10-Q 1 alk10-q12014.htm 10-Q ALK 10-Q1 2014


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

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

For the quarterly period ended March 31, 2014
 
OR

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

 For the transition period from                      to                      

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes T No £
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer   T
Accelerated filer  £ 
Non-accelerated filer   £
Smaller reporting company   £
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes £ No T
 
The registrant has 68,718,515 common shares, par value $1.00, outstanding at April 30, 2014.




ALASKA AIR GROUP, INC.
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2014

 TABLE OF CONTENTS


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

2




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

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

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

(in millions)
March 31,
2014
 
December 31,
2013
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
90

 
$
80

Marketable securities
1,330

 
1,250

Total cash and marketable securities
1,420

 
1,330

Receivables - net
212

 
152

Inventories and supplies - net
58

 
60

Deferred income taxes
120

 
113

Prepaid expenses and other current assets
124

 
107

Total Current Assets
1,934

 
1,762

 
 
 
 
Property and Equipment
 

 
 

Aircraft and other flight equipment
4,855

 
4,677

Other property and equipment
853

 
838

Deposits for future flight equipment
360

 
446

 
6,068

 
5,961

Less accumulated depreciation and amortization
2,138

 
2,068

Total Property and Equipment - Net
3,930

 
3,893

 
 
 
 
Other Assets
197

 
183

 
 
 
 
Total Assets
$
6,061

 
$
5,838


See accompanying notes to condensed consolidated financial statements.


4


ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(in millions, except share amounts)
March 31,
2014
 
December 31,
2013
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
75

 
$
64

Accrued wages, vacation and payroll taxes
146

 
211

Other accrued liabilities
672

 
624

Air traffic liability
749

 
564

Current portion of long-term debt
113

 
117

Total Current Liabilities
1,755

 
1,580

 
 
 
 
Long-Term Debt, Net of Current Portion
721

 
754

Other Liabilities and Credits
 

 
 

Deferred income taxes
725

 
709

Deferred revenue
334

 
335

Obligation for pension and postretirement medical benefits
122

 
123

Other liabilities
309

 
308

 
1,490

 
1,475

Commitments and Contingencies


 


Shareholders' Equity
 

 
 

Preferred stock, $1 par value Authorized: 5,000,000 shares, none issued or outstanding

 

Common stock, $1 par value, Authorized: 100,000,000 shares, Issued: 2014 - 68,798,330 shares; 2013 - 68,766,691 shares, Outstanding: 2014 - 68,788,557; 2013 - 68,745,953
69

 
69

Capital in excess of par value
524

 
538

Treasury stock (common), at cost: 2014 - 9,773 shares; 2013 - 20,738 shares
(1
)
 
(2
)
Accumulated other comprehensive loss
(181
)
 
(183
)
Retained earnings
1,684

 
1,607

 
2,095

 
2,029

Total Liabilities and Shareholders' Equity
$
6,061

 
$
5,838


See accompanying notes to condensed consolidated financial statements.


5


ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
 
Three Months Ended March 31,
(in millions, except per share amounts)
2014
 
2013
Operating Revenues
 
 
 
Passenger
 
 
 
Mainline
$
854

 
$
796

Regional
186

 
182

Total passenger revenue
1,040

 
978

Freight and mail
24

 
26

Other - net
158

 
129

Total Operating Revenues
1,222

 
1,133

 
 
 
 
Operating Expenses
 
 
 
Wages and benefits
272

 
264

Variable incentive pay
25

 
21

Aircraft fuel, including hedging gains and losses
358

 
381

Aircraft maintenance
51

 
66

Aircraft rent
28

 
30

Landing fees and other rentals
69

 
60

Contracted services
60

 
53

Selling expenses
46

 
38

Depreciation and amortization
70

 
69

Food and beverage service
21

 
20

Other
81

 
67

Total Operating Expenses
1,081

 
1,069

Operating Income
141

 
64

 
 
 
 
Nonoperating Income (Expense)
 
 
 
Interest income
5

 
4

Interest expense
(12
)
 
(16
)
Interest capitalized
5

 
5

Other - net
13

 
2

 
11

 
(5
)
Income before income tax
152

 
59

Income tax expense
58

 
22

Net Income
$
94

 
$
37

 
 
 
 
Basic Earnings Per Share:
$
1.37

 
$
0.52

Diluted Earnings Per Share:
$
1.35

 
$
0.51

 
 
 
 
Shares used for computation:
 
 
 
Basic
68.667

 
70.431

Diluted
69.411

 
71.414

 
 
 
 
Cash dividend declared per share:
$
0.25

 


See accompanying notes to condensed consolidated financial statements.

6


ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS (unaudited)

 
Three Months Ended March 31,
(in millions)
2014
 
2013
 
 
 
 
Net Income
$
94

 
$
37

 
 
 
 
Other comprehensive income (loss):
 
 
 
Related to marketable securities:
 
 
 
Unrealized holding gains (losses) arising during the period
3

 
(1
)
Reclassification of (gains) losses into net income
(within Nonoperating Income (Expense), Other - net)

 
(1
)
Income tax effect
(1
)
 
1

Total
2

 
(1
)
 
 
 
 
Related to employee benefit plans:
 
 
 
Reclassification adjustment for amortization of net pension expense
(within Wages and benefits)
2

 
10

Income tax effect
(1
)
 
(4
)
Total
1

 
6

 
 
 
 
Related to interest rate derivative instruments:
 
 
 
Unrealized holding gains (losses) arising during the period
(3
)
 
3

Reclassification of (gains) losses into net income (within Aircraft rent)
2

 
1

Income tax effect

 
(2
)
Total
(1
)
 
2

 
 
 
 
Other comprehensive income
2

 
7

 
 
 
 
Comprehensive income
$
96

 
$
44


See accompanying notes to condensed consolidated financial statements.


7


ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
 
Three Months Ended March 31,
(in millions)
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income
$
94

 
$
37

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

 
 

Depreciation and amortization
70

 
69

Stock-based compensation and other
4

 
14

Changes in certain assets and liabilities:
 
 
 
Changes in deferred income taxes
9

 
18

Increase in air traffic liability
185

 
157

Increase (decrease) in deferred revenue
(1
)
 
(2
)
Other - net
(119
)
 
(81
)
Net cash provided by operating activities
242

 
212

 
 
 
 
Cash flows from investing activities:
 

 
 

Property and equipment additions:
 

 
 

Aircraft and aircraft purchase deposits
(65
)
 
(90
)
Other flight equipment
(17
)
 
(6
)
Other property and equipment
(11
)
 
(7
)
Total property and equipment additions
(93
)
 
(103
)
Purchases of marketable securities
(305
)
 
(280
)
Sales and maturities of marketable securities
227

 
239

Proceeds from disposition of assets and changes in restricted deposits
7

 
(7
)
Net cash used in investing activities
(164
)
 
(151
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Long-term debt payments
(37
)
 
(88
)
Common stock repurchases
(30
)
 
(19
)
Dividends paid
(17
)
 

Other financing activities
16

 
19

Net cash used in financing activities
(68
)
 
(88
)
Net increase/(decrease) in cash and cash equivalents
10

 
(27
)
Cash and cash equivalents at beginning of year
80

 
122

Cash and cash equivalents at end of the period
$
90

 
$
95

 
 
 
 
Supplemental disclosure:
 

 
 

Cash paid during the period for:
 
 
 
Interest (net of amount capitalized)
$
11

 
$
15

Income taxes
6

 
6

See accompanying notes to condensed consolidated financial statements.

8



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

NOTE 1. GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

In preparing these statements, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities, as well as the reported amounts of revenues and expenses. Due to seasonal variations in the demand for air travel, the volatility of aircraft fuel prices, changes in global economic conditions, changes in the competitive environment, and other factors, operating results for the three months ended March 31, 2014, are not necessarily indicative of operating results for the entire year.

NOTE 2. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES

Components for cash, cash equivalents and marketable securities (in millions):
March 31, 2014
Cost Basis
 
Unrealized
Gains
 
Unrealized Losses
 
Fair Value
Cash
$
5

 
$

 
$

 
$
5

Cash equivalents
85

 

 

 
85

Cash and cash equivalents
90

 

 

 
90

U.S. government and agency securities
284

 

 
(1
)
 
283

Foreign government bonds
18

 

 

 
18

Asset-back securities
158

 

 

 
158

Mortgage-back securities
146

 
1

 
(1
)
 
146

Corporate notes and bonds
696

 
5

 
(1
)
 
700

Municipal securities
25

 

 

 
25

Marketable securities
1,327

 
6

 
(3
)
 
1,330

Total
$
1,417

 
$
6

 
$
(3
)
 
$
1,420


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

 
$

 
$

 
$
9

Cash equivalents
71

 

 

 
71

Cash and cash equivalents
80

 

 

 
80

U.S. government and agency securities
295

 
1

 
(2
)
 
294

Foreign government bonds
11

 

 

 
11

Asset-back securities
146

 

 

 
146

Mortgage-back securities
144

 
1

 
(2
)
 
143

Corporate notes and bonds
628

 
4

 
(2
)
 
630

Municipal securities
26

 

 

 
26

Marketable securities
1,250

 
6

 
(6
)
 
1,250

Total
$
1,330

 
$
6

 
$
(6
)
 
$
1,330


9



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, 2014.

Activity for marketable securities (in millions):  
 
Three Months Ended March 31,
 
2014
 
2013
Proceeds from sales and maturities
$
227

 
$
239

Gross realized gains
1

 
2

Gross realized losses
(1
)
 
(1
)
 
Maturities for marketable securities (in millions):
March 31, 2014
Cost Basis
 
Fair Value
Due in one year or less
$
144

 
$
145

Due after one year through five years
1,176

 
1,178

Due after five years through 10 years
7

 
7

Total
$
1,327

 
$
1,330


NOTE 3. DERIVATIVE INSTRUMENTS

Fuel Hedge Contracts

The Company’s operations are inherently dependent upon the price and availability of aircraft fuel. To manage economic risks associated with fluctuations in aircraft fuel prices, the Company periodically enters into call options for crude oil and swap agreements for jet fuel refining margins.

As of March 31, 2014, the Company had outstanding fuel hedge contracts covering 264 million gallons of crude oil that will be settled from April 2014 to March 2016. Refer to the contractual obligations and commitments section of Item 2 for further information.

Interest Rate Swap Agreements

The Company has interest rate swap agreements with a third party designed to hedge the volatility of the underlying variable interest rate in the Company's aircraft lease agreements for six Boeing 737-800 aircraft. The agreements stipulate that the Company pay a fixed interest rate over the term of the contract and receive a floating interest rate. All significant terms of the swap agreement match the terms of the lease agreements, including interest-rate index, rate reset dates, termination dates and underlying notional values. The agreements expire from February 2020 through March 2021 to coincide with the lease termination dates.


10



Fair Values of Derivative Instruments

Fair values of derivative instruments on the consolidated balance sheet (in millions):
 
March 31,
2014
 
December 31,
2013
Derivative Instruments Not Designated as Hedges
 
 
 
Fuel hedge contracts
 
 
 
Fuel hedge contracts, current assets
$
12

 
$
12

Fuel hedge contracts, noncurrent assets
3

 
4

Fuel hedge contracts, current liabilities
(2
)
 

 
 
 
 
Derivative Instruments Designated as Hedges
 
 
 
Interest rate swaps
 
 
 
Other accrued liabilities
(7
)
 
(7
)
Other liabilities
(11
)
 
(10
)
Losses in accumulated other comprehensive loss (AOCL)
(18
)
 
(17
)

The net cash received (paid) for new positions and settlements was ($7) million and nil during the three months ended March 31, 2014 and 2013, respectively.

Pretax effect of derivative instruments on earnings (in millions):
 
Three Months Ended March 31,
 
2014
 
2013
Derivative Instruments Not Designated as Hedges
 
 
 
Fuel hedge contracts
 
 
 
Gains (losses) recognized in aircraft fuel expense
$
(10
)
 
$
(24
)
 
 
 
 
Derivative Instruments Designated as Hedges
 
 
 
Interest rate swaps
 
 
 
Losses recognized in aircraft rent
(2
)
 
(1
)
Gains (losses) recognized in other comprehensive income (OCI)
(3
)
 
3


The amounts shown as recognized in aircraft rent for cash flow hedges (interest rate swaps) represent the realized losses transferred out of AOCL to aircraft rent. The amounts shown as recognized in OCI are prior to the losses recognized in the income statement as aircraft rent during the period. The Company expects $7 million to be reclassified from OCI to aircraft rent within the next twelve months.

Credit Risk and Collateral

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

The Company posted collateral of $8 million and $7 million as of March 31, 2014 and December 31, 2013, respectively. The collateral was provided to one counterparty associated with the net liability position of the interest rate swap agreements, offset by the net asset position of the fuel hedge contracts under a master netting arrangement.


11



NOTE 4. FAIR VALUE MEASUREMENTS

Fair Value of Financial Instruments on a Recurring Basis

Fair values of financial instruments on the consolidated balance sheet (in millions):
March 31, 2014
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
283

 
$

 
$
283

Foreign government bonds

 
18

 
18

Asset-back securities

 
158

 
158

Mortgage-back securities

 
146

 
146

Corporate notes and bonds

 
700

 
700

Municipal securities

 
25

 
25

Derivative instruments
 
 
 
 
 
Call options

 
15

 
15

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Fuel hedge contracts

 
(2
)
 
(2
)
Interest rate swap agreements

 
(18
)
 
(18
)

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

 
$

 
$
294

Foreign government bonds

 
11

 
11

Asset-back securities

 
146

 
146

Mortgage-back securities

 
143

 
143

Corporate notes and bonds

 
630

 
630

Municipal securities

 
26

 
26

Derivative instruments
 
 
 
 
 
Call options

 
16

 
16

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Fuel hedge contracts

 

 

Interest rate swap agreements

 
(17
)
 
(17
)

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

The Company uses the market approach and the income approach to determine the fair value of derivative instruments. Fuel hedge contracts that are not traded on a public exchange are Level 2 as the fair value is primarily based on inputs which are readily available in active markets or can be derived from information available in active markets. The fair value for call options is determined utilizing an option pricing model based on inputs that are readily available in active markets, or can be derived from information available in active markets. In addition, the fair value considers the exposure to credit losses in the event of nonperformance by counterparties. The fair value of jet fuel refining margins (fuel hedge contracts) is determined based on inputs readily available in public markets and provided by brokers who regularly trade these contracts. Interest rate

12



swap agreements are Level 2 as the fair value of these contracts is determined based on the difference between the fixed interest rate in the agreements and the observable LIBOR-based forward interest rates at period end, multiplied by the total notional value.

The Company has no financial assets that are measured at fair value on a nonrecurring basis at March 31, 2014.

Fair Value of Other Financial Instruments

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

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

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

Fixed-rate debt that is not carried at fair value on the consolidated balance sheet and the estimated fair value of long-term fixed-rate debt (in millions):
 
March 31,
2014
 
December 31,
2013
Carrying amount
$
678

 
$
703

Fair value
733

 
762


NOTE 5. MILEAGE PLAN

Alaska's Mileage Plan liabilities and deferrals on the consolidated balance sheets (in millions):
 
March 31,
2014
 
December 31,
2013
Current Liabilities:
 
 
 
Other accrued liabilities
$
335

 
$
314

Other Liabilities and Credits:
 
 
 
Deferred revenue
324

 
323

Other liabilities
19

 
19

Total
$
678

 
$
656

 
Alaska's Mileage Plan revenue included in the consolidated statements of operations (in millions):
 
Three Months Ended March 31,
 
2014
 
2013
Passenger revenues
$
55

 
$
46

Other - net revenues
73

 
54

Total
$
128

 
$
100



13



NOTE 6. LONG-TERM DEBT
 
Long-term debt obligations on the consolidated balance sheet (in millions):
 
March 31,
2014
 
December 31,
2013
Fixed-rate notes payable due through 2024
$
678

 
$
703

Variable-rate notes payable due through 2023
156

 
168

Long-term debt
834

 
871

Less current portion
113

 
117

Total
$
721

 
$
754

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

During the three months ended March 31, 2014, the Company made debt payments of $37 million.

At March 31, 2014, long-term debt principal payments for the next five years and thereafter are as follows (in millions):
 
Total
Remainder of 2014
$
80

2015
113

2016
111

2017
116

2018
147

Thereafter
267

Total
$
834

 
Bank Lines of Credit
 
The Company has two $100 million credit facilities. Both facilities have variable interest rates based on LIBOR plus a specified margin. One of the $100 million facilities, which expires in August 2015, is secured by aircraft. The other $100 million facility, which expires in March 2017, is secured by certain accounts receivable, spare engines, spare parts and ground service equipment. The Company has no immediate plans to borrow using either of these facilities. These facilities have a requirement to maintain a minimum unrestricted cash and marketable securities balance of $500 million. The Company is in compliance with this covenant at March 31, 2014.

NOTE 7. EMPLOYEE BENEFIT PLANS

Net periodic benefit costs recognized included the following components for the three months ended March 31, 2014 (in millions): 
 
Three Months Ended March 31,
 
Qualified
 
Nonqualified
 
Postretirement Medical
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Service cost
$
8

 
$
11

 
$

 
$

 
$
1

 
$
1

Interest cost
20

 
18

 

 
1

 
1

 
1

Expected return on assets
(29
)
 
(27
)
 

 

 

 

Amortization of prior service cost

 

 

 

 

 

Recognized actuarial loss (gain)
3

 
10

 

 

 
(1
)
 

Total
$
2

 
$
12

 
$

 
$
1

 
$
1

 
$
2




14



NOTE 8. COMMITMENTS

Future minimum fixed payments for commitments (in millions):
March 31, 2014
Aircraft Leases
 
Facility Leases
 
Aircraft Commitments
 
Capacity Purchase Agreements
 
Engine Maintenance
Remainder of 2014
$
37

 
$
72

 
$
238

 
$
38

 
$
8

2015
103

 
85

 
369

 
44

 
10

2016
82

 
75

 
304

 
32

 

2017
51

 
71

 
354

 
32

 

2018
36

 
23

 
429

 
14

 

Thereafter
43

 
140

 
1,034

 

 

Total
$
352

 
$
466

 
$
2,728

 
$
160

 
$
18


Lease Commitments

At March 31, 2014, the Company had lease contracts for 59 aircraft, which have remaining noncancelable lease terms ranging from 2014 to 2021. Of these aircraft, 14 are non-operating (i.e. not in the Company's fleet) and subleased to third-party carriers. The majority of airport and terminal facilities are also leased. Rent expense for aircraft and facility leases was $75 million and $70 million for the three months ended March 31, 2014 and 2013, respectively.

Aircraft Commitments
 
As of March 31, 2014, the Company is committed to purchasing 65 B737 aircraft (28 B737-900ER aircraft and 37 B737 MAX aircraft), with deliveries in 2014 through 2022. In addition, the Company has options to purchase an additional 62 B737 aircraft and seven Q400 aircraft.

Capacity Purchase Agreements (CPAs)
 
At March 31, 2014, Alaska had CPAs with three carriers, including the Company's wholly-owned subsidiary, Horizon. Horizon sells 100% of its capacity to Alaska under a CPA, which is eliminated upon consolidation. In addition, Alaska has CPAs with SkyWest Airlines, Inc. (SkyWest) to fly certain routes and Peninsula Airways, Inc. (PenAir) to fly one route in the state of Alaska. Under these agreements, Alaska pays the third-party carriers an amount which is based on a determination of their cost of operating those flights and other factors. The costs paid by Alaska to Horizon are based on similar data and are intended to approximate market rates for those services. Future payments (excluding those due to Horizon) are based on contractually required minimum levels of flying by the third-party carriers, which could differ materially due to variable payments based on actual levels of flying and certain costs associated with operating flights, such as fuel.

Engine Maintenance
 
The Company has a power-by-the-hour (PBH) maintenance agreement for some of the B737-700 and B737-900 engines. This agreement transfers risk to a third-party service provider and fixes the amount the Company pays per flight hour in exchange for maintenance and repairs under a predefined maintenance program. Future payments are based on minimum flight hours.

NOTE 9. SHAREHOLDERS' EQUITY

Dividends

During the three months ended March 31, 2014, the Company declared and paid a quarterly dividend of $0.25 per share, or $17 million.

Common Stock Repurchase

In September 2012, the Board of Directors authorized a $250 million share repurchase program, which does not have an expiration date, but is expected to be completed in 2014.

15



Share repurchase activity (in millions, except share amounts):
 
Three Months Ended March 31,
 
2014
 
2013
 
Shares
 
Amount
 
Shares
 
Amount
2012 Repurchase Program - $250 million
352,851

 
$
30

 
373,185

 
$
19

 
Accumulated Other Comprehensive Loss
 
Components of accumulated other comprehensive income (loss), net of tax (in millions):
 
March 31,
2014
 
December 31,
2013
Marketable securities
$
2

 
$

Employee benefit plans
(172
)
 
(173
)
Interest rate derivatives
(11
)
 
(10
)
Total
$
(181
)
 
$
(183
)

Earnings Per Share (EPS)

Diluted EPS is calculated by dividing net income by the average common shares outstanding plus 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, 2014 and 2013, 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 primarily in operational roles. Horizon sells 100% of its capacity to Alaska under a CPA, which is eliminated upon consolidation. In addition, Alaska has CPAs with SkyWest to fly certain routes and PenAir to fly one route in the state of Alaska. The Company attributes revenue between Mainline and Regional based on the coupon fare in effect on the date of issuance relative to the origin and destination of each flight segment. To manage the two operating airlines and the revenues and expenses associated with the CPAs, management views the business in three operating segments.
Alaska Mainline - Flying Boeing 737 jets and all associated revenues and costs.
Alaska Regional - Alaska's CPAs with Horizon, SkyWest and PenAir. In this segment, Alaska Regional records actual on-board passenger revenue, less costs such as fuel, distribution costs, and payments made to Horizon, SkyWest and PenAir under the respective CPAs. Additionally, Alaska Regional includes an allocation of corporate overhead such as IT, finance, and other administrative costs incurred by Alaska on behalf of Horizon.
Horizon - Horizon operates turboprop Q400 aircraft. All of Horizon's capacity is sold to Alaska under a CPA.  Expenses include those typically borne by regional airlines such as crew costs, ownership costs, and maintenance costs. The results of Horizon's operations are eliminated upon consolidation.
Additionally, the following table reports “Air Group adjusted,” which is not a measure determined in accordance with GAAP. The Company's chief operating decision-makers and others in management use this measure to evaluate operational performance and determine resources allocations. Adjustments are further explained below in reconciling to consolidated GAAP results. Operating segment information is as follows (in millions):

16



 
Three Months Ended March 31, 2014
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Consolidating
 
Air Group Adjusted(a)
 
Special Items(b)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
854

 
$

 
$

 
$

 
$
854

 
$

 
$
854

Regional

 
186

 

 

 
186

 

 
186

Total passenger revenues
854

 
186

 

 

 
1,040

 

 
1,040

CPA revenues

 

 
91

 
(91
)
 

 

 

Freight and mail
23

 
1

 

 

 
24

 

 
24

Other - net
140

 
17

 
1

 

 
158

 

 
158

Total operating revenues
1,017

 
204

 
92

 
(91
)
 
1,222

 

 
1,222

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
576

 
151

 
86

 
(90
)
 
723

 

 
723

Economic fuel
318

 
48

 

 

 
366

 
(8
)
 
358

Total operating expenses
894

 
199

 
86

 
(90
)
 
1,089

 
(8
)
 
1,081

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
5

 

 

 

 
5

 

 
5

Interest expense
(8
)
 

 
(4
)
 

 
(12
)
 

 
(12
)
Other
18

 
(1
)
 
1

 

 
18

 

 
18

 
15

 
(1
)
 
(3
)
 

 
11

 

 
11

Income (loss) before income tax
$
138

 
$
4

 
$
3

 
$
(1
)
 
$
144

 
$
8

 
$
152

 
Three Months Ended March 31, 2013
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Consolidating
 
Air Group Adjusted(a)
 
Special Items(b)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
796

 
$

 
$

 
$

 
$
796

 
$

 
$
796

Regional

 
182

 

 

 
182

 

 
182

Total passenger revenues
796

 
182

 

 

 
978

 

 
978

CPA revenues

 

 
94

 
(94
)
 

 

 

Freight and mail
25

 
1

 

 

 
26

 

 
26

Other - net
113

 
14

 
2

 

 
129

 

 
129

Total operating revenues
934

 
197

 
96

 
(94
)
 
1,133

 

 
1,133

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
547

 
147

 
89

 
(95
)
 
688

 

 
688

Economic fuel
323

 
46

 

 

 
369

 
12

 
381

Total operating expenses
870

 
193

 
89

 
(95
)
 
1,057

 
12

 
1,069

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
4

 

 

 

 
4

 

 
4

Interest expense
(11
)
 

 
(3
)
 
(2
)
 
(16
)
 

 
(16
)
Other
6

 

 

 
1

 
7

 

 
7

 
(1
)
 

 
(3
)
 
(1
)
 
(5
)
 

 
(5
)
Income (loss) before income tax
$
63

 
$
4

 
$
4

 
$

 
$
71

 
$
(12
)
 
$
59

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

17




Total assets were as follows (in millions):
 
March 31,
2014
 
December 31,
2013
Alaska(a)
$
6,124

 
$
5,832

Horizon
849

 
840

Parent company
2,913

 
2,762

Elimination of inter-company accounts
(3,825
)
 
(3,596
)
Consolidated
$
6,061

 
$
5,838

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

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 and the risks mentioned in Item 1A. "Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2013. This overview summarizes the MD&A, which includes the following sections:
 
First Quarter Review—highlights from the first quarter of 2014 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, 2014. 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 2014
  
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 $152 million during the first quarter of 2014, compared to $59 million in the first quarter of 2013. The increase of $93 million was mainly due to increased revenues of $89 million, decreased aircraft fuel expense of $23 million, and non-operating income of $11 million in the current period compared to non-operating expense of $5 million in the prior period. These improvements were partially offset by increased non-fuel operating expenses of $35 million. The increase in revenue was primarily due to due to a 4.1% increase in traffic and 2.2% higher ticket yields.

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 87.1% and 84.7% of their flights arrived on time, respectively. For the twelve months ended February 2014, Alaska maintained its ranking as the top carrier among the nine largest U.S. airlines for on-time performance, according to the U.S. Department of Transportation.


18



Update on Labor Negotiations

In February 2014, Alaska Airlines' flight attendants, represented by the Association of Flight Attendants (AFA), rejected a tentative five-year agreement. The current agreement was amendable in May 2012 and we have been in negotiations with the AFA since November 2011. We expect to reopen negotiations through mediation in May 2014.

In April 2014, Alaska Airlines' clerical, office, and passenger service employees (COPS), represented by the International Association of Machinist and Aerospace Workers (IAM), ratified a new five-year contract. The contract was approved by 62% of those who voted and included pay increases and improved productivity commitments.

In April 2014, Horizon Air's dispatchers, represented by the Transport Workers Union (TWU), ratified a new four-year contract. The contract was approved by 82% of those who voted.

New Markets

During the first quarter of 2014 we began Q400 service from Anchorage to Fairbanks and Kodiak in the state of Alaska. We have also recently announced Mainline service to New Orleans, Tampa, Detroit, Baltimore, and Albuquerque from Seattle, as well as Regional service to Kalispell from Portland. Additionally, we will begin seasonal nonstop service between Seattle and Cancun, Mexico, pending approval by the U.S. Department of Transportation and the Mexico Dirección General de Aeronáutica Civil.

Capital Allocation

During the first quarter of 2014, we paid cash dividends of $17 million and we repurchased 352,851 shares of our common stock for $30 million under the $250 million repurchase program authorized by our Board of Directors in September 2012. We expect the repurchase program to be completed in 2014. Since 2007, we have repurchased 21 million shares of common stock under such programs for $433 million for an average price of $20 per share. During the month of April, we repurchased 97,282 shares of our common stock for $9 million, resulting in 68,718,515 shares outstanding at April 30, 2014. For 2014, we expect to deploy at least $350 million through a combination of dividends and share repurchases.

Outlook

Our April load factor was flat, compared to April 2013, and our advance bookings suggest our load factors for May and June will be flat and up a point, respectively, compared to the same periods in 2013. This is on an expected ~ 4.5% increase in capacity for the second quarter. In addition to our own capacity growth, competitive capacity is expected to be up 8% in the second quarter, which will pressure yields and load factors. Throughout 2014, current airline schedules indicate that competitive capacity will be up 7% and 8% for the third and fourth quarters, respectively. The largest competitive capacity is coming from Delta Air Lines, which is much larger than our company and has considerable financial resources. Delta is expected to have approximately 150 daily competing flights in and out of Seattle by the end of 2014, compared to 64 as of March 31, 2014. We believe we are well positioned to compete against these incursions because of our low cost structure, award-winning service, loyal customer base, and our ability to redeploy capacity effectively in order to match demand and optimize revenue. We currently expect our unit costs to be higher in the second quarter compared to 2013, and are now targeting flat unit costs for the full year of 2014 compared to 2013.

Our current expectations for capacity and CASM excluding fuel and special items are summarized below:
 
Forecast
Q2 2014
 
Change
Y-O-Y
 
Forecast
Full Year 2014
 
Change
Y-O-Y
Consolidated:
 
 
 
 
 
 
 
ASMs (000,000) "capacity"
8,925 - 8,975
 
~ 4.5%
 
35,600 - 36,100
 
~ 6.5%
CASM excluding fuel (cents)
8.41¢ - 8.46¢
 
~ 1.5%
 
8.43¢ - 8.48¢
 
~ flat
 
 
 
 
 
 
 
 
Mainline:
 
 
 
 
 
 
 
ASMs (000,000) "capacity"
8,025 - 8,075
 
~ 4%
 
32,000 - 32,500
 
~ 6%
CASM excluding fuel (cents)
7.46¢ - 7.51¢
 
~ 2%
 
7.53¢ - 7.58¢
 
~ flat


19



RESULTS OF OPERATIONS
 
COMPARISON OF THREE MONTHS ENDED MARCH 31, 2014 COMPARED TO THREE MONTHS ENDED MARCH 31, 2013

Our consolidated net income for the first quarter of 2014 was $94 million, or $1.35 per diluted share, compared to net income of $37 million, or $0.51 per diluted share, in the first quarter of 2013. Significant items impacting the comparability between the periods are as follows:

Both periods include adjustments to reflect the timing of unrealized mark-to-market adjustments related to our fuel hedge positions. For the first quarter of 2014, we recognized mark-to-market unrealized gains of $8 million ($5 million after tax, or $0.07 per diluted share) compared to unrealized losses of $12 million ($7 million after tax, or $0.11 per diluted share) in the first quarter of 2013.


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:

We believe it is the basis by which we are evaluated by industry analysts;

By eliminating fuel expense and certain special items from our unit metrics, we believe that we have better visibility into the results of our non-fuel continuing operations.  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;

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;

Our results excluding fuel expense and certain special items serve as the basis for our various employee incentive plans, thus the information allows investors to better understand the changes in variable incentive pay expense in our consolidated statements of operations; and

It is useful to monitor performance without these items as it improves a reader’s ability to compare our results to those of other airlines.

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 2014 was $89 million, or $1.28 per diluted share, compared to an adjusted consolidated net income of $44 million, or $0.62 per diluted share, in the first quarter of 2013.
 
Three Months Ended March 31,
 
2014
 
2013
(in millions, except per share amounts)
Dollars
 
Diluted EPS
 
Dollars
 
Diluted EPS
Net income and diluted EPS as reported
$
94

 
$
1.35

 
$
37

 
$
0.51

Mark-to-market fuel hedge adjustments, net of tax
(5
)
 
(0.07
)
 
7

 
0.11

Non-GAAP adjusted income and per-share amounts
$
89

 
$
1.28

 
$
44

 
$
0.62



20



Our operating costs per ASM are summarized below:
 
Three Months Ended March 31,
(in cents)
2014
 
2013
 
% Change
Consolidated:
 
 
 
 
 
CASM

12.94
¢
 

13.39
¢
 
(3.4
)
Less the following components:
 
 
 

 
 

Aircraft fuel, including hedging gains and losses
4.28

 
4.77

 
(10.3
)
CASM excluding fuel

8.66
¢
 

8.62
¢
 
0.5

 
 
 
 
 
 
Mainline:
 
 
 
 
 
CASM

11.82
¢
 

12.24
¢
 
(3.4
)
Less the following components:
 
 
 

 
 

Aircraft fuel, including hedging gains and losses
4.14

 
4.65

 
(11.0
)
CASM excluding fuel

7.68
¢
 

7.59
¢
 
1.2



21



OPERATING STATISTICS SUMMARY (unaudited)
Alaska Air Group, Inc.

Below are operating statistics we use to measure operating performance. We often refer to unit revenues and adjusted unit costs, which is a non-GAAP measure.
 
Three Months Ended March 31,
 
2014
 
2013
 
Change
Consolidated Operating Statistics:(a)
 
 
 
 
 
Revenue passengers (000)
6,649
 
6,346
 
4.8%
Revenue passenger miles (RPM) (000,000) "traffic"
7,078
 
6,796
 
4.1%
Available seat miles (ASM) (000,000) "capacity"
8,352
 
7,983
 
4.6%
Load factor
84.7%
 
85.1%
 
(0.4) pts
Yield
14.70¢
 
14.38¢
 
2.2%
Passenger revenue per ASM (PRASM)
12.45¢
 
12.24¢
 
1.7%
Revenue per ASM (RASM)
14.64¢
 
14.19¢
 
3.2%
Operating expense per ASM (CASM) excluding fuel(b)
8.66¢
 
8.62¢
 
0.5%
Economic fuel cost per gallon(b)
$3.32
 
$3.48
 
(4.6%)
Fuel gallons (000,000)
110
 
106
 
3.8%
Average number of full-time equivalent employees (FTEs)
12,386
 
12,013
 
3.1%
 
 
 
 
 
 
Mainline Operating Statistics:
 
 
 
 
 
Revenue passengers (000)
4,737
 
4,534
 
4.5%
RPMs (000,000) "traffic"
6,402
 
6,172
 
3.7%
ASMs (000,000) "capacity"
7,495
 
7,203
 
4.1%
Load factor
85.4%
 
85.7%
 
(0.3) pts
Yield
13.34¢
 
12.90¢
 
3.4%
PRASM
11.40¢
 
11.05¢
 
3.2%
RASM
13.57¢
 
12.97¢
 
4.6%
CASM excluding fuel(b)
7.68¢
 
7.59¢
 
1.2%
Economic fuel cost per gallon(b)
$3.32
 
$3.47
 
(4.3%)
Fuel gallons (000,000)
96
 
93
 
3.2%
Average number of FTEs
9,591
 
9,351
 
2.6%
Aircraft utilization
10.2
 
10.6
 
(3.8%)
Average aircraft stage length
1,201
 
1,203
 
(0.2%)
Mainline operating fleet at period-end
133
 
127
 
6 a/c
 
 
 
 
 
 
Regional Operating Statistics:(c)
 
 
 
 
 
Revenue passengers (000)
1,912
 
1,812
 
5.5%
RPMs (000,000) "traffic"
675
 
624
 
8.2%
ASMs (000,000) "capacity"
857
 
780
 
9.9%
Load factor
78.8%
 
80.0%
 
(1.2 pts)
Yield
27.53¢
 
29.09¢
 
(5.4%)
PRASM
21.69¢
 
23.27¢
 
(6.8%)
Operating fleet (Horizon only)
51
 
48
 
3 a/c
(a) 
Except for FTEs, data includes information related to third-party Regional CPA arrangements.
(b) 
See reconciliation of this measure to the most directly related GAAP measure in the "Results of Operations" section.
(c) 
Data presented includes information related to Regional CPAs.

22



OPERATING REVENUES

Total operating revenues increased $89 million, or 8%, during the first quarter of 2014 compared to the same period in 2013. The changes are summarized in the following table:
 
Three Months Ended March 31,
(in millions)
2014
 
2013
 
% Change
Passenger
 
 
 
 
 
Mainline
$
854

 
$
796

 
7

Regional
186

 
182

 
2

Total passenger revenue
1,040

 
978

 
6

Freight and mail
24

 
26

 
(8
)
Other - net
158

 
129

 
22

Total operating revenues
$
1,222

 
$
1,133

 
8


Passenger Revenue – Mainline

Mainline passenger revenue for the first quarter of 2014 increased by 7% due to a 4.1% increase in capacity and a 3.2% increase in PRASM compared to 2013. The increase in capacity was driven by the annualization of new routes added to expand our service in Seattle, San Diego, Anchorage, and Portland. The increase in PRASM was driven by a 3.4% increase in ticket yield partially offset by a 0.3 point decrease in load factor compared to the prior-year quarter. Displaced passengers from other airlines due to irregular weather and revenue allocated from Regional increased PRASM by approximately 1%.

Passenger Revenue – Regional

Regional passenger revenue increased by $4 million, or 2%, compared to the first quarter of 2013, due to a 9.9% increase in capacity, partially offset by a 6.8% decrease in PRASM. The decrease in PRASM is due to a decrease in yield of 5.4%, and a decrease in load factor of 1.2 points. The decline in yield was driven mostly by a change in revenue allocation between Mainline and Regional service because of certain industry pricing changes. Additionally, the average trip length for our Regional flights increased 2.9%, which also put downward pressure on yields.

Other – Net

Other - net revenue increased $29 million, or 22%, from the first quarter of 2013. Mileage plan revenue increased $19 million compared to the first quarter of 2013, due to an increase in miles sold, an increase in cash received per mile, and an increase in the percentage of cash proceeds allocated to the marketing deliverables under the affinity card agreement, which was modified in July 2013. Additionally, bags fees and ticket change fees are up 19% and 11%, respectively, due to changes in our fee structure that took effect in November 2013.

OPERATING EXPENSES

Total operating expenses increased $12 million, or 1%, compared to the first quarter of 2013. 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)
2014
 
2013
 
% Change
Fuel expense
$
358

 
$
381

 
(6
)
Non-fuel expenses
723

 
688

 
5

Total Operating Expenses
$
1,081

 
$
1,069

 
1


Significant operating expense variances from 2013 are more fully described below.

23



Wages and Benefits

Wages and benefits increased during the first quarter of 2014 by $8 million.  The primary components of wages and benefits are shown in the following table:
 
Three Months Ended March 31,
(in millions)
2014
 
2013
 
% Change
Wages
$
209

 
$
192

 
9

Pension - Defined benefit plans
2

 
13

 
(85
)
Defined contribution plans
13

 
11

 
18

Medical and other benefits
33

 
33

 

Payroll taxes
15

 
15

 

Total wages and benefits
$
272

 
$
264

 
3


Wages increased 9% with a 3.1% increase in FTEs. The annualization of the new agreement ratified by Alaska Pilot's in July 2013 and the Alaska COPS contract that was ratified in April 2014, and effective January 1, 2014, led to increased wage rates, while FTEs increased across most work groups compared to the prior year due to flight activity growth. Additionally, late last year we started converting one of our work groups from contractors to employees.

Pension expense decreased 85%, compared to the same period in the prior year. The decline is largely due to the improved funded status of the plan and the freezing of plan benefits for our non-union employees beginning January 1, 2014.

Variable Incentive Pay

Variable incentive pay increased $4 million, or 19% compared to 2013. With our first quarter results, we are exceeding our incentive plan financial goals by more than we were at this time last year.

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 is very volatile, even between quarters, 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 $23 million, or 6% compared to 2013. The elements of the change are illustrated in the following table: 
 
Three Months Ended March 31,
 
2014
 
2013
(in millions, except for per gallon amounts)
Dollars
 
Cost/Gal