Edgar Filing: ALASKA AIR GROUP, INC.

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-K


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

For the fiscal year ended December 31, 2017


¨	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

Securities registered pursuant to Section 12(b) of the Act:



Common Stock, $0.01 Par Value	New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

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 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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:

Large accelerated filer x 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 x

As of January 31, 2018, shares of common stock outstanding totaled 122,996,587. The aggregate market value of the shares of common stock of Alaska Air Group, Inc. held by nonaffiliates on June 30, 2017, was approximately $11.1 billion (based on the closing price of $89.76 per share on the New York Stock Exchange on that date).

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Definitive Proxy Statement relating to 2018 Annual Meeting of Shareholders are incorporated by reference in Part III.

ALASKA AIR GROUP, INC.

ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2017

TABLE OF CONTENTS



PART I		4
ITEM 1.	OUR BUSINESS	4
ITEM 1A.	RISK FACTORS	20
ITEM 1B.	UNRESOLVED STAFF COMMENTS	27
ITEM 2.	PROPERTIES	27
ITEM 3.	LEGAL PROCEEDINGS	28
ITEM 4.	MINE SAFETY DISCLOSURES	28
PART II		28
ITEM 5.	MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES	28
ITEM 6.	SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA	31
ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	33
ITEM 7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK	59
ITEM 8.	CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	59
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	94
ITEM 9A.	CONTROLS AND PROCEDURES	94
ITEM 9B.	OTHER INFORMATION	97
PART III		97
ITEM 10.	DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE	97
ITEM 11.	EXECUTIVE COMPENSATION	97
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT, AND RELATED STOCKHOLDER MATTERS	97
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE	98
ITEM 14.	PRINCIPAL ACCOUNTANT FEES AND SERVICES	98
PART IV		98
ITEM 15.	EXHIBITS	98
	SIGNATURES	99

As used in this Form 10-K, 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,” respectively, and together as our “airlines.”

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

In addition to historical information, this Form 10-K 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.

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 in this Form 10-K, see “Item 1A: Risk Factors.” Please consider our forward-looking statements in light of those risks as you read this report.

Table of Contents

PART I

ITEM 1. OUR BUSINESS

Air Group operates three airlines, Alaska, Virgin America and Horizon. McGee Air Services, an aviation services provider, is a wholly-owned subsidiary of Alaska. Together with regional partner airlines, we fly to 118 destinations with 1,200 daily departures through an expansive network across the United States, Mexico, Canada, and Costa Rica. With global airline partners, we provide our guests with a network of more than 900 destinations worldwide. During 2017, we carried an all-time high 44 million guests and earned consolidated net income of $1.0 billion, which represents a 27% increase over net income of $814 million in 2016. Our adjusted net income was $823 million, which excludes special items and merger-related costs of $118 million, and a $280 million benefit from new tax laws enacted in 2017.

Our mission is "creating an airline people love." The "ing" is to recognize that we are never done; we are continually working to improve. We believe our success depends on our ability to provide safe air transportation, develop relationships with guests by providing exceptional customer service and low fares, and maintain a low cost structure to compete effectively. It is important to us that we achieve our objective as a socially responsible company that values not just performance, but people, the communities we serve, and environment.

In 2017 we focused much of our energy on integrating Virgin America. We achieved several milestones, including merging most back office functions, kicking off station co-locations and launching technology that enables our front-line employees to be agile between Alaska and Virgin America applications. In January 2018, Alaska and Virgin America obtained a single operating certificate from the Federal Aviation Administration (FAA), our most significant integration milestone to date. These accomplishments will ease our transition to a single Passenger Service System (PSS) in the Spring of 2018, which will help us unlock many of the revenue synergies expected from the acquisition. We remain on track to complete all of our integration milestones on schedule, and continue to be optimistic about the value of our combined company.

With the integration well underway, we remain committed to our strategic focus to become the go-to airline for people on the West Coast. The acquisition of Virgin America positioned us as the fifth largest airline in the U.S., with an unparalleled ability to serve West Coast travelers. To do so, we believe we need to meet our guest's evolving needs through innovation in our onboard offerings and provide unique destinations with better schedules, while retaining the best of both the Alaska and Virgin America brand experiences. We have begun to implement this strategy in a number of ways, including merging our loyalty programs, allowing us to bring the award winning benefits of our Mileage Plan™ program to Virgin America's loyal customer base; rolling out Free Movies and Free Chat to Virgin America's entire fleet; and kicking off the first of several cabin enhancements of Alaska's Boeing aircraft with expressive mood lighting.

While aircraft and technology enable us to provide air transportation, we recognize this is fundamentally a people business. Our employees maintain and strengthen our relationships with guests, and our success depends on our employees working together to successfully execute our strategy. In 2017, Alaska was once again named one of America's Best Employers by Forbes Magazine for the third year in a row. We know that engaged employees provide excellent service. In that vein, in 2017, Alaska ranked highest in J.D. Power and Associates annual survey of customer satisfaction among traditional network carriers for the tenth year in a row. Virgin America was also recognized for excellent service by Conde Nast Traveler and Travel + Leisure magazine also for the tenth year in a row. Customer service matters, and we believe the combination of Alaska and Virgin America will only enhance the experience for our guests.

Operationally, Alaska held the No. 1 spot in the Wall Street Journal's "Middle Seat" scorecard for U.S. airlines for four consecutive years and the No. 2 spot for 2017. Although we were not the leader in on-time performance in 2017, we led the industry for on-time performance among major airlines for the previous seven years. We are focused on becoming the industry leader in operational performance once again as we fully integrate Alaska and Virgin America operations and we are off to a great start in 2018. For achieving safety, customer service, operational and financial goals, we rewarded our employees with $135 million for their service in 2017.

In support of the communities that we serve, we strive to be an industry leader in environmental and community stewardship. Our combined fleet is one of the youngest, most fuel-efficient fleets in North America and we look forward to further enhancements in this area. As a result of our environmental and corporate sustainability leadership, we ranked higher than any other North American airline in this year's Dow Jones Sustainability Index. We are also proud of our community stewardship - Air Group donated $14 million to over 1,300 charitable organizations, and our employees volunteered more than 32,000 hours of community service, focused on youth and education, medical research, and transportation and community outreach in 2017.

One of our leadership principles is to "give back" and we are proud of the efforts and voluntarism of our employees across the system.

We continued to generate strong profits in 2017, marking our 14th consecutive annual profit on an adjusted basis. Our liquidity and capital position remain strong, positioning us among those of high-quality industrial companies. Due to our strong financial health and outlook, we are one of only three U.S. airlines with investment grade credit ratings. With the cash generated by our continued success, we have been able to invest in our business to achieve profitable growth and to enhance the guest experience.

As we look to the future, we will build on our success by executing our strategic plan in the following areas:

Be Safe and On time

We have an unwavering commitment to run a safe operation, and we will not compromise this commitment in the pursuit of other initiatives. Alaska and Horizon were the first U.S. major airlines to receive FAA validation and acceptance of our Safety Management System (SMS) in 2016. In 2017, Virgin America adopted SMS, ensuring a consistent safety process across our carriers. Additionally, all Virgin America employees received training for the Alaska Air Group SMS, our "Ready, Safe, Go" principles, and our mobile safety reporting system. Once again, in 2017, 100% of our Alaska and Horizon aircraft technicians completed the requirements for the FAA's "Diamond Certificate of Excellence" award. This is the 16th consecutive year Alaska Airlines has received the award and the 16th time in the last 18 years Horizon has received this award. We also believe that maintaining safe operations, through adherence to well-defined processes, and ensuring every Air Group employee is aware of their individual contribution to our operation, is critical to ensuring on-time performance. The rigor we apply to running a safe operation has resulted in Alaska consistently being one of the top airlines in North America for on-time performance.

Focus on People

Our business is fundamentally a people business, and our success depends on our nearly 23,000 employees. Engaged employees deliver higher productivity, superior execution and better customer service. In merging Alaska Airlines and Virgin America employees and labor groups, we kept a vigilant focus on creating an unbeatable culture. In January 2017, we rolled out "Momentum" training for all Virgin America employees to help bridge the two airlines and blend our cultures. We implemented Culture Champion initiatives to help employees build relationships across airlines, allowing them to share concerns and feedback directly with executive leadership. Similarly, our "QX Factor" program brought new energy to the Horizon employee experience. Our people programs and integration plan are focused on ensuring employees feel valued, informed and engaged in meaningful ways as we build our future.

Aligning our employees' goals with Air Group's goals is important in achieving success. All permanent employees of our airlines participate in our Performance-Based Pay (PBP) and Operational Performance Rewards (OPR) programs, which encourage employees to work together to achieve metrics related to safety, profitability, on-time performance, low costs, customer loyalty, and customer satisfaction. Over the last five years, our incentive programs have paid out on average more than one month's pay, for most employees.

Build a deep emotional connection for our brand

To be the go-to airline for people on the West Coast, we must be recognized for creating an airline that people love. In 2017, we built upon the strong brand connection we have with our guests in our Pacific Northwest markets and the state of Alaska by broadening our focus to include California. We rolled out fresh, modern marketing campaigns showcasing benefits such as our network growth, low fares, our Buy One Get One companion fare credit card promotional offer, and unique onboard experience elements. We are enthusiastic about our plans for continued investment in key products that will provide meaningful improvements to our guests, such as Gogo satellite internet which we will begin installing in early 2018. Additionally, we partnered with key sponsors in the Bay Area, including sports franchises such as the San Francisco Giants and the San Jose Sharks, as well as noted professional athletes including Kevin Durant of the Golden State Warriors.

We continue to invest in key products that will provide meaningful improvements to our guests and further drive an emotional connection to our brand. This includes Free Chat and Free Movies and the launch of Gogo satellite service, already mentioned above. We’ve rolled out new digital products to improve the guest experience, including a new inflight entertainment portal and the beta launch of First Class meal pre-select. We’ve nearly completed retrofits of our Boeing fleet to include Premium Class, while adding larger overhead bins to many of our aircraft. Expanding our airport lounge portfolio, we’ve opened a third lounge at Sea-Tac airport and plan to open a lounge at JFK in 2018. Finally, guests can also look forward to an integrated onboard food and beverage program in 2018, which will emphasize fresh and local West Coast products on our aircraft.

Defend and grow our customer base

Competition in our markets is fierce and we know we must defend our customer base as we grow our network presence, by providing our guests with an increased choice of schedule times and fares, and allowing us to effectively compete for new guests. We will continue to introduce guests to our award-winning service, Mileage Plan™ program, and Visa signature credit card as we grow our network. We work hard to ensure our guests have a great experience on our airlines and provide an exceptional product at a low fare.

Win with low costs and low fares

We believe that our low-fare model gives us a competitive advantage by providing value to, and building trust with our guests. We also know that, in order to provide low fares in our growing network, while returning value to our shareholders, it is imperative for us to maintain a competitive cost structure. In 2017, our unit costs, excluding fuel and special items, remained flat year over year on a consolidated basis. We understand the importance of low costs to the business model and the success of the company and we have a long track record of reducing unit costs. Although our unit costs are expected to rise in 2018 primarily due to pilot wages and maintenance costs, we continue to focus on productivity, cost management, low overhead and leveraging capacity growth. We also manage increasing fuel costs by flying larger, more fuel-efficient aircraft, which have increased our fuel efficiency as measured by available seat miles flown per gallon by 3.5% over the last five years. As we continue to integrate Virgin America into our operations, we are committed to achieving our stated cost and revenue synergy goals. It is critical that we achieve these goals in order to continue our cost reduction efforts.

During fiscal 2017, we added 44 new markets to the combined network. For 2018, we plan to grow our system-wide capacity approximately 7.5% as compared to 2017. Approximately 70% of growth in 2018 is attributable to existing routes and locations, with the rest attributable to our plans to fly 13 daily departures from Paine Field-Snohomish County Airport in Everett, Washington to eight West Coast markets starting in fall 2018.

AIR GROUP

Alaska Air Group is a Delaware corporation incorporated in 1985 and the holding company of Alaska, Virgin America, Horizon, McGee Air Services, a wholly-owned subsidiary of Alaska, and other business units. Alaska, Virgin America and Horizon operate as airlines however, the business plans, competition and economic risks differ substantially for Horizon in comparison to Alaska and Virgin America. McGee Air Services operates as an aviation services provider, focused on providing ground and ramp handling services to airlines. Alaska Airlines is an Alaska corporation that was organized in 1932 and incorporated in 1937. Virgin America is a Delaware corporation that was incorporated in 2004 and acquired by Air Group on December 14, 2016. Horizon is a Washington corporation that began service and was incorporated in 1981. It was acquired by Air Group in 1986. McGee Air Services is a Delaware corporation that was incorporated in 2016. Alaska and Virgin America operate fleets of narrowbody passenger jets. Together, the operations of Alaska and Virgin America are referred to as "mainline" operations. Alaska also contracts with Horizon, SkyWest Airlines, Inc. (SkyWest) and Peninsula Airways, Inc. (PenAir) for regional capacity such that Alaska receives all passenger revenue from those flights. Horizon began operating E175 regional jet aircraft in 2017 in addition to its fleet of turboprop aircraft and sells all of its capacity to Alaska pursuant to a capacity purchase agreement (CPA). The majority of our revenues are generated by transporting passengers. The percentage of revenues by category is as follows:



	2017		2016^(a)		2015		2014		2013
Mainline passenger revenue	74	%	69	%	70	%	70	%	70	%
Regional passenger revenue	12	%	15	%	15	%	15	%	16	%
Other revenue	13	%	14	%	13	%	13	%	12	%
Freight and Mail revenue	1	%	2	%	2	%	2	%	2	%
Total	100	%	100	%	100	%	100	%	100	%


(a)	Includes information for Virgin America for the period December 14, 2016 through December 31, 2016.

We attempt to deploy aircraft into the network in ways that best optimize our revenues and profitability and reduce our seasonality.

The percentage of our capacity by region is as follows:



	2017		2016^(a)		2015		2014		2013
West Coast	28	%	34	%	36	%	36	%	34	%
Transcon/midcon	43	%	29	%	24	%	22	%	22	%
Hawaii and Costa Rica	13	%	17	%	18	%	18	%	19	%
Alaska	10	%	14	%	15	%	15	%	16	%
Mexico	5	%	5	%	6	%	6	%	7	%
Canada	1	%	1	%	1	%	3	%	2	%
Total	100	%	100	%	100	%	100	%	100	%


(a)	Includes information for Virgin America for the period December 14, 2016 through December 31, 2016.

MAINLINE

Our mainline operations include Boeing 737 (B737) and Airbus family (A319, A320, and A321neo) jet service offered by Alaska and Virgin America. We offer extensive passenger service from the western U.S. throughout the contiguous United States, Alaska, Hawaii, Canada, Mexico, and Costa Rica. Our largest concentration of departures are in Seattle, Portland, and the Bay Area. We also offer cargo service throughout our network and have dedicated cargo aircraft that operate primarily to and within the state of Alaska.

In 2017, we carried 35 million revenue passengers in our mainline operations. At December 31, 2017, our mainline operating fleet consisted of 154 B737 jet aircraft and 67 Airbus A320 family jet aircraft compared to 155 B737 aircraft and 63 Airbus aircraft as of December 31, 2016.

The percentage of mainline passenger capacity by region and average stage length is presented below:



	2017		2016^(a)		2015		2014		2013
West Coast	24	%	30	%	31	%	31	%	28	%
Transcon/midcon	45	%	30	%	27	%	25	%	25	%
Hawaii	15	%	19	%	20	%	20	%	21	%
Alaska	11	%	15	%	16	%	16	%	18	%
Mexico	5	%	6	%	6	%	7	%	7	%
Canada	—	%	—	%	—	%	1	%	1	%
Total	100	%	100	%	100	%	100	%	100	%

Average Stage Length	1,301		1,225		1,195		1,182		1,177


(a)	Includes information for Virgin America for the period December 14, 2016 through December 31, 2016.

REGIONAL

Our regional operations consist of flights operated by Horizon, SkyWest and PenAir. In 2017, our regional operations carried approximately 9 million revenue passengers, primarily in the states of Washington, Oregon, Idaho and California. Horizon is the largest regional airline in the Pacific Northwest and carries approximately 74% of Air Group's regional revenue passengers.

Based on 2017 Horizon passenger enplanements on regional aircraft, our most significant concentration of regional activity was in Seattle and Portland. At December 31, 2017, Horizon’s operating fleet consisted of 10 Embraer 175 (E175) jet aircraft and 50 Bombardier Q400 turboprop aircraft. The regional fleet operated by SkyWest consisted of 23 E175 aircraft.

The percentage of regional passenger capacity by region and average stage length is presented below:



	2017		2016		2015		2014		2013
West Coast	59	%	60	%	62	%	66	%	66	%
Pacific Northwest	13	%	16	%	19	%	19	%	21	%
Canada	4	%	5	%	7	%	8	%	9	%
Alaska	3	%	4	%	5	%	4	%	2	%
Midcon	21	%	15	%	6	%	2	%	1	%
Mexico	—	%	—	%	1	%	1	%	1	%
Total	100	%	100	%	100	%	100	%	100	%

Average Stage Length	422		381		348		339		329

FREQUENT FLYER PROGRAM

In 2017, we maintained two frequent flyer plans: the Alaska Airlines Mileage Plan™ and Virgin America Elevate®. To provide consistency and clarity to our guests, we merged the two programs throughout the year, and Elevate® was officially sunset in December 2017.

Alaska Airlines Mileage Plan™ provides a comprehensive suite of frequent flyer benefits. Miles can be earned by flying on our airlines or on one of our 18 airline partners, by using the Alaska Airlines credit card, or through other non-airline partners. Alaska's extensive list of airline partners includes carriers associated with each of the three major global alliances, making it easier for our members to earn miles and reach elite status in our frequent flyer program. Through Alaska and our global partners, Mileage Plan™ members have access to a large network of over 900 worldwide travel destinations. Further, members can receive 30,000 bonus miles upon signing up for the Alaska Airlines Visa Signature card and meeting a minimum spend threshold, and earn triple miles on Alaska Airlines and Virgin America purchases. Alaska Airlines Visa Signature cardholders and small business cardholders in the U.S., and Platinum and World Elite Mastercard holders in Canada, also receive an annual companion ticket that allows members to purchase an additional ticket for $99 plus taxes, with no restrictions or black-out dates, and a free first checked bag for up to seven people traveling in the same itinerary. Earned miles can be redeemed for flights on our airlines, or partner airlines, or for upgrades to First Class on Alaska Airlines. We believe all of these benefits give our Mileage Plan™ members more value for their travel.

Mileage Plan™ and Elevate® revenues represented approximately 11% of Air Group's total revenues in 2017. Mileage Plan™ helps drive revenue growth by attracting new customers and building customer loyalty through the benefits that we provide.

AGREEMENTS WITH OTHER AIRLINES

Our agreements fall into three different categories: Frequent Flyer, Codeshare and Interline agreements. Frequent Flyer agreements offer mileage credits and redemptions for our Mileage Plan™ members. Alaska offers one of the most comprehensive frequent flyer programs for our Mileage Plan™ members through frequent flyer partnerships with 18 domestic and international carriers.

Codeshare agreements allow one or more marketing carriers to sell seats on a single operating carrier that services passengers under multiple flight numbers. The sale of codeshare seats can vary depending on the sale arrangement. For example, in a free-sale arrangement, the marketing carrier sells the operating carrier's inventory without any restriction; whereas in a block space arrangement, a fixed amount of seats are sold to the marketing carrier by the operating carrier. The interchangeability of the flight code between carriers provides a greater selection of flights for customers, along with increased flexibility for mileage accrual and redemption.

Interline agreements allow airlines to jointly offer a competitive, single-fare itinerary to customers traveling via multiple carriers to a final destination. An interline itinerary offered by one airline may not necessarily be offered by the other, and the fares collected from passengers are prorated and distributed to interline partners according to preexisting agreements between the carriers. Frequent flyer, codeshare and interline agreements help increase our traffic and revenue by providing more route choices to our guests.

Alaska has marketing alliances with a number of airlines that provide frequent flyer and codesharing opportunities. Alliances are an important part of our strategy and enhance our revenues by:


•	offering our guests more travel destinations and better mileage credit/redemption opportunities, including elite qualifying miles on U.S. and international airline partners;


•	giving our frequent flyer program a competitive advantage because of our partnership with carriers from all three of the major global alliances;


•	giving us access to more connecting traffic from other airlines; and


•	providing members of our alliance partners’ frequent flyer programs an opportunity to travel on Alaska, Virgin America and our regional partners while earning mileage credit in our partners’ programs.

Most of our codeshare relationships are free-sale codeshares, where the marketing carrier sells seats on the operating carrier’s flights from the operating carrier’s inventory, but takes no inventory risk. Our marketing agreements have various termination dates, and one or more may be in the process of renegotiation at any time.

The comprehensive summary of Alaska's alliances with other airlines is as follows:



		Codeshare
	Frequent Flyer Agreement	Alaska Flight # on Flights Operated by Other Airline	Other Airline Flight # on Flights Operated by Air Group
Major U.S. or International Airlines
American Airlines	Yes	Yes	Yes
Air France^(b)	Yes	No	Yes
British Airways	Yes	No	Yes
Cathay Pacific Airways	Yes	No	Yes
Condor Airlines^(a)	Yes	No	No
Emirates	Yes	No	Yes
Finnair	Yes	No	No
Icelandair	Yes	No	Yes
Hainan Airlines	Yes	No	No
Japan Airlines	Yes	No	No
KLM^(b)	Yes	No	Yes
Korean Air	Yes	No	Yes
LATAM	Yes	No	Yes
Fiji Airways^(a)	Yes	No	Yes
Qantas	Yes	No	Yes
Singapore Airlines	Yes	No	No
Regional Airlines
Ravn Alaska^(c)	Yes	Yes	No
PenAir^(a)	Yes	Yes	No
China Airlines^(d)	No	No	Yes
China Eastern^(d)	No	No	Yes
China Southern^(d)	No	No	Yes
Virgin Australia^(d)	No	No	Yes


(a)	These airlines do not have their own frequent flyer program. However, Alaska's Mileage Plan^TM members can earn and redeem miles on these airlines' route systems.


(b)	Codeshare agreements with Air France & KLM terminate on March 31, 2018; frequent flyer agreements terminate on April 30, 2018.


(c)	Alaska has temporarily suspended codeshare activity with Ravn (effective July 1, 2017) while Ravn takes steps to address certain operational considerations. The Frequent Flyer Agreement with Ravn has remained in place during this time.


(d)	These codeshare agreements were established with Virgin America on their reservations platform. After the conversion to a single Passenger Service System (PSS) in Q2 2018, these agreements will no longer exist.

The following is the financial impact of our marketing alliances:



	2017	2016^(a)	2015	2014	2013
Air Group Marketed Revenues	94%	92%	90%	91%	90%

Codeshare Agreements:
American Airlines	1%	3%	4%	3%	2%
Delta Air Lines	1%	1%	2%	2%	4%
Others	1%	1%	1%	1%	1%
Interline Agreements:
Domestic Interline	1%	2%	2%	2%	2%
International Interline	2%	1%	1%	1%	1%
Total Operating Revenue	100%	100%	100%	100%	100%


(a)	Includes information for Virgin America for the period December 14, 2016 through December 31, 2016.

OTHER REVENUE

Other revenue consists of freight and mail, certain frequent flyer and ancillary revenue. While some of our product features are included in our base pricing, we have unbundled certain ancillary features that our guests separately value. Major ancillary revenue products include checked bag fees, change fees and lounge memberships. We also promote and sell products in-flight to enhance the guest experience, including our Tom Douglas signature meals, snacks, alcoholic beverages, in-flight entertainment and Wi-Fi. Total other revenue, excluding frequent flyer program revenue, represents about 7% of our total revenues.

GENERAL

The airline industry is highly competitive and subject to various uncertainties, including economic conditions, volatile fuel prices, industry instability, new competition, a largely unionized work force, the need to finance large capital expenditures and the related availability of capital, government regulation—including taxes and fees, and potential aircraft incidents. Airlines have high fixed costs, primarily for wages, aircraft fuel, aircraft ownership and facilities rents. Because expenses of a flight do not vary significantly based on the number of passengers carried, a relatively small change in the number of passengers or in pricing has a disproportionate effect on an airline’s operating and financial results. In other words, a minor shortfall in expected revenue levels could cause a disproportionately negative impact on our operating and financial results. Passenger demand and ticket prices are, in large measure, influenced by the general state of the economy, current global economic and political events, and total available airline seat capacity.

In 2017, the airline industry's profits declined when compared to the record setting year of 2016, primarily due to rising fuel prices, higher labor costs, and increased competitive fare actions reducing ticket prices. Despite some of these headwinds, the industry continued to report strong profits in 2017. In the current strong industry environment, airlines are making significant investments in airports, in more fuel-efficient planes and in new services to differentiate their customer service offering. Thus, the level of competition is expected to continue to increase.

FUEL

Our business and financial results are highly affected by the price and the availability of aircraft fuel. The cost of aircraft fuel is volatile and outside of our control, and it can have a significant and immediate impact on our operating results. Over the past five years, aircraft fuel expense ranged from 18% to 34% of operating expenses. Fuel prices are impacted by changes in both the price of crude oil and refining margins and can vary by region in the U.S.

The prices we have paid for crude oil on an average annual basis for the past five years have ranged from a low of $43 per barrel in 2016 to a high of $98 in 2013. For us, a $1 per barrel change in the price of oil equates to approximately $19 million of fuel cost annually. Said another way, a one-cent change in our fuel price per gallon will impact our expected annual fuel cost by approximately $8 million per year.

Refining margins, which represent the price of refining crude oil into aircraft fuel, are a smaller portion of the overall price of jet fuel but also contributed to the price volatility in recent years. Average annual West Coast refining margin prices have fluctuated between $13 per barrel and $36 per barrel in the last five years, and averaged $18 per barrel in 2017.

Generally, West Coast jet fuel prices are somewhat higher and more volatile than prices in the Gulf Coast or on the East Coast. Our average raw fuel cost per gallon increased 21% in 2017, after decreasing 19% in 2016 and 39% in 2015.

The percentages of our aircraft fuel expense by crude oil and refining margins, as well as the percentage of our aircraft fuel expense of operating expenses are as follows:



	2017		2016 ^(a)		2015		2014		2013
Crude oil	66	%	69	%	62	%	72	%	71	%
Refining margins	23	%	20	%	26	%	18	%	19	%
Other^(b)	11	%	11	%	12	%	10	%	10	%
Total	100	%	100	%	100	%	100	%	100	%

Aircraft fuel expense	22	%	18	%	22	%	32	%	34	%


(a)	Includes information for Virgin America for the period December 14, 2016 through December 31, 2016.


(b)	Other includes gains and losses on settled fuel hedges, unrealized mark-to-market fuel hedge gains or losses, taxes and other into-plane costs.

We use crude oil call options as hedges to decrease our exposure to the volatility of jet fuel prices. Call options effectively cap our pricing for crude oil, limiting our exposure to increasing fuel prices for about half of our planned fuel consumption. With call options, we are hedged against spikes in crude oil prices, and during a period of decline in crude oil prices, we only forfeit cash previously paid for hedge premiums. We begin hedging approximately 18 months in advance of crude oil consumption.

We believe that operating fuel-efficient aircraft is the best hedge against high fuel prices. Alaska operates an all-Boeing 737 fleet, Virgin America operates an all-Airbus A320 family fleet, and Horizon currently operates a fleet including Embraer 175 jet aircraft and Bombardier Q400 turboprop aircraft. Air Group's fuel-efficiency rate expressed in available seat miles flown per gallon (ASMs/g) improved from 75.3 ASMs/g in 2013 to 77.9 ASMs/g in 2017. These improvements have not only reduced our fuel consumption rate, but also the amount of greenhouse gases and other pollutants that our aircraft emit.

COMPETITION

Competition in the airline industry is intense and unpredictable. Our competitors consist primarily of other airlines and, to a lesser extent, other forms of transportation. Competition can be direct, in the form of another carrier flying the exact non-stop route, or indirect, where a carrier serves the same two cities non-stop from an alternative airport in that city or via an itinerary requiring a connection at another airport. We compete with other domestic airlines and a limited number of international airlines on nearly all of our scheduled routes. Our largest competitor is Delta, who has significantly increased its capacity in Seattle over the past few years. Approximately 75% of our capacity to and from Seattle competes with Delta. As we grow in California and expand our transcontinental route offerings, United Airlines and Southwest Airlines have also become large competitors and have increased their capacity in markets we serve. Our California and transcontinental routes have a higher concentration of competitors when compared to our historical route structure which was predominately concentrated in the Pacific Northwest. Based on schedules filed with the U.S. Department of Transportation, we expect the amount of competitive capacity overlap with all carriers to increase by more than 6% in the first half of 2018, weighted based on our network.

We believe that the following principal competitive factors are important to our guests:


•	Safety record

Safety is our top priority and is at the core of everything we do. In 2017, we were ranked by AirlineRatings.com as one of only two U.S. airlines in the Top 20 safest airlines in the world. We also received our 16th Diamond Award of Excellence from the Federal Aviation Administration, recognizing both Alaska and Horizon aircraft technicians for their commitment to training.


•	Customer service and reputation

We compete with other airlines in areas of customer service such as on-time performance, guest amenities—including first class and other premium seating, quality of on-board products, aircraft type and comfort. In 2017, Alaska Airlines ranked highest in customer satisfaction among traditional network carriers by J.D. Power and Associates for the tenth year in a row. We have installed Boeing Space Bins on the majority of our Boeing 737-900ER fleet, providing additional overhead bin space for our guests. In 2017, we launched a Premium Class of service on our B737 aircraft that provides extra

legroom, early boarding, premium snacks and a complimentary alcoholic beverage. Additionally, in 2017 we increased the distance between seats in our first class cabins on the Alaska B737-900 and B737-900ER fleet, providing significantly more space for guests flying in the First Class cabin. We expect to fully complete the First Class cabin upgrades on the B737-900 and B737-900ER fleet in early 2018.

Starting in 2018, we will begin reconfiguring the interior and livery of the Airbus fleet. The new livery and interior reconfiguration will provide guests a consistent brand experience across the Mainline fleet. The projects are expected to be complete in late 2019.

Our employees are a key element of our product. We have a highly engaged workforce that strives to provide a high degree of service and hospitality to our guests both at the airport and in flight. We heavily emphasize our service standards with our employees through training and education programs and monetary incentives related to operational performance and guest surveys.


•	Fares and ancillary services

Fare pricing is a significant competitive factor in the airline industry, and the increased availability of fare information on the Internet allows travelers to easily compare fares and identify competitor promotions and discounts. Pricing is driven by a variety of factors including, but not limited to, market-specific capacity, market share per route/geographic area, cost structure, fare vs. ancillary revenue strategies, and demand.

For example, airlines often discount fares to drive traffic in new markets or to stimulate traffic when necessary to improve load factors. In addition, traditional network carriers have been able to reduce their operating costs through bankruptcies and mergers, while low-cost carriers have continued to grow their fleets and expand their networks, potentially enabling them to better control costs per available seat mile (the average cost to fly an aircraft seat one mile), which in turn may enable them to lower their fares. These factors can reduce our pricing power and that of the airline industry as a whole.

Domestic airline capacity is dominated by four large carriers, representing over 80% of total seats. Accordingly, if these carriers discount their fares or enter into our core markets, we must match those fares in order to maintain our load factors, often resulting in year-over-year decreases in our yields. We will defend our core markets and, if necessary, redeploy capacity to better match supply with demand. We believe the restructuring we've completed over the past decade has decreased our costs, enabling us to offer competitive fares while still earning returns for our shareholders.


•	Routes served, flight schedules, codesharing and interline relationships, and frequent flyer programs

We also compete with other airlines based on markets served, the frequency of service to those markets and frequent flyer opportunities. Some airlines have more extensive route structures than we do, and they offer significantly more international routes. In order to expand opportunities for our guests, we enter into codesharing and interline relationships with other airlines that provide reciprocal frequent flyer mileage credit and redemption privileges. These relationships allow us to offer our guests access to more destinations than we can on our own, gain exposure in markets we don't serve and allow our guests more opportunities to earn and redeem frequent flyer miles. The Mileage Plan™ offers some of the most comprehensive benefits to our members with the ability to earn and redeem miles on 18 partner carriers.

In addition to domestic or foreign airlines that we compete with on most of our routes, we compete with ground transportation in our short-haul markets. To some extent, our airlines also compete with technology, such as video conferencing and internet-based meeting tools that have changed the need for, or frequency of, face-to-face business meetings.

TICKET DISTRIBUTION

Our tickets are distributed through three primary channels:

•

Direct to customer: It is less expensive for us to sell through our direct channels at alaskaair.com and virginamerica.com. As a result, we continue to take steps to drive more business to our websites. In addition, we believe these channels are preferable from a branding and customer-relationship standpoint in that we can establish ongoing communication with the customer and tailor offers accordingly.


•	Traditional and online travel agencies: Both traditional and online travel agencies typically use Global Distribution Systems (GDS) to obtain their fare and inventory data from airlines. Bookings made through these agencies result in a fee

that is charged to the airline. Many of our large corporate customers require us to use these agencies. Some of our competitors do not use this distribution channel and, as a result, have lower ticket distribution costs.


•	Reservation call centers: Our call centers are located in Phoenix, AZ, Kent, WA, and Boise, ID. We generally charge a $15 fee for booking reservations through the call centers.

Our sales by channel are as follows:



	2017		2016 ^(a)		2015		2014		2013
Direct to customer	62	%	61	%	60	%	57	%	55	%
Traditional agencies	22	%	23	%	23	%	25	%	27	%
Online travel agencies	11	%	11	%	11	%	12	%	13	%
Reservation call centers	5	%	5	%	6	%	6	%	5	%
Total	100	%	100	%	100	%	100	%	100	%


(a)	Includes results for Virgin America for the period December 14, 2016 through December 31, 2016.

SEASONALITY AND OTHER FACTORS

Our results of operations for any interim period are not necessarily indicative of those for the entire year because our business is subject to seasonal fluctuations. Our profitability is generally lowest during the first and fourth quarters due principally to fewer departures and passengers. Profitability typically increases in the second quarter and then reaches its highest level during the third quarter as a result of vacation travel, including increased activity in the state of Alaska. However, we have significantly improved the seasonality of our operations by our continued growth from the West Coast to leisure destinations, like Hawaii and Costa Rica, and expansion to leisure and business destinations in the mid-continental and eastern U.S.

In addition to passenger loads, factors that could cause our quarterly operating results to vary include:


•	pricing initiatives by us or our competitors,

• changes in fuel costs,


•	increases in competition at our primary airports,


•	general economic conditions and resulting changes in passenger demand, and


•	increases or decreases in passenger and volume-driven variable costs.

Many of the markets we serve experience inclement weather conditions in the winter, causing increased costs associated with deicing aircraft, canceling flights and accommodating displaced passengers. Due to our geographic area of operations, we can be more susceptible to adverse weather conditions, particularly in the state of Alaska and the Pacific Northwest, than some of our competitors who may be better able to spread weather-related risks over larger route systems. We also are susceptible to Air Traffic Control due to our heavy concentration of departures from Seattle and San Francisco.

No material part of our business, or that of our subsidiaries, is dependent upon a single customer, or upon a few high-volume customers.

EMPLOYEES

Our business is labor intensive. As of December 31, 2017, we employed 23,156 (13,896 at Alaska, 3,538 at Virgin America, 3,943 at Horizon, and 1,779 at McGee Air Services) active full-time and part-time employees. Wages and benefits, including variable incentive pay, represented approximately 39% of our total non-fuel operating expenses in 2017 and 40% in 2016.

Most major airlines, including Alaska, Virgin America, and Horizon, have employee groups that are covered by collective bargaining agreements (CBA). Airlines with unionized work forces generally have higher labor costs than carriers without unionized work forces, and they may not have the ability to adjust labor costs downward quickly enough to respond to new competition or slowing demand.

As part of the integration, we have been working to bring represented Alaska Airlines and Virgin America work groups under single collective bargaining agreements. The process for combining workgroups begins with the union filing a petition with the National Mediation Board (NMB), at which point the NMB performs a review to assess a ‘single carrier determination’ for the airlines. Following this single carrier determination, the NMB makes a representation determination depending on size of the pre-merger bargaining units and will either extend the certification if one is significantly larger than the other or require a vote. Once representation is determined, the NMB certifies the union as the bargaining representative for the work group. The parties must also work together to achieve agreed upon single collective bargaining agreements. Integration also requires the pre-merger work groups to agree upon and finalize integrated seniority lists. As of December 31, 2017 we have labor integration agreements with pilots and clerical, office, and passenger services employees, meaning all agreements are completed to define how and when we will combine the Alaska and Virgin America groups into one. The remaining work groups are still in process of completing similar such agreements. The time frame to reach single CBA and full transition to work rules for each group will vary.

At December 31, 2017, labor unions represented 84% of Alaska’s, 84% of Virgin America's, 44% of Horizon’s, and 90% of McGee Air Services' employees.

Our relations with U.S. labor organizations are governed by the Railway Labor Act (RLA). Under the RLA, collective bargaining agreements do not expire but instead become amendable as of a stated date. If either party wishes to modify the terms of any such agreement, it must notify the other party in the manner prescribed by the RLA and/or described in the agreement. After receipt of such notice, the parties must meet for direct negotiations, and if no agreement is reached, either party may request the NMB to initiate a process including mediation, arbitration, and a potential “cooling off” period that must be followed before either party may engage in self-help.

Alaska’s union contracts at December 31, 2017 were as follows:



Union	Employee Group	Number of Employees	Contract Status
Air Line Pilots Association, International (ALPA)	Pilots	1,970	Amendable 4/1/2020
Association of Flight Attendants (AFA)	Flight attendants	4,392	Amendable 12/17/2019
International Association of Machinists and Aerospace Workers (IAM)	Ramp service and stock clerks	673	Amendable 7/19/2018
IAM	Clerical, office and passenger service	3,733	Amendable 1/1/2019
Aircraft Mechanics Fraternal Association (AMFA)	Mechanics, inspectors and cleaners	706	Amendable 10/17/2021
Mexico Workers Association of Air Transport	Mexico airport personnel	106	Amendable 2/1/2018
Transport Workers Union of America (TWU)	Dispatchers	52	Amendable 3/24/2019

Virgin America's union contracts at December 31, 2017 were as follows:



Union	Employee Group	Number of Employees	Contract Status
ALPA	Pilots	858	Amendable 4/1/2020
AFA	Inflight teammates	1,209	Not completed
IAM	Clerical, office and passenger service	865	Amendable 1/1/2019
TWU	Dispatchers	36	Not completed

Horizon’s union contracts at December 31, 2017 were as follows:



Union	Employee Group	Number of Employees	Contract Status
International Brotherhood of Teamsters (IBT)	Pilots	729	Amendable 12/14/2024
AFA	Flight attendants	660	Amendable 7/18/2019
IBT	Mechanics and related classifications	283	Amendable 12/16/2020
Unifor	Station personnel in Vancouver and Victoria, BC, Canada	37	Amendable 2/14/2019
TWU	Dispatchers	21	Amendable 8/26/2018

McGee Air Services union contract at December 31, 2017 was as follows:



Union	Employee Group	Number of Employees	Contract Status
IAM	Fleet and ramp	1,596	Amendable 7/19/2023

EXECUTIVE OFFICERS

The executive officers of Air Group, and executive officers of Alaska, Virgin America and Horizon who have significant decision-making responsibilities, their positions and their respective ages are as follows:



Name	Position	Age	Air Group or Subsidiary Officer Since
Bradley D. Tilden	Chairman and Chief Executive Officer of Alaska Air Group, Inc., Chairman of Alaska Airlines, Inc. and Virgin America Inc., Chairman of Horizon Air Industries, Inc.	57	1994

Benito Minicucci	President and Chief Operating Officer of Alaska Airlines, Inc. and Chief Executive Officer of Virgin America Inc.	51	2004

Brandon S. Pedersen	Executive Vice President/Finance and Chief Financial Officer of Alaska Air Group, Inc. and Alaska Airlines, Inc., and Chief Financial Officer of Virgin America Inc.	51	2003

Andrew R. Harrison	Executive Vice President and Chief Commercial Officer of Alaska Airlines, Inc.	47	2008

Kyle B. Levine	Vice President Legal, General Counsel and Corporate Secretary of Alaska Air Group, Inc. and Alaska Airlines, Inc. and Chief Ethics and Compliance Officer of Alaska Air Group, Inc.	46	2016

David L. Campbell	Former President and Chief Executive Officer of Horizon Air Industries, Inc.	56	2014

Gary L. Beck	President and Chief Executive Officer of Horizon Air Industries, Inc.	70	2018

Peter D. Hunt	President and Chief Operating Officer of Virgin America Inc.	48	2017

Shane R. Tackett	Senior Vice President, Revenue and E-commerce of Alaska Airlines, Inc.	39	2017

Andrea L. Schneider	Vice President People of Alaska Airlines, Inc.	52	2017

Diana Birkett Rakow	Vice President External Relations of Alaska Airlines, Inc.	40	2017

Mr. Tilden joined Alaska Airlines in 1991, became Controller of Alaska Air Group and Alaska Airlines in 1994 and was named Vice President/Finance at Alaska Airlines in January 1999 and at Alaska Air Group in February 2000. He was elected Alaska Airlines Chief Financial Officer in February 2000, Executive Vice President/Finance and Chief Financial Officer of both companies in January 2002 and Executive Vice President/Finance and Planning of Alaska Airlines in April 2007. Mr. Tilden was named President of Alaska Airlines in December 2008 and, in May 2012, he was elected President and CEO of Alaska Air Group and Alaska Airlines and CEO of Horizon Air. He leads Air Group’s Management Executive Committee and was elected to the Air Group Board in 2010 and became Chairman of the Board in January 2014. In December 2017, Mr. Tilden was elected as President and CEO of Horizon Air, effective January 5, 2018, until Mr. Beck was elected effective January 15, 2018.

Mr. Minicucci joined Alaska Airlines in 2004 as Staff Vice President of Maintenance and Engineering and was promoted to Vice President of Seattle Operations in June 2008. He was elected Executive Vice President/Operations and Chief Operating Officer of Alaska Airlines in December 2008. In May 2016, he was named President of Alaska Airlines and, in December 2016, Chief Executive Officer of Virgin America. He is a member of Air Group’s Management Executive Committee.

Mr. Pedersen joined Alaska Airlines in 2003 as Staff Vice President/Finance and Controller of Alaska Air Group and Alaska Airlines and was elected Vice President/Finance and Controller for both entities in 2006. He was elected Chief Financial Officer of Alaska Air Group and Alaska Airlines in June 2010 and Executive Vice President/Finance and Chief Financial

Officer of both entities in 2014. In December 2016, he was named Chief Financial Officer of Virgin America Inc. He is a member of Air Group's Management Executive Committee.

Mr. Harrison joined Alaska Airlines in 2003 as the Managing Director of Internal Audit and was elected Vice President of Planning and Revenue Management in 2008. He was elected Senior Vice President of Planning and Revenue Management in 2014. He was elected Executive Vice President and Chief Revenue Officer in February 2015 and named Executive Vice President and Chief Commercial Officer in August 2015. He is a member of Air Group's Management Executive Committee.

Mr. Campbell resigned as President and CEO of Horizon Air Industries, Inc. effective January 5, 2018. He joined Horizon Air in 2014 as President and Chief Operating Officer and was named President and Chief Executive Officer in May 2016. Prior to joining Horizon Air, Mr. Campbell served more than 25 years in maintenance and flight operations. He was a member of Air Group's Management Executive Committee.

Mr. Levine was elected Vice President Legal and General Counsel of Alaska Air Group and Alaska Airlines in January 2016 and is a member of Air Group’s Management Executive Committee. He was elected Corporate Secretary of Alaska Air Group and Alaska Airlines in August 2017. Mr. Levine joined Alaska Airlines in February 2006 as a Senior Attorney. He also served as Associate General Counsel and Managing Director Commercial Law and General Litigation from July 2009 to February 2011 and, subsequently, as Deputy General Counsel and Managing Director of Legal at Alaska Airlines from February 2011 to January 2016. He was appointed Assistant Corporate Secretary of Horizon Air in August 2017 and Virgin America in November 2017.

Mr. Beck was elected President and CEO of Horizon Air effective January 15, 2018 and is a member of Air Group’s Management Executive Committee. Mr. Beck previously served as Vice President, Flight Operations at Alaska Airlines, Inc. until retiring in June 2015. Since then, he has provided consulting services to Alaska Airlines, Inc. in connection with the integration to a single operating certificate with Virgin America Inc.

Mr. Hunt was elected President and Chief Operating Officer of Virgin America Inc. in December 2016, effective with the merger of Alaska Airlines, Inc. and Virgin America Inc. He became a member of Air Group’s Management Executive Committee in January 2017. Mr. Hunt previously served as Senior Vice President and Chief Financial Officer at Virgin America (2011 - 2016). Prior to joining Virgin America, Mr. Hunt was Vice President and CFO of Pinnacle Airlines Corp. (2004-2011).

Mr. Tackett was elected Senior Vice President of Revenue and E-commerce in August 2017 and became a member of Air Group’s Management Executive Committee at that time. Mr. Tackett previously served in a number of capacities since joining Alaska Airlines in 2000, including Managing Director Financial Planning and Analysis, (2008-2010), Vice President Labor Relations (2010-2015) and Vice President Revenue Management in 2016.

Ms. Schneider was elected Vice President of People at Alaska Airlines in August 2017 and became a member of Air Group’s Management Executive Committee at that time. Ms. Schneider was previously Vice President of Inflight Services at Alaska (2011-2017), later also taking responsibility for Call Centers at Alaska (February 2017). She began her career at Alaska as Manager of Financial Accounting in 1989. Since that time, she has held a number of positions, including Senior Vice President of People and Customer Services at Horizon Air Industries (2009-2011).

Ms. Birkett Rakow was elected Vice President of External Relations at Alaska Airlines in September 2017 and became a member of Air Group’s Management Executive Committee at that time. She was previously Vice President of Public Affairs, Communications and Brand Management for Kaiser Permanente (2017). From 2006-2017, Ms. Birkett Rakow held a number of positions at Group Health Cooperative, including Executive Vice President, Marketing and Public Affairs (2014-2017), Vice President Marketing and Public Affairs (2014) and Vice President Public Affairs (2013-2014). From 2003-2006, Ms. Birkett Rakow was a member of the United States Senate Finance Committee as its Health Policy Advisor.

REGULATION

GENERAL

The airline industry is highly regulated, most notably by the federal government. The Department of Transportation (DOT), the Federal Aviation Administration (FAA) and the Transportation Security Administration (TSA) exercise significant regulatory authority over air carriers.

•

DOT: In order to provide passenger and cargo air transportation in the U.S., a domestic airline is required to hold a certificate of public convenience and necessity issued by the DOT. Subject to certain individual airport capacity, noise and other restrictions, this certificate permits an air carrier to operate between any two points in the U.S. Certificates do not expire, but may be revoked for failure to comply with federal aviation statutes, regulations, orders or the terms of the certificates. While airlines are permitted to establish their own fares without government regulation, the DOT has jurisdiction over the approval of international codeshare agreements, marketing alliance agreements between major domestic carriers, international and some domestic route authorities, Essential Air Service market subsidies, carrier liability for personal or property damage, and certain airport rates and charges disputes. International treaties may also contain restrictions or requirements for flying outside of the U.S. and impose different carrier liability limits than those applicable to domestic flights. The DOT has been active in implementing a variety of “consumer protection” regulations, covering subjects such as advertising, passenger communications, denied boarding compensation and tarmac delay response. Airlines are subject to enforcement actions that are brought by the DOT from time to time for alleged violations of consumer protection and other economic regulations. We are not aware of any enforcement proceedings that could either materially affect our financial position or impact our authority to operate.

•

FAA: The FAA, through Federal Aviation Regulations (FARs), generally regulates all aspects of airline operations, including establishing personnel, maintenance and flight operation standards. Domestic airlines are required to hold a valid air carrier operating certificate issued by the FAA. Pursuant to these regulations, we have established, and the FAA has approved, our operations specifications and a maintenance program for each type of aircraft we operate. Each maintenance program provides for the ongoing maintenance of the relevant aircraft type, ranging from frequent routine inspections to major overhauls. From time to time, the FAA issues airworthiness directives (ADs) that must be incorporated into our aircraft maintenance program and operations. All airlines are subject to enforcement actions that are brought by the FAA from time to time for alleged violations of FARs or ADs. At this time, we are not aware of any enforcement proceedings that could either materially affect our financial position or impact our authority to operate.

•

TSA: Airlines serving the U.S. must operate a TSA-approved Aircraft Operator Standard Security Program (AOSSP), and comply with TSA Security Directives (SDs) and regulations. Under TSA authority, we are required to collect a September 11 Security Fee of $5.60 per one-way trip from passengers and remit that sum to the government to fund aviation security measures. Airlines are subject to enforcement actions that are brought by the TSA from time to time for alleged violations of the AOSSP, SDs or security regulations. We are not aware of any enforcement proceedings that could either materially affect our financial position or impact our authority to operate.

The Department of Justice and DOT have jurisdiction over airline antitrust matters. The U.S. Postal Service has jurisdiction over certain aspects of the transportation of mail and related services. Labor relations in the air transportation industry are regulated under the Railway Labor Act. To the extent we continue to fly to foreign countries and pursue alliances with international carriers, we may be subject to certain regulations of foreign agencies and international treaties.

ENVIRONMENTAL AND OCCUPATIONAL SAFETY MATTERS

We are subject to various laws and government regulations concerning environmental matters and employee safety and health in the U.S. and other countries. We are also subject to the oversight of the Occupational Safety and Health Administration (OSHA) concerning employee safety and health matters. The U.S. Environmental Protection Agency, OSHA, and other federal agencies have been authorized to create and enforce regulations that have an impact on our operations. In addition to these federal activities, various states have been delegated certain authorities under these federal statutes. Many state and local governments have adopted environmental and employee safety and health laws and regulations. We maintain our safety, health and environmental programs in order to meet or exceed these requirements.

In the future there may be legislation to reduce carbon and other greenhouse gas emissions. Over the course of several years, we have transitioned to more fuel-efficient aircraft fleets and reduced our emissions with the goal of continuing that trend.

The Airport Noise and Capacity Act recognizes the rights of airport operators with noise problems to implement local noise abatement programs so long as they do not interfere unreasonably with interstate or foreign commerce or the national air transportation system. Authorities in several cities have established aircraft noise reduction programs, including the imposition of nighttime curfews. We believe we have sufficient scheduling flexibility to accommodate local noise restrictions.

Although we do not currently anticipate that these regulatory matters, individually or collectively, will have a material effect on our financial condition, results of operations or cash flows, new regulations or compliance issues that we do not currently anticipate could have the potential to harm our financial condition, results of operations or cash flows in future periods.

INSURANCE

We carry insurance of types customary in the airline industry and in amounts deemed adequate to protect our interests and property and to comply both with federal regulations and certain credit and lease agreements. The insurance policies principally provide coverage for Airline Hull, Spares and Comprehensive Legal Liability, War and Allied Perils, and Workers’ Compensation. In addition, we currently carry a Cyber Insurance policy in the event of security breaches from malicious parties.

We believe that our emphasis on safety and our state-of-the-art flight deck safety technology help to control the cost of our insurance.

WHERE YOU CAN FIND MORE INFORMATION

Our filings with the Securities and Exchange Commission, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available on our website at www.alaskaair.com, free of charge, as soon as reasonably practicable after the electronic filing of these reports with the Securities and Exchange Commission. The information contained on our website is not a part of this annual report on Form 10-K.

GLOSSARY OF TERMS

Aircraft Utilization - block hours per day; this represents the average number of hours per day our aircraft are in transit

Aircraft Stage Length - represents the average miles flown per aircraft departure

ASMs - available seat miles, or “capacity”; represents total seats available across the fleet multiplied by the number of miles flown

CASM - operating costs per ASM, or "unit cost"; represents all operating expenses including fuel and special items

CASMex - operating costs excluding fuel and special items per ASM; this metric is used to help track progress toward reduction of non-fuel operating costs since fuel is largely out of our control

Debt-to-capitalization ratio - represents adjusted debt (long-term debt plus the present value of future operating lease payments) divided by total equity plus adjusted debt

Diluted Earnings per Share - represents earnings per share (EPS) using fully diluted shares outstanding

Diluted Shares - represents the total number of shares that would be outstanding if all possible sources of conversion, such as stock options, were exercised

Economic Fuel - best estimate of the cash cost of fuel, net of the impact of our fuel-hedging program

Free Cash Flow - total operating cash flow generated less cash paid for capital expenditures

Load Factor - RPMs as a percentage of ASMs; represents the number of available seats that were filled with paying passengers

Mainline - represents flying Boeing 737 and Airbus 320 family jets and all associated revenues and costs

PRASM - passenger revenue per ASM; commonly called “passenger unit revenue”

Productivity - number of revenue passengers per full-time equivalent employee

RASM - operating revenue per ASMs, or "unit revenue"; operating revenue includes all passenger revenue, freight & mail, Mileage Plan™ and other ancillary revenue; represents the average total revenue for flying one seat one mile

Regional - represents capacity purchased by Alaska from Horizon, SkyWest and PenAir. In this segment, 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 capacity purchased arrangement (CPAs). Additionally, Regional includes an allocation of corporate overhead such as IT, finance, and other administrative costs incurred by Alaska and on behalf of Horizon.

RPMs - revenue passenger miles, or "traffic"; represents the number of seats that were filled with paying passengers; one passenger traveling one mile is one RPM

Yield - passenger revenue per RPM; represents the average revenue for flying one passenger one mile

ITEM 1A. RISK FACTORS

If any of the following occurs, our business, financial condition and results of operations could suffer. The trading price of our common stock could also decline. We operate in a continually changing business environment. In this environment, new risks may emerge, and already identified risks may vary significantly in terms of impact and likelihood of occurrence. Management cannot predict such developments, nor can it assess the impact, if any, on our business of such new risk factors or of events described in any forward-looking statements.

We have adopted an enterprise-wide risk analysis and oversight program designed to identify the various risks faced by the organization, assign responsibility for managing those risks to individual executives as well as align these risks with Board oversight. These enterprise-wide risks have been aligned to the risk factors discussed below.

SAFETY, COMPLIANCE AND OPERATIONAL EXCELLENCE

Our reputation and financial results could be harmed in the event of an airline accident or incident.

An accident or incident involving one of our aircraft or an aircraft operated by one of our codeshare partners or CPA carriers could involve a significant loss of life and result in a loss of confidence in our Company by the flying public and/or aviation authorities. We could experience significant claims from injured passengers, bystanders and surviving relatives as well as costs for the repair or replacement of a damaged aircraft and temporary or permanent loss from service. We maintain liability insurance in amounts and of the type generally consistent with industry practice, as do our codeshare partners and CPA carriers. However, the amount of such coverage may not be adequate to fully cover all claims, and we may be forced to bear substantial economic losses from such event. Substantial claims resulting from an accident in excess of our related insurance coverage would harm our business and financial results. Moreover, any aircraft accident or incident, even if it is fully insured and does not involve one of our aircraft, could cause a public perception that our airlines or the aircraft we or our partners fly are less safe or reliable than other transportation alternatives. This would harm our business.

Our operations are often affected by factors beyond our control, including delays, cancellations and other conditions, which could harm our business, financial condition and results of operations.

As is the case for all airlines, our operations often are affected by delays, cancellations and other conditions caused by factors largely beyond our control.

Factors that might impact our operations include:


•	congestion and/or space constraints at airports, specifically in our hub locations of Seattle, Los Angeles, and San Francisco;


•	air traffic control problems;


•	lack of operational approval (e.g. new routes, aircraft deliveries, etc.);


•	adverse weather conditions;


•	increased security measures or breaches in security;


•	contagious illness and fear of contagion;


•	changes in international treaties concerning air rights;


•	international or domestic conflicts or terrorist activity; and


•	other changes in business conditions.

Due to our concentration of flights along the West Coast and Alaska, we believe a large portion of our operation is more susceptible to air traffic control delays. Additionally, due to our concentration of flights in the Pacific Northwest and Alaska we believe a large portion of our operation is more susceptible to adverse weather conditions. A general reduction in airline passenger traffic as a result of any of the above-mentioned factors could harm our business, financial condition and results of operations.

Changes in government regulation imposing additional requirements and restrictions on our operations could increase our operating costs and result in service delays and disruptions.

Airlines are subject to extensive regulatory and legal requirements, both domestically and internationally, that involve significant compliance costs. In the last several years, Congress has passed laws, and the U.S. DOT, the TSA and the FAA have issued regulations that have required significant expenditures relating to maintenance of aircraft, operation of airlines and broadening of consumer protections.

Similarly, there are a number of legislative and regulatory initiatives and reforms at the federal, state and local levels. These initiatives include increasingly stringent laws to protect the environment, minimum wage requirements, mandatory paid sick or family leave, and health care mandates. They could affect our relationship with our workforce and the vendors that serve our airlines and cause our expenses to increase without an ability to pass through these costs.

Almost all commercial service airports are owned and/or operated by units of local or state governments. Airlines are largely dependent on these governmental entities to provide adequate airport facilities and capacity at an affordable cost. Many airports have increased their rates and charges to air carriers to reflect higher costs of security, updates to infrastructure and other. Additional laws, regulations, taxes, airport rates and airport charges may be occasionally proposed that could significantly increase the cost of airline operations or reduce the demand for air travel. Although lawmakers may impose these additional fees and view them as “pass-through” costs, we believe that a higher total ticket price will influence consumer purchase and travel decisions and may result in an overall decline in passenger traffic, which would harm our business.

The airline industry continues to face potential security concerns and related costs.

Terrorist attacks, the fear of such attacks or other hostilities involving the U.S. could have a significant negative effect on the airline industry, including us, and could:


•	significantly reduce passenger traffic and yields as a result of a potentially dramatic drop in demand for air travel;


•	significantly increase security and insurance costs;


•	make war risk or other insurance unavailable or extremely expensive;


•	increase fuel costs and the volatility of fuel prices;


•	increase costs from airport shutdowns, flight cancellations and delays resulting from security breaches and perceived safety threats; and


•	result in a grounding of commercial air traffic by the FAA.

The occurrence of any of these events would harm our business, financial condition and results of operations.

We rely on third-party vendors for certain critical activities.

We rely on outside vendors for a variety of services and functions critical to our business, including airframe and engine maintenance, regional flying, ground handling, fueling, computer reservation system hosting, telecommunication systems, information technology infrastructure and services, and deicing.

Even though we strive to formalize agreements with these vendors that define expected service levels, our use of outside vendors increases our exposure to several risks. In the event that one or more vendors go into bankruptcy, ceases operation or fails to perform as promised, replacement services may not be readily available at competitive rates, or at all. If one of our vendors fails to perform adequately, we may experience increased costs, delays, maintenance issues, safety issues or negative

public perception of our airline. Vendor bankruptcies, unionization, regulatory compliance issues or significant changes in the competitive marketplace among suppliers could adversely affect vendor services or force us to renegotiate existing agreements on less favorable terms. These events could result in disruptions in our operations or increases in our cost structure.

INTEGRATION OF VIRGIN AMERICA

We may be unable to effectively integrate Virgin America’s business and realize the anticipated benefits of the acquisition.

We must devote significant management attention and resources to integrating the business practices and operations of Virgin America. Potential difficulties we may encounter as part of the integration process include the following:


•	the challenges associated with integrating Virgin America employees into Alaska's workforce, including seniority list integration, and negotiation of transition process agreements, while maintaining our focus on providing consistent, high quality customer service;


•	the inability to successfully attract and retain Virgin America guests upon integration with Alaska;


•	the challenges associated with integrating complex systems, technology, aircraft fleets, networks, facilities and other assets in a seamless manner that minimizes any adverse impact on guests, suppliers, employees and other constituents; and


•	the challenges associated with operating aircraft types new to our operations, specifically the Airbus A319, A320, and A321neo.

Any of the foregoing factors could adversely affect our ability to maintain relationships with guests, suppliers, employees and other constituencies or our ability to achieve the anticipated benefits of the acquisition on a timely basis, or at all. These factors could also reduce our earnings or otherwise adversely affect our business and financial results. In addition, integration requirements have caused, and may continue to cause, a delay of other strategic initiatives.

The need to integrate Virgin America’s workforce into collective bargaining agreements with Alaska's workforce presents the potential for delay in achieving expected synergies and other benefits or labor disputes that could adversely affect our operations and costs.

The successful integration of Virgin America and achievement of the anticipated benefits of the acquisition depend significantly on integrating Virgin America’s employees into Alaska and on maintaining productive employee relations. Failure to do so presents the potential for delays in achieving expected synergies and other benefits of integration or labor disputes that could adversely affect our operations and costs. The process for integrating labor groups in an airline merger is governed by a combination of the Railway Labor Act, the McCaskill-Bond Act, and where applicable, the existing provisions of our CBAs, in addition to internal union policies.

As part of the transition agreement with the pilot workgroup, there is a temporary “fence” between Alaska and Virgin America pilots requiring that only Alaska pilots operate Boeing aircraft and only Virgin America pilots operate Airbus aircraft. Through the implementation of the recent Joint Collective Bargaining Agreement that now applies to all pilots from both airlines, this fence will be removed when the two groups are combined into a single scheduling system later in 2018. In addition, flight attendants, dispatchers, and mechanics cannot be fully integrated until transition agreements have been reached and single seniority lists have been provided to the Company by each workgroup. Achievement of expected synergies and other benefits will be delayed until the time that operational integration is obtained.

We will need to launch certain branding or rebranding initiatives in connection with the integration that may take a significant amount of time and involve substantial costs and that may not be favorably received by our guests.

We may incur substantial costs as a result of rebranding Virgin America’s products and services, including updating the aircraft livery and configuration, and may not be able to achieve or maintain brand name recognition or status that is comparable to the recognition and status previously enjoyed by Virgin America in any of Virgin America’s markets. The failure of any such rebranding initiatives could adversely affect our ability to attract and retain guests, which could cause us not to realize some or all of the anticipated benefits contemplated to result from the acquisition.

We are expected to incur substantial expenses related to the integration of Virgin America.

We are expected to continue to incur substantial integration and transition expenses in connection with the acquisition of Virgin America, including the necessary costs associated with integrating the operations of Alaska and Virgin America. There are a large number of processes, policies, procedures, operations, technologies and systems that must be integrated, including ticketing/distribution, maintenance and flight operations. While we have assumed that a certain level of expenses will be incurred, there are many factors beyond our control that could affect the total amount or the timing of the integration expenses. Moreover, many of the expenses that will be incurred are, by their nature, difficult to estimate accurately. These expenses could, particularly in the near term, exceed the financial benefits we expect to achieve from the acquisition, including the elimination of duplicative expenses and the realization of economies of scale and cost savings. These integration expenses likely will continue to result in us taking charges against earnings in future periods, and the amount and timing of such charges are uncertain at present.

The application of the acquisition method of accounting resulted in us recording a significant amount of goodwill, which could result in significant future impairment charges and negatively affect our financial results.

In accordance with applicable acquisition accounting rules, we recorded goodwill on our consolidated balance sheet to the extent the Virgin America acquisition purchase price exceeded the net fair value of Virgin America’s tangible and identifiable intangible assets and liabilities as of the acquisition date. Goodwill is not amortized, but is tested for impairment at least annually. We could record impairment charges in our results of operations as a result of, among other items, extreme fuel price volatility, a significant decline in the fair value of certain tangible or intangible assets, unfavorable trends in forecasted results of operations and cash flows, uncertain economic environment and other uncertainties. We can provide no assurance that a significant impairment charge will not occur in one or more future periods. Any such charges may materially negatively affect our financial results.

We obtain our rights to use the Virgin brand under agreements with certain entities affiliated with the Virgin Group, and we would lose those rights if these agreements are terminated or not renewed.

Virgin America is a party to license agreements with certain entities affiliated with the Virgin Group pursuant to which we obtain rights to use the Virgin brand. The licensor may terminate the agreements upon the occurrence of a number of specified events including if Virgin America commits a material breach of its obligations under the agreements that is uncured for more than 10 business days or if it materially damages the Virgin brand. If we lose our rights to use the Virgin brand, our current plan to discontinue use of the Virgin America trademarks gradually would need to be accelerated, which could have an adverse impact on our financial condition.

The Virgin brand is not under our control, and negative publicity related to the Virgin brand name could materially adversely affect our business.

Virgin America licenses rights to the Virgin brand from certain entities affiliated with the Virgin Group on a non-exclusive basis. The Virgin brand is also licensed to and used by a number of other companies, including two airlines, Virgin Atlantic Airways and Virgin Australia Airlines, operating in other geographies. We rely on the general goodwill of consumers and our employees towards the Virgin brand. Consequently, any adverse publicity in relation to the Virgin brand name, its principals, particularly Sir Richard Branson who is closely associated with the brand, or another Virgin-branded company over which we have no control or influence could have a material adverse effect on our business.

STRATEGY

The airline industry is highly competitive and susceptible to price discounting and changes in capacity, which could have a material adverse effect on our business. If we cannot successfully compete in the marketplace, our business, financial condition, and operating results will be materially adversely affected.

The U.S. airline industry is characterized by substantial price competition. In recent years, the market share held by low-cost carriers and ultra low-cost carriers has increased significantly and is expected to continue to increase. Airlines also compete for market share by increasing or decreasing their capacity, route systems, and the number of markets served. Several of our competitors have increased their capacity in markets we serve, particularly in our key West Coast markets. The resulting increased competition in both domestic and international markets may have a material adverse effect on our results of operations, financial condition, or liquidity.

We continue to strive toward maintaining and improving our competitive cost structure by setting aggressive cost-reduction goals. This is an important part of our business strategy of offering the best value to our guests through low fares while achieving acceptable profit margins and return on capital. If we are unable to maintain our cost advantage over the long-term and achieve sustained targeted returns on invested capital, we will likely not be able to grow our business in the future or weather industry downturns. Therefore, our financial results may suffer.

The airline industry may undergo further restructuring, consolidation, or the creation or modification of alliances or joint ventures, any of which could have a material adverse effect on our business, financial condition and results of operations.

We continue to face strong competition from other carriers due to restructuring, consolidation, and the creation and modification of alliances and joint ventures. Since deregulation, both the U.S. and international airline industries have experienced consolidation through a number of mergers and acquisitions. Carriers may also improve their competitive positions through airline alliances, slot swaps/acquisitions and/or joint ventures. Certain airline joint ventures further competition by allowing airlines to coordinate routes, pool revenues and costs, and enjoy other mutual benefits, achieving many of the benefits of consolidation.

Our concentration in certain markets could cause us to be disproportionately impacted by adverse changes in circumstances in those locations.

Our strategy includes being the premier carrier for people living on the West Coast. This results in a high concentration of our business in key West Coast markets. A significant portion of our flights occur to and from our Seattle, Portland, and Bay Area hubs. In 2017, passengers to and from Seattle, Portland, and the Bay Area accounted for 81% of our total guests.

We believe that concentrating our service offerings in this way allows us to maximize our investment in personnel, aircraft and ground facilities, as well as to gain greater advantage from sales and marketing efforts in those regions. As a result, we remain highly dependent on our key markets. Our business could be harmed by any circumstances causing a reduction in demand for air transportation in our key markets. An increase in competition in our key markets could also cause us to reduce fares or take other competitive measures that, if sustained, could harm our business, financial condition and results of operations.

We are dependent on a limited number of suppliers for aircraft and parts.

Alaska is dependent on Boeing as its sole supplier for aircraft and many aircraft parts. Virgin America is similarly dependent on Airbus, and Horizon is dependent on Bombardier and Embraer. Additionally, each carrier is dependent on sole suppliers for aircraft engines for each aircraft type. As a result, we are more vulnerable to issues associated with the supply of those aircraft and parts including design defects, mechanical problems, contractual performance by the manufacturers, or adverse perception by the public that would result in customer avoidance or in actions by the FAA. Additionally, further consolidation amongst aircraft and aircraft parts manufacturers could further limit the number of suppliers. This could result in an inability to operate our aircraft or instability in the foreign countries, in which the aircraft and its parts are manufactured.

We rely on partner airlines for codeshare and frequent flyer marketing arrangements.

Our airlines are parties to marketing agreements with a number of domestic and international air carriers, or “partners." These agreements provide that certain flight segments operated by us are held out as partner “codeshare” flights and that certain partner flights are held out for sale as Alaska or Virgin America codeshare flights. In addition, the agreements generally provide that members of Alaska’s Mileage Plan™ program can earn credit on or redeem credit for partner flights and vice versa. We receive revenue from flights sold under codeshare and from interline arrangements. In addition, we believe that the frequent flyer arrangements are an important part of our frequent flyer program. The loss of a significant partner through bankruptcy, consolidation, or otherwise, could have a negative effect on our revenues or the attractiveness of our Mileage Plan™ program, which we believe is a source of competitive advantage.

We routinely engage in analysis and discussions regarding our own strategic position, including alliances, codeshare arrangements, interline arrangements, and frequent flyer program enhancements, and may have future discussions with other airlines regarding similar activities. If other airlines participate in consolidation or reorganization, those airlines may significantly improve their cost structures or revenue generation capabilities, thereby potentially making them stronger competitors of ours and potentially impairing our ability to realize expected benefits from our own strategic relationships.

Economic uncertainty, or another recession, would likely impact demand for our product and could harm our financial condition and results of operations.

The airline industry, which is subject to relatively high fixed costs and highly variable and unpredictable demand, is particularly sensitive to changes in economic conditions. We are also highly dependent on U.S. consumer confidence and the health of the U.S. economy. Unfavorable U.S. economic conditions have historically driven changes in travel patterns and have resulted in reduced spending for both leisure and business travel. For some consumers, leisure travel is a discretionary expense, and shorter distance travelers, in particular, have the option to replace air travel with surface travel. Businesses are able to forgo air travel by using communication alternatives such as videoconferencing or may be more likely to purchase less expensive tickets to reduce costs, which can result in a decrease in average revenue per seat. Unfavorable economic conditions also hamper the ability of airlines to raise fares to counteract increased fuel, labor and other costs. Unfavorable or even uncertain economic conditions could negatively affect our financial condition and results of operations.

INFORMATION TECHNOLOGY

We rely heavily on automated systems to operate our business, and a failure to invest in new technology or a disruption of our current systems or their operators could harm our business.

We depend on automated systems to operate our business, including our airline reservation system, our telecommunication systems, our website, our maintenance systems, our check-in kiosks, mobile devices, and other systems. Substantially all of our tickets are issued to our guests as electronic tickets, and the majority of our customers check in using our website, airport kiosks, or our mobile application. We depend on our reservation system to be able to issue, track and accept these electronic tickets. In order for our operations to work efficiently, we must continue to invest in new technology to ensure that our website, reservation system and check-in systems are able to accommodate a high volume of traffic, maintain information security and deliver important flight information. Substantial or repeated website, reservations system or telecommunication systems failures or service disruptions could reduce the attractiveness of our services and cause our guests to do business with another airline. In addition, we rely on other automated systems for crew scheduling, flight dispatch and other operational needs. We also plan to move our primary data center location. Disruptions, failed migration, untimely recovery, or a breach of these systems or the data center could result in the loss of important data, an increase of our expenses, an impact on our operational performance, or a possible temporary cessation of our operations.

If we do not maintain the privacy and security of our information, we could damage our reputation and incur substantial legal and regulatory costs.

We accept, store and transmit information about our guests, our employees, our business partners, and our business. In addition, we frequently rely on third-party hosting sites and data processors, including cloud providers. Our sensitive information relies on secure transmission over public and private networks. A compromise of our systems, the security of our infrastructure or those of other business partners that result in our information being accessed or stolen by unauthorized persons could adversely affect our operations and our reputation.

FINANCIAL CONDITION AND FINANCIAL MARKETS

Our business, financial condition and results of operations are substantially exposed to the volatility of jet fuel prices. Significant increases in jet fuel costs would harm our business.

Fuel costs constitute a significant portion of our total operating expenses. Future increases in the price of jet fuel may harm our business, financial condition and results of operations unless we are able to increase fares and fees or add additional ancillary services to attempt to recover increasing fuel costs.

Our indebtedness and other fixed obligations could lead to liquidity constraints that may restrict our activities.

We incurred a significant amount of new debt to finance our acquisition of Virgin America. We now have, and will continue to have for the foreseeable future, a substantial amount of debt. Due to our high fixed costs, including aircraft lease commitments and debt service, a decrease in revenues would result in a disproportionately greater decrease in earnings.

Our outstanding long-term debt and other fixed obligations could have important consequences. For example, they could limit our ability to obtain additional financing to fund our future capital expenditures, working capital or other purposes; require us to dedicate a material portion of our operating cash flow to fund lease payments and interest payments on indebtedness, thereby reducing funds available for other purposes; or limit our ability to withstand competitive pressures and reduce our flexibility in responding to changing business and economic conditions.

Although we have historically been able to generate sufficient cash flow from our operations to pay our debt and other fixed obligations when they become due, we cannot ensure we will be able to do so in the future. If we fail to do so, our business could be harmed.

Our maintenance costs will increase as our fleet ages, and we will periodically incur substantial maintenance costs due to the timing of maintenance events of our aircraft.

As of December 31, 2017, the average age of our NextGen aircraft (B737-800, -900, -900ERs) was approximately 7.5 years, the average age of our A319, A320, and A321neo aircraft was approximately 7.3 years, the average age of our Embraer E175 aircraft was approximately 1.2 years, and the average age of our Q400 aircraft was approximately 11 years. Our relatively new aircraft require less maintenance currently than they will in the future. Any significant increase in maintenance expenses could have a material adverse effect on our results of operations.

Our ability to use Virgin America’s net operating loss carryforwards to offset future taxable income for U.S. federal and state income tax purposes may be limited if we are unable to earn adequate taxable income in future periods.

Our ability to use the net operating loss carryforwards (NOLs) will depend on the amount of taxable income generated in future periods. The NOLs may expire before we can generate sufficient taxable income to utilize the NOLs.

BRAND AND REPUTATION

As we evolve our brand to appeal to a changing demographic and grow into new markets, we will engage in strategic initiatives that may not be favorably received by all of our guests.

We continue to focus on strategic initiatives designed to increase our brand appeal to a diverse and evolving demographic of airline travelers. These efforts could include significant enhancements to our in-airport and on-board environments, increasing our direct customer relationships through improvements to our purchasing portals (digital and mobile) and optimization of our customer loyalty programs.

In pursuit of these efforts we may negatively affect our reputation with some of our existing customer base.

LABOR RELATIONS AND LABOR STRATEGY

A significant increase in labor costs, unsuccessful attempts to strengthen our relationships with union employees or loss of key personnel could adversely affect our business and results of operations.

Labor costs are a significant component of our total expenses. Each of Alaska, Horizon, Virgin America, and McGee Air Service's represented employee groups has a separate collective bargaining agreement. In relation to the Virgin America integration, the workgroups that have not yet reached a transition agreement could make demands that would increase our operating expenses and adversely affect our financial performance if we agree to them. The same result could apply if we experience a significant increase in vendor labor costs, including wage rate increases, which could ultimately flow through to us under the applicable services agreement.

Although we have a long track record of fostering good communications, negotiating approaches and developing other strategies to enhance workforce engagement in our long-term vision, future uncertainty around open contracts-including the collective bargaining negotiations for the integration of Alaska's and Virgin America's represented work groups-could be a distraction, affecting employee focus on our business and diverting management’s attention from other projects and issues.

We compete against the major U.S. airlines and other businesses for labor in many highly skilled positions. If we are unable to hire, train and retain qualified employees at a reasonable cost, achieve and sustain employee engagement in our strategic vision, or if we are unsuccessful at implementing succession plans for our key staff, we may be unable to grow or sustain our business.

Employees could also engage in job actions such as slow-downs, work-to-rule campaigns, sick-outs or other actions designed to disrupt our normal operations in an attempt to pressure us to acquiesce to wage or other demands during Section 6 negotiations or transition agreement discussions. Although the Railway Labor Act makes such “self-help” unlawful until the National Mediation Board releases the parties following lengthy mediation attempts, such actions could cause significant harm even if we were ultimately successful in seeking injunctive relief or other remedies.

The inability to attract, retain and train regional pilots could result in guest impact and adversely affect our business and results of operations.

In recent years, there have been shortages of pilots for hire in the regional market, and there is an anticipated pilot shortage in hiring in the mainline markets in the next two to three years. Attrition beyond normal levels, or the inability to attract new pilots, could negatively impact our operating results, and our business prospects could be harmed. In addition, the ability to train pilot candidates in a timely manner to support Alaska’s operational needs may continue to be a challenge for Horizon Air. Due to the high volume of turnover, partially driven by the hiring needs of mainline carriers, pilot training may face added stress associated with ensuring initial training, recurrent training and upgrades from first officer to captain are accomplished in a manner timely enough to support Alaska’s operational needs. Any of these outcomes would possibly result in guest impact and harm to our business, financial condition and results of operations.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

AIRCRAFT

The following table describes the aircraft we operate and their average age at December 31, 2017:



Aircraft Type	Seats	Owned	Leased	Total	Average Age in Years
B737 Freighters	—	3	—	3	17.5
B737 NextGen	124-181	141	10	151	7.5
A319	119	—	10	10	10.2
A320	146-149	10	43	53	7.3
A321neo	185	—	4	4	0.4
Total Mainline Fleet		154	67	221	7.6
Q400	76	35	15	50	11.0
E175	76	10	23	33	1.2
Total Regional Fleet		45	38	83	7.1
Total		199	105	304	7.4

“Management’s Discussion and Analysis of Financial Condition and Results of Operations" discusses future orders and options for additional aircraft. “Liquidity and Capital Resources" provides more information about aircraft that are used to secure long-term debt arrangements or collateralize credit facilities.

Alaska’s leased B737 aircraft have lease expiration dates between 2018 and 2026. Virgin America's leased A319, A320, and A321neo aircraft have expiration dates between 2019 and 2029. Horizon’s leased Q400 aircraft have expiration dates between 2018 and 2021. The leased E175 aircraft are through our capacity purchase agreement with SkyWest. Alaska, Virgin America and Horizon have the option to extend some of the leases for additional periods, or the right to purchase the aircraft at the end of the lease term, usually at the fair-market value of the aircraft.

GROUND FACILITIES AND SERVICES

We own terminal buildings in various cities in the state of Alaska and several buildings located at or near Seattle-Tacoma International Airport (Sea-Tac) near Seattle, WA. These include a multi-bay hangar and shops complex (used primarily for line maintenance), a flight operations and training center, an air cargo facility, an information technology office and data center, and various other commercial office buildings. Additionally, in 2017 we entered into a contract to acquire property near our existing headquarters facility for the development of additional office space.

We lease ticket counters, gates, cargo and baggage space, ground equipment, office space and other support areas at the majority of the airports we serve. Airport leases contain provisions for periodic adjustments of lease rates. We are typically responsible for maintenance, insurance and other facility-related expenses and services under these agreements. We also lease operations, training, administrative, and data center facilities in Burlingame, CA; Portland, OR; Quincy, WA; and Spokane, WA as well as line maintenance stations in Boise, ID; Bellingham, WA; Eugene, OR; San Jose, CA; Medford, OR; Redmond, OR; Seattle, WA; Kent, WA; and Spokane, WA. Further, we lease call center facilities in Phoenix, AZ, and Boise, ID.

ITEM 3. LEGAL PROCEEDINGS

We are a party to routine litigation matters incidental to our business. Management believes the ultimate disposition of these matters is not likely to materially affect our 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 judges and juries.

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.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

As of December 31, 2017, there were 129,903,498 shares of common stock of Alaska Air Group, Inc. issued, 123,060,638 shares outstanding, and 2,044 shareholders of record. In 2017, we paid quarterly dividends of $0.300 per share in March, June, September and December. Our common stock is listed on the New York Stock Exchange (symbol: ALK). The following table shows the trading range of Alaska Air Group, Inc. common stock on the New York Stock Exchange:



	2017				2016
	High		Low		High		Low
First Quarter	$	101.43	$	86.22	$	83.05	$	61.58
Second Quarter	93.16		82.03		83.09		54.53
Third Quarter	95.75		71.17		71.57		56.47
Fourth Quarter	82.68		61.10		91.88		65.60

SALES OF NON-REGISTERED SECURITIES

None.

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS



	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares (or units) Purchased as Part of Publicly Announced Plans or Programs	Maximum remaining dollar value of shares that can be purchased under the plan (in millions)
October 1, 2017 - October 31, 2017 ^(a)	369,182	$	67.72	369,182
November 1, 2017 - November 30, 2017	—	—		—
December 1, 2017 - December 31, 2017	—	—		—
Total	369,182	$	67.72	369,182	$	612


^(a)	Purchased pursuant to the $1 billion repurchase plan authorized by the Board of Directors in August 2015.

PERFORMANCE GRAPH

The following graph compares our cumulative total stockholder return since December 31, 2012 with the S&P 500 Index and the Dow Jones U.S. Airlines Index. The graph assumes that the value of the investment in our common stock and each index (including reinvestment of dividends) was $100 on December 31, 2012.

ITEM 6. SELECTED FINANCIAL AND OPERATING DATA

As the acquisition of Virgin America closed on December 14, 2016, results below include Virgin America for the twelve months ended December 31, 2017, but only for the period December 14, 2016 through December 31, 2016 in the twelve months ended December 31, 2016.



Year Ended December 31 (in millions, except per-share amounts):	2017			2016			2015		2014		2013
CONSOLIDATED OPERATING RESULTS (audited)
Operating Revenues	$	7,933		$	5,931		$	5,598	$	5,368	$	5,156
Operating Expenses	6,673			4,582			4,300		4,406		4,318
Operating Income	1,260			1,349			1,298		962		838
Nonoperating income (expense), net of interest capitalized^(a)	(53		)	(4		)	14		13		(22		)
Income before income tax	1,207			1,345			1,312		975		816
Net Income	$	1,034		$	814		$	848	$	605	$	508
Average basic shares outstanding	123.211			123.557			128.373		135.445		139.910
Average diluted shares outstanding	123.854			124.389			129.372		136.801		141.878
Basic earnings per share	$	8.39		$	6.59		$	6.61	$	4.47	$	3.63
Diluted earnings per share	$	8.35		$	6.54		$	6.56	$	4.42	$	3.58
Cash dividends declared per share	$	1.20		$	1.10		$	0.80	$	0.50	0.20
CONSOLIDATED FINANCIAL POSITION (audited)
At End of Period (in millions):
Total assets	$	10,740		$	9,962		$	6,530	$	6,059	$	5,719
Long-term debt, including current portion	$	2,569		$	2,964		$	683	$	798	$	865
Shareholders' equity	$	3,721		$	2,931		$	2,411	$	2,127	$	2,029
OPERATING STATISTICS (unaudited)^(d)
Consolidated:^(b)
Revenue passengers (000)	44,034			34,289			31,883		29,287		27,414
RPMs (000,000) "traffic"	52,338			37,209			33,578		30,718		28,833
ASMs (000,000) "capacity"	62,072			44,135			39,914		36,078		33,672
Load factor	84.3%			84.3%			84.1%		85.1%		85.6%
Yield	13.03¢			13.45¢			14.27¢		14.91¢		14.80¢
PRASM	10.98¢			11.34¢			12.01¢		12.69¢		12.67¢
RASM	12.78¢			13.44¢			14.03¢		14.88¢		14.74¢
CASMex^(c)	8.23¢			8.23¢			8.30¢		8.36¢		8.47¢
Mainline:
Revenue passengers (000)	34,539			24,838			22,869		20,972		19,737
RPMs (000,000) "traffic"	48,238			33,489			30,340		27,778		26,172
ASMs (000,000) "capacity"	56,945			39,473			35,912		32,430		30,411
Load factor	84.7%			84.8%			84.5%		85.7%		86.1%
Yield	12.14¢			12.24¢			12.98¢		13.58¢		13.33¢
PRASM	10.29¢			10.38¢			10.97¢		11.64¢		11.48¢
CASMex^(c)	7.47¢			7.30¢			7.39¢		7.45¢		7.54¢
Regional ^(b):
Revenue passengers (000)	9,495			9,452			9,015		8,306		7,677
RPMs (000,000) "traffic"	4,101			3,720			3,238		2,940		2,661
ASMs (000,000) "capacity"	5,127			4,662			4,002		3,648		3,261
Load factor	80.0%			79.8%			80.9%		80.6%		81.6%
Yield	23.41¢			24.42¢			26.37¢		27.40¢		29.20¢
PRASM	18.72¢			19.49¢			21.34¢		22.08¢		23.83¢


(a)	Capitalized interest was $17 million, $25 million, $34 million, $20 million and $21 million for 2017, 2016, 2015, 2014 and 2013.


(b)	Includes flights under Capacity Purchase Agreements operated by SkyWest and PenAir.


(c)	See reconciliation to the most directly related Generally Accepted Accounting Principles (GAAP) measure in the "Results of Operations" section.


(d)	See "Glossary of Terms" for definitions of the abbreviated terms.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand our company, our operations and our present business environment. MD&A is provided as a supplement to – and should be read in conjunction with – our consolidated financial statements and the accompanying notes. All statements in the following discussion that are not statements of historical information or descriptions of current accounting policy are forward-looking statements. Please consider our forward-looking statements in light of the risks referred to in this report’s introductory cautionary note and the risks mentioned in Part I, “Item 1A. Risk Factors.” This overview summarizes the MD&A, which includes the following sections:


•	Year in Review—highlights from 2017 outlining some of the major events that happened during the year and how they affected our financial performance.

•

Results of Operations—an in-depth analysis of our revenues by segment and our expenses from a consolidated perspective for the three years presented in our consolidated financial statements. To the extent material to the understanding of segment profitability, we more fully describe the segment expenses per financial statement line item. Financial and statistical data is also included here. As Virgin America was acquired on December 14, 2016, its financial and operational results are reflected in the year ended December 31, 2017, but not in the comparative prior period. However, for comparability purposes, we have added "Combined Comparative" information for the prior year, which is more fully described below. This section includes forward-looking statements regarding our view of 2018. Further information about the acquisition of Virgin America can be found in Note 2 to the consolidated financial statements.


•	Liquidity and Capital Resources—an overview of our financial position, analysis of cash flows, sources and uses of cash, contractual obligations and commitments and off-balance sheet arrangements.


•	Critical Accounting Estimates—a discussion of our accounting estimates that involve significant judgment and uncertainties.

YEAR IN REVIEW

In 2017, we expanded our network at a record pace, adding 44 new markets across the network during the year. Additionally, we devoted a significant amount of energy and resources to integrating Alaska and Virgin America. We achieved many integration milestones, including merging many back-office functions, co-locating many stations, and launching technology for front-line employees to enable them to serve our customers seamlessly between carriers.

In 2017, we posted our 14th consecutive annual profit on an adjusted basis. Our pretax income was $1.2 billion, compared to $1.3 billion in 2016. Our 2017 pretax income on an adjusted basis (a non-GAAP financial measure) was $1.3 billion, a decrease of 9% from 2016. Adjusted pretax income for 2017 excludes $118 million of merger-related costs associated with our acquisition of Virgin America and $7 million of mark-to-market fuel hedge benefit.

The decrease in adjusted pretax income was driven largely by an increase in operating expenses, excluding fuel and special items, of $1.5 billion, and an increase in fuel expense of $616 million. The increase in operating expense was primarily due to the full-year impact of Virgin America in our financial results. The increased costs were partially offset by an increase in operating revenues of $2.0 billion.

The growth in revenues of $2.0 billion was driven by the growth in our business, attributable to the inclusion of Virgin America in our results for the full year, as well as our expansion into 44 new markets entered into during the year. On the regional side of our business, Horizon began flying the new Embraer E175 regional jets in 2017 — the first 10 of 33 aircraft scheduled for delivery over a three year period. We believe we have a strong future ahead of us and look forward to the many new opportunities our combined networks will bring our company.

See “Results of Operations” below for further discussion of changes in revenues and operating expenses and our reconciliation of Non-GAAP measures to the most directly comparable GAAP measure.

Accomplishments and Highlights

Recognition and Awards - Alaska


•	Ranked "Highest in Customer Satisfaction Among Traditional Carriers" in 2017 by J.D. Power for the tenth year in a row.


•	Ranked first in the U.S. News & World Report's list of Best Travel Rewards Programs for the third consecutive year.


•	Won the "Best Rewards Program" for Mileage Plan™ for carriers in the "Americas" region in the sixth annual FlyerTalk Award.


•	Mileage Plan™ ranked Best Airline Elite Status Program in the U.S. by The Points Guy.


•	Ranked among Forbes' 2017 "America's Best Employers" for the third year in a row.


•	Received 16th Diamond Award of Excellence from the Federal Aviation Administration, recognizing both Alaska and Horizon's aircraft technicians for their commitment to training.


•	Ranked by AirlineRatings.com as one of only two U.S. airlines in the Top 20 safest airlines in the world.


•	Rated "Best Airline Staff in North America" and "Best Regional Airline in North America" by Skytrax World Airline Awards.


•	Awarded TripAdvisor's 2017 Travelers' Choice Award for second-best midsize and low-cost airlines in North America and one of the top 10 best airlines in the world.


•	Recognized by the Puget Sound Business Journal as the 2017 Board Diversity Champion, as well as by the Women Corporate Directors Global Institute for diversity among our Directors.


•	Ranked as the top U.S. airline in the Dow Jones Sustainability Index (DJSI), receiving perfect scores for “efficiency” and “reliability.”


•	Recognized as No. 1 in fuel efficiency for U.S. airlines by the International Council on Clean Transportation for the 7th consecutive year.


•	Named one of the overall five-star major regional airlines at the Passenger Choice Awards during the APEX EXPO.


•	Ranked fifth of most engaged companies in the U.S. by Forbes Insights, which measured social media engagement, net promoter scores, and year-over-year sales growth.

Recognition and Awards - Virgin America


•	Rated Best U.S. Airline by Conde Nast Traveler in their "Annual Readers' Choice Awards" for the tenth year in a row.


•	Rated Best Domestic Airline in Travel + Leisure "World's Best Awards" for the tenth year in a row.


•	Received a five-star rating for low-cost carrier, and received a top honor with a Passenger Choice Award for “Best Seat Comfort” during the APEX EXPO.

Our People and Communities


•	Awarded $135 million in incentive pay to employees for 2017.


•	Awarded employees a $1,000 bonus in January 2018 in connection with the passing of the Tax Cuts and Jobs Act, amounting to approximately $25 million.


•	Donated over $14 million and contributed more than 32,000 volunteer hours to support nonprofits in our local communities, focusing on youth and education, medical (research/transportation) and community outreach.

Shareholder Return

In 2017, we paid cash dividends of $148 million and repurchased approximately 981 thousand shares of our common stock for $75 million under the $1 billion share repurchase program authorized by our Board of Directors in August 2015. As of December 31, 2017, the Company has repurchased approximately 5 million shares for $388 million under this program.

Since 2007, we have repurchased 60 million shares of common stock for $1.6 billion for an average price of approximately $26.72 per share. In 2017, we increased our quarterly dividend 9% from $0.275 per share to $0.300 per share, and, subsequent to December 31, 2017, we announced a 7% increase to $0.32 per share for 2018. Overall, we returned $223 million to shareholders during 2017. We expect to continue to return capital to shareholders in 2018, primarily in the form of dividends.

Outlook

In 2018 and beyond, we are focused on successfully completing the integration of Virgin America with Alaska. In January 2018 Alaska and Virgin America received a Single Operating Certificate (SOC), our most significant integration milestone to date. The integration milestones achieved thus far will help to ease our transition to a single Passenger Service System (PSS) on April 25, 2018. This will allow us to provide one reservation system, one website and one inventory of flights to our guests, which will help unlock many of the revenue synergies expected from the acquisition. In conjunction with PSS, at all gates, ticketing and check-in areas, guests will be greeted with Alaska branding.

We will continue to make investments to enhance our onboard guest experience. Some of the more notable projects underway include adding satellite connectivity to our entire Boeing and Airbus fleets to offer high-speed satellite Wi-Fi, further upgrades to our onboard menu offerings, updating and expanding airport lounges in the JFK and Seattle airports, and investment in our Seattle hub airport to open a state-of-the-art 20-gate North Terminal facility.

In 2018, we expect to continue to experience cost pressure, due in large part to pilot wage increases, which became effective in the fourth quarter of 2017, and a new maintenance cost-per-hour agreement that will result in higher maintenance costs in 2018, but will help to reduce the volatility of maintenance expense over the next several years. We also expect to continue to incur further costs associated with the ongoing integration of Virgin America. For the first quarter of 2018, we expect unit revenues (RASM) to decline 3.5% - 4.5% and unit costs, excluding fuel and special items (CASM, ex fuel) to increase approximately 6%. In addition, we expect the price per gallon of jet fuel to increase approximately 21% from the prior-year period. Based on these current estimates, we are likely to report a loss in the first quarter although we expect our unit costs and unit revenues to improve throughout 2018.

Our priority throughout the integration process is to run two great airlines and to maintain safe and compliant operations, while providing a great experience for our guests. We are particularly focused on merging the Alaska and Virgin America cultures and brands that our guests respect and trust. We intend to minimize any disruption to our guests during our integration efforts by being transparent about our progress and how the changes may affect them. Employee engagement throughout the integration will remain a top priority as well, ensuring that employees remain engaged, informed and excited about the new Company's future. Additionally, we will remain focused on capturing the value and synergies created by combining these two great airlines.

We expect to grow our combined network capacity in 2018 by approximately 7.5%, compared to a 7.1% combined growth in 2017. Current schedules indicate competitive capacity will be roughly 6 points higher in the first quarter of 2018. We believe that our product, our operation, our engaged employees, our award-winning service, and our competitive Mileage Plan™, combined with our strong balance sheet, give us the ability to compete vigorously in our markets.

RESULTS OF OPERATIONS

ADJUSTED (NON-GAAP) RESULTS AND PER-SHARE AMOUNTS

We believe disclosure of earnings excluding the impact of merger-related costs, mark-to-market gains or losses or other individual special revenues or expenses is useful information to investors because:

•

By excluding fuel expense and certain special items (including merger-related costs) from our unit metrics, we believe that we have better visibility into the results of operations and our non-fuel cost initiatives. Our industry is highly competitive and is characterized by high fixed costs, so even a small reduction in non-fuel operating costs can lead to a significant improvement in operating results. In addition, we believe that all domestic carriers are similarly impacted by changes in jet fuel costs over the long run, so it is important for management (and investors) to understand the impact of (and trends in) company-specific cost drivers, such as labor rates and productivity, airport costs, maintenance costs, etc., which are more controllable by management.


•	Cost per ASM (CASM) excluding fuel and certain special items, such as merger-related costs, is one of the most important measures used by management and by the Air Group Board of Directors in assessing quarterly and annual cost performance.


•	Adjusted income before income tax and CASM excluding fuel (and other items as specified in our plan documents) are important metrics for the employee incentive plan, which covers the majority of Air Group employees.


•	CASM excluding fuel and certain special items is a measure commonly used by industry analysts and we believe it is an important metric by which they compare our airlines to others in the industry. The measure is also the subject of frequent questions from investors.

•

Disclosure of the individual impact of certain noted items provides investors the ability to measure and monitor performance both with and without these special items. We believe that disclosing the impact of certain items, such as merger-related costs and mark-to-market hedging adjustments, is important because it provides information on significant items that are not necessarily indicative of future performance. Industry analysts and investors consistently measure our performance without these items for better comparability between periods and among other airlines.

•

Although we disclose our passenger unit revenues, we do not (nor are we able to) evaluate unit revenues excluding the impact that changes in fuel costs have had on ticket prices. Fuel expense represents a large percentage of our total operating expenses. Fluctuations in fuel prices often drive changes in unit revenues in the mid-to-long term. Although we believe it is useful to evaluate non-fuel unit costs for the reasons noted above, we would caution readers of these financial statements not to place undue reliance on unit costs excluding fuel as a measure or predictor of future profitability because of the significant impact of fuel costs on our business.

Although we are presenting these non-GAAP amounts for the reasons above, investors and other readers should not necessarily conclude that these amounts are non-recurring, infrequent, or unusual in nature.

2017 COMPARED WITH 2016

Our consolidated net income for 2017 was $1 billion, or $8.35 per diluted share, compared to net income of $814 million, or $6.54 per diluted share, in 2016. As the acquisition of Virgin America closed on December 14, 2016, our 2016 financial results include Virgin America for the period of December 14, 2016 through December 31, 2016 and the impact of purchase accounting as of December 14, 2016. Refer to the "Critical Accounting Estimates" section for further information regarding purchase accounting.

Excluding the impact of merger-related costs, mark-to-market fuel hedge adjustments and a special tax benefit as a result of tax reform, our adjusted consolidated net income for 2017 was $823 million, or $6.64 per diluted share, compared to an adjusted consolidated net income of $911 million, or $7.32 per share, in 2016. The following table reconciles our adjusted net income and earnings per diluted share (EPS) during the full year 2017 and 2016 to amounts as reported in accordance with GAAP.



	Twelve Months Ended December 31,
	2017						2016
(in millions, except per-share amounts)	Dollars			Diluted EPS			Dollars			Diluted EPS
Reported GAAP net income and diluted EPS	$	1,034		$	8.35		$	814		$	6.54
Mark-to-market fuel hedge (benefit)/expense	(7		)	(0.06		)	(13		)	(0.11		)
Special items—merger-related costs and other^(a)	118			0.95			117			0.94
Income tax effect on special items and fuel hedge adjustments^(b)	(42		)	(0.34		)	(24		)	(0.19		)
Special tax (benefit)/expense^(c)	(280		)	(2.26		)	17			0.14
Non-GAAP adjusted net income and diluted EPS	$	823		$	6.64		$	911		$	7.32


(a)	Refer to Note 10 to the consolidated financial statement for the description of special items.


(b)	Certain merger-related costs are non-deductible for tax purposes, resulting in a smaller income tax effect for 2016 adjusting items.


(c)	Special tax (benefit)/expense in 2017 is due to the remeasurement of deferred tax liabilities as a result of the Tax Cuts and Jobs Act signed into law on December 22, 2017, offset by certain state tax law enactments. In 2016 it represents discrete impacts of adjustments to our position on income sourcing in various states.

CASM is summarized below:



	Twelve Months Ended December 31,
	2017			2016			% Change
Consolidated:
Total CASM		10.75	¢		10.38	¢	3.6	%
Less the following components:
Aircraft fuel, including hedging gains and losses	2.33			1.88			23.9	%
Special items—merger-related costs and other^(a)	0.19			0.27			(29.6	)%
CASM, excluding fuel and special items		8.23	¢		8.23	¢	—	%

Mainline:
Total CASM		9.92	¢		9.39	¢	5.6	%
Less the following components:
Aircraft fuel, including hedging gains and losses	2.24			1.79			25.1	%
Special items—merger-related costs and other^(a)	0.21			0.30			(30.0	)%
CASM, excluding fuel and special items		7.47	¢		7.30	¢	2.3	%


(a)	Refer to Note 10 to the consolidated financial statement for the description of special items.

Impact of Accounting Changes

The following discussion of 2017 compared with 2016 results reflects balances as reported within this 10-K. On January 1, 2018 we will implement ASU 2014-09, "Revenue from Contracts with Customers," and ASU 2017-07, "Compensation- Retirement Benefits." We have elected to apply both standards using the full retrospective approach, which will require us to restate prior period financial information under the new standards. When providing forward looking guidance on line items that will be recast under the new standards, we have included provisional recast amounts herein.

Under the new revenue recognition standard, the primary changes to our financial information relate to Mileage Plan™ accounting, ticket breakage, and ancillary revenue geography.


•	Mileage Plan™ miles earned through travel have historically been accounted for using the incremental cost approach. Under the new standard, we will allocate a portion of the ticket price to deferred revenue.


•	Ticket breakage was historically recognized at time of expiration. Under the new standard, ticket breakage will be recorded based on an estimate at the original departure date.


•	Ancillary revenues related to passenger travel, which were historically presented as Other revenue, will be reclassified to Passenger Revenue.

As a result of the new revenue recognition standard, we expect to restate 2017 and 2016 financial information in our future filings. We expect 2017 reported revenues will be reduced by approximately $41 million, and reported non-fuel operating costs will increase by approximately $13 million, resulting in a net reduction of $54 million to reported adjusted pretax profit. We expect a similar impact in 2018.

Although less significant, the new retirement benefits accounting standard is also effective January 1, 2018. Under this new standard, all components of net periodic benefit cost will be presented in Nonoperating income (expense), except service cost, which will remain in Wages and benefits. This change has an impact on CASM.

Management believes it is useful to compare forecasted results with the restated results under the new standards, as noted in the impacted areas below. The implementation of the new standards will impact common industry metrics such as PRASM, RASM, and CASM excluding fuel and special items. We will provide restated metrics in a separate filing.

OPERATING STATISTICS SUMMARY (unaudited)

Alaska Air Group, Inc.

Below are operating statistics we use to measure performance. As the acquisition of Virgin America closed on December 14, 2016, Consolidated and Mainline amounts presented below include Virgin America results for the twelve months ended December 31, 2017, but only for the period December 14, 2016 through December 31, 2016 in the twelve months ended December 31, 2016 results below. We often refer to unit revenues and adjusted unit costs, which is a non-GAAP measure.



	Twelve Months Ended December 31,
	2017	2016	Change	2015	Change
Consolidated Operating Statistics:^(a)
Revenue passengers (000)	44,034	34,289	28.4%	31,883	7.5%
RPMs (000,000) "traffic"	52,338	37,209	40.7%	33,578	10.8%
ASMs (000,000) "capacity"	62,072	44,135	40.6%	39,914	10.6%
Load factor	84.3%	84.3%	—	84.1%	0.2 pts
Yield	13.03¢	13.45¢	(3.1)%	14.27¢	(5.7)%
PRASM	10.98¢	11.34¢	(3.2)%	12.01¢	(5.6)%
RASM	12.78¢	13.44¢	(4.9)%	14.03¢	(4.2)%
CASM excluding fuel and special items^(b)	8.23¢	8.23¢	—%	8.30¢	(0.8)%
Economic fuel cost per gallon^(b)	$1.82	$1.52	19.7%	$1.88	(19.1)%
Fuel gallons (000,000)	797	554	43.9%	508	9.1%
ASM's per gallon	77.9	79.7	(2.3)%	78.6	1.4%
Average number of full-time equivalent employees (FTEs)	20,183	14,760	36.7%	13,858	6.5%

Mainline Operating Statistics:
Revenue passengers (000)	34,539	24,838	39.1%	22,869	8.6%
RPMs (000,000) "traffic"	48,238	33,489	44.0%	30,340	10.4%
ASMs (000,000) "capacity"	56,945	39,473	44.3%	35,912	9.9%
Load factor	84.7%	84.8%	(0.1) pts	84.5%	0.3 pts
Yield	12.14¢	12.24¢	(0.8)%	12.98¢	(5.7)%
PRASM	10.29¢	10.38¢	(0.9)%	10.97¢	(5.4)%
CASM excluding fuel and special items^(b)	7.47¢	7.30¢	2.3%	7.39¢	(1.2)%
Economic fuel cost per gallon^(b)	$1.82	$1.52	19.7%	$1.87	(18.7)%
Fuel gallons (000,000)	706	474	48.9%	439	8.0%
ASM's per gallon	80.7	83.3	(3.1)%	81.8	1.8%
Average number of FTEs	15,653	11,447	36.7%	10,750	6.5%
Aircraft utilization	11.2	10.5	6.7%	10.8	(2.8)%
Average aircraft stage length	1,301	1,225	6.2%	1,195	2.5%
Mainline operating fleet at period-end	221 a/c	218 a/c	3 a/c	147 a/c	71 a/c

Regional Operating Statistics:^(c)
Revenue passengers (000)	9,495	9,452	0.5%	9,015	4.8%
RPMs (000,000) "traffic"	4,101	3,720	10.2%	3,238	14.9%
ASMs (000,000) "capacity"	5,127	4,662	10.0%	4,002	16.5%
Load factor	80.0%	79.8%	0.2 pts	80.9%	(1.1) pts
Yield	23.41¢	24.42¢	(4.1)%	26.37¢	(7.4)%
PRASM	18.72¢	19.49¢	(4.0)%	21.34¢	(8.7)%


^(a)	Except for FTEs, data includes information related to regional CPA flying with Horizon, SkyWest and PenAir.


^(b)	See reconciliation of this measure to the most directly related GAAP measure in the "Results of Operations" section.


^(c)	Data presented includes information related to regional CPAs.

We believe that analysis of specific financial and operational results on a combined basis provides more meaningful year-over-year comparisons. The discussion below includes "Combined Comparative" results for 2016, determined as the sum of the historical consolidated results of Air Group and Virgin America. Virgin America's financial information has been conformed to reflect Air Group's historical financial statement presentation. This information does not purport to reflect what our financial and operational results would have been had the acquisition been consummated at the beginning of the periods presented.

COMBINED COMPARATIVE OPERATING STATISTICS



	Twelve Months Ended December 31,
	2017	2016 as Reported	2016 Virgin America	2016 Combined	Change
Consolidated:
Revenue passengers (in 000)	44,034	34,289	7,658	41,947	5.0%
RPMs (in 000,000)	52,338	37,209	11,545	48,754	7.4%
ASMs (in 000,000)	62,072	44,135	13,818	57,953	7.1%
Load Factor	84.3%	84.3%	(a)	84.1%	0.2 pts
PRASM	10.98¢	11.34¢	(a)	11.08¢	(0.9)%
RASM	12.78¢	13.44¢	(a)	12.93¢	(1.2)%
CASMex	8.23¢	8.23¢	(a)	8.04¢	2.4%
FTEs	20,183	14,760	2,618	17,378	16.1%

Mainline:
RPMs (in 000,000)	48,238	33,489	11,545	45,034	7.1%
ASMs (in 000,000)	56,945	39,473	13,818	53,291	6.9%
Load Factor	84.7%	84.8%	(a)	84.5%	0.2 pts
PRASM	10.29¢	10.38¢	(a)	10.34¢	(0.5)%


^(a)	2016 Combined operating statistics have been recalculated using the combined results.

OPERATING REVENUES

Total operating revenues increased $2.0 billion, or 34%, during 2017 compared to the same period in 2016. On a Combined Comparative basis, total operating revenues increased $438 million or 6%. The changes, including the reconciliation of the impact of Virgin America on the comparative results, are summarized in the following table:

Twelve Months Ended December 31,

Change

(in millions)