Edgar Filing: ALASKA AIR GROUP, INC.

10-Q

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 March 31, 2016

£ 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 123,252,559 common shares, par value $0.01, outstanding at April 30, 2016.

ALASKA AIR GROUP, INC.

FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2016

TABLE OF CONTENTS



PART I.	FINANCIAL INFORMATION	4
ITEM 1.	CONDENSED CONSOLIDATED FINANCIAL STATEMENTS	4
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	19
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK	31
ITEM 4.	CONTROLS AND PROCEDURES	31
PART II.	OTHER INFORMATION	32
ITEM 1.	LEGAL PROCEEDINGS	32
ITEM 1A.	RISK FACTORS	32
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	34
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	34
ITEM 4.	MINE SAFETY DISCLOSURES	34
ITEM 5.	OTHER INFORMATION	34
ITEM 6.	EXHIBITS	35
	SIGNATURES	35

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.”

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:


•	our pending acquisition and the subsequent integration of Virgin America Inc. (Virgin America);


•	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, 2015, and Item 1A. "Risk Factors" included herein. Please consider our forward-looking statements in light of those risks as you read this report.

PART I

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)



(in millions)	March 31, 2016		December 31, 2015
ASSETS
Current Assets
Cash and cash equivalents	$	78	$	73
Marketable securities	1,486		1,255
Total cash and marketable securities	1,564		1,328
Receivables - net	235		212
Inventories and supplies - net	45		51
Prepaid expenses and other current assets	79		72
Total Current Assets	1,923		1,663

Property and Equipment
Aircraft and other flight equipment	5,945		5,690
Other property and equipment	967		955
Deposits for future flight equipment	617		771
	7,529		7,416
Less accumulated depreciation and amortization	2,699		2,614
Total Property and Equipment - Net	4,830		4,802

Other Assets	76		65

Total Assets	$	6,829	$	6,530

See accompanying notes to condensed consolidated financial statements.

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)



(in millions, except share amounts)	March 31, 2016			December 31, 2015
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable	$	63		$	63
Accrued wages, vacation and payroll taxes	213			298
Air traffic liability	868			669
Other accrued liabilities	809			661
Current portion of long-term debt	116			114
Total Current Liabilities	2,069			1,805

Long-Term Debt, Net of Current Portion	531			569
Other Liabilities and Credits
Deferred income taxes	678			682
Deferred revenue	467			431
Obligation for pension and postretirement medical benefits	270			270
Other liabilities	359			362
	1,774			1,745
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: 2016 - 128,901,410 shares; 2015 - 128,442,099 shares, Outstanding: 2016 - 123,913,223 shares; 2015 - 125,175,325 shares	1			1
Capital in excess of par value	86			73
Treasury stock (common), at cost: 2016 - 4,988,187 shares; 2015 - 3,266,774 shares	(377		)	(250		)
Accumulated other comprehensive loss	(294		)	(303		)
Retained earnings	3,039			2,890
	2,455			2,411
Total Liabilities and Shareholders' Equity	$	6,829		$	6,530

See accompanying notes to condensed consolidated financial statements.

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)



	Three Months Ended March 31,
(in millions, except per share amounts)	2016			2015
Operating Revenues
Passenger
Mainline	$	927		$	901
Regional	206			186
Total passenger revenue	1,133			1,087
Freight and mail	24			23
Other - net	190			159
Total Operating Revenues	1,347			1,269

Operating Expenses
Wages and benefits	336			306
Variable incentive pay	32			26
Aircraft fuel, including hedging gains and losses	167			235
Aircraft maintenance	68			63
Aircraft rent	29			26
Landing fees and other rentals	80			71
Contracted services	60			52
Selling expenses	49			53
Depreciation and amortization	88			76
Food and beverage service	31			25
Third-party regional carrier expense	23			15
Other	94			83
Total Operating Expenses	1,057			1,031
Operating Income	290			238

Nonoperating Income (Expense)
Interest income	6			5
Interest expense	(13		)	(11		)
Interest capitalized	8			8
Other - net	1			—
	2			2
Income before income tax	292			240
Income tax expense	108			91
Net Income	$	184		$	149

Basic Earnings Per Share:	$	1.47		$	1.13
Diluted Earnings Per Share:	$	1.46		$	1.12

Shares used for computation:
Basic	124.550			131.120
Diluted	125.328			132.230

Cash dividend declared per share:	$	0.275		$	0.20

See accompanying notes to condensed consolidated financial statements.

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS (unaudited)



	Three Months Ended March 31,
(in millions)	2016			2015

Net Income	$	184		$	149

Other Comprehensive Income (Loss):
Related to marketable securities:
Unrealized holding gains (losses) arising during the period	12			7
Reclassification of (gains) losses into Other-net nonoperating income (expense)	—			—
Income tax effect	(4		)	(3		)
Total	8			4

Related to employee benefit plans:
Reclassification of net pension expense into Wages and benefits	5			3
Income tax effect	(2		)	(1		)
Total	3			2

Related to interest rate derivative instruments:
Unrealized holding gains (losses) arising during the period	(5		)	(4		)
Reclassification of (gains) losses into Aircraft rent	1			2
Income tax effect	2			1
Total	(2		)	(1		)

Other Comprehensive Income	9			5

Comprehensive Income	$	193		$	154

See accompanying notes to condensed consolidated financial statements.

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)



	Three Months Ended March 31,
(in millions)	2016			2015
Cash flows from operating activities:
Net income	$	184		$	149
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	88			76
Stock-based compensation and other	9			9
Changes in certain assets and liabilities:
Changes in deferred tax provision	(8		)	(6		)
Increase (decrease) in air traffic liability	199			183
Increase (decrease) in deferred revenue	36			8
Other - net	17			95
Net cash provided by operating activities	525			514

Cash flows from investing activities:
Property and equipment additions:
Aircraft and aircraft purchase deposits	(91		)	(245		)
Other flight equipment	(15		)	(21		)
Other property and equipment	(13		)	(13		)
Total property and equipment additions, including capitalized interest	(119		)	(279		)
Purchases of marketable securities	(358		)	(403		)
Sales and maturities of marketable securities	140			259
Proceeds from disposition of assets and changes in restricted deposits	1			2
Net cash used in investing activities	(336		)	(421		)

Cash flows from financing activities:
Long-term debt payments	(36		)	(35		)
Common stock repurchases	(127		)	(102		)
Dividends paid	(34		)	(26		)
Other financing activities	13			14
Net cash used in financing activities	(184		)	(149		)
Net increase (decrease) in cash and cash equivalents	5			(56		)
Cash and cash equivalents at beginning of year	73			107
Cash and cash equivalents at end of the period	$	78		$	51

Supplemental disclosure:
Cash paid during the period for:
Interest (net of amount capitalized)	$	8		$	7
Income taxes paid (received)	13			(65		)

See accompanying notes to condensed consolidated financial statements.

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, 2015. In the opinion of management, all adjustments have been made that are necessary to present fairly the Company’s financial position as of March 31, 2016, as well as the results of operations for the three months ended March 31, 2016 and 2015. 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 months ended March 31, 2016, are not necessarily indicative of operating results for the entire year.

Certain reclassifications 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, 2018. The standard permits the use of either the retrospective or cumulative effect transition method. At this time, the Company believes the most significant impact to the financial statements will be in Mileage Plan revenues and liabilities. The Company currently uses the incremental cost approach for miles earned through travel. This standard eliminates that option and the Company will be required to increase its liability for earned miles through a relative selling price model. The Company has not evaluated the full impact of the standard, although application is expected to result in a material increase to Deferred Revenue. The Company has not yet selected a transition method.

In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30), which requires debt issuance costs related to a debt liability be presented as a direct deduction from the carrying value of the debt liability. The amendment was adopted as of January 1, 2016. Prior period debt balances have been adjusted to reflect the adoption of ASU 2015-03. The adoption of the ASU had no impact on the Statements of Operations or retained earnings.

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. The new standard would be effective for the Company on January 1, 2019. Early adoption of the standard is permitted. The Company is evaluating the effect that ASU 2016-02 will have on its financial statements and related disclosures. The Company has not yet determined whether it will early adopt the standard.

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606), Principal versus Agent Considerations. The proposed standard provides guidance when a revenue transaction involves a third party in providing goods or services to a customer in determining whether the Company is considered the principal or the agent in the transaction. When an entity is engaged to provide the underlying good or service, such entity is classified as the principal in the transaction. When an entity is engaged to arrange for a third party to provide the goods or services, such entity is classified as the agent in the transaction. This ASU has the same effective date as the new revenue standard. Entities are required to adopt this ASU using

the same transition method they use to adopt the new revenue accounting standard. The Company is evaluating the effect that ASU 2016-08 will have on its consolidated financial statements and related disclosures. The Company has not yet elected a transition method nor has it determined whether it will early adopt.

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718). The proposed standard simplifies several aspects of accounting for employee share-based payment awards, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The Company is evaluating the effect of ASU 2016-09 on the consolidated financial statements and related disclosures. The ASU will be effective for the Company beginning January 1, 2017, however early adoption is permitted. The Company has not yet elected a transition method nor has it determined whether it will early adopt.

NOTE 2. PROPOSED ACQUISITION OF VIRGIN AMERICA INC.

On April 1, 2016 the Company entered into an agreement to acquire Virgin America Inc. (Virgin America). The Company has agreed to pay Virgin America shareholders $57 per share, or approximately $2.6 billion, in cash for the outstanding common stock of Virgin America. In addition, the Company expects to assume Virgin America's debt and lease obligations, other than related party debt, on the date of acquisition. The merger is subject to approval by Virgin America's shareholders and various regulatory bodies, among other customary closing conditions. To date, the financial impacts of the pending acquisition have not been material, and future financial impacts are not yet estimable. The Company currently expects the acquisition will close no later than January 1, 2017.

NOTE 3. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES

Components for cash, cash equivalents and marketable securities (in millions):



March 31, 2016	Cost Basis		Unrealized Gains		Unrealized Losses			Fair Value
Cash	$	3	$	—	$	—		$	3
Cash equivalents	75		—		—			75
Cash and cash equivalents	78		—		—			78
U.S. government and agency securities	410		2		—			412
Foreign government bonds	28		—		—			28
Asset-backed securities	154		1		(1		)	154
Mortgage-backed securities	120		1		—			121
Corporate notes and bonds	749		6		(1		)	754
Municipal securities	17		—		—			17
Marketable securities	1,478		10		(2		)	1,486
Total	$	1,556	$	10	$	(2	)	$	1,564



December 31, 2015	Cost Basis		Unrealized Gains		Unrealized Losses			Fair Value
Cash	$	4	$	—	$	—		$	4
Cash equivalents	69		—		—			69
Cash and cash equivalents	73		—		—			73
U.S. government and agency securities	254		—		(1		)	253
Foreign government bonds	31		—		—			31
Asset-backed securities	130		—		—			130
Mortgage-backed securities	117		—		(1		)	116
Corporate notes and bonds	711		1		(4		)	708
Municipal securities	17		—		—			17
Marketable securities	1,260		1		(6		)	1,255
Total	$	1,333	$	1	$	(6	)	$	1,328

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 March 31, 2016.

Activity for marketable securities (in millions):



	Three Months Ended March 31,
	2016		2015
Proceeds from sales and maturities	$	140	$	259
Gross realized gains	—		1
Gross realized losses	—		(1		)

Maturities for marketable securities (in millions):



March 31, 2016	Cost Basis		Fair Value
Due in one year or less	$	258	$	258
Due after one year through five years	1,218		1,226
Due after five years through 10 years	2		2
Due after 10 years	—		—
Total	$	1,478	$	1,486

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

Fair values of financial instruments on the consolidated balance sheet (in millions):



March 31, 2016	Level 1		Level 2			Total
Assets
Marketable securities
U.S. government and agency securities	$	412	$	—		$	412
Foreign government bonds	—		28			28
Asset-backed securities	—		154			154
Mortgage-backed securities	—		121			121
Corporate notes and bonds	—		754			754
Municipal securities	—		17			17
Total Marketable securities	412		1,074			1,486
Derivative instruments
Fuel hedge call options	—		8			8
Total Assets	412		1,082			1,494

Liabilities
Derivative instruments
Interest rate swap agreements	—		(22		)	(22		)
Total Liabilities	—		(22		)	(22		)



December 31, 2015	Level 1		Level 2			Total
Assets
Marketable securities
U.S. government and agency securities	$	253	$	—		$	253
Foreign government bonds	—		31			31
Asset-backed securities	—		130			130
Mortgage-backed securities	—		116			116
Corporate notes and bonds	—		708			708
Municipal securities	—		17			17
Total Marketable securities	253		1,002			1,255
Derivative instruments
Fuel hedge call options	—		4			4
Total Assets	253		1,006			1,259

Liabilities
Derivative instruments
Interest rate swap agreements	—		(18		)	(18		)
Total Liabilities	—		(18		)	(18		)

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

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.

The Company has no financial assets that are measured at fair value on a nonrecurring basis at March 31, 2016.

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 flows 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) is as follows:



	March 31, 2016		December 31, 2015
Carrying amount	$	491	$	520
Fair value	529		557

NOTE 5. MILEAGE PLAN

Alaska's Mileage Plan liabilities and deferrals on the consolidated balance sheets (in millions):



	March 31, 2016		December 31, 2015
Current Liabilities:
Other accrued liabilities	$	388	$	368
Other Liabilities and Credits:
Deferred revenue	464		427
Other liabilities	19		19
Total	$	871	$	814

Alaska's Mileage Plan revenue included in the consolidated statements of operations (in millions):



	Three Months Ended March 31,
	2016		2015
Passenger revenues	$	69	$	64
Other - net revenues	103		76
Total	$	172	$	140

NOTE 6. LONG-TERM DEBT

Long-term debt obligations on the consolidated balance sheet (in millions):



	March 31, 2016			December 31, 2015
Fixed-rate notes payable due through 2024	$	491		$	520
Variable-rate notes payable due through 2025	159			166
Less debt issuance costs	(3		)	(3		)
Total debt	647			683
Less current portion	116			114
Long-term debt, less current portion	$	531		$	569

Weighted-average fixed-interest rate	5.7		%	5.7		%
Weighted-average variable-interest rate	2.1		%	1.8		%

During the three months ended March 31, 2016, the Company made debt payments of $36 million. As discussed in Note 1, the Company adopted ASU 2015-03 which resulted in a reclassification of debt issuance costs as an offset to debt in the consolidated balance sheet.

At March 31, 2016, long-term debt principal payments for the next five years and thereafter are as follows (in millions):



	Total
Remainder of 2016	$	79
2017	121
2018	151
2019	114
2020	116
Thereafter	69
Total	$	650

Bank Lines of Credit

The Company has two $100 million credit facilities and one $52 million credit facility. All three 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 $52 million facility expires in October 2016 with a mechanism for annual renewal and is secured by two 737-800 aircraft. The Company has no immediate plans to borrow using any of these facilities. All three credit facilities have a requirement to maintain a minimum unrestricted cash and marketable securities balance of $500 million. The Company is in compliance with this covenant at March 31, 2016.

NOTE 7. EMPLOYEE BENEFIT PLANS

Net periodic benefit costs recognized included the following components for the three months ended March 31, 2016 (in millions):



	Three Months Ended March 31,
	Qualified
	2016			2015
Service cost	$	9		$	10
Interest cost	18			21
Expected return on assets	(27		)	(31		)
Recognized actuarial loss (gain)	6			7
Total	$	6		$	7

NOTE 8. COMMITMENTS

Future minimum fixed payments for commitments (in millions):



March 31, 2016	Aircraft Leases		Facility Leases		Aircraft Purchase Commitments		Capacity Purchase Agreements ^(a)
Remainder of 2016	$	60	$	70	$	402	$	53
2017	104		90		516		90
2018	98		43		472		94
2019	90		42		381		99
2020	81		40		320		106
Thereafter	467		147		392		858
Total	$	900	$	432	$	2,483	$	1,300

^(a)Includes all non-aircraft lease costs associated with CPA arrangements.

Lease Commitments

At March 31, 2016, the Company had lease contracts for 27 B737 aircraft, 15 Q400 aircraft, 6 CRJ-700 aircraft (operated under the CPA with SkyWest) and 8 CRJ-700 aircraft that are subleased and operated by another carrier (i.e., not in the Company's fleet). The Company has 23 E175 lease commitments under the CPA with SkyWest, 7 of which are included in the fleet as of March 31, 2016. All lease contracts have remaining noncancelable lease terms ranging from 2016 to 2029. The Company has the option to increase capacity flown by SkyWest with eight additional E175 aircraft with 2017 and 2018 delivery dates.

The majority of airport and terminal facilities are also leased. Rent expense for aircraft and facility leases was $81 million and $73 million for the three months ended March 31, 2016 and 2015, respectively.

Aircraft Purchase Commitments

As of March 31, 2016, the Company is committed to purchasing 62 B737 aircraft (25 737-900ER aircraft and 37 737 MAX aircraft) and two Q400 aircraft, with deliveries in 2016 through 2022. As of March 31, 2016 we do not intend to take delivery

of the two Q400 aircraft that are currently contracted. In addition, the Company has options to purchase 46 B737 aircraft and five Q400 aircraft, which are not reflected in the commitments table above.

Subsequent to March 31, 2016, the Company placed an order for 30 Embraer E175 regional jets with options to purchase an additional 33. The above table does not reflect this purchase. See Note 11 for additional information.

Capacity Purchase Agreements (CPAs)

At March 31, 2016, Alaska had CPAs with three carriers, including the Company's wholly-owned subsidiary, Horizon. Horizon sells 100% of its capacity under a CPA with Alaska. In addition, Alaska has CPAs with SkyWest to fly certain routes and PenAir to fly certain routes in the state of Alaska. Under these agreements, Alaska pays the carriers an amount which is based on a determination of their cost of operating those flights and other factors intended to approximate market rates for those services. Future payments (excluding Horizon) are based on minimum levels of flying by the third-party carriers, which could differ materially due to variable payments based on actual levels of flying and certain costs associated with operating flights such as fuel.

Contingencies

The Company is a party to routine litigation matters incidental to its business and with respect to which no material liability is expected. 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 9. SHAREHOLDERS' EQUITY

Dividends

During the three months ended March 31, 2016, the Company declared and paid cash dividends of $0.275 per share, or $34 million.

Common Stock Repurchase

In May 2014, the Board of Directors authorized a $650 million share repurchase program, which was completed in October 2015. In August 2015, the Board of Directors authorized a $1 billion share repurchase program.

Share repurchase activity (in millions, except share amounts):



	Three Months Ended March 31,
	2016			2015
	Shares	Amount		Shares	Amount
2015 Repurchase Program - $1 billion	1,721,413	$	127	—	$	—
2014 Repurchase Program - $650 million	—	$	—	1,580,747	$	102
Total	1,721,413	$	127	1,580,747	$	102

Accumulated Other Comprehensive Loss

Components of accumulated other comprehensive income (loss), net of tax (in millions):



	March 31, 2016			December 31, 2015
Marketable securities	$	5		$	(3	)
Employee benefit plans	(285		)	(288		)
Interest rate derivatives	(14		)	(12		)
Total	$	(294	)	$	(303	)

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, 2016 and 2015, anti-dilutive shares excluded from the calculation of EPS were not material.

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. 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 - The Boeing 737 part of Alaska's business.

Alaska Regional - Alaska's shorter distance network. 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 CPAs. Additionally, Alaska Regional includes a small allocation of corporate overhead such as IT, finance and other administrative costs incurred by Alaska and on behalf of the regional operations.

Horizon - Horizon operates regional 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, station handling costs, and maintenance costs.

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 a reconciliation to consolidated GAAP results.

Operating segment information is as follows (in millions):



	Three Months Ended March 31, 2016
	Alaska
	Mainline			Regional		Horizon			Consolidating			Air Group Adjusted^(a)			Special Items^(b)			Consolidated
Operating revenues
Passenger
Mainline	$	927		$	—	$	—		$	—		$	927		$	—		$	927
Regional	—			206		—			—			206			—			206
Total passenger revenues	927			206		—			—			1,133			—			1,133
CPA revenues	—			—		103			(103		)	—			—			—
Freight and mail	23			1		—			—			24			—			24
Other - net	172			17		1			—			190			—			190
Total operating revenues	1,122			224		104			(103		)	1,347			—			1,347

Operating expenses
Operating expenses, excluding fuel	701			186		105			(102		)	890			—			890
Economic fuel	144			25		—			—			169			(2		)	167
Total operating expenses	845			211		105			(102		)	1,059			(2		)	1,057

Nonoperating income (expense)
Interest income	6			—		—			—			6			—			6
Interest expense	(12		)	—		(1		)	—			(13		)	—			(13		)
Other	7			—		—			2			9			—			9
	1			—		(1		)	2			2			—			2
Income (loss) before income tax	$	278		$	13	$	(2	)	$	1		$	290		$	2		$	292



	Three Months Ended March 31, 2015
	Alaska
	Mainline			Regional		Horizon			Consolidating			Air Group Adjusted^(a)			Special Items^(b)		Consolidated
Operating revenues
Passenger
Mainline	$	901		$	—	$	—		$	—		$	901		$	—	$	901
Regional	—			186		—			—			186			—		186
Total passenger revenues	901			186		—			—			1,087			—		1,087
CPA revenues	—			—		99			(99		)	—			—		—
Freight and mail	22			1		—			—			23			—		23
Other - net	142			16		1			—			159			—		159
Total operating revenues	1,065			203		100			(99		)	1,269			—		1,269

Operating expenses
Operating expenses, excluding fuel	639			164		91			(98		)	796			—		796
Economic fuel	203			32		—			—			235			—		235
Total operating expenses	842			196		91			(98		)	1,031			—		1,031

Nonoperating income (expense)
Interest income	5			—		—			—			5			—		5
Interest expense	(7		)	—		(4		)	—			(11		)	—		(11		)
Other	7			—		1			—			8			—		8
	5			—		(3		)	—			2			—		2
Income (loss) before income tax	$	228		$	7	$	6		$	(1	)	$	240		$	—	$	240


^(a)	The 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.


^(b)	Includes mark-to-market fuel-hedge accounting charges.

Total assets were as follows (in millions):



	March 31, 2016			December 31, 2015
Alaska^(a)	$	8,630		$	8,127
Horizon	717			717
Parent company	4,929			4,734
Elimination of inter-company accounts	(7,447		)	(7,048		)
Consolidated	$	6,829		$	6,530


^(a)	There are no assets associated with capacity purchase flying at Alaska.

NOTE 11. SUBSEQUENT EVENTS

See discussion of the pending acquisition of Virgin America at Note 2.

On April 11, 2016 Horizon placed an order for 30 Embraer E 175 regional aircraft (E175s), with the option to purchase an additional 33. The E175s will be flown by Horizon exclusively for Alaska beginning in 2017. An estimate of the future financial impacts related to the purchase agreement is included in our forward looking capital expenditures table within Item 2, MD&A.

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 the Company, our segment operations and our present business environment. MD&A is provided as a supplement to – and should be read in conjunction with – our consolidated financial statements and the accompanying notes. All statements in the following discussion that are not statements of historical information or descriptions of current accounting policy are forward-looking statements. Please consider our forward-looking statements in light of the risks referred to in this report’s introductory cautionary note, the risks mentioned in Item 1A. "Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2015, and Item 1A "Risk Factors" included herein. This overview summarizes the MD&A, which includes the following sections:


•	First Quarter Review—highlights from the first quarter of 2016 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, 2016. 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 2016.


•	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 $292 million during the first quarter of 2016, compared to $240 million in the first quarter of 2015. The increase of $52 million was mainly due to increased revenues of $78 million and lower aircraft fuel expense by $68 million, partially offset by an increase in non-fuel expenses of $94 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, both Alaska and Horizon continued their strong on-time performance, reporting that 87.5% and 87.9% of their flights arrived on time, respectively. For the twelve months ended February 2016, Alaska maintained its ranking as the top carrier among the six largest U.S. airlines for on-time performance, according to the U.S. Department of Transportation.

New Markets

New routes launched and announced are as follows:



New Non-Stop Routes Launched in Q1	New Non-Stop Routes Announced (Launch Dates)
Reno, Nevada to Orange County, California	San Diego, California to San Jose, California (6/8/16)
Orange County, California to Santa Rosa, California	Orange County, California to San Jose, California (6/8/16)
	Bellingham, Washington to Kona, Hawaii (11/12/16)

Shareholder Return

During the first quarter of 2016, we paid cash dividends of $34 million and we repurchased 1.7 million shares of our common stock for $127 million under the $1 billion repurchase program authorized by our Board of Directors in August 2015. Since 2007, we have repurchased 58 million shares of common stock under such programs for $1.5 billion for an average price of $25.14 per share. During the month of April, we repurchased 682 thousand shares of our common stock for $53 million, resulting in 123.3 million shares outstanding at April 30, 2016. Prior to the announcement of our pending acquisition of Virgin

America, we had planned to return a greater amount to shareholders in 2016 through dividends and stock repurchases than we did in 2015. Given the pending acquisition, we now expect to return approximately $325 million to shareholders in 2016, reflecting a reduction in the number of shares we had previously expected to repurchase under our $1 billion share repurchase program.

Outlook

On April 4, 2016, we announced plans to acquire Virgin America. If approved by Virgin America shareholders and regulators, we believe the combination of Virgin America and Alaska will create the premier airline for travelers on the West Coast, offering a premium product to our customers at the low fares both airlines are known for. The combined airline will provide 1,200 daily departures to our customers, greatly expanding the flight offerings to current Alaska and Virgin America customers, creating increased utility in the the combined network. We will also gain additional access to hard to come by landing slots and constrained gates at destinations such as New York (JFK), Newark, San Francisco, and Los Angeles. We believe that combining our loyalty programs and networks will provide greater benefits for our West Coast customers, and will expand our partner portfolio giving our customers an expansive global reach. The larger platform for growth, and the synergies the combined airline is expected to generate, will allow us to create greater value for our stakeholders. We have agreed to pay $57 per share, or approximately $2.6 billion, in cash for the outstanding common stock of Virgin America. We currently expect the acquisition will close by January 1, 2017, which would significantly impact our financial position and results.

We expect our own organic growth to continue in 2016, adding approximately 8% system-wide capacity in the current year. Over the past few years, we have seen competitive capacity increase significantly in our markets, especially in our hometown of Seattle. We expect to see even more competitive capacity in 2016. Current schedules indicate competitive capacity will be 14% higher in both the second and third quarters of 2016.

Our current expectations for capacity and CASM excluding fuel and special items, and excluding the impact of the pending acquisition of Virgin America, are summarized below:



	Forecast Q2 2016	Change Y-O-Y	Forecast Full Year 2016	Change Y-O-Y
Consolidated:
ASMs (000,000) "capacity"	11,000 - 11,050	~ 11%	43,100 - 43,200	~ 8%
CASM excluding fuel (cents)	8.00¢ - 8.05¢	~ (1)%	8.25¢ - 8.30¢	~ (0.5)%

Mainline:
ASMs (000,000) "capacity"	9,825 - 9,875	~ 9.5%	38,250 - 38,350	~ 6.5%
CASM excluding fuel (cents)	7.05¢ - 7.10¢	~ (1.5)%	7.35¢ - 7.40¢	~ (0.5)%

RESULTS OF OPERATIONS

COMPARISON OF THREE MONTHS ENDED MARCH 31, 2016 COMPARED TO THREE MONTHS ENDED MARCH 31, 2015

Our consolidated net income for the first quarter of 2016 was $184 million, or $1.46 per diluted share, compared to net income of $149 million, or $1.12 per diluted share, in the first quarter of 2015.

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

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

•

By eliminating fuel expense and certain special items from our unit metrics, we believe that we have better visibility into the results of operations and our non-fuel cost-reduction initiatives. Our industry is highly competitive and is characterized by high fixed costs, so even a small reduction in non-fuel operating costs can result in 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 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 that covers all Alaska and Horizon employees.


•	CASM excluding fuel and certain special items is a measure commonly used by industry analysts, and we believe it is the basis 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 mark-to-market hedging adjustments, is important because it provides information on significant items that are not necessarily indicative of future performance. Industry analysts and investors consistently measure our performance without these items for better comparability between periods and among other airlines.

•

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

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

Excluding the impact of mark-to-market fuel hedge adjustments, our adjusted consolidated net income for the first quarter of 2016 was $183 million, or $1.45 per diluted share, compared to an adjusted consolidated net income of $149 million, or $1.12 per diluted share, in the first quarter of 2015.



	Three Months Ended March 31,
	2016						2015
(in millions, except per share amounts)	Dollars			Diluted EPS			Dollars		Diluted EPS
Net income and diluted EPS as reported	$	184		$	1.46		$	149	$	1.12
Mark-to-market fuel hedge adjustments, net of tax	(1		)	(0.01		)	—		—
Non-GAAP adjusted income and per-share amounts	$	183		$	1.45		$	149	$	1.12

Our operating costs per ASM are summarized below:



	Three Months Ended March 31,
(in cents)	2016			2015			% Change
Consolidated:
CASM		10.11	¢		11.14	¢	(9.2	)%
Less the following components:
Aircraft fuel, including hedging gains and losses	1.60			2.53			(36.8	)%
CASM excluding fuel		8.51	¢		8.61	¢	(1.2	)%

Mainline:
CASM		9.01	¢		10.09	¢	(10.7	)%
Less the following components:
Aircraft fuel, including hedging gains and losses	1.52			2.43			(37.4	)%
CASM excluding fuel		7.49	¢		7.66	¢	(2.2	)%

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,
	2016	2015	Change
Consolidated Operating Statistics:^(a)
Revenue passengers (000)	7,835	7,316	7.1%
Revenue passenger miles (RPM) (000,000) "traffic"	8,571	7,723	11.0%
Available seat miles (ASM) (000,000) "capacity"	10,453	9,257	12.9%
Load factor	82.0%	83.4%	(1.4) pts
Yield	13.22¢	14.08¢	(6.1)%
Passenger revenue per ASM (PRASM)	10.84¢	11.74¢	(7.7)%
Revenue per ASM (RASM)	12.88¢	13.71¢	(6.1)%
Operating expense per ASM (CASM) excluding fuel^(b)	8.51¢	8.61¢	(1.2)%
Economic fuel cost per gallon^(b)	$1.29	$1.98	(34.8)%
Fuel gallons (000,000)	132	119	10.9%
ASMs per fuel gallon	79.2	77.8	1.8%
Average full-time equivalent employees (FTEs)	14,357	13,274	8.2%

Mainline Operating Statistics:
Revenue passengers (000)	5,642	5,236	7.8%
RPMs (000,000) "traffic"	7,716	6,994	10.3%
ASMs (000,000) "capacity"	9,354	8,347	12.1%
Load factor	82.5%	83.8%	(1.3) pts
Yield	12.01¢	12.88¢	(6.8)%
PRASM	9.91¢	10.79¢	(8.2)%
RASM	11.99¢	12.75¢	(6.0)%
CASM excluding fuel^(b)	7.49¢	7.66¢	(2.2)%
Economic fuel cost per gallon^(b)	$1.28	$1.97	(35.0)%
Fuel gallons (000,000)	113	103	9.7%
ASMs per fuel gallon	82.8	81.0	2.2%
Average FTEs	11,123	10,380	7.2%
Aircraft utilization	10.6	10.6	—%
Average aircraft stage length	1,237	1,199	3.2%
Operating fleet	152	137	15 a/c

Regional Operating Statistics:^(c)
Revenue passengers (000)	2,192	2,080	5.4%
RPMs (000,000) "traffic"	855	728	17.4%
ASMs (000,000) "capacity"	1,100	910	20.9%
Load factor	77.7%	80.0%	(2.3 pts)
Yield	24.09¢	25.58¢	(5.8)%
PRASM	18.72¢	20.46¢	(8.5)%
Operating fleet	67	60	7 a/c


^(a)	Except for FTEs, data includes information related to third-party regional capacity purchase flying arrangements.


^(b)	See reconciliation of operating expenses excluding fuel, a reconciliation of economic fuel costs in the accompanying pages.


^(c)	Data presented includes information related to flights operated by Horizon and third-party carriers.

Glossary of Terms

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

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

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

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

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

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

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

Free Cash Flow - total operating cash flow generated less cash paid for capital expenditures (shown as Total property and equipment additions on the statement of cash flows).

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

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

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

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

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

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

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

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

OPERATING REVENUES

Total operating revenues increased $78 million, or 6%, during the first quarter of 2016 compared to the same period in 2015. The changes are summarized in the following table:



	Three Months Ended March 31,
(in millions)	2016		2015		% Change
Passenger
Mainline	$	927	$	901	3	%
Regional	206		186		11	%
Total passenger revenue	1,133		1,087		4	%
Freight and mail	24		23		4	%
Other - net	190		159		19	%
Total operating revenues	$	1,347	$	1,269	6	%

Passenger Revenue – Mainline

Mainline passenger revenue for the first quarter of 2016 increased by 3% due to a 12.1% increase in capacity, largely offset by a decrease of 8.2% in PRASM compared to the first quarter of 2015. The increase in capacity was driven primarily by new routes and larger aircraft added to our fleet since the first quarter of 2015. The decrease in PRASM was driven by a 6.8% decline in ticket yield and a 1.3-point reduction in load factor compared to the prior-year quarter. The decrease in ticket yield was primarily due to increased competitive capacity in the markets we serve, and our own growth. Furthermore, the significant decline in fuel prices has contributed to lower ticket prices. The decline in load factor was also a result of increased capacity.

Passenger Revenue – Regional

Regional passenger revenue increased 11% compared to the first quarter of 2015 due to a 20.9% increase in capacity, partially offset by a 8.5% decrease in PRASM. The increase in capacity is due to an increase in departures, and average aircraft stage length as well as the annualization of new routes introduced over the past twelve months. The decrease in PRASM is due to a 5.8% decline in ticket yield, as well as a decrease in load factor of 2.3 points. The decrease in yield is due to an increase in competitive capacity in our regional markets and our own growth as we strengthen our network utility in the Pacific Northwest.

Other – Net

Other - net revenue increased $31 million, or 19%, from the first quarter of 2015, primarily due to increases in Mileage Plan revenue. Mileage Plan revenue increased $27 million, or 36%, due to increased miles sold and higher rates paid by our affinity credit card partner beginning January 1, 2016 as a result of a contract extension.

OPERATING EXPENSES

Total operating expenses increased $26 million, or 3%, compared to the first quarter of 2015. We believe it is useful to summarize operating expenses as follows, which is consistent with the way expenses are reported internally and evaluated by management:



	Three Months Ended March 31,
(in millions)	2016		2015		% Change
Fuel expense	$	167	$	235	(29	)%
Non-fuel expenses	890		796		12	%
Total Operating Expenses	$	1,057	$	1,031	3	%

Significant operating expense variances from 2015 are more fully described below.

Wages and Benefits

Wages and benefits increased during the first quarter of 2016 by $30 million. The primary components of wages and benefits are shown in the following table:



	Three Months Ended March 31,
(in millions)	2016		2015		% Change
Wages	$	251	$	230	9	%
Pension - Defined benefit plans	6		7		(14	)%
Defined contribution plans	16		15		7	%
Medical and other benefits	44		38		16	%
Payroll taxes	19		16		19	%
Total wages and benefits	$	336	$	306	10	%

Wages increased 9% with a 8.2% increase in FTEs. The increase in wages is primarily attributable to increased FTEs to support the growth in our business. In addition, we recognized pilot and flight attendant bonuses of approximately $3 million and severance costs of approximately $4 million at Horizon related to organizational restructuring.

Medical and other benefits increased 16% compared to the same period in the prior year. The increase is primarily due to an increase in medical claims with growth in the number of employees and increasing medical costs.

Variable Incentive Pay

Variable incentive pay expense increased $6 million, or 23%, compared to the first quarter of 2015. The increase is attributable in part to a 8.2% increase in FTEs coupled with a higher wage base. Additionally, we amended the participation rates of our Performance Based Pay incentive plan in the current year to increase the potential bonus earned by the vast majority of our supervisors and managers.

Aircraft Fuel

Aircraft fuel expense includes both raw fuel expense (as defined below) plus the effect of mark-to-market adjustments to our fuel hedge portfolio included in our consolidated statement of operations as the value of that portfolio increases and decreases. Our aircraft fuel expense can be volatile, because it includes these gains or losses in the value of the underlying instrument as crude oil prices and refining margins increase or decrease. Raw fuel expense is defined as the price that we generally pay at the airport, or the “into-plane” price, including taxes and fees. Raw fuel prices are impacted by world oil prices and refining costs, which can vary by region in the U.S. Raw fuel expense approximates cash paid to suppliers and does not reflect the effect of our fuel hedges.

Aircraft fuel expense decreased $68 million, or 29% compared to 2015. The elements of the change are illustrated in the following table:



	Three Months Ended March 31,
	2016						2015
(in millions, except for per gallon amounts)	Dollars			Cost/Gal			Dollars		Cost/Gal
Raw or "into-plane" fuel cost	$	165		$	1.26		$	229	$	1.93
Losses on settled hedges	4			0.03			6		0.05
Consolidated economic fuel expense	169			1.29			235		1.98
Mark-to-market fuel hedge adjustments	(2		)	(0.02		)	—		—
GAAP fuel expense	$	167		$	1.27		$	235	$	1.98
Fuel gallons	132						119

Fuel expense was lower than in the first quarter of 2015 as the raw fuel price per gallon decreased 35% on an 11% increase in fuel gallons. West Coast jet fuel prices are impacted by both the price of crude oil, as well as refining margins associated with the conversion of crude oil to jet