ALK 10-Q3 2014


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

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

For the quarterly period ended September 30, 2014
 
OR

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

 For the transition period from                      to                      

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes T No £
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer   T
Accelerated filer  £ 
Non-accelerated filer   £
Smaller reporting company   £
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes £ No T
 
The registrant has 132,631,936 common shares, par value $0.01, outstanding at October 31, 2014.



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

 TABLE OF CONTENTS

 

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

2



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

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

You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Our forward-looking statements are based on the information currently available to us and speak only as of the date on which this report was filed with the SEC. We expressly disclaim any obligation to issue any updates or revisions to our forward-looking statements, even if subsequent events cause our expectations to change regarding the matters discussed in those statements. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such differences might be significant and materially adverse to our shareholders. For a discussion of these and other risk factors, see Item 1A. "Risk Factors” of the Company’s annual report on Form 10-K for the year ended December 31, 2013, 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,
2014
 
December 31,
2013
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
34

 
$
80

Marketable securities
1,309

 
1,250

Total cash and marketable securities
1,343

 
1,330

Receivables - net
178

 
152

Inventories and supplies - net
64

 
60

Deferred income taxes
114

 
113

Prepaid expenses and other current assets
100

 
107

Total Current Assets
1,799

 
1,762

 
 
 
 
Property and Equipment
 

 
 

Aircraft and other flight equipment
5,100

 
4,677

Other property and equipment
883

 
838

Deposits for future flight equipment
511

 
446

 
6,494

 
5,961

Less accumulated depreciation and amortization
2,250

 
2,068

Total Property and Equipment - Net
4,244

 
3,893

 
 
 
 
Other Assets
193

 
183

 
 
 
 
Total Assets
$
6,236

 
$
5,838


See accompanying notes to condensed consolidated financial statements.


4

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(in millions, except share amounts)
September 30,
2014
 
December 31,
2013
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
68

 
$
64

Accrued wages, vacation and payroll taxes
201

 
211

Other accrued liabilities
680

 
624

Air traffic liability
703

 
564

Current portion of long-term debt
115

 
117

Total Current Liabilities
1,767

 
1,580

 
 
 
 
Long-Term Debt, Net of Current Portion
710

 
754

Other Liabilities and Credits
 

 
 

Deferred income taxes
738

 
709

Deferred revenue
356

 
335

Obligation for pension and postretirement medical benefits
124

 
123

Other liabilities
312

 
308

 
1,530

 
1,475

Commitments and Contingencies


 


Shareholders' Equity
 

 
 

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

 
—

Common stock, $0.01 par value, Authorized: 200,000,000 shares, Issued: 2014 - 133,584,527 shares; 2013 - 137,533,382 shares, Outstanding: 2014 - 133,468,522 shares; 2013 - 137,491,906
1

 
1

Capital in excess of par value
399

 
606

Treasury stock (common), at cost: 2014 - 116,005 shares; 2013 - 41,476 shares
(5
)
 
(2
)
Accumulated other comprehensive loss
(178
)
 
(183
)
Retained earnings
2,012

 
1,607

 
2,229

 
2,029

Total Liabilities and Shareholders' Equity
$
6,236

 
$
5,838


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)
2014
 
2013
 
2014
 
2013
Operating Revenues
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
Mainline
$
1,030

 
$
960

 
$
2,858

 
$
2,651

Regional
219

 
208

 
605

 
582

Total passenger revenue
1,249

 
1,168

 
3,463

 
3,233

Freight and mail
32

 
32

 
88

 
88

Other - net
184

 
165

 
511

 
433

Special mileage plan revenue
—

 
192

 
—

 
192

Total Operating Revenues
1,465

 
1,557

 
4,062

 
3,946

 
 
 
 
 
 
 
 
Operating Expenses
 
 
 
 
 

 
 

Wages and benefits
279

 
285

 
832

 
806

Variable incentive pay
30

 
26

 
84

 
68

Aircraft fuel, including hedging gains and losses
394

 
363

 
1,112

 
1,115

Aircraft maintenance
58

 
54

 
166

 
187

Aircraft rent
27

 
29

 
84

 
89

Landing fees and other rentals
74

 
71

 
207

 
207

Contracted services
66

 
54

 
188

 
161

Selling expenses
55

 
47

 
154

 
137

Depreciation and amortization
75

 
67

 
218

 
203

Food and beverage service
24

 
22

 
68

 
63

Other
67

 
69

 
229

 
202

Total Operating Expenses
1,149

 
1,087

 
3,342

 
3,238

Operating Income
316

 
470

 
720

 
708

 
 
 
 
 
 
 
 
Nonoperating Income (Expense)
 
 
 
 
 

 
 

Interest income
5

 
5

 
15

 
14

Interest expense
(12
)
 
(13
)
 
(36
)
 
(42
)
Interest capitalized
5

 
6

 
14

 
15

Other - net
2

 
(5
)
 
20

 
(4
)
 
—

 
(7
)
 
13

 
(17
)
Income before income tax
316

 
463

 
733

 
691

Income tax expense
118

 
174

 
276

 
261

Net Income
$
198

 
$
289

 
$
457

 
$
430

 
 
 
 
 
 
 
 
Basic Earnings Per Share:
$
1.47

 
$
2.07

 
$
3.35

 
$
3.06

Diluted Earnings Per Share:
$
1.45

 
$
2.04

 
$
3.31

 
$
3.02

 
 
 
 
 
 
 
 
Shares used for computation:
 
 
 
 
 
 
 

Basic
134.865

 
139.559

 
136.482

 
140.304

Diluted
136.158

 
141.383

 
137.825

 
142.213

 
 
 
 
 
 
 
 
Cash dividend declared per share:
$
0.125

 
$
0.100

 
$
0.375

 
$
0.100

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)
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Net Income
$
198

 
$
289

 
$
457

 
$
430

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

 
3

 
(8
)
Reclassification of (gains) losses into Other-net nonoperating income (expense)
(1
)
 
—

 
(2
)
 
(2
)
Income tax effect
2

 
(1
)
 
—

 
4

Total
(3
)
 
3

 
1

 
(6
)
 
 
 
 
 
 
 
 
Related to employee benefit plans:
 
 
 
 
 
 
 
Reclassification of net pension expense into Wages and benefits
2

 
11

 
7

 
32

Income tax effect
(1
)
 
(5
)
 
(3
)
 
(12
)
Total
1

 
6

 
4

 
20

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

 
(1
)
 
(5
)
 
9

Reclassification of (gains) losses into Aircraft rent
2

 
1

 
5

 
4

Income tax effect
—

 
1

 
—

 
(5
)
Total
2

 
1

 
—

 
8

 
 
 
 
 
 
 
 
Other comprehensive income
—

 
10

 
5

 
22

 
 
 
 
 
 
 
 
Comprehensive income
$
198

 
$
299

 
$
462

 
$
452


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)
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income
$
457

 
$
430

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

 
 

Depreciation and amortization
218

 
203

Stock-based compensation and other
27

 
26

Changes in certain assets and liabilities:
 
 
 
Changes in deferred income taxes
27

 
121

Increase in air traffic liability
139

 
93

Increase (decrease) in deferred revenue
21

 
(147
)
Other - net
3

 
96

Net cash provided by operating activities
892

 
822

 
 
 
 
Cash flows from investing activities:
 

 
 

Property and equipment additions:
 

 
 

Aircraft and aircraft purchase deposits
(414
)
 
(353
)
Other flight equipment
(92
)
 
(16
)
Other property and equipment
(53
)
 
(26
)
Total property and equipment additions
(559
)
 
(395
)
Purchases of marketable securities
(794
)
 
(994
)
Sales and maturities of marketable securities
739

 
712

Proceeds from disposition of assets and changes in restricted deposits
(4
)
 
(3
)
Net cash used in investing activities
(618
)
 
(680
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Proceeds from issuance of debt
51

 
—

Long-term debt payments
(97
)
 
(139
)
Common stock repurchases
(242
)
 
(83
)
Dividends paid
(51
)
 
(14
)
Other financing activities
19

 
13

Net cash used in financing activities
(320
)
 
(223
)
Net increase (decrease) in cash and cash equivalents
(46
)
 
(81
)
Cash and cash equivalents at beginning of year
80

 
122

Cash and cash equivalents at end of the period
$
34

 
$
41

 
 
 
 
Supplemental disclosure:
 

 
 

Cash paid during the period for:
 
 
 
Interest (net of amount capitalized)
$
26

 
$
31

Income taxes
185

 
100

See accompanying notes to condensed consolidated financial statements.

8


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

NOTE 1. GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

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

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

Recently Issued Accounting Pronouncements

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

NOTE 2. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES

Components for cash, cash equivalents and marketable securities (in millions):
September 30, 2014
Cost Basis
 
Unrealized
Gains
 
Unrealized Losses
 
Fair Value
Cash
$
5

 
$
—

 
$
—

 
$
5

Cash equivalents
29

 
—

 
—

 
29

Cash and cash equivalents
34

 
—

 
—

 
34

U.S. government and agency securities
204

 
—

 
(1
)
 
203

Foreign government bonds
21

 
—

 
—

 
21

Asset-backed securities
166

 
—

 
—

 
166

Mortgage-backed securities
149

 
1

 
(1
)
 
149

Corporate notes and bonds
747

 
3

 
(1
)
 
749

Municipal securities
21

 
—

 
—

 
21

Marketable securities
1,308

 
4

 
(3
)
 
1,309

Total
$
1,342

 
$
4

 
$
(3
)
 
$
1,343



9


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

 
$
—

 
$
—

 
$
9

Cash equivalents
71

 
—

 
—

 
71

Cash and cash equivalents
80

 
—

 
—

 
80

U.S. government and agency securities
295

 
1

 
(2
)
 
294

Foreign government bonds
11

 
—

 
—

 
11

Asset-backed securities
146

 
—

 
—

 
146

Mortgage-backed securities
144

 
1

 
(2
)
 
143

Corporate notes and bonds
628

 
4

 
(2
)
 
630

Municipal securities
26

 
—

 
—

 
26

Marketable securities
1,250

 
6

 
(6
)
 
1,250

Total
$
1,330

 
$
6

 
$
(6
)
 
$
1,330


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

Activity for marketable securities (in millions):  
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Proceeds from sales and maturities
$
341

 
$
247

 
$
739

 
$
712

Gross realized gains
1

 
—

 
3

 
3

Gross realized losses
—

 
—

 
(1
)
 
(1
)
 
Maturities for marketable securities (in millions):
September 30, 2014
Cost Basis
 
Fair Value
Due in one year or less
$
178

 
$
178

Due after one year through five years
1,121

 
1,122

Due after five years through 10 years
8

 
8

Due after 10 years
1

 
1

Total
$
1,308

 
$
1,309


NOTE 3. DERIVATIVE INSTRUMENTS

Fuel Hedge Contracts

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

As of September 30, 2014, the Company had outstanding fuel hedge contracts covering 236 million gallons of crude oil that will be settled from October 2014 to March 2016. Refer to the contractual obligations and commitments section of Item 2 for further information.

Interest Rate Swap Agreements

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

10


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

Fair Values of Derivative Instruments

Fair values of derivative instruments on the consolidated balance sheet (in millions):
 
September 30,
2014
 
December 31,
2013
Derivative Instruments Not Designated as Hedges
 
 
 
Fuel hedge contracts
 
 
 
Fuel hedge contracts, current assets
$
3

 
$
12

Fuel hedge contracts, noncurrent assets
1

 
4

 
 
 
 
Derivative Instruments Designated as Hedges
 
 
 
Interest rate swaps
 
 
 
Other accrued liabilities
(6
)
 
(7
)
Other liabilities
(11
)
 
(10
)
Losses in accumulated other comprehensive loss (AOCL)
(17
)
 
(17
)

The net cash received (paid) for new positions and settlements was $1 million and $6 million during the three months ended September 30, 2014 and 2013, respectively. The net cash received (paid) for new positions and settlements was $(4) million and $(3) million during the nine months ended September 30, 2014 and 2013, respectively.

Pretax effect of derivative instruments on earnings (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Derivative Instruments Not Designated as Hedges
 
 
 
 
 
 
 
Fuel hedge contracts
 
 
 
 
 
 
 
Gains (losses) recognized in aircraft fuel expense
$
(11
)
 
$
10

 
$
(17
)
 
$
(39
)
 
 
 
 
 
 
 
 
Derivative Instruments Designated as Hedges
 
 
 
 
 
 
 
Interest rate swaps
 
 
 
 
 
 
 
Losses recognized in aircraft rent
(2
)
 
(1
)
 
(5
)
 
(4
)
Gains (losses) recognized in other comprehensive income (OCI)
—

 
(1
)
 
(5
)
 
9


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

Credit Risk and Collateral

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


11


The Company posted collateral of $9 million and $7 million as of September 30, 2014 and December 31, 2013, respectively. The collateral was provided to one counterparty associated with the net liability position of the interest rate swap agreements, offset by the net asset position of the fuel hedge contracts under a master netting arrangement.

NOTE 4. FAIR VALUE MEASUREMENTS

Fair Value of Financial Instruments on a Recurring Basis

Fair values of financial instruments on the consolidated balance sheet (in millions):
September 30, 2014
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
203

 
$
—

 
$
203

Foreign government bonds
—

 
21

 
21

Asset-backed securities
—

 
166

 
166

Mortgage-backed securities
—

 
149

 
149

Corporate notes and bonds
—

 
749

 
749

Municipal securities
—

 
21

 
21

Derivative instruments
 
 
 
 
 
Fuel hedge call options
—

 
4

 
4

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Interest rate swap agreements
—

 
(17
)
 
(17
)

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

 
$
—

 
$
294

Foreign government bonds
—

 
11

 
11

Asset-backed securities
—

 
146

 
146

Mortgage-backed securities
—

 
143

 
143

Corporate notes and bonds
—

 
630

 
630

Municipal securities
—

 
26

 
26

Derivative instruments
 
 
 
 
 
Fuel hedge call options
—

 
16

 
16

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Interest rate swap agreements
—

 
(17
)
 
(17
)

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

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

12


event of nonperformance 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 forward interest rates at period end, multiplied by the total notional value.

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

Fair Value of Other Financial Instruments

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

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

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

Fixed-rate debt that is not carried at fair value on the consolidated balance sheet and the estimated fair value of long-term fixed-rate debt (in millions):
 
September 30,
2014
 
December 31,
2013
Carrying amount
$
633

 
$
703

Fair value
687

 
762


NOTE 5. MILEAGE PLAN

Alaska's Mileage Plan liabilities and deferrals on the consolidated balance sheets (in millions):
 
September 30,
2014
 
December 31,
2013
Current Liabilities:
 
 
 
Other accrued liabilities
$
346

 
$
314

Other Liabilities and Credits:
 
 
 
Deferred revenue
348

 
323

Other liabilities
21

 
19

Total
$
715

 
$
656

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

 
$
54

 
$
180

 
$
150

Other - net revenues
77

 
74

 
223

 
184

Special mileage plan revenue
—

 
192

 
—

 
192

Total
$
139

 
$
320

 
$
403

 
$
526



13


NOTE 6. LONG-TERM DEBT
 
Long-term debt obligations on the consolidated balance sheet (in millions):
 
September 30,
2014
 
December 31,
2013
Fixed-rate notes payable due through 2024
$
633

 
$
703

Variable-rate notes payable due through 2025
192

 
168

Long-term debt
825

 
871

Less current portion
115

 
117

Total
$
710

 
$
754

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

During the nine months ended September 30, 2014, the Company made debt payments of $97 million. In addition, the company financed $51 million for the three Q400's that were delivered in Q4 2013.

At September 30, 2014, long-term debt principal payments for the next five years and thereafter are as follows (in millions):
 
Total
Remainder of 2014
$
23

2015
116

2016
115

2017
121

2018
151

Thereafter
299

Total
$
825

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

NOTE 7. EMPLOYEE BENEFIT PLANS

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

 
$
11

 
$
—

 
$
—

 
$
1

 
$
1

Interest cost
21

 
19

 
—

 
—

 
1

 
1

Expected return on assets
(30
)
 
(27
)
 
—

 
—

 
—

 
—

Amortization of prior service cost
—

 
(1
)
 
—

 
—

 
—

 
—

Recognized actuarial loss (gain)
3

 
11

 
—

 
—

 
(1
)
 
—

Total
$
2

 
$
13

 
$
—

 
$
—

 
$
1

 
$
2



14


Net periodic benefit costs recognized included the following components for the nine months ended September 30, 2014 (in millions): 
 
Nine Months Ended September 30,
 
Qualified
 
Nonqualified
 
Postretirement Medical
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Service cost
24

 
34

 
—

 
1

 
2

 
3

Interest cost
61

 
55

 
1

 
1

 
3

 
3

Expected return on assets
(88
)
 
(82
)
 
—

 
—

 
—

 
—

Amortization of prior service cost
(1
)
 
(1
)
 
—

 
—

 
—

 
—

Recognized actuarial loss
10

 
32

 
—

 
—

 
(2
)
 
—

Total
6

 
38

 
1

 
2

 
3

 
6


NOTE 8. COMMITMENTS

Future minimum fixed payments for commitments (in millions):
September 30, 2014
Aircraft Leases
 
Facility Leases
 
Aircraft Commitments
 
Capacity Purchase Agreements
 
Engine Maintenance
Remainder of 2014
$
11

 
$
23

 
$
77

 
$
13

 
$
3

2015
107

 
90

 
331

 
44

 
10

2016
84

 
88

 
359

 
32

 
13

2017
54

 
84

 
382

 
32

 
—

2018
39

 
36

 
430

 
14

 
—

Thereafter
52

 
207

 
1,044

 
—

 
—

Total
$
347

 
$
528

 
$
2,623

 
$
135

 
$
26


Lease Commitments

At September 30, 2014, the Company had lease contracts for 57 aircraft, which have remaining noncancelable lease terms ranging from 2015 to 2022. Of these aircraft, 14 are non-operating (i.e. not in the Company's fleet) and subleased to third-party carriers. The majority of airport and terminal facilities are also leased. Rent expense for aircraft and facility leases was $74 million and $75 million for the three months ended September 30, 2014 and 2013, respectively, and $215 million and $228 million for the nine months ended September 30, 2014 and 2013, respectively.

Aircraft Commitments
 
As of September 30, 2014, the Company is committed to purchasing 64 B737 aircraft (27 737-900ER aircraft and 37 737 MAX aircraft) and one Q400 aircraft, with deliveries in 2014 through 2022. In addition, the Company has options to purchase 58 additional B737 aircraft and seven Q400 aircraft.

Subsequent to September 30, 2014. the Company exercised 10 options for 737-900ER aircraft with deliveries in 2016 and 2017.

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


15


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

NOTE 9. SHAREHOLDERS' EQUITY

Dividends

During the three months ended September 30, 2014, the Company declared and paid a cash dividend of $0.125 per share, or $17 million. During the nine months ended September 30, 2014, the Company declared and paid cash dividends of $0.375 per share, or $51 million.

Common Stock Repurchase

In September 2012, the Board of Directors authorized a $250 million share repurchase program, which was completed in July 2014. In May 2014, the Board of Directors authorized a $650 million share repurchase program, which began immediately after the $250 million program was completed.
Share repurchase activity (in millions, except share amounts):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
2014 Repurchase Program - $650 million
3,438,723

 
$
159

 
—

 
$
—

 
3,438,723

 
$
159

 
—

 
$
—

2012 Repurchase Program - $250 million
5,268

 
$
—

 
1,074,016

 
$
32

 
1,819,304

 
$
83

 
2,909,580

 
$
83

Total
3,443,991

 
$
159

 
1,074,016

 
$
32

 
5,258,027

 
$
242

 
2,909,580

 
$
83

 
Accumulated Other Comprehensive Loss
 
Components of accumulated other comprehensive income (loss), net of tax (in millions):
 
September 30,
2014
 
December 31,
2013
Marketable securities
$
1

 
$
—

Employee benefit plans
(169
)
 
(173
)
Interest rate derivatives
(10
)
 
(10
)
Total
$
(178
)
 
$
(183
)

Earnings Per Share (EPS)

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


16


NOTE 10. OPERATING SEGMENT INFORMATION
 
Air Group has two operating airlines - Alaska Airlines and Horizon Air. Each is a regulated airline with separate management teams primarily in operational roles. Horizon sells 100% of its capacity to Alaska under a CPA, which is eliminated upon consolidation. In addition, Alaska has CPAs with SkyWest to fly certain routes and PenAir to fly one route in the state of Alaska. The Company attributes revenue between Mainline and Regional based on the coupon fare in effect on the date of issuance relative to the origin and destination of each flight segment. To manage the two operating airlines and the revenues and expenses associated with the CPAs, management views the business in three operating segments.
Alaska Mainline - Flying Boeing 737 jets and all associated revenues and costs.
Alaska Regional - Alaska's CPAs with Horizon, SkyWest and PenAir. In this segment, Alaska Regional records actual on-board passenger revenue, less costs such as fuel, distribution costs, and payments made to Horizon, SkyWest and PenAir under the respective CPAs. Additionally, Alaska Regional includes an allocation of corporate overhead such as IT, finance, and other administrative costs incurred by Alaska on behalf of Horizon.
Horizon - Horizon operates turboprop Q400 aircraft. All of Horizon's capacity is sold to Alaska under a CPA.  Expenses include those typically borne by regional airlines such as crew costs, ownership costs, and maintenance costs. The results of Horizon's operations are eliminated upon consolidation.
Additionally, the following table reports “Air Group adjusted,” which is not a measure determined in accordance with GAAP. The Company's chief operating decision-makers and others in management use this measure to evaluate operational performance and determine resource allocations. Adjustments are further explained below in reconciliation to consolidated GAAP results. Operating segment information is as follows (in millions):
 
Three Months Ended September 30, 2014
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Consolidating
 
Air Group Adjusted(a)
 
Special Items(b)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
1,030

 
$
—

 
$
—

 
$
—

 
$
1,030

 
$
—

 
$
1,030

Regional
—

 
219

 
—

 
—

 
219

 
—

 
219

Total passenger revenues
1,030

 
219

 
—

 
—

 
1,249

 
—

 
1,249

CPA revenues
—

 
—

 
99

 
(99
)
 
—

 
—

 
—

Freight and mail
30

 
2

 
—

 
—

 
32

 
—

 
32

Other - net
161

 
22

 
1

 
—

 
184

 
—

 
184

Total operating revenues
1,221

 
243

 
100

 
(99
)
 
1,465

 
—

 
1,465

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
605

 
162

 
85

 
(97
)
 
755

 
—

 
755

Economic fuel
338

 
52

 
—

 
—

 
390

 
4

 
394

Total operating expenses
943

 
214

 
85

 
(97
)
 
1,145

 
4

 
1,149

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
5

 
—

 
—

 
—

 
5

 
—

 
5

Interest expense
(8
)
 
—

 
(4
)
 
—

 
(12
)
 
—

 
(12
)
Other
7

 
—

 
—

 
—

 
7

 
—

 
7

 
4

 
—

 
(4
)
 
—

 
—

 
—

 
—

Income (loss) before income tax
$
282

 
$
29

 
$
11

 
$
(2
)
 
$
320

 
$
(4
)
 
$
316


17


 
Three Months Ended September 30, 2013
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Consolidating
 
Air Group Adjusted(a)
 
Special Items(b)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
960

 
$
—

 
$
—

 
$
—

 
$
960

 
$
—

 
$
960

Regional
—

 
208

 
—

 
—

 
208

 
—

 
208

Total passenger revenues
960

 
208

 
—

 
—

 
1,168

 
—

 
1,168

CPA revenues
—

 
—

 
88

 
(88
)
 
—

 
—

 
—

Freight and mail
31

 
1

 
—

 
—

 
32

 
—

 
32

Other - net
145

 
19

 
1

 
—

 
165

 
192

 
357

Total operating revenues
1,136

 
228

 
89

 
(88
)
 
1,365

 
192

 
1,557

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
588

 
144

 
80

 
(88
)
 
724

 
—

 
724

Economic fuel
337

 
46

 
—

 
—

 
383

 
(20
)
 
363

Total operating expenses
925

 
190

 
80

 
(88
)
 
1,107

 
(20
)
 
1,087

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
5

 
—

 
—

 
—

 
5

 
—

 
5

Interest expense
(9
)
 
—

 
(4
)
 
—

 
(13
)
 
—

 
(13
)
Other
8

 
(8
)
 
1

 
—

 
1

 
—

 
1

 
4

 
(8
)
 
(3
)
 
—

 
(7
)
 
—

 
(7
)
Income (loss) before income tax
$
215

 
$
30

 
$
6

 
$
—

 
$
251

 
$
212

 
$
463


 
Nine Months Ended September 30, 2014
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Consolidating
 
Air Group Adjusted(a)
 
Special Items(b)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
2,858

 
$
—

 
$
—

 
$
—

 
$
2,858

 
$
—

 
$
2,858

Regional
—

 
605

 
—

 
—

 
605

 
—

 
605

Total passenger revenues
2,858

 
605

 
—

 
—

 
3,463

 
—

 
3,463

CPA revenues
—

 
—

 
277

 
(277
)
 
—

 
—

 
—

Freight and mail
84

 
4

 
—

 
—

 
88

 
—

 
88

Other - net
448

 
59

 
4

 
—

 
511

 
—

 
511

Total operating revenues
3,390

 
668

 
281

 
(277
)
 
4,062

 
—

 
4,062

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
1,783

 
464

 
257

 
(274
)
 
2,230

 
—