ALK 10-Q2 2014


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 

T    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014
 
OR

£    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 For the transition period from                      to                      

Commission File Number 1-8957
ALASKA AIR GROUP, INC.
 
Delaware
 
91-1292054
(State of Incorporation)
 
(I.R.S. Employer Identification No.)

 
19300 International Boulevard, Seattle, Washington 98188
Telephone: (206) 392-5040

 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes T  No £ 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes T No £
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer   T
Accelerated filer  £ 
Non-accelerated filer   £
Smaller reporting company   £
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes £ No T
 
The registrant has 134,882,465 common shares, par value $0.01, outstanding at July 31, 2014.



ALASKA AIR GROUP, INC.
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2014

 TABLE OF CONTENTS

 

As used in this Form 10-Q, the terms “Air Group,” the "Company," “our,” “we” and "us," refer to Alaska Air Group, Inc. and its subsidiaries, unless the context indicates otherwise. Alaska Airlines, Inc. and Horizon Air Industries, Inc. are referred to as “Alaska” and “Horizon,” respectively, and together as our “airlines.”
 

2



CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
Cautionary Note Regarding Forward-Looking Statements
In addition to historical information, this Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. You can generally identify forward-looking statements as statements containing the words "believe," "expect," "will," "anticipate," "intend," "estimate," "project," "assume" or other similar expressions, although not all forward-looking statements contain these identifying words. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from historical experience or the Company’s present expectations. Some of the things that could cause our actual results to differ from our expectations are:

•
the competitive environment in our industry;
•
changes in our operating costs, primarily fuel, which can be volatile;
•
general economic conditions, including the impact of those conditions on customer travel behavior;
•
our ability to meet our cost reduction goals;
•
operational disruptions;
•
an aircraft accident or incident;
•
labor disputes and our ability to attract and retain qualified personnel;
•
the concentration of our revenue from a few key markets;
•
actual or threatened terrorist attacks, global instability and potential U.S. military actions or activities;
•
our reliance on automated systems and the risks associated with changes made to those systems;
•
changes in laws and regulations.

You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Our forward-looking statements are based on the information currently available to us and speak only as of the date on which this report was filed with the SEC. We expressly disclaim any obligation to issue any updates or revisions to our forward-looking statements, even if subsequent events cause our expectations to change regarding the matters discussed in those statements. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such differences might be significant and materially adverse to our shareholders. For a discussion of these and other risk factors, see Item 1A. "Risk Factors” of the Company’s annual report on Form 10-K for the year ended December 31, 2013. Please consider our forward-looking statements in light of those risks as you read this report.


3


PART I
 
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(in millions)
June 30,
2014
 
December 31,
2013
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
22

 
$
80

Marketable securities
1,488

 
1,250

Total cash and marketable securities
1,510

 
1,330

Receivables - net
203

 
152

Inventories and supplies - net
61

 
60

Deferred income taxes
112

 
113

Prepaid expenses and other current assets
134

 
107

Total Current Assets
2,020

 
1,762

 
 
 
 
Property and Equipment
 

 
 

Aircraft and other flight equipment
4,993

 
4,677

Other property and equipment
867

 
838

Deposits for future flight equipment
431

 
446

 
6,291

 
5,961

Less accumulated depreciation and amortization
2,189

 
2,068

Total Property and Equipment - Net
4,102

 
3,893

 
 
 
 
Other Assets
192

 
183

 
 
 
 
Total Assets
$
6,314

 
$
5,838


See accompanying notes to condensed consolidated financial statements.


4

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(in millions, except share amounts)
June 30,
2014
 
December 31,
2013
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
71

 
$
64

Accrued wages, vacation and payroll taxes
166

 
211

Other accrued liabilities
706

 
624

Air traffic liability
807

 
564

Current portion of long-term debt
114

 
117

Total Current Liabilities
1,864

 
1,580

 
 
 
 
Long-Term Debt, Net of Current Portion
745

 
754

Other Liabilities and Credits
 

 
 

Deferred income taxes
725

 
709

Deferred revenue
342

 
335

Obligation for pension and postretirement medical benefits
123

 
123

Other liabilities
315

 
308

 
1,505

 
1,475

Commitments and Contingencies


 


Shareholders' Equity
 

 
 

Preferred stock, $0.01 par value Authorized: 5,000,000 shares, none issued or outstanding
—

 
—

Common stock, $0.01 par value, Authorized: 200,000,000 shares, Issued: 2014 - 136,845,596 shares; 2013 - 137,533,382 shares, Outstanding: 2014 - 136,738,034; 2013 - 137,491,906
1

 
1

Capital in excess of par value
551

 
606

Treasury stock (common), at cost: 2014 - 107,562 shares; 2013 - 41,476 shares
(5
)
 
(2
)
Accumulated other comprehensive loss
(178
)
 
(183
)
Retained earnings
1,831

 
1,607

 
2,200

 
2,029

Total Liabilities and Shareholders' Equity
$
6,314

 
$
5,838


See accompanying notes to condensed consolidated financial statements.


5

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in millions, except per share amounts)
2014
 
2013
 
2014
 
2013
Operating Revenues
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
Mainline
$
974

 
$
896

 
$
1,828

 
$
1,692

Regional
200

 
192

 
386

 
374

Total passenger revenue
1,174

 
1,088

 
2,214

 
2,066

Freight and mail
32

 
30

 
56

 
56

Other - net
169

 
138

 
327

 
268

Total Operating Revenues
1,375

 
1,256

 
2,597

 
2,390

 
 
 
 
 
 
 
 
Operating Expenses
 
 
 
 
 

 
 

Wages and benefits
281

 
258

 
553

 
522

Variable incentive pay
29

 
21

 
54

 
42

Aircraft fuel, including hedging gains and losses
360

 
372

 
718

 
753

Aircraft maintenance
57

 
67

 
108

 
133

Aircraft rent
29

 
30

 
57

 
59

Landing fees and other rentals
64

 
75

 
133

 
136

Contracted services
62

 
54

 
122

 
107

Selling expenses
53

 
51

 
99

 
89

Depreciation and amortization
73

 
68

 
143

 
136

Food and beverage service
23

 
21

 
44

 
41

Other
81

 
65

 
161

 
133

Total Operating Expenses
1,112

 
1,082

 
2,192

 
2,151

Operating Income
263

 
174

 
405

 
239

 
 
 
 
 
 
 
 
Nonoperating Income (Expense)
 
 
 
 
 

 
 

Interest income
5

 
4

 
10

 
9

Interest expense
(12
)
 
(14
)
 
(25
)
 
(29
)
Interest capitalized
4

 
5

 
9

 
9

Other - net
5

 
—

 
18

 
1

 
2

 
(5
)
 
12

 
(10
)
Income before income tax
265

 
169

 
417

 
229

Income tax expense
100

 
65

 
158

 
88

Net Income
$
165

 
$
104

 
$
259

 
$
141

 
 
 
 
 
 
 
 
Basic Earnings Per Share:
$
1.20

 
$
0.75

 
$
1.88

 
$
1.00

Diluted Earnings Per Share:
$
1.19

 
$
0.74

 
$
1.86

 
$
0.99

 
 
 
 
 
 
 
 
Shares used for computation:
 
 
 
 
 
 
 

Basic
137.274

 
140.504

 
137.304

 
140.683

Diluted
138.711

 
142.319

 
138.776

 
142.594

 
 
 
 
 
 
 
 
Cash dividend declared per share:
$
0.125

 
—

 
$
0.250

 
—


See accompanying notes to condensed consolidated financial statements.

6

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS (unaudited)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in millions)
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Net Income
$
165

 
$
104

 
$
259

 
$
141

 
 
 
 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
 
 
 
Related to marketable securities:
 
 
 
 
 
 
 
Unrealized holding gains (losses) arising during the period
4

 
(11
)
 
7

 
(12
)
Reclassification of (gains) losses into Other-net nonoperating income (expense)
(1
)
 
(1
)
 
(1
)
 
(2
)
Income tax effect
(1
)
 
4

 
(2
)
 
5

Total
2

 
(8
)
 
4

 
(9
)
 
 
 
 
 
 
 
 
Related to employee benefit plans:
 
 
 
 
 
 
 
Reclassification of net pension expense into Wages and benefits
3

 
11

 
5

 
21

Income tax effect
(1
)
 
(3
)
 
(2
)
 
(7
)
Total
2

 
8

 
3

 
14

 
 
 
 
 
 
 
 
Related to interest rate derivative instruments:
 
 
 
 
 
 
 
Unrealized holding gains (losses) arising during the period
(2
)
 
7

 
(5
)
 
10

Reclassification of (gains) losses into Aircraft rent
1

 
2

 
3

 
3

Income tax effect
—

 
(4
)
 
—

 
(6
)
Total
(1
)
 
5

 
(2
)
 
7

 
 
 
 
 
 
 
 
Other comprehensive income
3

 
5

 
5

 
12

 
 
 
 
 
 
 
 
Comprehensive income
$
168

 
$
109

 
$
264

 
$
153


See accompanying notes to condensed consolidated financial statements.


7

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
 
Six Months Ended June 30,
(in millions)
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income
$
259

 
$
141

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
143

 
136

Stock-based compensation and other
21

 
17

Changes in certain assets and liabilities:
 
 
 
Changes in deferred income taxes
14

 
16

Increase in air traffic liability
243

 
190

Increase (decrease) in deferred revenue
7

 
12

Other - net
(52
)
 
80

Net cash provided by operating activities
635

 
592

 
 
 
 
Cash flows from investing activities:
 

 
 

Property and equipment additions:
 

 
 

Aircraft and aircraft purchase deposits
(255
)
 
(233
)
Other flight equipment
(60
)
 
(12
)
Other property and equipment
(35
)
 
(13
)
Total property and equipment additions
(350
)
 
(258
)
Purchases of marketable securities
(628
)
 
(720
)
Sales and maturities of marketable securities
398

 
465

Proceeds from disposition of assets and changes in restricted deposits
(2
)
 
1

Net cash used in investing activities
(582
)
 
(512
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Proceeds from issuance of debt
51

 
—

Long-term debt payments
(64
)
 
(109
)
Common stock repurchases
(83
)
 
(51
)
Dividends paid
(34
)
 
—

Other financing activities
19

 
15

Net cash used in financing activities
(111
)
 
(145
)
Net increase/(decrease) in cash and cash equivalents
(58
)
 
(65
)
Cash and cash equivalents at beginning of year
80

 
122

Cash and cash equivalents at end of the period
$
22

 
$
57

 
 
 
 
Supplemental disclosure:
 

 
 

Cash paid during the period for:
 
 
 
Interest (net of amount capitalized)
$
16

 
$
21

Income taxes
93

 
6

See accompanying notes to condensed consolidated financial statements.

8


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

NOTE 1. GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Basis of Presentation
 
The interim condensed consolidated financial statements include the accounts of Alaska Air Group, Inc. (Air Group or the Company) and its subsidiaries, Alaska Airlines, Inc. (Alaska) and Horizon Air Industries, Inc. (Horizon), through which the Company conducts substantially all of its operations. All intercompany balances and transactions have been eliminated. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information. Consistent with these requirements, this Form 10-Q does not include all the information required by GAAP for complete financial statements. As a result, this Form 10-Q should be read in conjunction with the Consolidated Financial Statements and accompanying Notes in the Form 10-K for the year ended December 31, 2013. In the opinion of management, all adjustments have been made that are necessary to present fairly the Company’s financial position as of June 30, 2014, as well as the results of operations for the three and six months ended June 30, 2014 and 2013. The adjustments made were of a normal recurring nature.

In preparing these statements, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities, as well as the reported amounts of revenues and expenses. Due to seasonal variations in the demand for air travel, the volatility of aircraft fuel prices, changes in global economic conditions, changes in the competitive environment, and other factors, operating results for the three and six months ended June 30, 2014, are not necessarily indicative of operating results for the entire year.

Certain reclassifications, such as changes in our equity structure, have been made to prior year financial statements to conform with classifications used in the current year.

Recently Issued Accounting Pronouncements

In May 2014, the FASB issued Accounting Standard Update 2014-09, "Revenue from Contracts with Customers" (ASU 2014-09), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on January 1, 2017. Early adoption is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

NOTE 2. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES

Components for cash, cash equivalents and marketable securities (in millions):
June 30, 2014
Cost Basis
 
Unrealized
Gains
 
Unrealized Losses
 
Fair Value
Cash
$
2

 
$
—

 
$
—

 
$
2

Cash equivalents
20

 
—

 
—

 
20

Cash and cash equivalents
22

 
—

 
—

 
22

U.S. government and agency securities
289

 
1

 
(1
)
 
289

Foreign government bonds
17

 
—

 
—

 
17

Asset-backed securities
186

 
—

 
—

 
186

Mortgage-backed securities
171

 
1

 
(1
)
 
171

Corporate notes and bonds
794

 
6

 
—

 
800

Municipal securities
25

 
—

 
—

 
25

Marketable securities
1,482

 
8

 
(2
)
 
1,488

Total
$
1,504

 
$
8

 
$
(2
)
 
$
1,510



9


December 31, 2013
Cost Basis
 
Unrealized
Gains
 
Unrealized Losses
 
Fair Value
Cash
$
9

 
$
—

 
$
—

 
$
9

Cash equivalents
71

 
—

 
—

 
71

Cash and cash equivalents
80

 
—

 
—

 
80

U.S. government and agency securities
295

 
1

 
(2
)
 
294

Foreign government bonds
11

 
—

 
—

 
11

Asset-backed securities
146

 
—

 
—

 
146

Mortgage-backed securities
144

 
1

 
(2
)
 
143

Corporate notes and bonds
628

 
4

 
(2
)
 
630

Municipal securities
26

 
—

 
—

 
26

Marketable securities
1,250

 
6

 
(6
)
 
1,250

Total
$
1,330

 
$
6

 
$
(6
)
 
$
1,330


Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence as of June 30, 2014.

Activity for marketable securities (in millions):  
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Proceeds from sales and maturities
$
171

 
$
226

 
$
398

 
$
465

Gross realized gains
1

 
1

 
2

 
3

Gross realized losses
—

 
—

 
(1
)
 
(1
)
 
Maturities for marketable securities (in millions):
June 30, 2014
Cost Basis
 
Fair Value
Due in one year or less
$
205

 
$
205

Due after one year through five years
1,270

 
1,276

Due after five years through 10 years
7

 
7

Total
$
1,482

 
$
1,488


NOTE 3. DERIVATIVE INSTRUMENTS

Fuel Hedge Contracts

The Company’s operations are inherently dependent upon the price and availability of aircraft fuel. To manage economic risks associated with fluctuations in aircraft fuel prices, the Company periodically enters into call options for crude oil and historically entered into swap agreements for jet fuel refining margins. Effective in July 2014, the Company no longer enters into refining margin swap agreements.

As of June 30, 2014, the Company had outstanding fuel hedge contracts covering 245 million gallons of crude oil that will be settled from July 2014 to March 2016. Refer to the contractual obligations and commitments section of Item 2 for further information.

Interest Rate Swap Agreements

The Company has interest rate swap agreements with a third party designed to hedge the volatility of the underlying variable interest rate in the Company's aircraft lease agreements for six Boeing 737-800 aircraft. The agreements stipulate that the Company pay a fixed interest rate over the term of the contract and receive a floating interest rate. All significant terms of the swap agreement match the terms of the lease agreements, including interest-rate index, rate reset dates, termination dates and

10


underlying notional values. The agreements expire from February 2020 through March 2021 to coincide with the lease termination dates.

Fair Values of Derivative Instruments

Fair values of derivative instruments on the consolidated balance sheet (in millions):
 
June 30,
2014
 
December 31,
2013
Derivative Instruments Not Designated as Hedges
 
 
 
Fuel hedge contracts
 
 
 
Fuel hedge contracts, current assets
$
15

 
$
12

Fuel hedge contracts, noncurrent assets
2

 
4

Fuel hedge contracts, current liabilities
(1
)
 
—

 
 
 
 
Derivative Instruments Designated as Hedges
 
 
 
Interest rate swaps
 
 
 
Other accrued liabilities
(6
)
 
(7
)
Other liabilities
(13
)
 
(10
)
Losses in accumulated other comprehensive loss (AOCL)
(19
)
 
(17
)

The net cash received (paid) for new positions and settlements was $1 million and $(9) million during the three months ended June 30, 2014 and 2013, respectively. The net cash received (paid) for new positions and settlements was $(6) million and $(9) million during the six months ended June 30, 2014 and 2013, respectively.

Pretax effect of derivative instruments on earnings (in millions):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Derivative Instruments Not Designated as Hedges
 
 
 
 
 
 
 
Fuel hedge contracts
 
 
 
 
 
 
 
Gains (losses) recognized in aircraft fuel expense
$
5

 
$
(25
)
 
$
(6
)
 
$
(49
)
 
 
 
 
 
 
 
 
Derivative Instruments Designated as Hedges
 
 
 
 
 
 
 
Interest rate swaps
 
 
 
 
 
 
 
Losses recognized in aircraft rent
(1
)
 
(2
)
 
(3
)
 
(3
)
Gains (losses) recognized in other comprehensive income (OCI)
(2
)
 
7

 
(5
)
 
10


The amounts shown as recognized in aircraft rent for cash flow hedges (interest rate swaps) represent the realized losses transferred out of AOCL to aircraft rent. The amounts shown as recognized in OCI are prior to the losses recognized in the income statement as aircraft rent during the period. The Company expects $6 million to be reclassified from OCI to aircraft rent within the next twelve months.

Credit Risk and Collateral

The Company is exposed to credit losses in the event of nonperformance by counterparties to these derivative instruments. To mitigate exposure, the Company periodically evaluates the counterparties' potential risk of nonperformance by monitoring the absolute exposure levels and credit ratings. The Company maintains security agreements with a number of its counterparties which may require the Company to post collateral if the fair value of the selected derivative instruments fall below specified mark-to-market thresholds. The posted collateral does not offset the fair value of the derivative instruments and is included in "Prepaid expenses and other current assets" on the consolidated balance sheet.


11


The Company posted collateral of $7 million and $7 million as of June 30, 2014 and December 31, 2013, respectively. The collateral was provided to one counterparty associated with the net liability position of the interest rate swap agreements, offset by the net asset position of the fuel hedge contracts under a master netting arrangement.

NOTE 4. FAIR VALUE MEASUREMENTS

Fair Value of Financial Instruments on a Recurring Basis

Fair values of financial instruments on the consolidated balance sheet (in millions):
June 30, 2014
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
289

 
$
—

 
$
289

Foreign government bonds
—

 
17

 
17

Asset-backed securities
—

 
186

 
186

Mortgage-backed securities
—

 
171

 
171

Corporate notes and bonds
—

 
800

 
800

Municipal securities
—

 
25

 
25

Derivative instruments
 
 
 
 
 
Fuel hedge call options
—

 
17

 
17

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Fuel hedge swaps
—

 
(1
)
 
(1
)
Interest rate swap agreements
—

 
(19
)
 
(19
)

December 31, 2013
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
294

 
$
—

 
$
294

Foreign government bonds
—

 
11

 
11

Asset-backed securities
—

 
146

 
146

Mortgage-backed securities
—

 
143

 
143

Corporate notes and bonds
—

 
630

 
630

Municipal securities
—

 
26

 
26

Derivative instruments
 
 
 
 
 
Fuel hedge call options
—

 
16

 
16

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Fuel hedge swaps
—

 
—

 
—

Interest rate swap agreements
—

 
(17
)
 
(17
)

The Company uses the market and income approach to determine the fair value of marketable securities. U.S. government securities are Level 1 as the fair value is based on quoted prices in active markets. Foreign government bonds, asset-backed securities, mortgage-backed securities, corporate notes and bonds, and municipal securities are Level 2 as the fair value is based on industry standard valuation models that are calculated based on observable inputs such as quoted interest rates, yield curves, credit ratings of the security and other observable market information.

The Company uses the market approach and the income approach to determine the fair value of derivative instruments. Fuel hedge contracts that are not traded on a public exchange are Level 2 as the fair value is primarily based on inputs which are readily available in active markets or can be derived from information available in active markets. The fair value for call

12


options is determined utilizing an option pricing model based on inputs that are readily available in active markets, or can be derived from information available in active markets. In addition, the fair value considers the exposure to credit losses in the event of nonperformance by counterparties. The fair value of jet fuel refining margins (fuel hedge contracts) is determined based on inputs readily available in public markets and provided by brokers who regularly trade these contracts. Interest rate swap agreements are Level 2 as the fair value of these contracts is determined based on the difference between the fixed interest rate in the agreements and the observable LIBOR-based forward interest rates at period end, multiplied by the total notional value.

The Company has no financial assets that are measured at fair value on a nonrecurring basis at June 30, 2014.

Fair Value of Other Financial Instruments

The Company used the following methods and assumptions to determine the fair value of financial instruments that are not recognized at fair value as described below.

Cash and Cash Equivalents: Carried at amortized cost, which approximates fair value.

Debt: The carrying amount of the Company's variable-rate debt approximates fair values. For fixed-rate debt, the Company uses the income approach to determine the estimated fair value, by using discounted cash flow using borrowing rates for comparable debt over the weighted life of the outstanding debt. The estimated fair value of the fixed-rate debt is Level 3 as certain inputs used are unobservable.

Fixed-rate debt that is not carried at fair value on the consolidated balance sheet and the estimated fair value of long-term fixed-rate debt (in millions):
 
June 30,
2014
 
December 31,
2013
Carrying amount
$
659

 
$
703

Fair value
713

 
762


NOTE 5. MILEAGE PLAN

Alaska's Mileage Plan liabilities and deferrals on the consolidated balance sheets (in millions):
 
June 30,
2014
 
December 31,
2013
Current Liabilities:
 
 
 
Other accrued liabilities
$
340

 
$
314

Other Liabilities and Credits:
 
 
 
Deferred revenue
333

 
323

Other liabilities
20

 
19

Total
$
693

 
$
656

 
Alaska's Mileage Plan revenue included in the consolidated statements of operations (in millions):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Passenger revenues
$
62

 
$
50

 
$
118

 
$
96

Other - net revenues
73

 
56

 
146

 
110

Total
$
135

 
$
106

 
$
264

 
$
206



13


NOTE 6. LONG-TERM DEBT
 
Long-term debt obligations on the consolidated balance sheet (in millions):
 
June 30,
2014
 
December 31,
2013
Fixed-rate notes payable due through 2024
$
660

 
$
703

Variable-rate notes payable due through 2025
199

 
168

Long-term debt
859

 
871

Less current portion
114

 
117

Total
$
745

 
$
754

 
 
 
 
Weighted-average fixed-interest rate
5.7
%
 
5.7
%
Weighted-average variable-interest rate
1.6
%
 
1.7
%

During the six months ended June 30, 2014, the Company made debt payments of $64 million. In addition, the company financed $51 million for the three Q400's that were delivered in Q4 2013.

At June 30, 2014, long-term debt principal payments for the next five years and thereafter are as follows (in millions):
 
Total
Remainder of 2014
$
56

2015
117

2016
115

2017
121

2018
151

Thereafter
299

Total
$
859

 
Bank Lines of Credit
 
The Company has two $100 million credit facilities. Both facilities have variable interest rates based on LIBOR plus a specified margin. One of the $100 million facilities, which expires in August 2015, is secured by aircraft. The other $100 million facility, which expires in March 2017, is secured by certain accounts receivable, spare engines, spare parts and ground service equipment. The Company has no immediate plans to borrow using either of these facilities. These facilities have a requirement to maintain a minimum unrestricted cash and marketable securities balance of $500 million. The Company is in compliance with this covenant at June 30, 2014.

NOTE 7. EMPLOYEE BENEFIT PLANS

Net periodic benefit costs recognized included the following components for the three months ended June 30, 2014 (in millions): 
 
Three Months Ended June 30,
 
Qualified
 
Nonqualified
 
Postretirement Medical
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Service cost
$
8

 
$
12

 
$
—

 
$
1

 
$
—

 
$
1

Interest cost
20

 
18

 
1

 
—

 
1

 
1

Expected return on assets
(29
)
 
(28
)
 
—

 
—

 
—

 
—

Amortization of prior service cost
(1
)
 
—

 
—

 
—

 
—

 
—

Recognized actuarial loss (gain)
4

 
11

 
—

 
—

 
—

 
—

Total
$
2

 
$
13

 
$
1

 
$
1

 
$
1

 
$
2



14


Net periodic benefit costs recognized included the following components for the six months ended June 30, 2014 (in millions): 
 
Six Months Ended June 30,
 
Qualified
 
Nonqualified
 
Postretirement Medical
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Service cost
16

 
23

 
—

 
1

 
1

 
2

Interest cost
40

 
36

 
1

 
1

 
2

 
2

Expected return on assets
(58
)
 
(55
)
 
—

 
—

 
—

 
—

Amortization of prior service cost
(1
)
 
—

 
—

 
—

 
—

 
—

Recognized actuarial loss
7

 
21

 
—

 
—

 
(1
)
 
—

Total
4

 
25

 
1

 
2

 
2

 
4


NOTE 8. COMMITMENTS

Future minimum fixed payments for commitments (in millions):
June 30, 2014
Aircraft Leases
 
Facility Leases
 
Aircraft Commitments
 
Capacity Purchase Agreements
 
Engine Maintenance
Remainder of 2014
$
26

 
$
47

 
$
149

 
$
25

 
$
5

2015
103

 
89

 
423

 
44

 
10

2016
82

 
86

 
359

 
32

 
—

2017
52

 
83

 
382

 
32

 
—

2018
36

 
36

 
430

 
14

 
—

Thereafter
43

 
211

 
1,037

 
—

 
—

Total
$
342

 
$
552

 
$
2,780

 
$
147

 
$
15


Lease Commitments

At June 30, 2014, the Company had lease contracts for 59 aircraft, which have remaining noncancelable lease terms ranging from 2014 to 2021. Of these aircraft, 16 are non-operating (i.e. not in the Company's fleet) and 14 are subleased to third-party carriers. The majority of airport and terminal facilities are also leased. Rent expense for aircraft and facility leases was $66 million and $83 million for the three months ended June 30, 2014 and 2013, respectively, and $141 million and $153 million for the six months ended June 30, 2014 and 2013, respectively.

Aircraft Commitments
 
As of June 30, 2014, the Company is committed to purchasing 66 B737 aircraft (29 737-900ER aircraft and 37 737 MAX aircraft), with deliveries in 2014 through 2022. In addition, the Company has options to purchase 58 additional B737 aircraft and seven Q400 aircraft.

Capacity Purchase Agreements (CPAs)
 
At June 30, 2014, Alaska had CPAs with three carriers, including the Company's wholly-owned subsidiary, Horizon. Horizon sells 100% of its capacity to Alaska under a CPA, which is eliminated upon consolidation. In addition, Alaska has CPAs with SkyWest Airlines, Inc. (SkyWest) to fly certain routes and Peninsula Airways, Inc. (PenAir) to fly one route in the state of Alaska. Under these agreements, Alaska pays the third-party carriers an amount which is based on a determination of their cost of operating those flights and other factors. The costs paid by Alaska to Horizon are based on similar data and are intended to approximate market rates for those services. Future payments (excluding those due to Horizon) are based on contractually required minimum levels of flying by the third-party carriers, which could differ materially due to variable payments based on actual levels of flying and certain costs associated with operating flights, such as fuel.


15


Engine Maintenance
 
The Company has a power-by-the-hour (PBH) maintenance agreement for some of the engines equipped on 737-700 and 737-900 aircraft. This agreement transfers risk to a third-party service provider and fixes the amount the Company pays per flight hour in exchange for maintenance and repairs under a predefined maintenance program. Future payments are based on minimum flight hours.

NOTE 9. SHAREHOLDERS' EQUITY

Common Stock Changes

During the second quarter of 2014, shareholders voted to increase the number of authorized shares from 100 million to 200 million shares, reduce the par value of common stock from $1 per share to $0.01 per share, and the Board of Directors declared a two-for-one stock split by means of a stock distribution. The additional shares were distributed on July 9, 2014, to the shareholders of record on June 23, 2014. The stock split increased the Company's outstanding shares from approximately 68.4 million shares to 136.7 million shares as of June 30, 2014. All historical share and per share information has been recast to reflect the changes in the Company's equity structure.

Dividends

During the three months ended June 30, 2014, the Company declared and paid a cash dividend of $0.125 per share, or $17 million. During the six months ended June 30, 2014, the Company declared and paid cash dividends of $0.250 per share, or $34 million.

Common Stock Repurchase

In September 2012, the Board of Directors authorized a $250 million share repurchase program, which was completed in July 2014. In May 2014, the Board of Directors authorized a $650 million share repurchase program, which began immediately after the $250 million program was completed.
Share repurchase activity (in millions, except share amounts):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
2012 Repurchase Program - $250 million
1,108,334

 
$
53

 
1,089,194

 
$
32

 
1,814,036

 
$
83

 
1,835,564

 
$
51

 
Accumulated Other Comprehensive Loss
 
Components of accumulated other comprehensive income (loss), net of tax (in millions):
 
June 30,
2014
 
December 31,
2013
Marketable securities
$
4

 
$
—

Employee benefit plans
(170
)
 
(173
)
Interest rate derivatives
(12
)
 
(10
)
Total
$
(178
)
 
$
(183
)

Earnings Per Share (EPS)

Diluted EPS is calculated by dividing net income by the average number of common shares outstanding plus the number of additional common shares that would have been outstanding assuming the exercise of in-the-money stock options and restricted stock units, using the treasury-stock method. For the three and six months ended June 30, 2014 and 2013, anti-dilutive shares excluded from the calculation of EPS were not material.


16


NOTE 10. OPERATING SEGMENT INFORMATION
 
Air Group has two operating airlines - Alaska Airlines and Horizon Air. Each is a regulated airline with separate management teams primarily in operational roles. Horizon sells 100% of its capacity to Alaska under a CPA, which is eliminated upon consolidation. In addition, Alaska has CPAs with SkyWest to fly certain routes and PenAir to fly one route in the state of Alaska. The Company attributes revenue between Mainline and Regional based on the coupon fare in effect on the date of issuance relative to the origin and destination of each flight segment. To manage the two operating airlines and the revenues and expenses associated with the CPAs, management views the business in three operating segments.
Alaska Mainline - Flying Boeing 737 jets and all associated revenues and costs.
Alaska Regional - Alaska's CPAs with Horizon, SkyWest and PenAir. In this segment, Alaska Regional records actual on-board passenger revenue, less costs such as fuel, distribution costs, and payments made to Horizon, SkyWest and PenAir under the respective CPAs. Additionally, Alaska Regional includes an allocation of corporate overhead such as IT, finance, and other administrative costs incurred by Alaska on behalf of Horizon.
Horizon - Horizon operates turboprop Q400 aircraft. All of Horizon's capacity is sold to Alaska under a CPA.  Expenses include those typically borne by regional airlines such as crew costs, ownership costs, and maintenance costs. The results of Horizon's operations are eliminated upon consolidation.
Additionally, the following table reports “Air Group adjusted,” which is not a measure determined in accordance with GAAP. The Company's chief operating decision-makers and others in management use this measure to evaluate operational performance and determine resource allocations. Adjustments are further explained below in reconciling to consolidated GAAP results. Operating segment information is as follows (in millions):
 
Three Months Ended June 30, 2014
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Consolidating
 
Air Group Adjusted(a)
 
Special Items(b)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
974

 
$
—

 
$
—

 
$
—

 
$
974

 
$
—

 
$
974

Regional
—

 
200

 
—

 
—

 
200

 
—

 
200

Total passenger revenues
974

 
200

 
—

 
—

 
1,174

 
—

 
1,174

CPA revenues
—

 
—

 
87

 
(87
)
 
—

 
—

 
—

Freight and mail
31

 
1

 
—

 
—

 
32

 
—

 
32

Other - net
147

 
20

 
2

 
—

 
169

 
—

 
169

Total operating revenues
1,152

 
221

 
89

 
(87
)
 
1,375

 
—

 
1,375

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
602

 
151

 
86

 
(87
)
 
752

 
—

 
752

Economic fuel
324

 
49

 
—

 
—

 
373

 
(13
)
 
360

Total operating expenses
926

 
200

 
86

 
(87
)
 
1,125

 
(13
)
 
1,112

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
5

 
—

 
—

 
—

 
5

 
—

 
5

Interest expense
(9
)
 
(1
)
 
(2
)
 
—

 
(12
)
 
—

 
(12
)
Other
9

 
1

 
(1
)
 
—

 
9

 
—

 
9

 
5

 
—

 
(3
)
 
—

 
2

 
—

 
2

Income (loss) before income tax
$
231

 
$
21

 
$
—

 
$
—

 
$
252

 
$
13

 
$
265


17


 
Three Months Ended June 30, 2013
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Consolidating
 
Air Group Adjusted(a)
 
Special Items(b)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
896

 
$
—

 
$
—

 
$
—

 
$
896

 
$
—

 
$
896

Regional
—

 
192

 
—

 
—

 
192

 
—

 
192

Total passenger revenues
896

 
192

 
—

 
—

 
1,088

 
—

 
1,088

CPA revenues
—

 
—

 
91

 
(91
)
 
—

 
—

 
—

Freight and mail
29

 
1

 
—

 
—

 
30

 
—

 
30

Other - net
120

 
16

 
2

 
—

 
138

 
—

 
138

Total operating revenues
1,045

 
209

 
93

 
(91
)
 
1,256

 
—

 
1,256

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
569

 
149

 
84

 
(92
)
 
710

 
—

 
710

Economic fuel
327

 
44

 
—

 
—

 
371

 
1

 
372

Total operating expenses
896

 
193

 
84

 
(92
)
 
1,081

 
1

 
1,082

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
4

 
—

 
—

 
—

 
4

 
—

 
4

Interest expense
(9
)
 
—

 
(4
)
 
(1
)
 
(14
)
 
—

 
(14
)
Other
6

 
(1
)
 
1

 
(1
)
 
5

 
—

 
5

 
1

 
(1
)
 
(3
)
 
(2
)
 
(5
)
 
—

 
(5
)
Income (loss) before income tax
$
150

 
$
15

 
$
6

 
$
(1
)
 
$
170

 
$
(1
)
 
$
169


 
Six Months Ended June 30, 2014
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Consolidating
 
Air Group Adjusted(a)
 
Special Items(b)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
1,828

 
$
—

 
$
—

 
$
—

 
$
1,828

 
$
—

 
$
1,828

Regional
—

 
386

 
—

 
—

 
386

 
—

 
386

Total passenger revenues
1,828

 
386

 
—

 
—

 
2,214

 
—

 
2,214

CPA revenues
—

 
—

 
178

 
(178
)
 
—

 
—

 
—

Freight and mail
54

 
2

 
—

 
—

 
56

 
—

 
56

Other - net
287

 
37

 
3

 
—

 
327

 
—

 
327

Total operating revenues
2,169

 
425

 
181

 
(178
)
 
2,597

 
—

 
2,597

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
1,178

 
302

 
172

 
(178
)
 
1,474

 
—

 
1,474

Economic fuel
642

 
97

 
—

 
—

 
739

 
(21
)
 
718

Total operating expenses
1,820

 
399

 
172

 
(178
)
 
2,213

 
(21
)
 
2,192