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EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - ALASKA AIR GROUP, INC.alk10-q32016ex322.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - ALASKA AIR GROUP, INC.alk10-q32016ex321.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - ALASKA AIR GROUP, INC.alk10-q32016ex312.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - ALASKA AIR GROUP, INC.alk10-q32016ex311.htm


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, 2016
 
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 123,271,393 common shares, par value $0.01, outstanding at October 31, 2016.




ALASKA AIR GROUP, INC.
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2016

 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:

our pending acquisition and the subsequent merger 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, as well as in other documents filed by Alaska Air Group with the SEC after the date thereof. 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,
2016
 
December 31,
2015
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
1,818

 
$
73

Marketable securities
1,408

 
1,255

Total cash and marketable securities
3,226

 
1,328

Receivables - net
232

 
212

Inventories and supplies - net
44

 
51

Prepaid expenses and other current assets
98

 
72

Total Current Assets
3,600

 
1,663

 
 
 
 
Property and Equipment
 

 
 

Aircraft and other flight equipment
6,398

 
5,690

Other property and equipment
1,021

 
955

Deposits for future flight equipment
489

 
771

 
7,908

 
7,416

Less accumulated depreciation and amortization
2,877

 
2,614

Total Property and Equipment - Net
5,031

 
4,802

 
 
 
 
Other Assets
68

 
65

 
 
 
 
Total Assets
$
8,699

 
$
6,530


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,
2016
 
December 31,
2015
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
71

 
$
63

Accrued wages, vacation and payroll taxes
257

 
298

Air traffic liability
785

 
669

Other accrued liabilities
735

 
661

Current portion of long-term debt
275

 
114

Total Current Liabilities
2,123

 
1,805

 
 
 
 
Long-Term Debt, Net of Current Portion
1,861

 
569

Other Liabilities and Credits
 

 
 

Deferred income taxes
733

 
682

Deferred revenue
491

 
431

Obligation for pension and postretirement medical benefits
272

 
270

Other liabilities
355

 
362

 
1,851

 
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 - 129,127,597 shares; 2015 - 128,442,099 shares, Outstanding: 2016 - 123,266,014 shares; 2015 - 125,175,325 shares
1

 
1

Capital in excess of par value
103

 
73

Treasury stock (common), at cost: 2016 - 5,861,583 shares; 2015 - 3,266,774 shares
(444
)
 
(250
)
Accumulated other comprehensive loss
(284
)
 
(303
)
Retained earnings
3,488

 
2,890

 
2,864

 
2,411

Total Liabilities and Shareholders' Equity
$
8,699

 
$
6,530


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)
2016
 
2015
 
2016
 
2015
Operating Revenues
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
Mainline
$
1,073

 
$
1,057

 
$
3,036

 
$
2,977

Regional
249

 
240

 
682

 
638

Total passenger revenue
1,322

 
1,297

 
3,718

 
3,615

Freight and mail
31

 
30

 
82

 
83

Other - net
213

 
188

 
607

 
523

Total Operating Revenues
1,566

 
1,515

 
4,407

 
4,221

 
 
 
 
 
 
 
 
Operating Expenses
 
 
 
 
 

 
 

Wages and benefits
340

 
312

 
1,008

 
923

Variable incentive pay
31

 
32

 
95

 
90

Aircraft fuel, including hedging gains and losses
225

 
245

 
593

 
741

Aircraft maintenance
64

 
67

 
197

 
182

Aircraft rent
25

 
26

 
80

 
78

Landing fees and other rentals
89

 
80

 
232

 
217

Contracted services
63

 
54

 
183

 
157

Selling expenses
58

 
53

 
162

 
160

Depreciation and amortization
101

 
81

 
281

 
236

Food and beverage service
31

 
30

 
93

 
83

Third-party regional carrier expense
25

 
20

 
72

 
52

Other
92

 
82

 
267

 
259

Special items - merger-related costs
22

 

 
36

 

Total Operating Expenses
1,166

 
1,082

 
3,299

 
3,178

Operating Income
400

 
433

 
1,108

 
1,043

 
 
 
 
 
 
 
 
Nonoperating Income (Expense)
 
 
 
 
 

 
 

Interest income
7

 
5

 
20

 
16

Interest expense
(11
)
 
(10
)
 
(33
)
 
(32
)
Interest capitalized
6

 
9

 
21

 
25

Other - net

 

 
(2
)
 
1

 
2

 
4

 
6

 
10

Income before income tax
402

 
437

 
1,114

 
1,053

Income tax expense
146

 
163

 
414

 
396

Net Income
$
256

 
$
274

 
$
700

 
$
657

 
 
 
 
 
 
 
 
Basic Earnings Per Share:
$
2.08

 
$
2.15

 
$
5.66

 
$
5.08

Diluted Earnings Per Share:
$
2.07

 
$
2.14

 
$
5.63

 
$
5.05

 
 
 
 
 
 
 
 
Shares used for computation:
 
 
 
 
 
 
 

Basic
123.149

 
127.308

 
123.648

 
129.231

Diluted
123.833

 
128.205

 
124.393

 
130.200

 
 
 
 
 
 
 
 
Cash dividend declared per share:
$
0.275

 
$
0.20

 
$
0.825

 
$
0.60

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)
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Net Income
$
256

 
$
274

 
$
700

 
$
657

 
 
 
 
 
 
 
 
Other Comprehensive Income (Loss):
 
 
 
 
 
 
 
Related to marketable securities:
 
 
 
 
 
 
 
Unrealized holding gains (losses) arising during the period
(2
)
 

 
17

 
2

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

 

 
(1
)
 

Income tax effect

 

 
(6
)
 
(1
)
Total
(2
)
 

 
10

 
1

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

 
3

 
15

 
11

Income tax effect
(1
)
 
(1
)
 
(5
)
 
(4
)
Total
4

 
2

 
10

 
7

 
 
 
 
 
 
 
 
Related to interest rate derivative instruments:
 
 
 
 
 
 
 
Unrealized holding gains (losses) arising during the period
1

 
(5
)
 
(6
)
 
(8
)
Reclassification of (gains) losses into Aircraft rent
1

 
2

 
4

 
5

Income tax effect
(1
)
 
2

 
1

 
2

Total
1

 
(1
)
 
(1
)
 
(1
)
 
 
 
 
 
 
 
 
Other Comprehensive Income
3

 
1

 
19

 
7

 
 
 
 
 
 
 
 
Comprehensive Income
$
259

 
$
275

 
$
719

 
$
664


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)
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
700

 
$
657

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

 
 

Depreciation and amortization
281

 
236

Stock-based compensation and other
19

 
22

Changes in certain assets and liabilities:
 
 
 
Changes in deferred tax provision
47

 
(17
)
Increase (decrease) in air traffic liability
116

 
129

Increase (decrease) in deferred revenue
60

 
42

Other - net
(17
)
 
160

Net cash provided by operating activities
1,206

 
1,229

 
 
 
 
Cash flows from investing activities:
 

 
 

Property and equipment additions:
 

 
 

Aircraft and aircraft purchase deposits
(408
)
 
(563
)
Other flight equipment
(35
)
 
(61
)
Other property and equipment
(66
)
 
(44
)
Total property and equipment additions, including capitalized interest
(509
)
 
(668
)
Purchases of marketable securities
(775
)
 
(876
)
Sales and maturities of marketable securities
638

 
818

Proceeds from disposition of assets and changes in restricted deposits
5

 
(1
)
Net cash used in investing activities
(641
)
 
(727
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Proceeds from issuance of debt
1,546

 

Long-term debt payments
(93
)
 
(93
)
Common stock repurchases
(193
)
 
(381
)
Dividends paid
(102
)
 
(78
)
Other financing activities
22

 
31

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

 
(521
)
Net increase (decrease) in cash and cash equivalents
1,745

 
(19
)
Cash and cash equivalents at beginning of year
73

 
107

Cash and cash equivalents at end of the period
$
1,818

 
$
88

 
 
 
 
Supplemental disclosure:
 

 
 

Cash paid during the period for:
 
 
 
Interest (net of amount capitalized)
$
12

 
$
9

Income taxes paid
321

 
262

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 primary 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 September 30, 2016, as well as the results of operations for the three and nine months ended September 30, 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 and nine months ended September 30, 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 Standards 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. In March 2016, the FASB issued ASU 2016-08, "Revenue from Contracts with Customers" (Topic 606), Principal versus Agent Considerations, which 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. Entities are permitted to use either a full retrospective or cumulative effect transition method, and are required to adopt all parts of the new revenue standard using the same transition method. The new standard is effective for the Company on January 1, 2018. At this time, the Company believes the most significant impact to the financial statements will be 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 continues to evaluate the full impact of the standard, and currently plans to apply the full retrospective 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 is 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 2016-09, "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

9



evaluating the effect of ASU 2016-09 on the consolidated financial statements and related disclosures. The ASU is effective for the Company beginning January 1, 2017. The Company has not yet elected a transition method.

NOTE 2. PROPOSED ACQUISITION OF VIRGIN AMERICA

On April 1, 2016 the Company entered into an agreement to acquire 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 has been approved by Virgin America's shareholders and is subject to final approval by various regulatory bodies. The Department of Justice (DOJ) is currently reviewing the transaction.

As of September 30, 2016, the Company has incurred merger-related costs of $36 million. Costs classified as merger-related are directly attributable to merger activities. These costs are classified as special items within the Statement of Operations. The Company expects to continue to incur merger-related costs in the future if the transaction closes.

NOTE 3. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES

Components for cash, cash equivalents and marketable securities (in millions):
September 30, 2016
Cost Basis
 
Unrealized
Gains
 
Unrealized Losses
 
Fair Value
Cash
$
16

 
$

 
$

 
$
16

Cash equivalents
1,802

 

 

 
1,802

Cash and cash equivalents
1,818

 

 

 
1,818

U.S. government and agency securities
330

 
2

 

 
332

Foreign government bonds
36

 

 

 
36

Asset-backed securities
153

 
1

 

 
154

Mortgage-backed securities
102

 

 

 
102

Corporate notes and bonds
760

 
8

 
(1
)
 
767

Municipal securities
17

 

 

 
17

Marketable securities
1,398

 
11

 
(1
)
 
1,408

Total
$
3,216

 
$
11

 
$
(1
)
 
$
3,226


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


The large increase in cash and cash equivalents is due to debt financing received in anticipation of the pending merger with Virgin America.

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, 2016.


10



Activity for marketable securities (in millions):  
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Proceeds from sales and maturities
$
280

 
$
142

 
$
638

 
$
818

Gross realized gains

 

 
2

 
2

Gross realized losses

 

 
(1
)
 
(2
)
 
Maturities for marketable securities (in millions):
September 30, 2016
Cost Basis
 
Fair Value
Due in one year or less
$
283

 
$
283

Due after one year through five years
1,108

 
1,118

Due after five years through 10 years
7

 
7

Due after 10 years

 

Total
$
1,398

 
$
1,408


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):
September 30, 2016
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
332

 
$

 
$
332

Foreign government bonds

 
36

 
36

Asset-backed securities

 
154

 
154

Mortgage-backed securities

 
102

 
102

Corporate notes and bonds

 
767

 
767

Municipal securities

 
17

 
17

Total Marketable securities
332

 
1,076

 
1,408

Derivative instruments
 
 
 
 
 
Fuel hedge call options

 
16

 
16

Total Assets
332

 
1,092

 
1,424

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Interest rate swap agreements

 
(20
)
 
(20
)
Total Liabilities

 
(20
)
 
(20
)


11



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 September 30, 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 which is not carried at fair value on the consolidated balance sheet, has an estimated fair value of (in millions):
 
September 30,
2016
 
December 31,
2015
Carrying amount
$
730

 
$
520

Fair value
759

 
557





12



NOTE 5. MILEAGE PLAN

Alaska's Mileage Plan liabilities and deferrals on the consolidated balance sheets (in millions):
 
September 30,
2016
 
December 31,
2015
Current Liabilities:
 
 
 
Other accrued liabilities
$
405

 
$
368

Other Liabilities and Credits:
 
 
 
Deferred revenue
489

 
427

Other liabilities
19

 
19

Total
$
913

 
$
814

 
Alaska's Mileage Plan revenue included in the consolidated statements of operations (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Passenger revenues
$
73

 
$
66

 
$
215

 
$
199

Other - net revenues
107

 
85

 
318

 
244

Total
$
180

 
$
151

 
$
533

 
$
443


NOTE 6. LONG-TERM DEBT
 
Long-term debt obligations on the consolidated balance sheet (in millions):
 
September 30,
2016
 
December 31,
2015
Fixed-rate notes payable due through 2026
$
730

 
$
520

Variable-rate notes payable due through 2028
1,423

 
166

Less debt issuance costs
(17
)
 
(3
)
Total debt
2,136

 
683

Less current portion
275

 
114

Long-term debt, less current portion
$
1,861

 
$
569

 
 
 
 
Weighted-average fixed-interest rate
4.6
%
 
5.7
%
Weighted-average variable-interest rate
2.3
%
 
1.8
%

During the nine months ended September 30, 2016, the Company made debt payments of $93 million. In the current quarter the Company obtained approximately $1.5 billion of secured debt financing from multiple lenders in anticipation of the pending merger with Virgin America. The loans are secured by a total of 53 aircraft, including 34 737-900ER aircraft and 19 737-800 aircraft.

To hedge the volatility of the underlying variable interest rates on $300 million of the debt obtained in the third quarter of 2016, the Company entered into two interest rate swap agreements. The interest rate swap agreements stipulate that the Company pay a fixed interest rate over the term of the loans and receive a floating interest rate. We have designated these agreements as qualifying hedging instruments and are accounting for them as cash flow hedges. The interest rate swap agreements expire October 2022 and September 2026 to coincide with the debt termination dates.

Interest rate swaps are recognized at fair value on the balance sheet, and changes in the fair value are recognized in accumulated other comprehensive income (loss). The effective portion of the derivative represents the change in fair value of the hedge that offsets the change in fair value of the hedged item. To the extent the change in fair value of the hedge does not perfectly offset the change in the fair value of the hedged item, the ineffective portion of the hedge is recognized in interest expense, if material.

Subsequent to September 30, 2016, the Company obtained an additional $100 million of secured debt financing in anticipation of the pending merger with Virgin America. Subsequent events are further discussed in Note 11.

13




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 September 30, 2016, scheduled long-term debt principal payments for the next five years and thereafter are as follows (in millions):
 
Total
Remainder of 2016
$
47

2017
282

2018
315

2019
281

2020
286

Thereafter
942

Total
$
2,153

 
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 2017 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 September 30, 2016.

NOTE 7. EMPLOYEE BENEFIT PLANS

The Company has a number of employee benefit plans, including qualified and nonqualified defined-benefit plans, defined-contribution plans, postretirement medical benefits, and long-term disability benefits. In relation to the qualified plans, net periodic benefit costs recognized included the following components for the three and nine months ended September 30, 2016 (in millions). Amounts recognized in relation to all other plans were immaterial to the quarter. 
 
Qualified Defined - Benefit Plans
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Service cost
$
9

 
$
11

 
$
27

 
$
31

Interest cost
18

 
21

 
55

 
63

Expected return on assets
(27
)
 
(31
)
 
(81
)
 
(92
)
Amortization of prior service costs
(1
)
 
(1
)
 
(1
)
 
(1
)
Recognized actuarial loss (gain)
7

 
7

 
19

 
20

Total
$
6

 
$
7

 
$
19

 
$
21




14



NOTE 8. COMMITMENTS

Future minimum fixed payments for commitments (in millions):
September 30, 2016
Aircraft Leases
 
Facility Leases
 
Aircraft Purchase Commitments
 
Capacity Purchase Agreements (a)
Remainder of 2016
$
20

 
$
24

 
$
146

 
$
17

2017
99

 
91

 
931

 
78

2018
90

 
43

 
724

 
81

2019
82

 
43

 
645

 
86

2020
73

 
40

 
334

 
92

Thereafter
400

 
188

 
397

 
746

Total
$
764

 
$
429

 
$
3,177

 
$
1,100

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

Lease Commitments

At September 30, 2016, the Company’s fleet includes lease contracts for 18 B737 aircraft and 15 Q400s. Additionally, the fleet includes 16 lease commitments under the CPA with SkyWest, comprising 3 CRJ-700s and 13 E175s. 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 8 additional E175 aircraft with delivery in 2019.

The majority of airport and terminal facilities are also leased. Rent expense for aircraft and facility leases was $82 million and $77 million for the three months ended September 30, 2016 and 2015, respectively. Rent expense for aircraft and facility leases was $226 million and $217 million for the nine months ended September 30, 2016 and 2015, respectively.

Aircraft Purchase Commitments
 
As discussed in Note 11, subsequent to September 30, 2016 the Company deferred the delivery of four 737-MAX aircraft with deliveries in 2017 and 2018, and exercised five 737-900ER options for delivery in 2018. These changes are not reflected in the commitments table above. Inclusive of these changes, the Company is committed to purchasing 56 B737 aircraft (19 737-900ER aircraft and 37 737 MAX aircraft), and 33 E175 aircraft, with deliveries in 2016 through 2023. In addition, the Company has options to purchase 41 B737 aircraft, and 30 E175 aircraft, which are not reflected in the commitments table above.

Capacity Purchase Agreements (CPAs)
 
At September 30, 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 in the Lower 48 and with 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 is subject to various contingencies, including the potential costs and risks associated with litigation and the actions of arbitrators, judges and juries.

On September 7, 2016, a private antitrust action captioned Daniel Grace, et al., v. Alaska Air Group, Inc., et al. was filed in the United States District Court for the Northern District of California, against the Company.  The complaint was subsequently amended by the plaintiffs on October 28, 2016 to, among other matters, add Virgin America Inc. as a defendant and modify the list of named plaintiffs. The plaintiffs, each of whom the complaint describes as air passengers, allege that the pending merger

15



of Virgin America Inc. with the Company would violate Section 7 of the Clayton Antitrust Act (15 U.S.C. §18), as well as Section 1 of the Sherman Antitrust Act (15 U.S.C. §1).  The complaint seeks, among other matters, to preliminarily as well as permanently enjoin the pending merger, and also seeks attorneys’ fees.  On October 19, 2016, the Court held a hearing on plaintiffs’ motion for a preliminary injunction.  The Court did not rule at the hearing on whether to issue the preliminary injunction, but did subsequently issue an order requiring the defendants to provide the Court and the plaintiffs with at least seven calendar days’ notice before consummating the merger, noting that any consummation of the merger would be subject to divestiture.  At the Court’s direction, the parties have submitted to the Court a proposed pretrial and trial schedule assuming a December 2016 trial date.  The Company believes the allegations in this complaint are without merit and we intend to defend against them vigorously.

NOTE 9. SHAREHOLDERS' EQUITY

Dividends

During the three months ended September 30, 2016, the Company declared and paid cash dividends of $0.275 per share, or $34 million. During the nine months ended September 30, 2016, the Company declared and paid cash dividends of $0.825 per share, or $102 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, which was paused in the second quarter of 2016 in anticipation of the pending acquisition of Virgin America.
Share repurchase activity (in millions, except share amounts):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
2015 Repurchase Program - $1 billion

 
$

 

 
$

 
2,594,809

 
$
193

 


$

2014 Repurchase Program - $650 million

 

 
1,588,251

 
119

 

 

 
5,649,805

 
381

Total

 
$

 
1,588,251

 
$
119

 
2,594,809

 
$
193

 
5,649,805

 
$
381

 
Accumulated Other Comprehensive Loss
 
Components of accumulated other comprehensive income (loss), net of tax (in millions):
 
September 30,
2016
 
December 31,
2015
Marketable securities
$
7

 
$
(3
)
Employee benefit plans
(278
)
 
(288
)
Interest rate derivatives
(13
)
 
(12
)
Total
$
(284
)
 
$
(303
)


16




NOTE 10. OPERATING SEGMENT INFORMATION
 
Air Group has two operating airlines - Alaska and Horizon. 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 and costs such as fuel, distribution costs, and payments made to Horizon, SkyWest and PenAir for the capacity purchased under CPAs. Additionally, Alaska Regional includes an allocation of corporate overhead such as IT, finance and other administrative costs incurred by Alaska 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.

17



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

 
$

 
$

 
$

 
$
1,073

 
$

 
$
1,073

Regional

 
249

 

 

 
249

 

 
249

Total passenger revenues
1,073

 
249

 

 

 
1,322

 

 
1,322

CPA revenues

 

 
109

 
(109
)
 

 

 

Freight and mail
30

 
1

 

 

 
31

 

 
31

Other - net
190

 
21

 
1

 
1

 
213

 

 
213

Total operating revenues
1,293

 
271

 
110

 
(108
)
 
1,566

 

 
1,566

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
727

 
202

 
99

 
(109
)
 
919

 
22

 
941

Economic fuel
188

 
34

 

 

 
222

 
3

 
225

Total operating expenses
915

 
236

 
99

 
(109
)
 
1,141

 
25

 
1,166

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
7

 

 

 

 
7

 

 
7

Interest expense
(7
)
 

 
(2
)
 
(2
)
 
(11
)
 

 
(11
)
Other
5

 

 

 
1

 
6

 

 
6

 
5

 

 
(2
)
 
(1
)
 
2

 

 
2

Income (loss) before income tax
$
383

 
$
35

 
$
9

 
$

 
$
427

 
$
(25
)
 
$
402


18



 
Three Months Ended September 30, 2015
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Parent & Consolidating(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
1,057

 
$

 
$

 
$

 
$
1,057

 
$

 
$
1,057

Regional

 
240

 

 

 
240

 

 
240

Total passenger revenues
1,057

 
240

 

 

 
1,297

 

 
1,297

CPA revenues

 

 
105

 
(105
)
 

 

 

Freight and mail
29

 
1

 

 

 
30

 

 
30

Other - net
167

 
20

 
1

 

 
188

 

 
188

Total operating revenues
1,253

 
261

 
106

 
(105
)
 
1,515

 

 
1,515

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
667

 
181

 
93

 
(104
)
 
837

 

 
837

Economic fuel
205

 
35

 

 

 
240

 
5

 
245

Total operating expenses
872

 
216

 
93

 
(104
)
 
1,077

 
5

 
1,082

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
5

 

 

 

 
5

 

 
5

Interest expense
(7
)
 

 
(3
)
 

 
(10
)
 

 
(10
)
Other
7

 

 

 
2

 
9

 

 
9

 
5

 

 
(3
)
 
2

 
4

 

 
4

Income (loss) before income tax
$
386

 
$
45

 
$
10

 
$
1

 
$
442

 
$
(5
)
 
$
437

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




$


$


$
3,036


$


$
3,036

Regional


682






682




682

Total passenger revenues
3,036


682






3,718




3,718

CPA revenues




322


(322
)






Freight and mail
79


3






82




82

Other - net
546


57


3


1


607




607

Total operating revenues
3,661


742


325


(321
)

4,407




4,407

 




















Operating expenses




















Operating expenses, excluding fuel
2,107


580


305


(322
)

2,670


36


2,706

Economic fuel
512


90






602


(9
)

593

Total operating expenses
2,619


670


305


(322
)

3,272


27


3,299

 




















Nonoperating income (expense)



















Interest income
19




1




20




20

Interest expense
(23
)



(7
)

(3
)

(33
)



(33
)
Other
15






4


19




19

 
11




(6
)