Document


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

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

For the quarterly period ended September 30, 2017
 
OR

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

 For the transition period from                      to                      

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer   x
Accelerated filer  ¨
Non-accelerated filer   ¨ 
(Do not check if a smaller reporting company)
Smaller reporting company   ¨
Emerging growth company   ¨

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
 
The registrant has 123,044,897 common shares, par value $0.01, outstanding at October 31, 2017.




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

 TABLE OF CONTENTS

 

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

2




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

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

You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Our forward-looking statements are based on the information currently available to us and speak only as of the date on which this report was filed with the SEC. We expressly disclaim any obligation to issue any updates or revisions to our forward-looking statements, even if subsequent events cause our expectations to change regarding the matters discussed in those statements. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such differences might be significant and materially adverse to our shareholders. For a discussion of these and other risk factors, see Item 1A. "Risk Factors” of the Company’s annual report on Form 10-K for the year ended December 31, 2016, and Item 1A. "Risk Factors" included herein. Please consider our forward-looking statements in light of those risks as you read this report.


3



PART I
 
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(in millions)
September 30, 2017
 
December 31, 2016
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
144

 
$
328

Marketable securities
1,596

 
1,252

Total cash and marketable securities
1,740

 
1,580

Receivables—net
301

 
302

Inventories and supplies—net
57

 
47

Prepaid expenses and other current assets
116

 
121

Total Current Assets
2,214

 
2,050

 
 
 
 
Property and Equipment
 

 
 

Aircraft and other flight equipment
7,590

 
6,947

Other property and equipment
1,187

 
1,103

Deposits for future flight equipment
531

 
545

 
9,308

 
8,595

Less accumulated depreciation and amortization
3,078

 
2,929

Total Property and Equipment—Net
6,230

 
5,666

 
 
 
 
Goodwill
1,934

 
1,934

Intangible assets
135

 
143

Other noncurrent assets
226

 
169

Other Assets
2,295

 
2,246

 
 
 
 
Total Assets
$
10,739

 
$
9,962


See accompanying notes to condensed consolidated financial statements.


4


ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(in millions, except share amounts)
September 30, 2017
 
December 31, 2016
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
97

 
$
92

Accrued wages, vacation and payroll taxes
345

 
397

Air traffic liability
1,103

 
849

Other accrued liabilities
886

 
878

Current portion of long-term debt
334

 
319

Total Current Liabilities
2,765

 
2,535

 
 
 
 
Long-Term Debt, Net of Current Portion
2,367

 
2,645

Other Liabilities and Credits
 

 
 

Deferred income taxes
682

 
463

Deferred revenue
682

 
640

Obligation for pension and postretirement medical benefits
323

 
331

Other liabilities
429

 
417

 
2,116

 
1,851

Commitments and Contingencies


 


Shareholders' Equity
 

 
 

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

 

Common stock, $0.01 par value, Authorized: 400,000,000 shares, Issued: 2017 - 129,860,836 shares; 2016 - 129,189,634 shares, Outstanding: 2017 - 123,387,158 shares; 2016 - 123,328,051 shares
1

 
1

Capital in excess of par value
156

 
110

Treasury stock (common), at cost: 2017 - 6,473,678 shares; 2016 - 5,861,583 shares
(494
)
 
(443
)
Accumulated other comprehensive loss
(289
)
 
(305
)
Retained earnings
4,117

 
3,568

 
3,491

 
2,931

Total Liabilities and Shareholders' Equity
$
10,739

 
$
9,962


See accompanying notes to condensed consolidated financial statements.


5


ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions, except per share amounts)
2017
 
2016
 
2017
 
2016
Operating Revenues
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
Mainline
$
1,562

 
$
1,073

 
$
4,390

 
$
3,036

Regional
262

 
249

 
725

 
682

Total passenger revenue
1,824

 
1,322

 
5,115

 
3,718

Freight and mail
32

 
31

 
88

 
82

Other—net
264

 
213

 
768

 
607

Total Operating Revenues
2,120

 
1,566

 
5,971

 
4,407

 
 
 
 
 
 
 
 
Operating Expenses
 
 
 
 
 

 
 

Wages and benefits
475

 
340

 
1,392

 
1,008

Variable incentive pay
40

 
31

 
98

 
95

Aircraft fuel, including hedging gains and losses
368

 
225

 
1,051

 
593

Aircraft maintenance
88

 
64

 
271

 
197

Aircraft rent
70

 
25

 
204

 
80

Landing fees and other rentals
124

 
89

 
338

 
232

Contracted services
76

 
63

 
234

 
183

Selling expenses
91

 
58

 
269

 
162

Depreciation and amortization
95

 
101

 
275

 
281

Food and beverage service
50

 
31

 
145

 
93

Third-party regional carrier expense
30

 
25

 
84

 
72

Special items—merger-related costs
24

 
22

 
88

 
36

Other
150

 
92

 
424

 
267

Total Operating Expenses
1,681

 
1,166

 
4,873

 
3,299

Operating Income
439

 
400

 
1,098

 
1,108

 
 
 
 
 
 
 
 
Nonoperating Income (Expense)
 
 
 
 
 

 
 

Interest income
9

 
7

 
25

 
20

Interest expense
(26
)
 
(11
)
 
(77
)
 
(33
)
Interest capitalized
5

 
6

 
13

 
21

Other—net

 

 
(1
)
 
(2
)
 
(12
)
 
2

 
(40
)
 
6

Income before income tax
427

 
402

 
1,058

 
1,114

Income tax expense
161

 
146

 
397

 
414

Net Income
$
266

 
$
256

 
$
661

 
$
700

 
 
 
 
 
 
 
 
Basic Earnings Per Share:
$
2.15

 
$
2.08

 
$
5.35

 
$
5.66

Diluted Earnings Per Share:
$
2.14

 
$
2.07

 
$
5.31

 
$
5.63

Shares used for computation:
 
 
 
 
 
 
 

Basic
123.467

 
123.149

 
123.501

 
123.648

Diluted
124.220

 
123.833

 
124.341

 
124.393

 
 
 
 
 
 
 
 
Cash dividend declared per share:
$
0.30

 
$
0.275

 
$
0.90

 
$
0.825

See accompanying notes to condensed consolidated financial statements.

6


ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS (unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions)
2017
 
2016
 
2017
 
2016
Net Income
$
266

 
$
256

 
$
661

 
$
700

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

 
(2
)
 
5

 
17

Reclassification of (gain) loss into Other—net nonoperating income (expense)
(1
)
 

 

 
(1
)
Income tax effect

 

 
(2
)
 
(6
)
Total

 
(2
)
 
3

 
10

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

 
5

 
16

 
15

Income tax effect
(2
)
 
(1
)
 
(5
)
 
(5
)
Total
3

 
4

 
11

 
10

 
 
 
 
 
 
 
 
Related to interest rate derivative instruments:
 
 
 
 
 
 
 
Unrealized holding gain (loss) arising during the period

 
1

 
(2
)
 
(6
)
Reclassification of (gain) loss into Aircraft rent
2

 
1

 
4

 
4

Income tax effect
(1
)
 
(1
)
 
(1
)
 
1

Total
1

 
1

 
1

 
(1
)
 
 
 
 
 
 
 
 
Other Comprehensive Income
4

 
3

 
15

 
19

 
 
 
 
 
 
 
 
Comprehensive Income
$
270

 
$
259

 
$
676

 
$
719


See accompanying notes to condensed consolidated financial statements.


7


ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
 
Nine Months Ended September 30,
(in millions)
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
661

 
$
700

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

 
 

Depreciation and amortization
275

 
281

Stock-based compensation and other
43

 
19

Changes in certain assets and liabilities:
 
 
 
Changes in deferred tax provision
217

 
47

Increase in air traffic liability
254

 
116

Increase in deferred revenue
46

 
60

Other—net
(139
)
 
(17
)
Net cash provided by operating activities
1,357

 
1,206

 
 
 
 
Cash flows from investing activities:
 

 
 

Property and equipment additions:
 

 
 

Aircraft and aircraft purchase deposits
(679
)
 
(408
)
Other flight equipment
(70
)
 
(35
)
Other property and equipment
(92
)
 
(66
)
Total property and equipment additions, including capitalized interest
(841
)
 
(509
)
Purchases of marketable securities
(1,408
)
 
(775
)
Sales and maturities of marketable securities
1,069

 
638

Other investing activities
38

 
5

Net cash used in investing activities
(1,142
)
 
(641
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Proceeds from issuance of debt

 
1,546

Long-term debt payments
(265
)
 
(93
)
Common stock repurchases
(50
)
 
(193
)
Dividends paid
(111
)
 
(102
)
Other financing activities
27

 
22

Net cash provided (used) by financing activities
(399
)
 
1,180

Net increase (decrease) in cash and cash equivalents
(184
)
 
1,745

Cash and cash equivalents at beginning of year
328

 
73

Cash and cash equivalents at end of the period
$
144

 
$
1,818

 
 
 
 
Supplemental disclosure:
 

 
 

Cash paid during the period for:
 
 
 
Interest (net of amount capitalized)
$
68

 
$
12

Income taxes
129

 
321


See accompanying notes to condensed consolidated financial statements.

8



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

NOTE 1. GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Basis of Presentation
 
The condensed consolidated financial statements include the accounts of Air Group, and its primary subsidiaries, Alaska, Horizon, McGee Air Services and, starting December 14, 2016, Virgin America. The Company conducts substantially all of its operations through these subsidiaries. All significant intercompany balances and transactions have been eliminated. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") for interim financial information. Consistent with these requirements, this Form 10-Q does not include all the information required by GAAP for complete financial statements. It should be read in conjunction with the consolidated financial statements and accompanying notes in the Form 10-K for the year ended December 31, 2016. In the opinion of management, all adjustments have been made that are necessary to fairly present the Company’s financial position as of September 30, 2017 and the results of operations for the three and nine months ended September 30, 2017 and 2016. Such adjustments were of a normal recurring nature.

In preparing these statements, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities, as well as the reported amounts of revenues and expenses. Due to seasonal variations in the demand for air travel, the volatility of aircraft fuel prices, changes in global economic conditions, changes in the competitive environment and other factors, operating results for the three and nine months ended September 30, 2017 are not necessarily indicative of operating results for the entire year.

Recently Issued Accounting Pronouncements

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

At this time, the Company believes the most significant impact to the financial statements will be to Mileage Plan™ revenues and liabilities. The Company currently uses the incremental cost approach for miles earned through travel. As this approach will be eliminated with the standard, the Company will be required to allocate a portion of the ticket price through a relative selling price model and defer revenue recognition until the ticket is flown or unused mileage credits expire. Additionally, unused companion certificates that were previously recognized at expiration will be subject to advanced breakage under the new standard. The Company estimates a net increase to Mileage Plan deferred revenues of approximately $340 million to $380 million at the time of adoption. The allocated value to miles earned through travel will offset passenger revenue during the period they are issued, rather than recorded using the incremental cost approach. As the program is growing significantly, the Company expects revenue recognized under Topic 606 will be less on an annual basis than current accounting practice.

The adoption of the new standard is also expected to result in a change in income statement classification of the majority of ancillary revenues from Other revenue to Passenger revenue. This will affect common industry metrics, such as PRASM and RASM. Certain commission revenue from interline arrangements that were previously offset against related expense will now be classified as Other revenue, which will impact RASM and CASM. Unused ticket revenue that was previously recorded at the time of expiration will now be recorded at the original departure date if that ticket has not been changed or refunded prior to that date, based on estimates of expected expiration. This concept is referred to as ticket breakage. The Company estimates the change in ticket breakage methodology will not have a significant impact on the statements of operations, but will decrease air traffic liability by approximately $70 million to $80 million.

The Company continues to evaluate and model the full impact of the standard and will apply the full retrospective transition method. The overall impact to equity as of the beginning of the retroactive reporting period, including the changes discussed above, as well as other less material changes, is expected to be between $160 million and $190 million.

9




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

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

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

In March 2017, the FASB issued ASU 2017-07, "Compensation—Retirement Benefits" (Topic 715), which will require the Company to present the service cost component of net periodic benefit cost as Wages and benefits in the statements of operations. All other components of net periodic benefit cost will be required to be presented in Nonoperating income (expense) in the statements of operations. These components will not be eligible for capitalization in assets.  The ASU is effective for the Company beginning January 1, 2018. Changes to the statements of operations under the ASU are applicable retrospectively. The adoption of this standard will have no impact on Income before income tax or Net income for the periods subject to retrospective reclassification. See Note 6 for the current components of the Company's net periodic benefit costs.

In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." The ASU expands the activities that qualify for hedge accounting and simplifies the rules for reporting hedging relationships. The ASU is effective for the Company beginning January 1, 2019. Early adoption is permitted. The Company is currently evaluating the impact and has not yet determined whether it will early adopt.

NOTE 2. ACQUISITION OF VIRGIN AMERICA

Virgin America

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

Merger-related costs

The Company incurred pretax merger-related costs of $24 million and $22 million for the three months ended September 30, 2017 and 2016, respectively, and $88 million and $36 million for the nine months ended September 30, 2017 and 2016, respectively. Costs classified as merger-related are directly attributable to merger activities and are recorded as "Special items—merger-related costs" within the statements of operations. The Company expects to continue to incur merger-related costs in the future as the integration continues.




10



Fair values of the assets acquired and the liabilities assumed

The transaction has been accounted for as a business combination using the acquisition method of accounting, which requires, among other things, assets acquired and liabilities assumed to be recognized on the balance sheet at their fair values as of the acquisition date. As of September 30, 2017 the fair values of property and equipment and certain liabilities, included in other accrued liabilities and other liabilities, goodwill, intangible assets and deferred income taxes have been prepared on a preliminary basis and are subject to further adjustments as the Company completes its analysis. There were no significant fair value adjustments made during the three and nine months ended September 30, 2017. The Company will finalize the amounts recognized by December 14, 2017.

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

 
$
645

Receivables
54

 
44

Prepaid expenses and other current assets
18

 
16

Property and equipment—provisional
561

 
560

Intangible assets—provisional
141

 
143

Goodwill—provisional
1,934

 
1,934

Other assets
89

 
84

Total assets
3,442

 
3,426

 

 
 
Accounts payable
22

 
22

Accrued wages, vacation and payroll taxes
54

 
51

Air traffic liabilities
172

 
172

Other accrued liabilities—provisional
197

 
196

Current portion of long-term debt
125

 
125

Long-term debt, net of current portion
360

 
360

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

 
126

Other liabilities—provisional
97

 
82

Total liabilities
846

 
830

 

 
 
Total purchase price
$
2,596

 
$
2,596


NOTE 3. FAIR VALUE MEASUREMENTS

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

11



Fair Value of Financial Instruments on a Recurring Basis

As of September 30, 2017, total cost basis for all marketable securities was $1.6 billion. There were no significant differences between the cost basis and fair value of any individual class of marketable securities.

Fair values of financial instruments on the consolidated balance sheet (in millions):
September 30, 2017
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
359

 
$

 
$
359

Foreign government bonds

 
48

 
48

Asset-backed securities

 
232

 
232

Mortgage-backed securities

 
113

 
113

Corporate notes and bonds

 
828

 
828

Municipal securities

 
16

 
16

Total Marketable securities
359

 
1,237

 
1,596

Derivative instruments
 
 
 
 
 
Fuel hedge call options

 
10

 
10

Interest rate swap agreements

 
8

 
8

Total Assets
359

 
1,255

 
1,614

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Interest rate swap agreements

 
(11
)
 
(11
)
Total Liabilities

 
(11
)
 
(11
)
December 31, 2016
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
287

 
$

 
$
287

Foreign government bonds

 
36

 
36

Asset-backed securities

 
138

 
138

Mortgage-backed securities

 
89

 
89

Corporate notes and bonds

 
691

 
691

Municipal securities

 
11

 
11

Total Marketable securities
287

 
965

 
1,252

Derivative instruments
 
 
 
 
 
Fuel hedge call options

 
20

 
20

Total Assets
287

 
985

 
1,272

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Interest rate swap agreements

 
(5
)
 
(5
)
Total Liabilities

 
(5
)
 
(5
)

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


12



The Company uses the market approach and the income approach to determine the fair value of derivative instruments. The fair value for fuel hedge call options is determined utilizing an option pricing model based on inputs that are readily available in active markets or can be derived from information available in active markets. In addition, the fair value considers the exposure to credit losses in the event of non-performance by counterparties. Interest rate swap agreements are Level 2 as the fair value of these contracts is determined based on the difference between the fixed interest rate in the agreements and the observable LIBOR-based interest forward rates at period end multiplied by the total notional value.

Activity and Maturities for Marketable Securities

Activity for marketable securities (in millions):  
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Proceeds from sales and maturities
$
528

 
$
280

 
$
1,069

 
$
638


Maturities for marketable securities (in millions):
September 30, 2017
Cost Basis
 
Fair Value
Due in one year or less
$
193

 
$
193

Due after one year through five years
1,367

 
1,367

Due after five years through 10 years
36

 
36

Due after 10 years

 

Total
$
1,596

 
$
1,596


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

Fair Value of Other Financial Instruments

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

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

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

Fixed-rate debt that is not carried at fair value on the consolidated balance sheet and the estimated fair value of long-term fixed-rate debt is as follows (in millions):
 
September 30, 2017
 
December 31, 2016
Carrying amount
$
1,024

 
$
1,179

Fair value
1,034

 
1,199


Assets and Liabilities Measured at Fair Value on Nonrecurring Basis

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


13



NOTE 4. FREQUENT FLYER PROGRAMS

Frequent flyer program deferred revenue and liabilities included in the consolidated balance sheets (in millions):
 
September 30, 2017
 
December 31, 2016
Current Liabilities:
 
 
 
Other accrued liabilities
$
509

 
$
484

Other Liabilities and Credits:
 
 
 
Deferred revenue
682

 
638

Other liabilities
24

 
21

Total
$
1,215

 
$
1,143

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

 
$
73

 
$
276

 
$
215

Other—net revenues
122

 
107

 
369

 
318

Total
$
216

 
$
180

 
$
645

 
$
533


NOTE 5. LONG-TERM DEBT
 
Long-term debt obligations on the consolidated balance sheet (in millions):
 
September 30, 2017
 
December 31, 2016
Fixed-rate notes payable due through 2028
$
1,024

 
$
1,179

Variable-rate notes payable due through 2028
1,693

 
1,803

Less debt issuance costs
(16
)
 
(18
)
Total debt
2,701

 
2,964

Less current portion
334

 
319

Long-term debt, less current portion
$
2,367

 
$
2,645

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

During the nine months ended September 30, 2017, the Company made debt payments of $265 million.

At September 30, 2017, long-term debt principal payments for the next five years and thereafter are as follows (in millions):
 
Total
Remainder of 2017
$
55

2018
350

2019
422

2020
449

2021
422

Thereafter
1,016

Total
$
2,714

 

14



Bank Lines of Credit
 
The Company has three credit facilities with availability totaling $475 million. All three facilities have variable interest rates based on LIBOR plus a specified margin. One credit facility increased from $100 million to $250 million in June 2017. It expires in June 2021 and is secured by aircraft. The second credit facility increased from $52 million to $75 million in September 2017. It expires in September 2018 with a mechanism for annual renewal and is secured by aircraft. The third credit facility increased from $100 million to $150 million in March 2017. It expires in March 2022 and is secured by certain accounts receivable, spare engines, spare parts and ground service equipment. The Company has secured letters of credit against the $75 million facility, but has no plans to borrow using either of the two other facilities. All three credit facilities have a requirement to maintain a minimum unrestricted cash and marketable securities balance of $500 million. The Company is in compliance with this covenant at September 30, 2017.

NOTE 6. EMPLOYEE BENEFIT PLANS

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

 
$
9

 
$
30

 
$
27

Interest cost
19

 
18

 
55

 
55

Expected return on assets
(27
)
 
(27
)
 
(80
)
 
(81
)
Amortization of prior service cost (credit)
(1
)
 
(1
)
 
(1
)
 
(1
)
Recognized actuarial loss (gain)
7

 
7

 
20

 
19

Total
$
8

 
$
6

 
$
24

 
$
19


The Company contributed $15 million to the defined-benefit pension plan during the three months ended September 30, 2017.

NOTE 7. COMMITMENTS AND CONTINGENCIES

Future minimum payments for commitments as of September 30, 2017 (in millions):
 
Aircraft Leases
 
Facility Leases
 
Aircraft Purchase Commitments
 
Capacity Purchase Agreements (a)
 
Aircraft Maintenance Deposits
 
Aircraft Maintenance and Parts Management
Remainder of 2017
$
77

 
$
34

 
$
168

 
$
21

 
$
15

 
$
8

2018
342

 
73

 
956

 
118

 
61

 
32

2019
344

 
65

 
806

 
151

 
65

 
35

2020
317

 
63

 
352

 
158

 
68

 
37

2021
280

 
55

 
273

 
165

 
63

 
40

Thereafter
1,263

 
204

 
355

 
1,250

 
90

 

Total
$
2,623

 
$
494

 
$
2,910

 
$
1,863

 
$
362

 
$
152

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

Lease Commitments

Aircraft lease commitments include future obligations for all of the Company's operating airlines—Alaska, Virgin America and Horizon, as well as aircraft leases operated by third-parties. At September 30, 2017, the Company had lease contracts for 10 Boeing 737 ("B737") aircraft, 55 Airbus aircraft, 15 Bombardier Q400 aircraft, and 21 Embraer 175 ("E175") with SkyWest Airlines, Inc. ("SkyWest"). The Company has an additional eight scheduled lease deliveries of A321neo aircraft through 2018, as well as 14 scheduled lease deliveries of E175 aircraft through 2018 to be flown by Skywest. All lease contracts have remaining non-cancelable lease terms ranging from 2017 to 2030. The Company has the option to increase capacity flown by SkyWest with eight additional E175 aircraft deliveries in 2020. Options to lease are not reflected in the commitments table above.


15



Facility lease commitments primarily include airport and terminal facilities and building leases. Total rent expense for aircraft and facility leases was $145 million and $82 million for the three months ended September 30, 2017 and 2016, and $406 million and $226 million for the nine months ended September 30, 2017 and 2016.

Aircraft Purchase Commitments
 
Aircraft purchase commitments include non-cancelable contractual commitments for aircraft and engines. As of September 30, 2017, the Company had commitments to purchase 48 B737 aircraft (16 B737 NextGen aircraft and 32 B737 MAX aircraft, with deliveries in the remainder of 2017 through 2023) and 23 E175 aircraft with deliveries in 2018 through 2019, which reflects Horizon's deferral of three E175 aircraft from 2017 to 2018. The Company also has cancelable purchase commitments for 30 Airbus A320neo aircraft with deliveries from 2020 through 2022. In addition, the Company has options to purchase 37 B737 aircraft and 30 E175 aircraft. The cancelable purchase commitments and option payments are not reflected in the table above.

Capacity Purchase Agreements ("CPAs")
 
At September 30, 2017, Alaska had CPAs with three carriers, including the Company's wholly-owned subsidiary, Horizon. Horizon sells 100% of its capacity to Alaska under a CPA with Alaska. In addition, Alaska has CPAs with SkyWest to fly certain routes in the Lower 48 and Canada and with Peninsula Airways, Inc. ("PenAir") to fly certain routes in the state of Alaska. Under these agreements, Alaska pays the carriers an amount which is based on a determination of their cost of operating those flights and other factors intended to approximate market rates for those services. Future payments (excluding Horizon) are based on minimum levels of flying by the third-party carriers, which could differ materially due to variable payments based on actual levels of flying and certain costs associated with operating flights such as fuel.

Aircraft Maintenance Deposits

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

Aircraft Maintenance and Parts Management

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

Subsequent to September 30, 2017, Alaska entered into a similar contract for maintenance on its B737-800 aircraft engines. Payments under this agreement are not reflected in the table above.

Contingencies

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

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

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

16




NOTE 8. SHAREHOLDERS' EQUITY

Dividends

During the three months ended September 30, 2017, the Company declared and paid cash dividends of $0.30 per share, or $37 million. During the nine months ended September 30, 2017, the Company declared and paid cash dividends of $0.90 per share, or $111 million.

Common Stock Repurchase

In August 2015, the Board of Directors authorized a $1 billion share repurchase program. The program was paused in the second quarter of 2016 in anticipation of the acquisition of Virgin America. The Company resumed the share repurchase program in the second quarter of 2017. As of September 30, 2017, the Company has repurchased 4.7 million shares for $363 million under this program. Subsequent to September 30, 2017, the Company repurchased an additional 369,182 shares for $25 million.
Share repurchase activity (in millions, except share amounts):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
2015 Repurchase Program—$1 billion
355,415

 
$
28

 

 
$

 
612,095

 
$
50

 
2,594,809

 
$
193


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

 
$
(3
)
Employee benefit plans
(287
)
 
(299
)
Interest rate derivatives
(2
)
 
(3
)
Total
$
(289
)
 
$
(305
)

Earnings Per Share ("EPS")

Diluted EPS is calculated by dividing net income by the average number of common shares outstanding plus the number of additional common shares that would have been outstanding assuming the exercise of in-the-money stock options and restricted stock units, using the treasury-stock method. For the three and nine months ended September 30, 2017 and 2016, anti-dilutive shares excluded from the calculation of EPS were not material.

NOTE 9. OPERATING SEGMENT INFORMATION

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

Under U.S. GAAP, operating segments are defined as components of a business for which there is discrete financial information that is regularly assessed by the Chief Operating Decision Maker ("CODM") in making resource allocation decisions. Financial performance for the operating airlines and CPAs is managed and reviewed by the Company's CODM as part of three reportable operating segments:
 
Mainline - includes Alaska's and Virgin America’s scheduled air transportation for passengers and cargo throughout the U.S., and in parts of Canada, Mexico, Costa Rica and Cuba.

17



Regional - includes Horizon's and other third-party carriers’ scheduled air transportation for passengers across a shorter distance network within the U.S. under CPAs. This segment includes the actual revenues and expenses associated with regional flying, as well as an allocation of corporate overhead incurred by Air Group on behalf of the regional operations.
Horizon - includes the capacity sold to Alaska under CPA. Expenses include those typically borne by regional airlines such as crew costs, ownership costs and maintenance costs.

The CODM makes resource allocation decisions for these reporting segments based on flight profitability data, aircraft type, route economics and other financial information. The "Consolidating and Other" column reflects parent company activity, consolidating entries and other immaterial business units of the company. The “Air Group Adjusted” column represents a non-GAAP measure that is used by the Company CODM to evaluate performance and allocate resources. Adjustments are further explained below in reconciling to consolidated GAAP results.

18



Operating segment information is as follows (in millions):
 
Three Months Ended September 30, 2017
 
Mainline
 
Regional
 
Horizon
 
Consolidating & Other(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
1,562

 
$

 
$

 
$

 
$
1,562

 
$

 
$
1,562

Regional

 
262

 

 

 
262

 

 
262

Total passenger revenues
1,562

 
262

 

 

 
1,824

 

 
1,824

CPA revenues

 

 
112

 
(112
)
 

 

 

Freight and mail
30

 
1

 
1

 

 
32

 

 
32

Other—net
242

 
21

 
1

 

 
264

 

 
264

Total operating revenues
1,834

 
284

 
114

 
(112
)
 
2,120

 

 
2,120

Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
1,077

 
219

 
105

 
(112
)
 
1,289

 
24

 
1,313

Economic fuel
328

 
45

 

 

 
373

 
(5
)
 
368

Total operating expenses
1,405

 
264

 
105

 
(112
)
 
1,662

 
19

 
1,681

Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
11

 

 

 
(2
)
 
9

 

 
9

Interest expense
(23
)
 

 
(4
)
 
1

 
(26
)
 

 
(26
)
Other
5

 

 

 

 
5

 

 
5

Total Nonoperating income (expense)
(7
)
 

 
(4
)
 
(1
)
 
(12
)
 

 
(12
)
Income (loss) before income tax
$
422

 
$
20

 
$
5

 
$
(1
)
 
$
446

 
$
(19
)
 
$
427

 
Three Months Ended September 30, 2016
 
Mainline
 
Regional
 
Horizon
 
Consolidating & Other(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
1,073

 
$

 
$

 
$

 
$
1,073

 
$

 
$
1,073

Regional

 
249

 

 

 
249

 

 
249

Total passenger revenues
1,073

 
249

 

 

 
1,322

 

 
1,322

CPA revenues

 

 
109

 
(109
)
 

 

 

Freight and mail
30

 
1

 

 

 
31

 

 
31

Other—net
190

 
21

 
1

 
1

 
213

 

 
213

Total operating revenues
1,293

 
271

 
110

 
(108
)
 
1,566

 

 
1,566

Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
727

 
202

 
99

 
(109
)
 
919

 
22

 
941

Economic fuel
188

 
34

 

 

 
222

 
3

 
225

Total operating expenses
915

 
236

 
99

 
(109
)
 
1,141

 
25

 
1,166

Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
7

 

 

 

 
7

 

 
7

Interest expense
(7
)
 

 
(2
)
 
(2
)
 
(11
)
 

 
(11
)
Other
5

 

 

 
1

 
6

 

 
6

Total Nonoperating income (expense)
5

 

 
(2
)
 
(1
)
 
2

 

 
2

Income (loss) before income tax
$
383

 
$
35

 
$
9

 
$

 
$
427

 
$
(25
)
 
$
402



19



 
Nine Months Ended September 30, 2017
 
Mainline
 
Regional
 
Horizon
 
Consolidating & Other(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
4,390

 
$

 
$

 
$

 
$
4,390

 
$

 
$
4,390

Regional

 
725

 

 

 
725

 

 
725

Total passenger revenues
4,390

 
725

 

 

 
5,115

 

 
5,115

CPA revenues

 

 
317

 
(317
)
 

 

 

Freight and mail
84

 
3

 
1

 

 
88

 

 
88

Other—net
708

 
57

 
3

 

 
768

 

 
768

Total operating revenues
5,182

 
785

 
321

 
(317
)
 
5,971

 

 
5,971

Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
3,101

 
625

 
324

 
(316
)
 
3,734

 
88

 
3,822

Economic fuel
924

 
120

 

 

 
1,044

 
7

 
1,051

Total operating expenses
4,025

 
745

 
324

 
(316
)
 
4,778

 
95

 
4,873

Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
27

 

 

 
(2
)
 
25

 

 
25

Interest expense
(68
)
 

 
(9
)
 

 
(77
)
 

 
(77
)
Other
11

 

 
1

 

 
12

 

 
12

Total Nonoperating income (expense)
(30
)
 

 
(8
)
 
(2
)
 
(40
)
 

 
(40
)
Income (loss) before income tax
1,127

 
40

 
(11
)
 
(3
)
 
1,153

 
(95
)
 
1,058

 
Nine Months Ended September 30, 2016
 
Mainline
 
Regional
 
Horizon
 
Consolidating & Other(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
3,036

 
$

 
$

 
$

 
$
3,036

 
$

 
$
3,036

Regional

 
682

 

 

 
682

 

 
682

Total passenger revenues
3,036

 
682

 

 

 
3,718

 

 
3,718

CPA revenues

 

 
322

 
(322
)
 

 

 

Freight and mail
79

 
3

 

 

 
82

 

 
82

Other—net
546

 
57

 
3

 
1

 
607

 

 
607

Total operating revenues
3,661

 
742

 
325

 
(321
)
 
4,407

 

 
4,407

Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
2,107

 
580

 
305

 
(322
)
 
2,670

 
36

 
2,706

Economic fuel
512

 
90

 

 

 
602

 
(9
)
 
593

Total operating expenses
2,619

 
670

 
305

 
(322
)
 
3,272

 
27

 
3,299

Nonoperating income (expense)