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 March 31, 2018
 
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 123,258,837 common shares, par value $0.01, outstanding at April 30, 2018.




ALASKA AIR GROUP, INC.
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2018

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

You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Our forward-looking statements are based on the information currently available to us and speak only as of the date on which this report was filed with the SEC. We expressly disclaim any obligation to issue any updates or revisions to our forward-looking statements, even if subsequent events cause our expectations to change regarding the matters discussed in those statements. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such differences might be significant and materially adverse to our shareholders. For a discussion of these and other risk factors, see Item 1A. "Risk Factors” of the Company’s annual report on Form 10-K for the year ended December 31, 2017, and Item 1A. "Risk Factors" included herein. Please consider our forward-looking statements in light of those risks as you read this report.


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

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(in millions)
March 31, 2018
 
December 31, 2017
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
177

 
$
194

Marketable securities
1,351

 
1,427

Total cash and marketable securities
1,528

 
1,621

Receivables—net
350

 
341

Inventories and supplies—net
62

 
57

Prepaid expenses and other current assets
174

 
133

Total Current Assets
2,114

 
2,152

 
 
 
 
Property and Equipment
 

 
 

Aircraft and other flight equipment
7,567

 
7,559

Other property and equipment
1,287

 
1,222

Deposits for future flight equipment
560

 
494

 
9,414

 
9,275

Less accumulated depreciation and amortization
3,011

 
2,991

Total Property and Equipment—Net
6,403

 
6,284

 
 
 
 
Goodwill
1,943

 
1,943

Intangible assets
132

 
133

Other noncurrent assets
256

 
234

Other Assets
2,331

 
2,310

 
 
 
 
Total Assets
$
10,848

 
$
10,746


Certain historical information has been adjusted to reflect the adoption of new accounting standards. See accompanying notes to condensed consolidated financial statements.


4


ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(in millions, except share amounts)
March 31, 2018
 
December 31, 2017
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
102

 
$
120

Accrued wages, vacation and payroll taxes
299

 
418

Air traffic liability
1,122

 
806

Other accrued liabilities
433

 
400

Deferred revenue
649

 
635

Current portion of long-term debt
387

 
307

Total Current Liabilities
2,992

 
2,686

 
 
 
 
Long-Term Debt, Net of Current Portion
2,062

 
2,262

Other Liabilities and Credits
 

 
 

Deferred income taxes
372

 
370

Deferred revenue
1,102

 
1,090

Obligation for pension and postretirement medical benefits
458

 
453

Other liabilities
423

 
425

 
2,355

 
2,338

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: 2018 - 130,378,645 shares; 2017 - 129,903,498 shares, Outstanding: 2018 - 123,350,124 shares; 2017 - 123,060,638 shares
1

 
1

Capital in excess of par value
190

 
164

Treasury stock (common), at cost: 2018 - 7,028,521 shares; 2017 - 6,842,860 shares
(531
)
 
(518
)
Accumulated other comprehensive loss
(440
)
 
(380
)
Retained earnings
4,219

 
4,193

 
3,439

 
3,460

Total Liabilities and Shareholders' Equity
$
10,848

 
$
10,746


Certain historical information has been adjusted to reflect the adoption of new accounting standards. See accompanying notes to condensed consolidated financial statements.



5


ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
 
Three Months Ended March 31,
(in millions, except per share amounts)
2018
 
2017
Operating Revenues
 
 
 
Passenger revenue
$
1,685

 
$
1,602

Mileage plan other revenue
107

 
100

Cargo and other
40

 
38

Total Operating Revenues
1,832

 
1,740

Operating Expenses
 
 
 
Wages and benefits
536

 
450

Variable incentive pay
39

 
31

Aircraft fuel, including hedging gains and losses
409

 
339

Aircraft maintenance
107

 
87

Aircraft rent
74

 
65

Landing fees and other rentals
126

 
115

Contracted services
81

 
81

Selling expenses
78

 
83

Depreciation and amortization
94

 
90

Food and beverage service
50

 
45

Third-party regional carrier expense
37

 
27

Other
141

 
131

Special items—merger-related costs
6

 
39

Special items—other
25

 

Total Operating Expenses
1,803

 
1,583

Operating Income
29

 
157

Nonoperating Income (Expense)
 
 
 
Interest income
8

 
7

Interest expense
(24
)
 
(25
)
Interest capitalized
5

 
4

Other—net
(12
)
 
(1
)
Total Nonoperating Income (Expense)
(23
)
 
(15
)
Income Before Income Tax
6

 
142

Income tax expense
2

 
49

Net Income
$
4

 
$
93

 
 
 
 
Basic Earnings Per Share:
$
0.03

 
$
0.75

Diluted Earnings Per Share:
$
0.03

 
$
0.75

Shares used for computation:
 
 
 
Basic
123.155

 
123.495

Diluted
123.630

 
124.299

 
 
 
 
Cash dividend declared per share:
$
0.32

 
$
0.30


Certain historical information has been adjusted to reflect the adoption of new accounting standards. See accompanying notes to condensed consolidated financial statements.


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ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS (unaudited)
 
Three Months Ended March 31,
(in millions)
2018
 
2017
Net Income
$
4

 
$
93

 
 
 
 
Other Comprehensive Income (Loss):
 
 
 
Related to marketable securities:
 
 
 
Unrealized holding gain (loss) arising during the period
(13
)
 
3

Reclassification of (gain) loss into Other—net nonoperating income (expense)
2

 

Income tax effect
3

 
(1
)
Total
(8
)
 
2

 
 
 
 
Related to employee benefit plans:
 
 
 
Reclassification of net pension expense into Wages and benefits
7

 
6

Income tax effect
(2
)
 
(2
)
Total
5

 
4

 
 
 
 
Related to interest rate derivative instruments:
 
 
 
Unrealized holding gain (loss) arising during the period
6

 
1

Reclassification of (gain) loss into Aircraft rent
1

 

Income tax effect
(2
)
 
(1
)
Total
5

 

 
 
 
 
Other Comprehensive Income
2

 
6

 
 
 
 
Comprehensive Income
$
6

 
$
99


Certain historical information has been adjusted to reflect the adoption of new accounting standards. See accompanying notes to condensed consolidated financial statements.



7


ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
 
Three Months Ended March 31,
(in millions)
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
4

 
$
93

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

 
 

Depreciation and amortization
94

 
90

Stock-based compensation and other
8

 
13

Changes in certain assets and liabilities:
 
 
 
Changes in deferred tax provision
2

 
44

Increase in air traffic liability
316

 
364

Increase in deferred revenue
26

 
31

Other—net
(144
)
 
(165
)
Net cash provided by operating activities
306

 
470

Cash flows from investing activities:
 

 
 

Property and equipment additions:
 

 
 

Aircraft and aircraft purchase deposits
(135
)
 
(160
)
Other flight equipment
(29
)
 
(20
)
Other property and equipment
(71
)
 
(36
)
Total property and equipment additions, including capitalized interest
(235
)
 
(216
)
Purchases of marketable securities
(238
)
 
(557
)
Sales and maturities of marketable securities
301

 
285

Other investing activities
8

 

Net cash used in investing activities
(164
)
 
(488
)
Cash flows from financing activities:
 

 
 

Long-term debt payments
(120
)
 
(101
)
Common stock repurchases
(12
)
 

Dividends paid
(39
)
 
(37
)
Other financing activities
15

 
11

Net cash used in financing activities
(156
)
 
(127
)
Net increase (decrease) in cash, cash equivalents, and restricted cash
(14
)
 
(145
)
Cash, cash equivalents, and restricted cash at beginning of year
197

 
328

Cash, cash equivalents, and restricted cash at end of the period
$
183

 
$
183

 
 
 
 
Cash paid during the period for:
 
 
 
Interest (net of amount capitalized)
$
24

 
$
26

Income taxes

 
2

 
 
 
 
Reconciliation of cash, cash equivalents, and restricted cash at end of the period
 
 
 
Cash and cash equivalents
$
177

 
$
183

Restricted cash included in Prepaid expenses and other current assets
6

 

Total cash, cash equivalents, and restricted cash at end of the period
$
183

 
$
183

 
 
 
 
Certain historical information has been adjusted to reflect the adoption of new accounting standards. See accompanying notes to condensed consolidated financial statements.

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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, or the Company, and its primary subsidiaries, Alaska, Horizon, and Virgin America. Our condensed consolidated financial statements also include McGee Air Services, a ground services subsidiary of Alaska. 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, 2017. In the opinion of management, all adjustments have been made that are necessary to fairly present the Company’s financial position as of March 31, 2018 and the results of operations for the three months ended March 31, 2018 and 2017. Such adjustments were of a normal recurring nature.

Certain reclassifications have been made to prior year financial statements to conform to classifications used in the current year.

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 months ended March 31, 2018 are not necessarily indicative of operating results for the entire year.

Recently Issued Accounting Pronouncements

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 and related liability associated with leased aircraft. Other leases, including airports and real estate, equipment, software and other miscellaneous leases continue to be assessed for impact as it relates to the ASU. In March 2018, the FASB approved amendments to Topic 842 that would give companies an alternative transition method which would not require adjusting comparative period financial information. The ASU codification of this new transition method has not yet been issued, but the Company will consider the alternative in greater detail upon issuance. The new standard is effective for the Company on January 1, 2019.

In November 2016, the FASB issued ASU 2016-18, "Statement of Cash Flows—Restricted Cash (Topic 230)" related to the presentation of restricted cash on the statement of cash flows, and within the accompanying footnotes. The Company adopted the standard effective January 1, 2018.

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. The Company will not early adopt the standard.

In February 2018, the FASB issued ASU 2018-02, "Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." The standard allows a reclassification from accumulated other comprehensive income (AOCI) to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The amount of the reclassification is the difference between the amount initially recorded directly to other comprehensive income at the previously enacted U.S. federal corporate income tax rate that remains in AOCI and the amount that would have been recorded directly to other comprehensive income using the newly enacted U.S. federal income tax rate. The standard is effective for interim and annual reporting periods beginning after December 15, 2018, and early adoption is permitted. The Company elected to early adopt the standard effective January 1, 2018. As a result, retained

9



earnings increased approximately $62 million due to the reclassification of tax effects in AOCI recorded in prior periods at previously enacted tax rates.

NOTE 2. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

Revenue Recognition and Retirement Benefits Accounting Standards

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)." The Company adopted the new standard as of January 1, 2018, utilizing a full retrospective transition method. Adoption of the new standard resulted in changes to accounting policies for revenue recognition related to frequent flyer activity, certain ancillary revenues such as change fees, air traffic liabilities, and sales and marketing expenses. As a result of adoption, the Company also changed certain financial statement line item disclosure captions. See Note 3 for a discussion of the impact of this standard.

Although less significant, in March 2017 the FASB issued ASU 2017-07, "Compensation - Retirement Benefits (Topic 715)," which requires the Company to present the service cost component of net periodic benefit cost as Wages and benefits in the statement of operations. The Company adopted the new standard as of January 1, 2018, utilizing a full retrospective transition method. Under this new standard, all components of net periodic benefit cost are presented in Nonoperating income (expense), except service cost, which remains in Wages and benefits.

Certain line item captions on the balance sheet and statement of operations changed as a result of the newly implemented standards. Accordingly, historical financial information presented below as reported has been presented using the new captions. The cumulative impact to retained earnings at January 1, 2016 as a result of the new revenue recognition standard was $171 million. Below are the impacts of these newly adopted accounting standards to the financial statements.

Consolidated balance sheet as of December 31, 2017 (in millions):
 
December 31, 2017
 
As Reported
 
Adjustments - Revenue Recognition
 
As Adjusted
Current Assets:
 
 
 
 
 
   Prepaid expenses and other current assets
$
127

 
$
6

 
$
133

Current Liabilities:
 
 
 
 
 
   Air traffic liability
937

 
(131
)
 
806

   Deferred revenue
518

 
117

 
635

Other liabilities and credits:
 
 
 
 
 
  Deferred income taxes
454

 
(84
)
 
370

  Deferred revenue
699

 
391

 
1,090

  Other liabilities
451

 
(26
)
 
425

Shareholders' Equity:
 
 
 
 
 
   Retained earnings
4,454

 
(261
)
 
4,193



10



Condensed consolidated statement of operations for the three months ended March 31, 2017 (in millions):
 
Three Months Ended March 31, 2017
 
As Reported
 
Adjustments - Revenue Recognition
 
Adjustments - Retirement Benefits
 
As Adjusted
Operating Revenues
 
 
 
 
 
 
 
Passenger Revenue
$
1,484

 
$
118

 
$

 
$
1,602

Mileage plan other revenue
119

 
(19
)
 

 
100

Cargo and other revenue
146

 
(108
)
 

 
38

Total Operating Revenue
1,749

 
(9
)
 

 
1,740

 
 
 
 
 
 
 
 
Operating Expenses
 
 
 
 
 
 
 
Wages and benefits
448

 

 
2

 
450

Selling expenses
81

 
2

 

 
83

Special items—merger-related costs
40

 
(1
)
 

 
39

All other operating expenses
1,011

 

 

 
1,011

Total Operating Expenses
1,580

 
1

 
2

 
1,583

 
 
 
 
 
 
 
 
Operating Income
169

 
(10
)
 
(2
)
 
157

 
 
 
 
 
 
 
 
Nonoperating Income (Expense)
 
 
 
 
 
 
 
Other—net
(3
)
 

 
2

 
(1
)
All other nonoperating income (expense)
(14
)
 

 

 
(14
)
 
(17
)
 

 
2

 
(15
)
Income (loss) before income tax
152

 
(10
)
 

 
142

Income tax expense (benefit)
53

 
(4
)
 

 
49

Net Income (Loss)
$
99

 
$
(6
)
 
$

 
$
93



11



Condensed consolidated statement of cash flows for the three months ended March 31, 2017 (in millions):
 
Three Months Ended March 31, 2017
 
As Reported
 
Adjustments - Revenue Recognition
 
As Adjusted
Cash flows from operating activities:
 
 
 
 
 
Net income
$
99

 
(6
)
 
$
93

 
 
 
 
 
 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
Depreciation and amortization
90

 

 
90

Stock-based compensation and other
13

 

 
13

Changes in certain assets and liabilities:
 
 
 
 
 
Changes in deferred tax provision
48

 
(4
)
 
44

Increase in air traffic liability
369

 
(5
)
 
364

Increase in deferred revenue
1

 
30

 
31

Other—net
(150
)
 
(15
)
 
(165
)
Net cash provided by operating activities
470

 

 
470

 
 
 
 
 
 
Net cash used in investing activities
(488
)
 

 
(488
)
 
 
 
 
 
 
Net cash used in financing activities
(127
)
 

 
(127
)
 
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents
(145
)
 

 
(145
)
Cash and cash equivalents at beginning of year
328

 

 
328

Cash and cash equivalents at end of the period
$
183

 

 
$
183


NOTE 3. REVENUE

Ticket revenue is recorded as Passenger revenue, and represents the primary source of the Company's revenue. Also included in Passenger revenue are passenger ancillary revenues such as bag fees, on-board food and beverage, ticket change fees, and certain revenue from the frequent flyer program. Mileage plan™ other revenue includes brand and marketing revenue from our co-branded credit card and other partners and certain interline frequent flyer revenue, net of commissions. Cargo and other revenue includes freight and mail revenue, and to a lesser extent, other ancillary revenue products such as lounge membership and certain commissions.

The Company disaggregates revenue by segment in Note 9. The level of detail within the Company’s statements of operations, segment disclosures, and in this footnote depict the nature, amount, timing and uncertainty of revenue and how cash flows are affected by economic and other factors.

Passenger Ticket and Ancillary Services Revenue

The primary performance obligation in a typical passenger ticket is to provide air travel to the Company’s passengers. Ticket revenue is collected in advance of travel and recorded as Air Traffic Liability (ATL) on the consolidated balance sheets. The Company satisfies its performance obligation and recognizes ticket revenue on each flight segment when the transportation is provided.

Ancillary passenger revenues relate to items such as checked-bag fees, ticket change fees, and on-board food and beverage sales, all of which are provided at time of flight. As such, the obligation to perform these services is satisfied at the time of travel and is recorded with ticket revenue in Passenger revenue.


12



Revenue is also recognized for tickets that are expected to expire unused, a concept referred to as “passenger ticket breakage.” Passenger ticket breakage is recorded in advance of the flight date using estimates based on the Company’s historical experience of expired tickets, and other facts such as program changes and modifications.

In addition to selling tickets on its own marketed flights, the Company has interline agreements with partner airlines where it sells multi-city tickets with one or more segments of the trip flown by a partner airline, or it operates a connecting flight sold by a partner airline. Each segment in a connecting flight represents a separate performance obligation. Revenue on segments sold and operated by the Company is recognized as Passenger revenue in the gross amount of the allocated ticket price when the travel occurs, while the commission paid to the partner airline is recognized as a selling expense when the related transportation is provided. Revenue on segments operated by a partner airline is deferred for the full amount of the consideration received at the time the ticket is sold and, once the segment has been flown the Company records the net amount, after compensating the partner airline, as Cargo and other revenue.

A portion of revenue from the Mileage Plan™ program is recorded in Passenger revenue. As members are awarded mileage credits on flown tickets, these credits become a distinct performance obligation to the Company. The Company allocates the transaction price to each performance obligation identified in a passenger ticket contract on a relative standalone selling price basis. The standalone selling price for loyalty mileage credits issued is discussed in the Loyalty Mileage Credits section of this Note below. The amount allocated to the mileage credits is deferred on the balance sheet. Once a member travels using a travel award redeemed with mileage credits on one of the Company's airline carriers, the revenue associated with those mileage credits is recorded as Passenger revenue.

Taxes collected from passengers, including transportation excise taxes, airport and security fees and other fees, are recorded on a net basis within passenger revenue in the consolidated statements of operations.

Passenger revenue recognized in the condensed consolidated statements of operations (in millions):
 
Three Months Ended March 31,
 
2018
 
2017
Passenger ticket revenue, including ticket breakage and net of taxes and fees
$
1,428

 
$
1,358

Passenger ancillary revenue
118

 
116

Mileage PlanTM passenger revenue
139

 
128

Total passenger revenue
$
1,685

 
$
1,602


As passenger tickets and related ancillary services are primarily sold via credit cards, certain amounts due from credit card processors are recorded as airline traffic receivables. These credit card receivables and receivables from our affinity credit card partner represent the majority of the receivables balance on the Balance Sheet.

For performance obligations with performance periods of less than one year,GAAP provides a practical expedient that allows the Company not to disclose the transaction price allocated to remaining performance obligations and the timing of related revenue recognition. As passenger tickets expire one year from ticketing, if unused or not exchanged, the Company elected to apply this practical expedient.

Mileage Plan™ Loyalty Program

Loyalty mileage credits

The Company’s Mileage Plan™ loyalty program provides frequent flyer travel awards to program members based upon accumulated loyalty mileage credits. Mileage credits are earned through travel, purchases using the Mileage Plan™ co-branded credit card and purchases from other participating partners. The program has a 24-month expiration period for unused mileage credits from the month of last account activity. The Company offers redemption of mileage credits through free, discounted or upgraded air travel on Alaska flights or on one of its 16 airline partners.

The Company uses a relative standalone selling price allocation to allocate consideration to material performance obligations in contracts with customers that include loyalty mileage credits. As directly observable selling prices for mileage credits are not available, the Company determines the standalone selling price of mileage credits primarily using actual ticket purchase prices for similar tickets flown, adjusted for the likelihood of redemption, or breakage. In determining similar tickets flown,

13



the Company considers current market prices, class of service, type of award, and other factors. For mileage credits accumulated through travel on partner airlines, the Company uses actual consideration received from the partners.

Revenue related to air transportation is deferred in the amount of the relative standalone selling price allocated to the loyalty mileage credits as they are issued. The Company satisfies its performance obligation when the mileage credits are redeemed and the related air transportation is delivered.

The Company estimates breakage for the portion of loyalty mileage credits not expected to be redeemed using a statistical analysis of historical data, including actual mileage credits expiring, slow-moving and low-credit accounts, among other factors. The breakage rate for the three months ended March 31, 2018 and 2017 was 17.4%. The Company reviews the breakage rate used on an annual basis.

Co-brand credit card agreement and other

In addition to mileage credits, the co-brand credit card agreement, referred to herein as the Agreement, also includes performance obligations for waived bag fees, Companion Fare™ offers to purchase an additional ticket at a discount, marketing, and the use of intellectual property including the brand (unlimited access to the use of the Company’s brand and frequent flyer member lists), which is the predominant element in the Agreement. The affinity card bank partner is the related customer for some elements, including the brand and marketing, while the Mileage Plan™ member is the customer for other elements such as mileage credits, bag waivers, and companion fares.

At the inception of the Agreement, management estimated the selling price of each of the deliverables, or performance obligations. The objective was to determine the price at which a sale would be transacted if the product or service was sold on a stand-alone basis. The Company determined its best estimate of selling price for each element by considering multiple inputs and methods including, but not limited to, the estimated selling price of comparable travel, discounted cash flows, brand value, published selling prices, number of miles awarded and number of miles redeemed. The Company estimated the selling prices and volumes over the term of the Agreement in order to determine the allocation of proceeds to each of the multiple deliverables. The estimates of the standalone selling prices of each element do not change subsequent to the original valuation of the contract unless the contract is materially modified, but the allocation between elements may change based upon the actual and updated projected volumes of each element delivered during the term of the contract.

Consideration received from the bank is variable and is primarily from consumer spend on the card, among other items. The Company allocates consideration to each of the performance obligations, including mileage credits, waived bag fees, companion fares, and brand and marketing, using their relative standalone selling price. Because the performance obligation related to providing use of intellectual property including the brand is satisfied over time, it is recognized in Mileage PlanTM other revenue in the period that those elements are sold. The Company records passenger revenue related to the air transportation and certificates for discounted companion travel when the transportation is delivered.

In contracts with non-bank partners, the Company has identified two performance obligations in most cases - travel and brand. Revenue is recognized using the residual method, where the travel performance obligation is deferred until transportation is provided in the amount of the estimated standalone selling price of the ticket, less breakage. The residual amount, if any, is recognized as commission revenue when the brand element is sold. Mileage credit sales recorded under the residual approach are immaterial to the overall program.

Interline loyalty

The Company has interline arrangements with certain airlines whereby its members may earn and redeem Mileage Plan™ credits on those airlines, and members of a partner airline’s loyalty program may earn and redeem frequent flyer program credits on Alaska. When a Mileage Plan™ member earns credits on a partner airline, the partner airline remits a contractually-agreed upon fee to the Company that is deferred and recognized as Passenger revenue for mileage credits redeemed and flown on the Company's airlines, and as Mileage Plan other revenue for mileage credits redeemed and flown on other airlines (less the cost paid to the other airlines based on contractual agreements). When a member of a partner airline redeems frequent flyer credits on Alaska, the partner airline remits a contractually-agreed upon amount to the Company, recognized as Passenger revenue upon travel. If the partner airline’s member earns frequent flyer program credits on an Alaska flight, the Company remits a contractually-agreed upon fee to the partner airline and records a commission expense.


14



Mileage Plan™ revenue included in the condensed consolidated statements of operations (in millions):
 
Three Months Ended March 31,
 
2018
 
2017
Passenger revenue
$
139

 
$
128

Mileage PlanTM other revenue
107

 
100

Total Mileage Plan™ revenue
$
246

 
$
228


Mileage Plan™ other revenue is primarily brand and marketing revenue from our affinity card products.

Cargo and Other

The Company provides freight and mail services (cargo). The majority of cargo services are provided to commercial businesses and the United States Postal Service. The Company satisfies cargo service performance obligations and recognizes revenue when the shipment arrives at its final destination, or is transferred to a third-party carrier for delivery.

The Company also earns other revenue for lounge memberships, hotel and car commissions, and certain other immaterial items not intrinsically tied to providing air travel to passengers. Revenue is recognized when these services are rendered and recorded as Cargo and other revenue. The transaction price for Cargo and other revenue is the price paid by the customer.

Cargo and other revenue included in the condensed consolidated statements of operations for the three months ended March 31, 2018 and 2017 (in millions):
 
Three Months Ended March 31,
 
2018
 
2017
Cargo revenue
$
26

 
$
24

Other revenue
14

 
14

Total Cargo and other revenue
$
40

 
$
38


Air Traffic Liability and Deferred Revenue

Passenger ticket and ancillary services liabilities

Air traffic liability included on the consolidated balance sheets represents the remaining obligation associated with passenger tickets and ancillary services. The air traffic liability balance fluctuates with seasonal travel patterns. The Company recognized Passenger revenue of $434 million and $431 million from the prior year-end air traffic liability balance for the three months ended March 31, 2018 and 2017.

Mileage PlanTM liabilities

The total Deferred revenue liability included on the consolidated balance sheets represents the remaining transaction price that has been allocated to Mileage PlanTM performance obligations not yet satisfied by the Company. In general, the current amounts will be recognized as revenue within 12 months and the long term amounts will be recognized as revenue over, on average, a period of approximately three to four years. This period of time represents the average time that members have historically earned and redeemed miles.

The Company records a receivable for amounts due from the affinity card partner and from other partners as mileage credits are sold until the payments are collected. The Company had $101 million of such receivables as of both March 31, 2018 and December 31, 2017.


15



Mileage credits are combined in one homogeneous pool and are not specifically identifiable. As such, loyalty revenues disclosed earlier in this Note are comprised of miles that were part of the deferred revenue and liabilities balances at the beginning of the period and miles that were issued during the period. The table below presents a roll forward of the total frequent flyer liability (in millions):
 
Three Months Ended March 31,
 
2018
 
2017
Total Deferred Revenue balance at January 1
$
1,726

 
$
1,535

Travel miles and companion certificate redemption - Passenger revenue
(139
)
 
(128
)
Miles redeemed on partner airlines - Other revenue
(19
)
 
(23
)
Increase in liability for mileage credits issued
183

 
185

Total Deferred Revenue balance at March 31
$
1,751

 
$
1,569

 
Selling Costs

Certain costs such as credit card fees, travel agency and other commissions paid, as well as Global Distribution Systems (GDS) booking fees are incurred when the Company sells passenger tickets and ancillary services in advance of the travel date. The Company defers such costs and recognizes them as expense when the travel occurs. Prepaid expense recorded on the consolidated balance sheets for such costs was $29 million and $24 million as of March 31, 2018 and December 31, 2017. The Company recorded related expense on the condensed consolidated statement of operations of $51 million and $56 million for the three months ended March 31, 2018 and 2017.

NOTE 4. 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.

Fair Value of Financial Instruments on a Recurring Basis

As of March 31, 2018, total cost basis for all marketable securities was $1.4 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):
March 31, 2018
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
330

 
$

 
$
330

Foreign government bonds

 
32

 
32

Asset-backed securities

 
208

 
208

Mortgage-backed securities

 
86

 
86

Corporate notes and bonds

 
685

 
685

Municipal securities

 
10

 
10

Total Marketable securities
330

 
1,021

 
1,351

Derivative instruments
 
 
 
 
 
Fuel hedge—call options

 
35

 
35

Interest rate swap agreements

 
13

 
13

Total Assets
330

 
1,069

 
1,399

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Interest rate swap agreements

 
(6
)
 
(6
)
Total Liabilities

 
(6
)
 
(6
)

16



December 31, 2017
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
328

 
$

 
$
328

Foreign government bonds

 
43

 
43

Asset-backed securities

 
209

 
209

Mortgage-backed securities

 
99

 
99

Corporate notes and bonds

 
726

 
726

Municipal securities

 
22

 
22

Total Marketable securities
328

 
1,099

 
1,427

Derivative instruments
 
 
 
 
 
Fuel hedge—call options

 
22

 
22

Interest rate swap agreements

 
9

 
9

Total Assets
328

 
1,130

 
1,458

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Interest rate swap agreements

 
(8
)
 
(8
)
Total Liabilities

 
(8
)
 
(8
)

The Company uses both 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.

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

Unrealized losses from marketable securities are primarily attributable to changes in interest rates. Management does not believe any unrealized losses represent other-than-temporary impairments based on its evaluation of available information as of March 31, 2018.

Maturities for marketable securities (in millions):
March 31, 2018
Cost Basis
 
Fair Value
Due in one year or less
$
141

 
$
141

Due after one year through five years
1,207

 
1,187

Due after five years through 10 years
23

 
23

Total
$
1,371

 
$
1,351


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.


17



Cash, Cash Equivalents and Restricted Cash: Cash equivalents consist of highly liquid investments with original maturities of three months or less, such as money market funds, commercial paper and certificates of deposit. They are carried at cost, which approximates fair value.

The Company's restricted cash balances are primarily used to guarantee various letters of credit, self-insurance programs or other contractual rights. Restricted cash consists of highly liquid securities with original maturities of three months or less. They are carried at cost, which approximates fair value.

Debt: Debt assumed in the acquisition of Virgin America was subject to a non-recurring fair valuation adjustment as part of purchase price accounting. The adjustment is amortized over the life of the associated debt. All other fixed-rate debt is carried at cost. To estimate the fair value of all fixed-rate debt as of March 31, 2018, the Company uses the income approach by discounting cash flows using borrowing rates for comparable debt over the remaining 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 on the consolidated balance sheet and the estimated fair value of long-term fixed-rate debt is as follows (in millions):
 
March 31, 2018
 
December 31, 2017
Fixed-rate debt at cost
$
874

 
$
956

Non-recurring purchase price accounting fair value adjustment
3

 
3

Total fixed-rate debt
877

 
959

 
 
 
 
Estimated fair value
871

 
959


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 months ended March 31, 2018 or March 31, 2017.

NOTE 5. LONG-TERM DEBT
 
Long-term debt obligations on the consolidated balance sheet (in millions):
 
March 31, 2018
 
December 31, 2017
Fixed-rate notes payable due through 2028
$
877

 
$
959

Variable-rate notes payable due through 2028
1,587

 
1,625

Less debt issuance costs
(15
)
 
(15
)
Total debt
2,449

 
2,569

Less current portion
387

 
307

Long-term debt, less current portion
$
2,062

 
$
2,262

 
 
 
 
Weighted-average fixed-interest rate
4.2
%
 
4.2
%
Weighted-average variable-interest rate
3.3
%
 
2.8
%

During the three months ended March 31, 2018 the Company made debt payments of $120 million, including the prepayment of $23 million of debt.


18



At March 31, 2018 long-term debt principal payments for the next five years and thereafter are as follows (in millions):
 
Total
Remainder of 2018
$
266

2019
321

2020
439

2021
421

2022
246

Thereafter
768

Total
$
2,461

 
Bank Lines of Credit
 
The Company has three credit facilities totaling $475 million. All three facilities have variable interest rates based on LIBOR plus a specified margin. One credit facility for $250 million expires in June 2021 and is secured by aircraft. A second credit facility for $75 million expires in September 2018, with a mechanism for annual renewal, and is secured by aircraft. A third credit facility for $150 million 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 was in compliance with this covenant at March 31, 2018.

NOTE 6. EMPLOYEE BENEFIT PLANS

See Note 2 for a discussion of the impacts of ASU 2017-07, "Compensation - Retirement Benefits" which became effective January 1, 2018.

Net periodic benefit costs for qualified defined-benefit plans include the following (in millions): 
 
Three Months Ended March 31,
 
2018
 
2017
Service cost
$
12

 
$
10

Pension expense included in Wages and benefits
12

 
10

 
 
 
 
Interest cost
20

 
18

Expected return on assets
(27
)
 
(27
)
Recognized actuarial loss (gain)
8

 
7

Pension expense (benefit) included in Nonoperating
$
1

 
$
(2
)

NOTE 7. COMMITMENTS AND CONTINGENCIES

Future minimum payments for commitments as of March 31, 2018 (in millions):
 
Aircraft Leases
 
Facility Leases
 
Aircraft Commitments(a)
 
Capacity Purchase Agreements (b)
 
Aircraft Maintenance Deposits
Remainder of 2018
$
265

 
$
58

 
$
610

 
$
100

 
$
60

2019
356

 
68

 
560

 
151

 
65

2020
330

 
61

 
514

 
159

 
68

2021
287

 
52

 
562

 
166

 
64

2022
264

 
33

 
303

 
174

 
52

Thereafter
1,037

 
141

 
141

 
1,205

 
38

Total
$
2,539

 
$
413

 
$
2,690

 
$
1,955

 
$
347


19



(a)
Includes non-cancelable contractual commitments for aircraft and engines, buyer furnished equipment, and aircraft maintenance and parts management.
(b)
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, as well as aircraft leases operated by third-parties. At March 31, 2018, the Company had lease contracts for 10 Boeing 737 (B737) aircraft, 59 Airbus aircraft, 15 Bombardier Q400 aircraft, and 25 Embraer 175 (E175) with SkyWest Airlines, Inc. (SkyWest). The Company has an additional four scheduled lease deliveries of A321neo aircraft through 2019, as well as 10 scheduled lease deliveries of E175 aircraft through 2018 to be operated by SkyWest. All lease contracts have remaining non-cancelable lease terms ranging from 2018 to 2031. The Company has the option to increase capacity flown by SkyWest with eight additional E175 aircraft with deliveries in 2020. Options to lease are not reflected in the commitments table above.

Facility lease commitments primarily include airport and terminal facilities and building leases. Total rent expense for aircraft and facility leases was $153 million and $138 million for the three months ended March 31, 2018 and 2017.

Aircraft Commitments
 
Aircraft purchase commitments include non-cancelable contractual commitments for aircraft and engines. As of March 31, 2018, the Company had commitments to purchase 43 B737 aircraft (11 B737 NextGen aircraft and 32 B737 MAX aircraft), with deliveries in the remainder of 2018 through 2023. In the first quarter of 2018 the Company entered into a supplemental agreement with Boeing to defer certain B737 deliveries and to convert 15 MAX8 aircraft orders to MAX9 aircraft orders. The Company also has commitments to purchase 22 E175 aircraft with deliveries in the remainder of 2018 through 2021. The Company also has cancelable purchase commitments for 30 Airbus A320neo aircraft with deliveries from 2021 through 2023. 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.

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. In January 2018, Virgin America filed a motion to decertify the class and Plaintiffs filed a motion for summary judgment seeking the court to rule in their favor on all remaining claims. The Company believes the claims in this case are without factual and legal merit and intends to defend this lawsuit.

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

NOTE 8. SHAREHOLDERS' EQUITY

Dividends

During the three months ended March 31, 2018, the Company declared and paid cash dividends of $0.32 per share, or $39 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 March 31, 2018, the Company has repurchased 5.3 million shares for $401 million under this program.

20



Share repurchase activity (in millions, except share amounts):
 
Three Months Ended March 31,
 
2018
 
2017
 
Shares
 
Amount
 
Shares
 
Amount
2015 Repurchase Program—$1 billion
185,661

 
$
12

 

 
$


Accumulated Other Comprehensive Loss
 
Components of accumulated other comprehensive loss, net of tax (in millions):
 
March 31, 2018
 
December 31, 2017
Related to marketable securities
$
(15
)
 
$
(5
)
Related to employee benefit plans
(431
)
 
(376
)
Related to interest rate derivatives
6

 
1

Total
$
(440
)
 
$
(380
)

During the three months ended March 31, 2018, the Company elected to early adopt ASU 2018-02. As a result, the Company reclassified approximately $62 million of tax effects in AOCI recorded in prior periods at previously enacted tax rates thus increasing Retained earnings.

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 months ended March 31, 2018 and 2017, anti-dilutive shares excluded from the calculation of EPS were not material.

NOTE 9. OPERATING SEGMENT INFORMATION

Alaska Air Group has two operating airlines—Alaska (including Virgin America after the single operating certificate received in January 2018) 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 scheduled air transportation on Alaska's Boeing or Airbus jet aircraft for passengers and cargo throughout the U.S., and in parts of Canada, Mexico, and Costa Rica.
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, McGee Air Services, 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.


21



Operating segment information is as follows (in millions):
 
Three Months Ended March 31, 2018
 
Mainline
 
Regional
 
Horizon
 
Consolidating & Other(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger revenues
$
1,442

 
$
243

 
$

 
$

 
$
1,685

 
$

 
$
1,685

CPA revenues

 

 
110

 
(110
)
 

 

 

Mileage plan other revenue
98

 
9

 

 

 
107

 

 
107

Cargo and other
39

 

 
1

 

 
40

 

 
40

Total operating revenues
1,579

 
252

 
111

 
(110
)
 
1,832

 

 
1,832

Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
1,131

 
239

 
104

 
(111
)
 
1,363

 
31

 
1,394

Economic fuel
367

 
55

 

 

 
422

 
(13
)
 
409

Total operating expenses
1,498

 
294

 
104

 
(111
)
 
1,785

 
18

 
1,803

Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
11

 

 

 
(3
)
 
8

 

 
8

Interest expense
(22
)
 

 
(5
)
 
3

 
(24
)
 

 
(24
)
Interest capitalized
4

 

 
1

 

 
5

 

 
5

Other—net
(5
)
 
(7
)
 

 

 
(12
)
 

 
(12
)
Total Nonoperating income (expense)
(12
)
 
(7
)
 
(4
)
 

 
(23
)
 

 
(23
)
Income (loss) before income tax
$
69

 
$
(49
)
 
$
3

 
$
1

 
$
24

 
$
(18
)
 
$
6

 
Three Months Ended March 31, 2017(d)
 
Mainline
 
Regional
 
Horizon
 
Consolidating & Other(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger revenues
$
1,375

 
$
227

 
$

 
$

 
$
1,602

 
$

 
$
1,602

CPA revenues

 

 
97

 
(97
)
 

 

 

Mileage plan other revenue
93

 
7

 

 

 
100

 

 
100

Cargo and other
36

 
1

 
1

 

 
38

 

 
38

Total operating revenues
1,504

 
235

 
98

 
(97
)
 
1,740

 

 
1,740

Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
1,000

 
200

 
103

 
(98
)
 
1,205

 
39

 
1,244

Economic fuel
292

 
37

 

 

 
329

 
10

 
339

Total operating expenses
1,292

 
237

 
103

 
(98
)
 
1,534

 
49

 
1,583

Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
7

 

 

 

 
7

 

 
7

Interest expense
(23
)
 

 
(2
)
 

 
(25
)
 

 
(25
)
Interest capitalized
4

 

 

 

 
4

 

 
4

Other—net
(1
)
 

 

 

 
(1
)
 

 
(1
)
Total Nonoperating income (expense)
(13
)
 

 
(2
)
 

 
(15
)
 

 
(15
)
Income (loss) before income tax
$
199

 
$
(2
)
 
$
(7
)
 
$
1

 
$
191

 
$
(49
)
 
$
142

(a)
Includes consolidating entries, Parent Company, McGee Air Services, and other immaterial business units.
(b)
The Air Group Adjusted column represents the financial information that is reviewed by management to assess performance of operations and determine capital allocations and does not include certain income and charges.
(c)
Includes merger-related costs, mark-to-market fuel-hedge accounting charges, and other special items.
(d)
Certain historical information has been adjusted to reflect the adoption of new accounting standards.


22



Total assets were as follows (in millions):
 
March 31, 2018
 
December 31, 2017
Mainline
$
15,088

 
$
16,663

Horizon
945

 
929

Consolidating & Other
(5,185
)
 
(6,846
)
Consolidated
$
10,848

 
$
10,746


ITEM 2. 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, segment operations and the 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 "Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2017. This overview summarizes the MD&A, which includes the following sections:
 
First Quarter Review—highlights from the first quarter of 2018 outlining some of the major events that happened during the period 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 months ended March 31, 2018. 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. This section includes forward-looking statements regarding our view of the remainder of 2018

Liquidity and Capital Resources—an overview of our financial position, analysis of cash flows, and relevant contractual obligations and commitments.

FIRST QUARTER REVIEW

Our consolidated pretax income was $6 million during the first quarter of 2018, compared to $142 million in the first quarter of 2017. The decrease in pretax income of $136 million was driven largely by an increase in non-fuel operating expenses of $150 million and an increase in fuel expense of $70 million, partially offset by an increase in operating revenues of $92 million.

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.

Operations Performance

During the first quarter of 2018, our Mainline and Regional operations improved on-time performance, reporting that 84.4% and 86.2% of our flights arrived on time, respectively. These on-time results are an improvement from the operational headwinds we encountered in 2017, and are in-line with our historical high standard of running an excellent operation.

New Markets

We launched three new routes during the first quarter of 2018, capping off the launch of 49 new routes since our acquisition of Virgin America in December 2016. Approximately 80% of projected growth in 2018 is attributable to existing routes and locations, with the rest attributable to our plans to operate 13 daily flights from Paine Field-Snohomish County Airport in Everett, Washington to eight cities on the West Coast beginning in late 2018, and service from Pittsburgh to Seattle starting in September 2018.


23



Shareholder Return

During the first quarter of 2018, we paid cash dividends of $39 million and repurchased 185,661 shares for $12 million.

Labor Update

In April 2018, mainline flight attendants, represented by the Association of Flight Attendants (AFA), ratified a merger transition agreement and contract extension. The agreement will provide pay increases to our nearly 5,700 mainline flight attendants with a wage rate increase of 4.5% for legacy Alaska flight attendants and 16.5% for legacy Virgin America flight attendants (12% to bring them to the existing Alaska rate plus the 4.5% step rate increase). The agreement is retroactive to January 1, 2018 and extends the existing contract from 2019 to 2021. In the first quarter we incurred approximately $9 million related to the retroactive pay and bringing sick and vacation accruals to the higher wage rates. We currently estimate the 2018 full year impact of this agreement will be approximately $30 million. With this ratification, three of our five unionized groups (pilots, flight attendants, and clerical, office and passenger service employees) have all of the merger transition agreements required to fully integrate. This is a major milestone just 16 months after the official close of the acquisition of Virgin America in December 2016. Dispatchers and aircraft technicians are the two labor groups that remain to be integrated. We are actively working with each of these groups toward such agreements.

Outlook

In 2018 and beyond, we are focused on successfully completing the integration of Virgin America with Alaska. We have now completed two of our most significant integration milestones to date. In January 2018, Alaska and Virgin America received a Single Operating Certificate (SOC) from the FAA, which recognizes Alaska and Virgin America as one airline. On April 25, 2018, we transitioned to a single Passenger Service System (PSS), which allows us to provide one reservation system, one website and one inventory of flights to our guests. Our transition to PSS allows us to unlock many of the revenue synergies expected from the acquisition. In connection with PSS, guests are now greeted with Alaska branding at all airport gates, ticketing and check-in areas presenting a seamless travel experience.

We 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, 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. Throughout 2018 we will also be introducing new food and beverage menus in first and premium class, which include more fresh and local offerings. Additionally, all Boeing and Airbus flights will have new beverage offerings, including craft beers.

In April 2018, we entered into a lease agreement with Southwest for 12 airport slots at LaGuardia Airport (LGA) and eight airport slots at Regan National Airport (DCA). The lease begins October 2018 and continues through 2028. This agreement enables us to monetize these valuable slots, and reallocate flying from Dallas Love Field (DAL) to more strategic and profitable opportunities on the West Coast. We maintain the right to resume flying using these slots, should we choose to do so, in 2028 when the agreement expires.

Currently, we expect to grow our combined network capacity in 2018 by approximately 6.5%. Current schedules indicate competitive capacity will increase by approximately 8% in the second quarter of 2018, and approximately 5% in the third quarter of 2018. We believe that our product, our operation, our engaged employees, our award-winning service, and our competitive Mileage Plan™ program, combined with our strong balance sheet, give us a competitive advantage in our markets.


24



Our current expectations for capacity and CASM excluding fuel and special items for the second quarter and full year 2018 are summarized below:
 
Forecast
Q2 2018
 
Q2 2017
 
% Change
Capacity (ASMs in millions)
16,910 - 16,960
 
15,612
 
~ 8.5%
Cost per ASM excluding fuel and special items (cents)(a)
8.34¢ - 8.39¢
 
7.98¢
 
~ 4.8%
 
Forecast
Full Year 2018
 
Full Year 2017
 
% Change
Capacity (ASMs in millions)
65,980 - 66,130
 
62,072
 
~ 6.5%
Cost per ASM excluding fuel and special items (cents)(a)
8.51¢ - 8.56¢
 
8.25¢
 
~ 3.5%
(a)
2017 CASMex reflects the impacts of the updated accounting standards, effective for the Company January 1, 2018.

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 thus 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 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.

25



OPERATING STATISTICS SUMMARY (unaudited)
Below are operating statistics we use to measure operating performance. We often refer to unit revenues and adjusted unit costs, which are non-GAAP measures.
 
Three Months Ended March 31,
 
2018
 
2017
 
Change
Consolidated Operating Statistics:(a)
 
 
 
 
 
Revenue passengers (000)
10,489
 
10,008
 
4.8%
RPMs (000,000) "traffic"
12,403
 
11,707
 
5.9%
ASMs (000,000) "capacity"
15,480
 
14,394
 
7.5%
Load factor
80.1%
 
81.3%
 
(1.2) pts
Yield(d)
13.59¢
 
13.69¢
 
(0.7)%
RASM(d)
11.84¢
 
12.09¢
 
(2.1)%
CASM excluding fuel and special items(b)(d)
8.81¢
 
8.38¢
 
5.1%
Economic fuel cost per gallon(b)
$2.14
 
$1.78
 
20.2%
Fuel gallons (000,000)
197
 
184
 
7.1%
ASMs per fuel gallon
78.6
 
78.2
 
0.5%
Average full-time equivalent employees (FTEs)
21,266
 
18,682
 
13.8%
Mainline Operating Statistics:
 
 
 
 
 
Revenue passengers (000)
8,211
 
7,774
 
5.6%
RPMs (000,000) "traffic"
11,360
 
10,827
 
4.9%
ASMs (000,000) "capacity"
14,098
 
13,260
 
6.3%
Load factor
80.6%
 
81.7%
 
(1.1) pts
Yield(d)
12.70¢
 
12.70¢
 
—%
RASM(d)
11.20¢
 
11.39¢
 
(1.7)%
CASM excluding fuel and special items(b)(d)
8.02¢
 
7.54¢
 
6.4%
Economic fuel cost per gallon(b)
$2.13
 
$1.78
 
19.7%
Fuel gallons (000,000)
172
 
164
 
4.9%
ASMs per fuel gallon
82.0
 
80.8
 
1.5%
Average FTEs
16,013
 
15,007
 
6.7%
Aircraft utilization
11.2
 
10.8
 
3.7%
Average aircraft stage length
1,285
 
1,245
 
3.2%
Operating fleet
224
 
217
 
7 a/c
Regional Operating Statistics:(c)
 
 
 
 
 
Revenue passengers (000)
2,278
 
2,234
 
2.0%
RPMs (000,000) "traffic"
1,043
 
880
 
18.5%
ASMs (000,000) "capacity"
1,382
 
1,134
 
21.9%
Load factor
75.5%
 
77.6%
 
(2.1 pts)
Yield(d)
23.70¢
 
25.36¢
 
(6.5)%
RASM(d)
18.26¢
 
20.14¢
 
(9.3)%
Operating fleet
83
 
73
 
10 a/c
(a)
Except for FTEs, data includes information related to third-party regional capacity purchase flying arrangements.
(b)
See reconciliation of this non-GAAP measure to the most directly related GAAP measure in the accompanying pages.
(c)
Data presented includes information related to flights operated by Horizon and third-party carriers.
(d)
Certain historical information has been adjusted to reflect the adoption of new accounting standards.


26



COMPARISON OF THREE MONTHS ENDED MARCH 31, 2018 TO THREE MONTHS ENDED MARCH 31, 2017

Our consolidated net income for the three months ended March 31, 2018 was $4 million, or $0.03 per diluted share, compared to net income of $93 million, or $0.75 per diluted share, for the three months ended March 31, 2017.

Excluding the impact of merger-related costs, mark-to-market fuel hedge adjustments, and a special employee tax bonus as a result of tax reform, our adjusted net income for the first quarter of 2018 was $18 million, or $0.14 per diluted share, compared to an adjusted net income of $124 million, or $0.99 per diluted share, in the first quarter of 2017. Historical information has been adjusted to reflect the adoption of new accounting standards effective for the Company January 1, 2018. The following tables reconcile our adjusted net income and adjusted earnings per diluted share (EPS) to amounts as reported in accordance with GAAP:
 
Three Months Ended March 31,
 
2018
 
2017
(in millions, except per share amounts)
Dollars
 
Diluted EPS
 
Dollars
 
Diluted EPS
GAAP net income and diluted EPS
$
4

 
$
0.03

 
$
93

 
$
0.75

Mark-to-market fuel hedge adjustments
(13
)
 
(0.11
)
 
10

 
0.08

Special items—employee tax reform bonus
25

 
0.20

 

 

Special items—merger-related costs
6

 
0.05

 
39

 
0.30

Income tax effect
(4
)
 
(0.03
)
 
(18
)
 
(0.14
)
Non-GAAP adjusted net income and diluted EPS
$
18

 
$
0.14

 
$
124

 
$
0.99


CASM reconciliation is summarized below:
 
Three Months Ended March 31,
(in cents)
2018
 
2017
 
% Change
Consolidated:
 
 
 
 
 
CASM

11.65
¢
 

11.00
¢
 
6
 %
Less the following components:
 
 
 

 
 
Aircraft fuel, including hedging gains and losses
2.64

 
2.36

 
12
 %
Special items—merger-related costs and other
0.20

 
0.26

 
(23
)%
CASM excluding fuel and special items

8.81
¢
 

8.38
¢
 
5
 %
 
 
 
 
 
 
Mainline:
 
 
 
 
 
CASM

10.72
¢
 

10.11
¢
 
6
 %
Less the following components:
 
 
 

 
 
Aircraft fuel, including hedging gains and losses
2.51

 
2.28

 
10
 %
Special items—merger-related costs and other
0.19

 
0.29

 
(35
)%
CASM excluding fuel and special items

8.02
¢
 

7.54
¢
 
6
 %

OPERATING REVENUES

Total operating revenues increased $92 million, or 5%, during the first quarter of 2018 compared to the same period in 2017. The changes are summarized in the following table:
 
Three Months Ended March 31,
(in millions)
2018
 
2017
 
% Change
Passenger revenue
$
1,685

 
$
1,602

 
5
%
Mileage plan other revenue
107

 
100

 
7
%
Cargo and other
40

 
38

 
5