Document


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

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

For the quarterly period ended June 30, 2017
 
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 x  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 x No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer   x
Accelerated filer  ¨
Non-accelerated filer   ¨ 
(Do not check if a smaller reporting company)
Smaller reporting company   ¨
Emerging growth company   ¨

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
 
The registrant has 123,525,463 common shares, par value $0.01, outstanding at July 31, 2017.



ALASKA AIR GROUP, INC.
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2017

 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., Virgin America Inc. and Horizon Air Industries, Inc. are referred to as “Alaska,” "Virgin America" and “Horizon” 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;
•
our ability to successfully integrate the operations of Virgin America into those of Alaska;
•
our ability to achieve anticipated synergies and timing thereof in connection with the acquisition of Virgin America.

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, 2016, and Item 1A. "Risk Factors" included herein. 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
 
ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(in millions)
June 30, 2017
 
December 31, 2016
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
198

 
$
328

Marketable securities
1,724

 
1,252

Total cash and marketable securities
1,922

 
1,580

Receivables—net
326

 
302

Inventories and supplies—net
52

 
47

Prepaid expenses and other current assets
125

 
121

Total Current Assets
2,425

 
2,050

 
 
 
 
Property and Equipment
 

 
 

Aircraft and other flight equipment
7,377

 
6,947

Other property and equipment
1,158

 
1,103

Deposits for future flight equipment
526

 
545

 
9,061

 
8,595

Less accumulated depreciation and amortization
3,059

 
2,929

Total Property and Equipment—Net
6,002

 
5,666

 
 
 
 
Goodwill
1,940

 
1,934

Intangible assets
137

 
143

Other noncurrent assets
216

 
169

Other Assets
2,293

 
2,246

 
 
 
 
Total Assets
$
10,720

 
$
9,962


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, 2017
 
December 31, 2016
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
95

 
$
92

Accrued wages, vacation and payroll taxes
308

 
397

Air traffic liability
1,255

 
849

Other accrued liabilities
979

 
878

Current portion of long-term debt
337

 
319

Total Current Liabilities
2,974

 
2,535

 
 
 
 
Long-Term Debt, Net of Current Portion
2,469

 
2,645

Other Liabilities and Credits
 

 
 

Deferred income taxes
598

 
463

Deferred revenue
652

 
640

Obligation for pension and postretirement medical benefits
336

 
331

Other liabilities
427

 
417

 
2,013

 
1,851

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: 400,000,000 shares, Issued: 2017 - 129,638,780 shares; 2016 - 129,189,634 shares, Outstanding: 2017 - 123,520,517 shares; 2016 - 123,328,051 shares
1

 
1

Capital in excess of par value
135

 
110

Treasury stock (common), at cost: 2017 - 6,118,263 shares; 2016 - 5,861,583 shares
(466
)
 
(443
)
Accumulated other comprehensive loss
(294
)
 
(305
)
Retained earnings
3,888

 
3,568

 
3,264

 
2,931

Total Liabilities and Shareholders' Equity
$
10,720

 
$
9,962


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)
2017
 
2016
 
2017
 
2016
Operating Revenues
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
Mainline
$
1,556

 
$
1,036

 
$
2,828

 
$
1,963

Regional
251

 
227

 
463

 
433

Total passenger revenue
1,807

 
1,263

 
3,291

 
2,396

Freight and mail
32

 
27

 
56

 
51

Other—net
263

 
204

 
504

 
394

Total Operating Revenues
2,102

 
1,494

 
3,851

 
2,841

 
 
 
 
 
 
 
 
Operating Expenses
 
 
 
 
 

 
 

Wages and benefits
469

 
332

 
917

 
668

Variable incentive pay
27

 
32

 
58

 
64

Aircraft fuel, including hedging gains and losses
344

 
201

 
683

 
368

Aircraft maintenance
96

 
65

 
183

 
133

Aircraft rent
69

 
26

 
134

 
55

Landing fees and other rentals
99

 
63

 
214

 
143

Contracted services
77

 
60

 
158

 
120

Selling expenses
97

 
55

 
178

 
104

Depreciation and amortization
90

 
92

 
180

 
180

Food and beverage service
50

 
31

 
95

 
62

Third-party regional carrier expense
27

 
24

 
54

 
47

Special items—merger-related costs
24

 
14

 
64

 
14

Other
140

 
81

 
274

 
175

Total Operating Expenses
1,609

 
1,076

 
3,192

 
2,133

Operating Income
493

 
418

 
659

 
708

 
 
 
 
 
 
 
 
Nonoperating Income (Expense)
 
 
 
 
 

 
 

Interest income
9

 
7

 
16

 
13

Interest expense
(26
)
 
(9
)
 
(51
)
 
(22
)
Interest capitalized
4

 
7

 
8

 
15

Other—net
(1
)
 
(3
)
 
(1
)
 
(2
)
 
(14
)
 
2

 
(28
)
 
4

Income before income tax
479

 
420

 
631

 
712

Income tax expense
183

 
160

 
236

 
268

Net Income
$
296

 
$
260

 
$
395

 
$
444

 
 
 
 
 
 
 
 
Basic Earnings Per Share:
$
2.40

 
$
2.11

 
$
3.19

 
$
3.58

Diluted Earnings Per Share:
$
2.38

 
$
2.10

 
$
3.17

 
$
3.56

Shares used for computation:
 
 
 
 
 
 
 

Basic
123.573

 
123.250

 
123.534

 
123.900

Diluted
124.332

 
123.988

 
124.374

 
124.715

 
 
 
 
 
 
 
 
Cash dividend declared per share:
$
0.30

 
$
0.275

 
$
0.60

 
$
0.55

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)
2017
 
2016
 
2017
 
2016
Net Income
$
296

 
$
260

 
$
395

 
$
444

 
 
 
 
 
 
 
 
Other Comprehensive Income (Loss):
 
 
 
 
 
 
 
Related to marketable securities:
 
 
 
 
 
 
 
Unrealized holding gains arising during the period
1

 
7

 
4

 
19

Reclassification of (gains) losses into Other—net nonoperating income (expense)
1

 
(1
)
 
1

 
(1
)
Income tax effect
(1
)
 
(2
)
 
(2
)
 
(6
)
Total
1

 
4

 
3

 
12

 
 
 
 
 
 
 
 
Related to employee benefit plans:
 
 
 
 
 
 
 
Reclassification of net pension expense into Wages and benefits
5

 
5

 
11

 
10

Income tax effect
(1
)
 
(2
)
 
(3
)
 
(4
)
Total
4

 
3

 
8

 
6

 
 
 
 
 
 
 
 
Related to interest rate derivative instruments:
 
 
 
 
 
 
 
Unrealized holding losses arising during the period
(3
)
 
(2
)
 
(2
)
 
(7
)
Reclassification of losses into Aircraft rent
2

 
2

 
2

 
3

Income tax effect
1

 
—

 
—

 
2

Total
—

 
—

 
—

 
(2
)
 
 
 
 
 
 
 
 
Other Comprehensive Income
5

 
7

 
11

 
16

 
 
 
 
 
 
 
 
Comprehensive Income
$
301

 
$
267

 
$
406

 
$
460


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)
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
395

 
$
444

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

 
 

Depreciation and amortization
180

 
180

Stock-based compensation and other
25

 
13

Changes in certain assets and liabilities:
 
 
 
Changes in deferred tax provision
132

 
41

Increase in air traffic liability
406

 
201

Increase in deferred revenue
15

 
48

Other—net
(69
)
 
(28
)
Net cash provided by operating activities
1,084

 
899

 
 
 
 
Cash flows from investing activities:
 

 
 

Property and equipment additions:
 

 
 

Aircraft and aircraft purchase deposits
(404
)
 
(268
)
Other flight equipment
(45
)
 
(31
)
Other property and equipment
(63
)
 
(41
)
Total property and equipment additions, including capitalized interest
(512
)
 
(340
)
Purchases of marketable securities
(1,010
)
 
(610
)
Sales and maturities of marketable securities
541

 
357

Other investing activities
10

 
3

Net cash used in investing activities
(971
)
 
(590
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Long-term debt payments
(159
)
 
(57
)
Common stock repurchases
(22
)
 
(193
)
Dividends paid
(74
)
 
(68
)
Other financing activities
12

 
17

Net cash used in financing activities
(243
)
 
(301
)
Net increase (decrease) in cash and cash equivalents
(130
)
 
8

Cash and cash equivalents at beginning of year
328

 
73

Cash and cash equivalents at end of the period
$
198

 
$
81

 
 
 
 
Supplemental disclosure:
 

 
 

Cash paid during the period for:
 
 
 
Interest (net of amount capitalized)
$
42

 
$
8

Income taxes
14

 
182


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 condensed consolidated financial statements include the accounts of Air Group, and its primary subsidiaries, Alaska, Horizon and, starting December 14, 2016, Virgin America. The Company conducts substantially all of its operations through these subsidiaries. All significant 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. It should be read in conjunction with the consolidated financial statements and accompanying notes in the Form 10-K for the year ended December 31, 2016. In the opinion of management, all adjustments have been made that are necessary to fairly present the Company’s financial position as of June 30, 2017 and the results of operations for the three and six months ended June 30, 2017 and 2016. Such adjustments 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, 2017 are not necessarily indicative of operating results for the entire year.

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, "Revenue from Contracts with Customers"(Topic 606), 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. This comprehensive new standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. In March 2016, the FASB issued ASU 2016-08, "Revenue from Contracts with Customers (Topic 606), Principal versus Agent Considerations" to clarify the guidance on determining whether the Company is considered the principal or the agent in a revenue transaction where a third party is providing goods or services to a customer. Entities are permitted to use either a full retrospective or cumulative effect transition method, and are required to adopt all parts of the new revenue standard using the same transition method. The new standard is effective for the Company on January 1, 2018.

At this time, the Company believes the most significant impact to the financial statements will be to Mileage Plan™ revenues and liabilities. The Company currently uses the incremental cost approach for miles earned through travel. As this approach will be eliminated with the standard, the Company will be required to allocate a portion of the ticket price through a relative selling price model and defer revenue recognition until the ticket is flown or unused mileage credits expire. The Company estimates an increase to the liability for earned miles of approximately $350 million to $450 million at the time of adoption. The allocated value to miles earned through travel will offset passenger revenue during the period they are issued, rather than recorded using the incremental cost approach.

The adoption of the new standard is also expected to result in a change in income statement classification of the majority of ancillary revenues from Other revenue to Passenger revenue. This will affect common industry metrics, such as PRASM and RASM. Certain commission revenue from interline arrangements that was previously offset against related expense will now be classified as Other revenue, which will impact RASM and CASM. Unused ticket revenue that was previously recorded at the time of expiration will now be recorded at the original departure date if that ticket has not been changed or refunded prior to that date, based on estimates of expected expiration. This concept is referred to as ticket breakage. The Company estimates the change in ticket breakage methodology will not have a significant impact on the statements of operations, but will decrease air traffic liability by approximately $80 million to $90 million.

The Company continues to evaluate and model the full impact of the standard and will apply the full retrospective transition method. The overall impact to equity as of the beginning of the retroactive reporting period, including the changes discussed above as well as other less material changes, is expected to be between $170 million and $250 million.

9



In February 2016, the FASB issued ASU 2016-02, "Leases" (Topic 842), which requires lessees to recognize assets and liabilities for leases currently classified as operating leases. Under the new standard, a lessee will recognize a liability on the balance sheet representing the lease payments owed, and a right-of-use-asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election not to recognize lease assets and lease liabilities. At this time, the Company believes the most significant impact to the financial statements will relate to the recording of a right-of-use asset associated with leased aircraft. Other leases, including airports and real estate, equipment, software and other miscellaneous leases continue to be assessed for impact of the ASU. The new standard is effective for the Company on January 1, 2019. Early adoption of the standard is permitted. The Company has determined that it will not early adopt the standard.

In March 2016, the FASB issued ASU 2016-09, "Compensation—Stock Compensation" (Topic 718), which simplifies several aspects of accounting for employee share-based payment awards, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. The ASU was adopted prospectively as of January 1, 2017. Prior periods have not been adjusted. The adoption of the standard did not have a material impact on the Company's statements of operations or financial position.

In January 2017, the FASB issued ASU 2017-04, "Intangibles—Goodwill and Other" (Topic 350), which eliminates step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. The ASU is effective for the Company beginning January 1, 2019. Early adoption of the standard is permitted. Beginning in fiscal 2017, the Company will be required to perform an impairment test for goodwill arising from its acquisition of Virgin America and has adopted the standard effective January 1, 2017.

In March 2017, the FASB issued ASU 2017-07, "Compensation—Retirement Benefits" (Topic 715), which will require the Company to separate service cost component from other components of net periodic benefit cost and report it in Wages and benefits in the statements of operations. The other components of net periodic benefit cost will be required to be presented in Nonoperating income (expense) in the statements of operations. These components will not be eligible for capitalization in assets.  The Company will be required to disclose the line(s) used to present these other components if not presented separately in the income statement. The ASU is effective for the Company beginning January 1, 2018. The Company is currently evaluating the impact.

NOTE 2. ACQUISITION OF VIRGIN AMERICA

Virgin America

On December 14, 2016, the Company acquired 100% of the outstanding common shares and voting interest of Virgin America for $57 per share, or total cash consideration of $2.6 billion. Virgin America offers scheduled air transportation throughout the United States and Mexico primarily from its hub cities of Los Angeles, San Francisco and, to a lesser extent, Dallas Love Field, to other major business and leisure destinations in North America. The Company believes the acquisition of Virgin America will provide broader national reach and position it to better serve people living on the West Coast. The combined airline has approximately 1,200 daily departures and leverages Alaska's strength in the Pacific Northwest with Virgin America's strength in California. The Company believes that combining loyalty programs and networks will provide greater benefits for its guests and expand its international partner portfolio, giving guests an even more expansive global reach.

Merger-related costs

The Company incurred pretax merger-related costs of $24 million and $14 million for the three months ended June 30, 2017 and 2016 and of $64 million and $14 million for the six months ended June 30, 2017 and 2016. Costs classified as merger-related are directly attributable to merger activities and are recorded as "Special items—merger-related costs" within the statements of operations. The Company expects to continue to incur merger-related costs in the future as the integration continues.

Fair values of the assets acquired and the liabilities assumed

The transaction has been accounted for as a business combination using the acquisition method of accounting, which requires, among other things, assets acquired and liabilities assumed to be recognized on the balance sheet at their fair values as of the acquisition date. As of June 30, 2017 the fair values of property and equipment and certain liabilities, included in Other accrued liabilities and Other liabilities, goodwill, intangible assets and deferred income taxes have been prepared on a preliminary basis and are subject to further adjustments as the Company completes its analysis. There were no significant fair value adjustments

10


made during the three and six months ended June 30, 2017. The Company will finalize the amounts recognized by December 14, 2017.

Fair values of the assets acquired and the liabilities assumed as of the acquisition date of December 14, 2016, at June 30, 2017 and December 31, 2016 were as follows (in millions):
 
June 30, 2017
 
December 31, 2016
Cash and cash equivalents
$
645

 
$
645

Receivables
44

 
44

Prepaid expenses and other current assets
16

 
16

Property and equipment—provisional
561

 
560

Intangible assets—provisional
141

 
143

Goodwill—provisional
1,940

 
1,934

Other assets
84

 
84

Total assets
3,431

 
3,426

 

 
 
Accounts payable
22

 
22

Accrued wages, vacation and payroll taxes
50

 
51

Air traffic liabilities
172

 
172

Other accrued liabilities—provisional
195

 
196

Current portion of long-term debt
125

 
125

Long-term debt, net of current portion
360

 
360

Deferred income taxes—provisional
(307
)
 
(304
)
Deferred revenue
126

 
126

Other liabilities—provisional
92

 
82

Total liabilities
835

 
830

 

 
 
Total purchase price
$
2,596

 
$
2,596


NOTE 3. FAIR VALUE MEASUREMENTS

In determining fair value, there is a three-level hierarchy based on the reliability of the inputs used. Level 1 refers to fair values based on quoted prices in active markets for identical assets or liabilities. Level 2 refers to fair values estimated using significant other observable inputs and Level 3 refers to fair values estimated using significant unobservable inputs.

11



Fair Value of Financial Instruments on a Recurring Basis

As of June 30, 2017, total cost basis for all marketable securities was $1.7 billion. There were no significant differences between the cost basis and fair value of any individual class of marketable securities.

Fair values of financial instruments on the consolidated balance sheet (in millions):
June 30, 2017
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
448

 
$
—

 
$
448

Foreign government bonds
—

 
39

 
39

Asset-backed securities
—

 
222

 
222

Mortgage-backed securities
—

 
113

 
113

Corporate notes and bonds
—

 
889

 
889

Municipal securities
—

 
13

 
13

Total Marketable securities
448

 
1,276

 
1,724

Derivative instruments
 
 
 
 
 
Fuel hedge call options
—

 
8

 
8

Interest rate swap agreements
—

 
8

 
8

Total Assets
448

 
1,292

 
1,740

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Interest rate swap agreements
—

 
(12
)
 
(12
)
Total Liabilities
—

 
(12
)
 
(12
)
December 31, 2016
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
287

 
$
—

 
$
287

Foreign government bonds
—

 
36

 
36

Asset-backed securities
—

 
138

 
138

Mortgage-backed securities
—

 
89

 
89

Corporate notes and bonds
—

 
691

 
691

Municipal securities
—

 
11

 
11

Total Marketable securities
287

 
965

 
1,252

Derivative instruments
 
 
 
 
 
Fuel hedge call options
—

 
20

 
20

Total Assets
287

 
985

 
1,272

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Interest rate swap agreements
—

 
(5
)
 
(5
)
Total Liabilities
—

 
(5
)
 
(5
)

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 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.


12


The Company uses the market approach and the income approach to determine the fair value of derivative instruments. The fair value for fuel hedge call 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 non-performance by counterparties. 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 interest forward rates at period end multiplied by the total notional value.

Activity and Maturities for Marketable Securities

Activity for marketable securities (in millions):  
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Proceeds from sales and maturities
$
256

 
$
217

 
$
541

 
$
357

Gross realized gains
—

 
2

 
1

 
2

Gross realized losses
(1
)
 
(1
)
 
(2
)
 
(1
)

Unrealized gains and losses (in millions):
 
June 30, 2017
 
December 31, 2016
Unrealized gains
4

 
2

Unrealized losses
(5
)
 
(7
)

Maturities for marketable securities (in millions):
June 30, 2017
Cost Basis
 
Fair Value
Due in one year or less
$
253

 
$
252

Due after one year through five years
1,453

 
1,453

Due after five years through 10 years
19

 
19

Due after 10 years
—

 
—

Total
$
1,725

 
$
1,724


Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on its evaluation of available information as of June 30, 2017.

Fair Value of Other Financial Instruments

The Company uses 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 value. For fixed-rate debt, the Company uses the income approach to determine the estimated fair value, calculated as the sum of future cash flows discounted at 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 is as follows (in millions):
 
June 30, 2017
 
December 31, 2016
Carrying amount
$
1,090

 
$
1,179

Fair value
1,105

 
1,199


Assets and Liabilities Measured at Fair Value on Nonrecurring Basis

13



Certain assets and liabilities are recognized or disclosed at fair value on a nonrecurring basis, including property, plant and equipment, goodwill, and intangible assets. These assets are subject to fair valuation when there is evidence of impairment. No impairment was recognized in the three and six months ended June 30, 2017 or June 30, 2016.

NOTE 4. FREQUENT FLYER PROGRAMS

Frequent flyer program deferred revenue and liabilities included in the consolidated balance sheets (in millions):
 
June 30, 2017
 
December 31, 2016
Current Liabilities:
 
 
 
Other accrued liabilities
$
499

 
$
484

Other Liabilities and Credits:
 
 
 
Deferred revenue
652

 
638

Other liabilities
23

 
21

Total
$
1,174

 
$
1,143

 
Frequent flyer program revenue included in the consolidated statements of operations (in millions):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Passenger revenues
$
94

 
$
73

 
$
180

 
$
143

Other—net revenues
128

 
108

 
248

 
211

Total
$
222

 
$
181

 
$
428

 
$
354


NOTE 5. LONG-TERM DEBT
 
Long-term debt obligations on the consolidated balance sheet (in millions):
 
June 30, 2017
 
December 31, 2016
Fixed-rate notes payable due through 2028
$
1,090

 
$
1,179

Variable-rate notes payable due through 2028
1,732

 
1,803

Less debt issuance costs
(16
)
 
(18
)
Total debt
2,806

 
2,964

Less current portion
337

 
319

Long-term debt, less current portion
$
2,469

 
$
2,645

 
 
 
 
Weighted-average fixed-interest rate
4.3
%
 
4.4
%
Weighted-average variable-interest rate
2.6
%
 
2.4
%

During the six months ended June 30, 2017, the Company made debt payments of $159 million.

At June 30, 2017, long-term debt principal payments for the next five years and thereafter are as follows (in millions):
 
Total
Remainder of 2017
$
161

2018
350

2019
422

2020
449

2021
422

Thereafter
1,015

Total
$
2,819

 

14


Bank Lines of Credit
 
The Company has three credit facilities with availability totaling $452 million. All three facilities have variable interest rates based on LIBOR plus a specified margin. One credit facility increased from $100 million to $250 million in June 2017. It expires in June 2021 and is secured by aircraft. The second credit facility is for $52 million, expires in October 2017 with a mechanism for annual renewal and is secured by aircraft. The third credit facility increased from $100 million to $150 million in March 2017. It expires in March 2022 and is secured by certain accounts receivable, spare engines, spare parts and ground service equipment. The Company has secured letters of credit against the $52 million facility, but has no plans to borrow using either of the two other facilities. All three credit 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, 2017.

NOTE 6. EMPLOYEE BENEFIT PLANS

Net periodic benefit costs for the qualified defined-benefit plans included the following components (in millions): 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Service cost
$
10

 
$
9

 
$
20

 
$
18

Interest cost
18

 
19

 
36

 
37

Expected return on assets
(26
)
 
(27
)
 
(53
)
 
(54
)
Recognized actuarial loss
6

 
6

 
13

 
12

Total
$
8

 
$
7

 
$
16

 
$
13


NOTE 7. COMMITMENTS AND CONTINGENCIES

Future minimum payments for commitments as of June 30, 2017 (in millions):
 
Aircraft Leases
 
Facility Leases
 
Aircraft Purchase Commitments
 
Capacity Purchase Agreements (a)
 
Aircraft Maintenance Deposits
 
Aircraft Maintenance and Parts Management
Remainder of 2017
$
152

 
$
60

 
$
463

 
$
38

 
$
29

 
$
15

2018
318

 
73

 
836

 
80

 
61

 
32

2019
306

 
64

 
758

 
85

 
65

 
35

2020
280

 
58

 
338

 
90

 
68

 
37

2021
243

 
51

 
260

 
94

 
63

 
40

Thereafter
954

 
178

 
362

 
676

 
90

 
—

Total
$
2,253

 
$
484

 
$
3,017

 
$
1,063

 
$
376

 
$
159

(a)
Includes all non-aircraft lease costs associated with capacity purchase agreements.

Lease Commitments

Aircraft lease commitments include future obligations for all of the Company's operating airlines—Alaska, Virgin America and Horizon, as well as aircraft leases operated by third-parties. At June 30, 2017, the Company had lease contracts for 14 Boeing 737 ("B737") aircraft, 55 Airbus aircraft (two of which were delivered during the second quarter of 2017), 15 Bombardier Q400 aircraft and 20 Embraer 175 ("E175") with SkyWest Airlines, Inc. ("SkyWest"). The Company has an additional eight scheduled lease deliveries of A321neo aircraft through 2018. All lease contracts have remaining non-cancelable lease terms ranging from 2017 to 2030. The Company has the option to increase capacity flown by SkyWest with eight additional E175 aircraft deliveries in 2020. Options to lease are not reflected in the commitments table above.

Facility lease commitments primarily include airport and terminal facilities and building leases. Total rent expense for aircraft and facility leases was $123 million and $63 million for the three months ended June 30, 2017 and 2016, and $261 million and $144 million for the six months ended June 30, 2017 and 2016.


15


Aircraft Purchase Commitments
 
Aircraft purchase commitments include non-cancelable contractual commitments for aircraft and engines. As of June 30, 2017, the Company had commitments to purchase 48 B737 aircraft (16 B737 NextGen aircraft and 32 B737 MAX aircraft, with deliveries in the remainder of 2017 through 2023) and 27 E175 aircraft with deliveries in 2017 through 2019. The Company also has cancelable purchase commitments for 30 Airbus A320neo aircraft with deliveries from 2020 through 2022. In addition, the Company has options to purchase 41 B737 aircraft and 30 E175 aircraft. The cancelable purchase commitments and option payments are not reflected in the table above.

Capacity Purchase Agreements ("CPAs")
 
At June 30, 2017, 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 with Alaska. In addition, Alaska has CPAs with SkyWest to fly certain routes in the Lower 48 and Canada and with Peninsula Airways, Inc. ("PenAir") to fly certain routes in the state of Alaska. Under these agreements, Alaska pays the carriers an amount which is based on a determination of their cost of operating those flights and other factors intended to approximate market rates for those services. Future payments (excluding Horizon) are based on 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.

Aircraft Maintenance Deposits

Through its acquisition of Virgin America, the Company is contractually required to make maintenance deposit payments to aircraft lessors, which represent maintenance reserves made solely to collateralize the lessor for future maintenance events should the Company not perform required maintenance. Most lease agreements provide that maintenance reserves are reimbursable upon completion of the major maintenance event in an amount equal to the lesser of (i) the amount qualified for reimbursement from maintenance reserves held by the lessor associated with the specific major maintenance event or (ii) the qualifying costs related to the specific major maintenance event.

Aircraft Maintenance and Parts Management

Through its acquisition of Virgin America, the Company has a separate maintenance-cost-per-hour contract for management and repair of certain rotable parts to support airframe and engine maintenance and repair. This agreement requires monthly payments based upon utilization, such as flight hours, cycles and age of the aircraft, and, in turn, the agreement transfers certain risks to the third-party service provider. There are minimum payments under this agreement, which are reflected in the table above. Accordingly, payments could differ materially based on actual aircraft utilization.

Contingencies

The Company is a party to routine litigation matters incidental to its business and with respect to which no material liability is expected. Liabilities for litigation related contingencies are recorded when a loss is determined to be probable and estimable.

In 2015, three flight attendants filed a class action lawsuit seeking to represent all Virgin America flight attendants for damages based on alleged violations of California and City of San Francisco wage and hour laws. Plaintiffs received class certification in November 2016. Virgin America filed a motion for summary judgment seeking to dismiss all claims on various federal preemption grounds. In January 2017, the Court denied in part and granted in part Virgin America’s motion. The Company believes the claims in this case are without factual and legal merit and intends to defend this lawsuit.

Management believes the ultimate disposition of these matters is not likely to materially affect the Company's financial position or results of operations. This forward-looking statement is based on management's current understanding of the relevant law and facts, and it is subject to various contingencies, including the potential costs and risks associated with litigation and the actions of arbitrators, judges and juries.

NOTE 8. SHAREHOLDERS' EQUITY

Dividends

During the three months ended June 30, 2017, the Company declared and paid cash dividends of $0.30 per share, or $37 million. During the six months ended June 30, 2017, the Company declared and paid cash dividends of $0.60 per share, or $74 million.

16



Common Stock Repurchase

In August 2015, the Board of Directors authorized a $1 billion share repurchase program. The program was paused in the second quarter of 2016 in anticipation of the acquisition of Virgin America. The Company resumed the share repurchase program in the current quarter. As of June 30, 2017, the Company has repurchased 4.4 million shares for $335 million under this program.
Share repurchase activity (in millions, except share amounts):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
2015 Repurchase Program—$1 billion
256,680

 
$
22

 
873,396

 
$
67

 
256,680

 
$
22

 
2,594,809

 
$
193


Accumulated Other Comprehensive Loss
 
Components of accumulated other comprehensive loss, net of tax (in millions):
 
June 30, 2017
 
December 31, 2016
Marketable securities
$
—

 
$
(3
)
Employee benefit plans
(291
)
 
(299
)
Interest rate derivatives
(3
)
 
(3
)
Total
$
(294
)
 
$
(305
)

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, 2017 and 2016, anti-dilutive shares excluded from the calculation of EPS were not material.

NOTE 9. OPERATING SEGMENT INFORMATION

Alaska Air Group has three operating airlines—Alaska, Virgin America and Horizon. Each is regulated by the U.S. Department of Transportation’s Federal Aviation Administration. Alaska has CPAs for regional capacity with Horizon, as well as with third-party carriers SkyWest and PenAir, under which Alaska receives all passenger revenues.

Under U.S. GAAP, operating segments are defined as components of a business for which there is discrete financial information that is regularly assessed by the Chief Operating Decision Maker ("CODM") in making resource allocation decisions. Financial performance for the operating airlines and CPAs is managed and reviewed by the Company's CODM as part of three reportable operating segments:
 
•
Mainline - includes Alaska's and Virgin America’s scheduled air transportation for passengers and cargo throughout the U.S., and in parts of Canada, Mexico, Costa Rica and Cuba.
•
Regional - includes Horizon's and other third-party carriers’ scheduled air transportation for passengers across a shorter distance network within the U.S. under CPAs. This segment includes the actual revenues and expenses associated with regional flying, as well as an allocation of corporate overhead incurred by Air Group on behalf of the regional operations.
•
Horizon - includes the capacity sold to Alaska under CPA. Expenses include those typically borne by regional airlines such as crew costs, ownership costs and maintenance costs.

The CODM makes resource allocation decisions for these reporting segments based on flight profitability data, aircraft type, route economics and other financial information.

The "Consolidating and Other" column reflects parent company activity, consolidating entries and other immaterial business units of the company. The “Air Group Adjusted” column represents a non-GAAP measure that is used by the Company CODM

17


to evaluate performance and allocate resources. Adjustments are further explained below in reconciling to consolidated GAAP results.

18


Operating segment information is as follows (in millions):
 
Three Months Ended June 30, 2017
 
Mainline
 
Regional
 
Horizon
 
Consolidating & Other(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
1,556

 
$
—

 
$
—

 
$
—

 
$
1,556

 
$
—

 
$
1,556

Regional
—

 
251

 
—

 
—

 
251

 
—

 
251

Total passenger revenues
1,556

 
251

 
—

 
—

 
1,807

 
—

 
1,807

CPA revenues
—

 
—

 
108

 
(108
)
 
—

 
—

 
—

Freight and mail
31

 
1

 
—

 
—

 
32

 
—

 
32

Other—net
244

 
19

 
1

 
(1
)
 
263

 
—

 
263

Total operating revenues
1,831

 
271

 
109

 
(109
)
 
2,102

 
—

 
2,102

Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
1,026

 
206

 
116

 
(107
)
 
1,241

 
24

 
1,265

Economic fuel
304

 
39

 
—

 
(1
)
 
342

 
2

 
344

Total operating expenses
1,330

 
245

 
116

 
(108
)
 
1,583

 
26

 
1,609

Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
9

 
—

 
—

 
—

 
9

 
—

 
9

Interest expense
(23
)
 
—

 
(3
)
 
—

 
(26
)
 
—

 
(26
)
Other
3

 
—

 
1

 
(1
)
 
3

 
—

 
3

Total Nonoperating income (expense)
(11
)
 
—

 
(2
)
 
(1
)
 
(14
)
 
—

 
(14
)
Income (loss) before income tax
$
490

 
$
26

 
$
(9
)
 
$
(2
)
 
$
505

 
$
(26
)
 
$
479

 
Three Months Ended June 30, 2016
 
Mainline
 
Regional
 
Horizon
 
Consolidating & Other(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
1,036

 
$
—

 
$
—

 
$
—

 
$
1,036

 
$
—

 
$
1,036

Regional
—

 
227

 
—

 
—

 
227

 
—

 
227

Total passenger revenues
1,036

 
227

 
—

 
—

 
1,263

 
—

 
1,263

CPA revenues
—

 
—

 
110

 
(110
)
 
—

 
—

 
—

Freight and mail
26

 
1

 
—

 
—

 
27

 
—

 
27

Other—net
184

 
19

 
1

 
—

 
204

 
—

 
204

Total operating revenues
1,246

 
247

 
111

 
(110
)
 
1,494

 
—

 
1,494

Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
679

 
192

 
101

 
(111
)
 
861

 
14

 
875

Economic fuel
180

 
31

 
—

 
—

 
211

 
(10
)
 
201

Total operating expenses
859

 
223

 
101

 
(111
)
 
1,072

 
4

 
1,076

Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
6

 
—

 
1

 
—

 
7

 
—

 
7

Interest expense
(4
)
 
—

 
(4
)
 
(1
)
 
(9
)
 
—

 
(9
)
Other
3

 
—

 
—

 
1

 
4

 
—

 
4

Total Nonoperating income (expense)
5

 
—

 
(3
)
 
—

 
2

 
—

 
2

Income (loss) before income tax
$
392

 
$
24

 
$
7

 
$
1

 
$
424

 
$
(4
)
 
$
420



19


 
Six Months Ended June 30, 2017
 
Mainline
 
Regional
 
Horizon
 
Consolidating & Other(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
2,828

 
$
—

 
$
—

 
$
—

 
$
2,828

 
$
—

 
$
2,828

Regional
—

 
463

 
—

 
—

 
463

 
—

 
463

Total passenger revenues
2,828

 
463

 
—

 
—

 
3,291

 
—

 
3,291

CPA revenues
—

 
—

 
205

 
(205
)
 
—

 
—

 
—

Freight and mail
54

 
2

 
—

 
—

 
56

 
—

 
56

Other—net
466

 
36

 
2

 
—

 
504

 
—

 
504

Total operating revenues
3,348

 
501

 
207

 
(205
)
 
3,851

 
—

 
3,851

Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
2,024

 
406

 
219

 
(204
)
 
2,445

 
64

 
2,509

Economic fuel
596

 
75

 
—

 
—

 
671

 
12

 
683

Total operating expenses
2,620

 
481

 
219

 
(204
)
 
3,116

 
76

 
3,192

Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
16

 
—

 
—

 
—

 
16

 
—

 
16

Interest expense
(45
)
 
—

 
(5
)
 
(1
)
 
(51
)
 
—

 
(51
)
Other
6

 
—

 
1

 
—

 
7

 
—

 
7

Total Nonoperating income (expense)
(23
)
 
—

 
(4
)
 
(1
)
 
(28
)
 
—

 
(28
)
Income (loss) before income tax
705

 
20

 
(16
)
 
(2
)
 
707

 
(76
)
 
631

 
Six Months Ended June 30, 2016
 
Mainline
 
Regional
 
Horizon
 
Consolidating & Other(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
1,963

 
$
—

 
$
—

 
$
—

 
$
1,963

 
$
—

 
$
1,963

Regional
—

 
433

 
—

 
—

 
433

 
—

 
433

Total passenger revenues
1,963

 
433

 
—

 
—

 
2,396

 
—

 
2,396

CPA revenues
—

 
—

 
213

 
(213
)
 
—

 
—

 
—

Freight and mail
49

 
2

 
—

 
—

 
51

 
—

 
51

Other—net
356

 
36

 
2

 
—

 
394

 
—

 
394

Total operating revenues
2,368

 
471

 
215

 
(213
)
 
2,841

 
—

 
2,841

Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
1,380

 
378

 
206

 
(213
)
 
1,751

 
14

 
1,765

Economic fuel
324

 
56

 
—

 
—

 
380

 
(12
)
 
368

Total operating expenses
1,704

 
434

 
206

 
(213
)
 
2,131

 
2

 
2,133

Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
12

 
—

 
1

 
—

 
13

 
—

 
13

Interest expense
(16
)
 
—

 
(5