase in cash from our bank partner. The recognition is going to be at a slower pace as you know, a good amount of this gets deferred and recognized over time. So I think through the P&L, you'll see this build throughout the rest of this year and even into next year as we get to start to recognize the cash that we're deferring today. So cash will come pretty quick, the recognition will take some more time.

Okay. Great. And then I guess just going back to your Investor Day, you were one of the first to really tease out this kind of more constructive revenue outlook for the year, certainly relative to where we were and where the Street was at that time. I wonder if you could just mark-to-market for us relative to Investor Day, what's changed since that time that has sort of further improved your forecast? What specifically has gotten better since Investor Day?

Duane, I think firstly, corporate business travel. I just think there was just a real step change over the last few weeks on that side. And as we've shared, certainly on the fares side. Just to be frank, as we close up the buckets in the inventory, the demand didn't stop. And so the fares kept going up, but the demand kept coming. So I think since Investor Day, we've just seen a more sustained and, in fact, increasing strength in the demand as we book in now into summer and later spring break.

Your next caller is Ravi Shanker of Morgan Stanley.

Just a follow up on the corporate commentary and then the tech group coming back. So is it fair to say that much of the corporate normalization that you're seeing so far and what do you expect to see in the coming weeks and months is just a return of the kind of historical Alaska corporate customer? Or are you seeing new customers as well, kind of given the American Alliance and maybe new destinations and outreach?

Yes. Thanks, Ravi. I think a little bit of both, just to be frank, but they certainly knew our agreement with American and our joint contracting has opened up a lot of doors for us. And we'll get a clearer picture of that as we move forward into Q2 and Q3. And as we start to see the tech travel pick up more and more. But I do believe, and just seeing our fair share, our fair market share of corporate travel, just the reports I just was looking at last week, we're actually seeing a positive movement in our share gap. So I feel like that's good, and that's sort of new traffic for us.

Great. And just a follow-up, and I apologize if I missed this in your commentary. I know it's only been a few days, but are you seeing any uptick in interest in your forward booking curve now that the mask mandate has been dropped at least temporarily or permanently?

It's very difficult for us to tell that. What I will tell you is that just even looking at yesterday's bookings that were even better than the day before. So I'm just still seeing very strong momentum here.

Your next caller is Andrew Didora of Bank of America.

So maybe sticking on the corporate theme. We've been hearing from a few hotel owners that they're seeing sort of a change in the corporate booking curve, it's shortening pretty dramatically. Just curious kind of, Andrew, what you're seeing on the corporate side, I guess, particularly as some more of these tech-heavy corporates come back on the road. Are you seeing any changes in the way they either book or they travel in the early parts of the recovery here?

There seems to be a significant increase in demand recently, with a noticeable 50-point change in booking levels among some major players over the last few weeks. This indicates a major shift, particularly in the tech sector. I expect to have a clearer understanding of any further developments in the coming month, but this is the current situation I observe.

Got it. And then, Ben, sorry if I missed this in your prepared remarks. But just I guess big picture when it comes to the operational issues that have popped up here causing the change in capacity. Just outside of pilot hiring or training, like, what else can you do to fix this? And just curious how much is it going to cost to finally get back towards normal utilization levels?

Andrew, yes, it's a great question. You've known us for a long time. This company is rooted in operational excellence. And what I can say, and I've been with the operation a long time is, and I look at it closely, the root cause has essentially been staffing. And not staffing because we weren't hiring people, but staffing because we weren't able to produce the people in time to execute the schedule. So when I look at the core operation, we are still very process-focused, system-focused, metric-focused, but you have to have the people there. What happened to us early in the month was pilots were stuck in the schoolhouse, and 60 pilots made it out on the line to go execute the schedule. So we're derisking the operation a little bit to give our pilots schoolhouse just a little breathing room as we train them. And again, this Airbus transition is a big strain as well as we exit the Airbus. So we're just putting a little more conservatism into the plan and making sure that what we're known for, what we're recognized for, our customers can count on us, our employees can count on us, just making sure that we operate reliably. So I appreciate the question, Andrew.

Your next caller is Mike Linenberg from Deutsche Bank.

Ben, I want to revisit Helane's question about the pilots. You mentioned that you're around halfway through your hiring, with a net count of 300. While there is attrition and potentially retirements, have you noticed an increase in your pilot hiring? This is the first time in my career where we're hearing that moving up to a captain seat with a major carrier can happen much faster than it has historically, which is quite appealing. Can you share any insights on the attrition?

Yes, Mike, that's a great question. Over the past two years, the industry has early-retired 10,000 pilots. As we aim to return to 2019 levels, we need to replace those 10,000 pilots and account for growth. Pilots now have the flexibility to choose their flying equipment and living locations. The transition from junior to senior pilot positions is happening quite rapidly, depending on the airline. I feel optimistic about our pilot recruitment plan, though it does pose a risk to our growth moving forward. As I mentioned to Helane, we are dedicating significant time and resources to ensure our pipeline remains robust. This is a shift from our historical approach, as we usually had a large pool of pilots. Now, we need to take proactive measures by engaging with high schools and encouraging young individuals from diverse backgrounds to consider aviation careers. The cost of pilot training has made it exclusive to certain demographics, but we are working to broaden access with financial assistance and attract more aspiring pilots. I believe that despite the challenges posed by the pilot shortage, this situation could ultimately be beneficial, as many airlines are connecting with communities that previously found this path inaccessible. With the financial opportunities available, we are engaging numerous interested candidates. For instance, we currently have 500 individuals in our pilot development program and are collaborating with a school. However, this issue will continue to persist across the industry, and we need to take initiative in addressing it.

Great. That's helpful. My second question is for Andrew. When I observe some of the markets you’ve been scaling back on, which you mentioned earlier to restore operational integrity, I've noticed a significant reduction in flights to Hawaii. Other carriers have also reduced flights to Hawaii, and some of this might be due to cutting down on certain flights to free up resources. Or perhaps it’s just that longer-haul flights, particularly those mainly focused on leisure, become harder to justify when fuel prices are over $350. Is there anything specific affecting the Hawaii market, like fuel availability on the islands? Or is it simply that the economics of incremental or long-haul flying make less sense now?

Yes, thanks for the question. I think what you've seen us do is maybe take a quarter down to a third. You've seen us cut back on some of the LA, Kones and Lahuis. I think right now, I don't know for whatever reason, Hawaii's lagged a little bit, just to be frank. It's also very expensive to actually vacation there having just come back from there last week. And so there's just the accommodations, the rental cars. I think there's confusion as it relates to preclear and getting tested and that just went away as well. But what I am seeing as we head into June in the summer period is sort of that traditional Hawaii strength. But I think just as we look at the network, we had to make decisions. I think we felt like a few flights coming out of Hawaii and then we cut across sort of the days of the week, the Tuesdays, the Wednesdays, and some Saturdays. High-frequency markets, we took down a few. And a little bit more where we're doing a little more aggressive growth, we sort of pulled it back. So we've tried to spread this across our network and Hawaii we felt like a couple of flights coming out would be fine.

Andrew, do you believe that as international long-haul travel, particularly transatlantic routes, begins to rebound, Hawaii was seen as the go-to exotic destination? Perhaps a year ago, following its reopening, there was a surge of visitors to Hawaii. Do you think this has led to a shift where travelers are now choosing other international exotic destinations instead, given that those places have relaxed their restrictions and are easier to access?

I probably don't have first-hand knowledge of that, except to say that you are very correct that the choice of where folks can vacation now has expanded massively. I also think Costa Ricas and the Belizes and the Floridas and the Mexicos. I mean, we're just seeing a lot of demand across all these locations. So I think historically, where Hawaii was sort of the go-to, I think there's just more options for travelers right now.

Your next call is Savi Syth with Raymond James.

Shane, it sounds like Ben might be setting a more ambitious goal for you, if I understand correctly. The return for the single fleet type was expected by the end of 2023, but it may have been moved up to early 2023. I also know you still have the A321s and Q400. Can you discuss what you still need to achieve to meet that target? Additionally, how should we consider cash flow in light of this, even if some aspects are viewed as special items?

Emily may provide information on the remaining lease return cash costs. Operationally, we need to transition between 600 to 700 Airbus pilots to Boeing in a manner that minimizes disruption to our network. Additionally, we must finalize our long-term strategy for pilot basing with Boeing. These decisions are crucial for our pilots as well. We previously indicated that we aim to complete our work on the Airbus A320 by early 2023. Ben and I, along with the rest of the team, are eager to move past this and recognize that it will be somewhat challenging. We are developing a solid plan, which may require adjustments as we proceed. We are currently working on our plans for the A321 fleet, of which we have ten, and we are committed to transitioning away from them by the end of 2023, with Nat actively managing this process. There are no further updates at this time, but Emily may have insights regarding the cash for lease return.

Yes. Savi, so in terms of the lease return costs, you got it right that the special items that we'll be taking going forward will include the acceleration of those lease return costs. So we had previously shared with folks that that was probably going to be in the range of around $250 million. The cash will not be accelerated because the contractual lease return dates for those aircraft are still what they were before. So we'll park those planes earlier. We'll continue to do the work as we move towards those lease return dates, and that cash will be spread over the original period. The only caveat I would share is that as we go through this exercise, we are continuing to have conversations with lessors. And of course, as we do less flying on those aircraft, that could impact the amount of cash that we actually incur. So hopefully, that's helpful.

And Savi, just a little more color on that is like one of the things we have to work through right now that will impact how we think about capacity going forward is. What I've told the teams, I don't want to train a pilot who we spent 90 days in training only to produce them in September and October to transition them in January. So we really have to think about when we stop actually training on Airbus and transition to all Boeing. And that will really decide how much capacity we have for the Airbus fleet going forward from the summer on. So that's something we're still going to work through, and we'll give you guys more color on that soon.

That's helpful. And maybe just a little bit tied to that. And I think this question was asked a little bit earlier too. On the second-half capacity, I guess, how much cushion have you built into that where you might not have to kind of pull meaningful amounts down? And how should we think about Q3 versus Q4? Because I'm guessing some of this Airbus aircraft coming happens more in Q4 than Q3, where you have the summer demand. Just any kind of color around that?

Yes, I believe this is a reasonable estimate. We're still waiting to make decisions about how much hiring we will do for the Airbus and when. It's difficult to provide more precise information at this point. I estimate that we operate around 10,000 Airbus hours monthly, give or take, and that number obviously cannot drop to zero. We generally fly between 75,000 and 80,000 total Airbus hours to give you a clearer picture of how much Airbus flying contributes to the overall total. Ideally, we aim for 8,000 to 10,000 Airbus hours while working to reduce that figure towards zero by the end of the year. However, this could decrease somewhat faster than we currently expect, but I don't foresee it being significantly impactful in the short term.

Yes, Savi, regarding the upcoming schedule cleanup next weekend, the summer capacity will be quite solid and well planned. To address Shane's point, about 4,000 of the 9,000 Airbus hours will be from the A321. We will begin that transition in the fourth quarter, which is currently the weakest part of our capacity forecast. However, we will tighten that up soon.

Your next caller is Brandon Oglenski of Barclays.

Andrew, I guess, as you guys have expectations coming off the back of that question to really ramp up flying in the second half of the year. It looks like to get to your guidance, we would take RASM down a little bit from maybe where you are in the second quarter. But is that necessarily the outcome that has to happen?

I don't have much visibility into the fourth quarter regarding RASM. However, my expectation is that as we become more precise and strategic about our capacity, it will likely enhance our ability to maintain strong unit revenues in the fourth quarter.

Okay. I mean, is there anything about the flying that would be new markets or developing markets that could set that back a little bit?

I mean I can safely say to you right now, you pretty much see what we're going to be flying this year as far as markets. And as I shared on Investor Day, 90% of all of our growth is going to be in existing markets and pretty much what you see already, the Miamis and such are our new markets for this year. So we're sort of done.

Your next caller is Conor Cunningham with MKM Partners.

I understand you've mentioned the corporate recovery in California, but could you provide more details about the overall market there? It seems that the California network has significantly outperformed compared to the Pacific Northwest as demand rebounded. I'm interested in your perspective on the recovery in those markets and your expectations for a full recovery. Also, at this stage, is California having a negative impact on RASM, or is it aligned with the overall system?

We're not going to probably get in the habit of providing that level of detail. But what your observations are correct, especially with the snapback looking at March and April. But the California demand is extremely strong, and we are seeing very, very solid unit revenue performance, especially on the yield side out of California in our current bookings. So if anything, just given we have less capacity there than we do in the Pacific Northwest, I think what I'm seeing right now is a very, very solid recovery out of California.

Okay. Your financials have recovered much faster than others, and your balance sheet is in excellent condition. One thing that stands out is the pilot contract, which has been a topic of discussion on this call regarding pilots in general. Is securing that now your top priority? I'm not asking you to negotiate right now, but it seems like it would take precedence in your focus.

It's an absolute priority for us, Conor. We're focused on getting a deal with our pilots, recognizing their contributions. And getting a deal that makes sense for a business model. So we are entirely focused on getting a deal with our pilots.

Your next caller is Myles Walton of UBS.

I was wondering, as an operator, an airline, you could comment or weigh in on the benefits and risks of requiring the MAX 10 to include a new flight crew alerting system. And if that were to come about, what would the cost-benefit tradeoff to you be given some of your fleet expansion’s obviously reliant on moving into the MAX 10?

Myles, good question. It's Nat. We're obviously observing the certification of the program really closely. And clearly, safety is first in that whole process and why it's so important. But to reinforce, we are really bullish on that airplane. We think it's got the potential to have the best seat cost of any airplane in our fleet. But obviously, that assumes a level of pilot commonality that runs through all of the models. It's hard to say and forecast where that goes. But should that not be the case, it's something we would reassess and obviously, the Dash 9 is a great airplane for us. We have 20 of them so far, and we'll have good optionality with Boeing.

Your next caller is ATL. Can you just level-set us as to what is set for expiry this year from the holdover maybe during COVID from travel credits?

Yes, this is Emily. So we look at the ATL kind of historical trend in terms of breakage rate every quarter. So from an accounting perspective, we've been updating those over time. Generally, there has not been a massive change in terms of the breakage and experience that we've been having. Separately, though, kind of on the guest front, the #1 priority for the company is to make sure that we're meeting guests where they are and making sure that we're honoring the flight that they want to have with us. So I think over time, if we start to see guests come back and look to redeem some of those tickets, we'll be generous in the way that we handle those things.

Your next caller is Catie O'Brien of Goldman Sachs.

So I guess the first one for Nat. Just a bit of a follow-up on the Airbus discussion. I know you're working on a solution for the A321s. But is there a potential for someone to maybe look to buy you out of your A320 leases, given aircraft supply constraints? Mostly, you've been focused on wide-bodies, but we've heard more about aircraft constraints again this earnings season. Understanding even your capacity plans for this year, but if you did get bought out, like maybe that changes the cash costs over the life of the lease and potentially the recognition on your P&L over the rest of this year, realizing that's special out of CASM, that was kind of nested question. So I appreciate the help.

Catie, it's a great question. I'll tell you initially that the ratio of calls I get on the A321s to the A320s is about 10:1. So it tells you from a market perspective that folks are much more focused on those airplanes. Part of it is they're 2 to 4 years old, Airbus is delayed in delivering new ones. So folks are interested in trying to take 10 young airplanes and grow their fleets that way. On the A320s, the lease expires by the end of 2025. As we answered earlier, we're focused on that return plan and Emily's run our numbers to focus on that. But there are opportunities with lessors to buy out of those leases early, especially if the lessor has a prospect on the other side. It can be actually a win-win, certainly for us, and it helps us get the airplane out of our fleet more quickly and maybe not have to do all the return conditions for then the lessor to modify the airplane for the new operator. So there's some gains that are potentially there, and we're working those really hard.

Got it. And then one for Andrew. You called out some of the new partner flights into your West Coast hubs during your prepared remarks. But could you maybe just give us broad strokes on how much partner capacity is up into your hubs as we look through the rest of the year? And I guess just any high-level read-through from your partners on how demand and yields are looking on those routes? And then lastly, how could that translate into incremental revenue for Alaska?

I think the largest as it relates to partners is international. In our prepared remarks, you're starting to see that come back. Japan Airlines as one is certainly still significantly down. So the long-haul carriers are starting to come back. Qatar obviously is sort of up. As we get beyond this summer and going forward, I think more and more there. I think some of our other comments that we shared on Investor Day is really taking a key city from Alaska flying into another key city of American and connecting beyond that, that continues to work. The vast majority of our passengers travel across our own network. But as we get into Q2 and Q3, we're going to have much better visibility on that partner traffic as demand fully returns there. So we'll give you more color on that in the next couple of quarters.

Operator, I think we have time for one more question.

Your next caller is Dan McKenzie of Seaport Global.

I have a couple of questions. First, for you, Andrew, what forward data are you monitoring that gives you confidence in unit revenues through the end of the year? Additionally, can you discuss how fare searches on alaska.com are trending compared to 2019? Are these searches connected to the revenue management systems to help inform your perspective on revenue trends?

Yes. One of the positive aspects of COVID is that we're monitoring bookings and searches daily. I can tell you that even with increasing yields, conversion rates are holding steady. RM is not directly linked to the booking schedule on alaska.com specifically, but we stay very connected. As I mentioned before, we review daily what was sold in each month at what yield, and we are observing strong performance across all regions for at least the next 4 to 5 months, with high percentages consistently every week.

Well, very good. Going back to the ULCC. What percent of revenue does this impact this summer? So I guess the question is, is it material? And then if you can just help us balance that with what the growth rate in premium seats is this summer, say, versus 2019? And I guess I didn't catch this earlier, but just tied to the premium seats this summer versus '19, what's the rate of corporate recovery here in the first quarter? And what's the expectation on the corporate recovery this summer? And I apologize if you shared that earlier. I joined late on the call here.

No, I believe that regarding the ULCC, regardless of market conditions, the overlap in our markets hasn’t changed significantly. Much of it is concentrated on the East Coast and the Midwest. Nothing has really shifted in that area for ULCC. As for premium seats, we haven’t provided specific details for the second or third quarters, but as I mentioned earlier, first-class revenues increased by 19% in the first quarter. We will keep monitoring the yields, and I anticipate that as business travel continues to rise, there will be ongoing strength in the premium segment.

Thanks, everyone, for joining us, and we'll talk to you next quarter.

Thank you for participating in today's conference call. This call will be available for future playback at alaskaair.com.