10-Q 1 alk10-q12017.htm 10-Q Document


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

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

For the quarterly period ended March 31, 2017
 
OR

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

 For the transition period from                      to                      

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer   x
Accelerated filer  ¨
Non-accelerated filer   ¨ 
(Do not check if a smaller reporting company)
Smaller reporting company   ¨
Emerging growth company   ¨

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
 
The registrant has 123,603,902 common shares, par value $0.01, outstanding at April 28, 2017.



ALASKA AIR GROUP, INC.
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2017

 TABLE OF CONTENTS


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

2



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

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, 2016, and Item 1A. "Risk Factors" included herein. Please consider our forward-looking statements in light of those risks as you read this report.


3


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

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(in millions)
March 31, 2017
 
December 31, 2016
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
183

 
$
328

Marketable securities
1,527

 
1,252

Total cash and marketable securities
1,710

 
1,580

Receivables—net
321

 
302

Inventories and supplies—net
50

 
47

Prepaid expenses and other current assets
132

 
121

Total Current Assets
2,213

 
2,050

 
 
 
 
Property and Equipment
 

 
 

Aircraft and other flight equipment
7,137

 
6,947

Other property and equipment
1,139

 
1,103

Deposits for future flight equipment
541

 
545

 
8,817

 
8,595

Less accumulated depreciation and amortization
3,008

 
2,929

Total Property and Equipment—Net
5,809

 
5,666

 
 
 
 
Goodwill
1,942

 
1,934

Intangible assets
139

 
143

Other noncurrent assets
199

 
169

Other Assets
2,280

 
2,246

 
 
 
 
Total Assets
$
10,302

 
$
9,962


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, 2017
 
December 31, 2016
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
95

 
$
92

Accrued wages, vacation and payroll taxes
281

 
397

Air traffic liability
1,218

 
849

Other accrued liabilities
909

 
878

Current portion of long-term debt
332

 
319

Total Current Liabilities
2,835

 
2,535

 
 
 
 
Long-Term Debt, Net of Current Portion
2,531

 
2,645

Other Liabilities and Credits
 

 
 

Deferred income taxes
509

 
463

Deferred revenue
641

 
640

Obligation for pension and postretirement medical benefits
334

 
331

Other liabilities
438

 
417

 
1,922

 
1,851

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: 2017 - 129,590,771 shares; 2016 - 129,189,634 shares, Outstanding: 2017 - 123,729,188 shares; 2016 - 123,328,051 shares
1

 
1

Capital in excess of par value
126

 
110

Treasury stock (common), at cost: 2017 - 5,861,583 shares; 2016 - 5,861,583 shares
(443
)
 
(443
)
Accumulated other comprehensive loss
(299
)
 
(305
)
Retained earnings
3,629

 
3,568

 
3,014

 
2,931

Total Liabilities and Shareholders' Equity
$
10,302

 
$
9,962


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)
2017
 
2016
Operating Revenues
 
 
 
Passenger
 
 
 
Mainline
$
1,272

 
$
927

Regional
212

 
206

Total passenger revenue
1,484

 
1,133

Freight and mail
24

 
24

Other—net
241

 
190

Total Operating Revenues
1,749

 
1,347

 
 
 
 
Operating Expenses
 
 
 
Wages and benefits
448

 
336

Variable incentive pay
31

 
32

Aircraft fuel, including hedging gains and losses
339

 
167

Aircraft maintenance
87

 
68

Aircraft rent
65

 
29

Landing fees and other rentals
115

 
80

Contracted services
81

 
60

Selling expenses
81

 
49

Depreciation and amortization
90

 
88

Food and beverage service
45

 
31

Third-party regional carrier expense
27

 
23

Special items—merger-related costs
40

 
—

Other
134

 
94

Total Operating Expenses
1,583

 
1,057

Operating Income
166

 
290

 
 
 
 
Nonoperating Income (Expense)
 
 
 
Interest income
7

 
6

Interest expense
(25
)
 
(13
)
Interest capitalized
4

 
8

Other—net
—

 
1

 
(14
)
 
2

Income before income tax
152

 
292

Income tax expense
53

 
108

Net Income
$
99

 
$
184

 
 
 
 
Basic Earnings Per Share:
$
0.80

 
$
1.47

Diluted Earnings Per Share:
$
0.79

 
$
1.46

Shares used for computation:
 
 
 
Basic
123.495

 
124.550

Diluted
124.299

 
125.328

 
 
 
 
Cash dividend declared per share:
$
0.30

 
$
0.275

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)
2017
 
2016
Net Income
$
99

 
$
184

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

 
12

Income tax effect
(1
)
 
(4
)
Total
2

 
8

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

 
5

Income tax effect
(2
)
 
(2
)
Total
4

 
3

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

 
(5
)
Reclassification of losses into Aircraft rent
—

 
1

Income tax effect
(1
)
 
2

Total
—

 
(2
)
 
 
 
 
Other Comprehensive Income
6

 
9

 
 
 
 
Comprehensive Income
$
105

 
$
193


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)
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
99

 
$
184

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

 
 

Depreciation and amortization
90

 
88

Stock-based compensation and other
13

 
9

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

 
(8
)
Increase in air traffic liability
369

 
199

Increase in deferred revenue
1

 
36

Other—net
(150
)
 
17

Net cash provided by operating activities
470

 
525

 
 
 
 
Cash flows from investing activities:
 

 
 

Property and equipment additions:
 

 
 

Aircraft and aircraft purchase deposits
(160
)
 
(91
)
Other flight equipment
(20
)
 
(15
)
Other property and equipment
(36
)
 
(13
)
Total property and equipment additions, including capitalized interest
(216
)
 
(119
)
Purchases of marketable securities
(557
)
 
(358
)
Sales and maturities of marketable securities
285

 
140

Other investing activities
—

 
1

Net cash used in investing activities
(488
)
 
(336
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Long-term debt payments
(101
)
 
(36
)
Common stock repurchases
—

 
(127
)
Dividends paid
(37
)
 
(34
)
Other financing activities
11

 
13

Net cash used in financing activities
(127
)
 
(184
)
Net increase (decrease) in cash and cash equivalents
(145
)
 
5

Cash and cash equivalents at beginning of year
328

 
73

Cash and cash equivalents at end of the period
$
183

 
$
78

 
 
 
 
Supplemental disclosure:
 

 
 

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

 
$
8

Income taxes paid
2

 
13


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 consolidated financial statements include the accounts of Air Group, or the Company, and its primary subsidiaries, Alaska, Horizon and, starting December 14, 2016, Virgin America. The Company conducts substantially all of its operations through these subsidiaries. All significant intercompany balances and transactions have been eliminated. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") for interim financial information. Consistent with these requirements, this Form 10-Q does not include all the information required by GAAP for complete financial statements. It should be read in conjunction with the consolidated financial statements and accompanying notes in the Form 10-K for the year ended December 31, 2016. 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, 2017 and the results of operations for the three months ended March 31, 2017 and 2016. Such adjustments 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, 2017 are not necessarily indicative of operating results for the entire year.

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, "Revenue from Contracts with Customers"(Topic 606), 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. This comprehensive new standard 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" to clarify the guidance on determining whether the Company is considered the principal or the agent in a revenue transaction where a third party is providing goods or services to a customer. 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 to Mileage Plan™ revenues and liabilities. The Company currently uses the incremental cost approach for miles earned through travel. As this approach will be eliminated with the standard, the Company will be required to increase its liability for earned miles through a relative selling price model by approximately $350 million to $450 million. The adoption of the new standard is also expected to result in a change in income statement classification for certain types of revenues, such as ancillary revenues, currently classified as Other revenue to Passenger revenue, which will affect common industry metrics such as PRASM and RASM. The Company continues to evaluate and model the full impact of the standard and plans to apply the full retrospective transition method.

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. At this time, the Company believes the most significant impact to the financial statements will relate to the recording of a right-of-use asset associated with leased aircraft. Other leases, including airports and real estate, equipment, software and other miscellaneous leases continue to be assessed for impact of the ASU. The Company has determined that it will not early adopt the standard.

In March 2016, the FASB issued ASU 2016-09, "Compensation—Stock Compensation" (Topic 718), which 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 ASU was adopted prospectively as of January 1, 2017. Prior periods have not been adjusted. The adoption of the standard did not have a material impact on the Company's statements of operations or financial position.


9


In January 2017, the FASB issued ASU 2017-04, "Intangibles—Goodwill and Other" (Topic 350), which eliminates step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. The ASU is effective for the Company beginning January 1, 2019. Early adoption of the standard is permitted. Beginning in fiscal 2017, the Company will be required to perform an impairment test for goodwill arising from its acquisition of Virgin America and has adopted the standard effective January 1, 2017.

In March 2017, the FASB issued ASU 2017-07, "Compensation—Retirement Benefits" (Topic 715), which requires employers to disaggregate the service cost component from the other components of net benefit cost and report it in the same line item(s) as other employee compensation costs arising from services rendered during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations. These components will not be eligible for capitalization in assets. Employers are also required to disclose the line(s) used to present the other components of net periodic benefit cost, if the components are not presented separately in the income statement. The ASU is effective for the Company beginning January 1, 2018. Early adoption is permitted at the beginning of the annual period for which financial statements have not yet been issued. The Company is evaluating the impact and management has determined not to early adopt the standard.

NOTE 2. ACQUISITION OF VIRGIN AMERICA INC.

Virgin America

On December 14, 2016, the Company acquired 100% of the outstanding common shares and voting interest of Virgin America for $57 per share, or total cash consideration of $2.6 billion. Virgin America offers scheduled air transportation throughout the United States and Mexico primarily from its focus cities of Los Angeles, San Francisco and, to a lesser extent, Dallas Love Field, to other major business and leisure destinations in North America. The Company believes the acquisition of Virgin America will provide broader national reach and position it to better serve people living on the West Coast. The combined airline has 1,200 daily departures and leverages Alaska's strength in the Pacific Northwest with Virgin America's strength in California. The Company believes that combining loyalty programs and networks will provide greater benefits for its guests and expand its international partner portfolio, giving guests an even more expansive global reach.

Merger-related costs

For the three months ended March 31, 2017, the Company incurred pretax merger-related costs of $40 million. Costs classified as merger-related are directly attributable to merger activities and are recorded as "Special items—merger-related costs" within the statements of operations. The Company expects to continue to incur merger-related costs in the future as the integration continues.

Fair values of the assets acquired and the liabilities assumed

The transaction has been accounted for as a business combination using the acquisition method of accounting, which requires, among other things, assets acquired and liabilities assumed to be recognized on the balance sheet at their fair values as of the acquisition date. The purchase price allocation has been prepared on a preliminary basis and is subject to further adjustments as additional information becomes available concerning the fair value of the assets acquired and liabilities assumed. There were no significant fair value adjustments made during the three months ended March 31, 2017. The Company expects to continue obtaining information to assist in determining the fair values of the net assets acquired and will finalize the amounts recognized by December 14, 2017.


10


Provisional fair values of the assets acquired and the liabilities assumed as of the acquisition date, December 14, 2016, as of March 31, 2017 and December 31, 2016 were as follows:
(in millions)
March 31, 2017
 
December 31, 2016
Cash and cash equivalents
$
645

 
$
645

Receivables
44

 
44

Prepaid expenses and other current assets
16

 
16

Property and equipment
561

 
560

Intangible assets
141

 
143

Goodwill
1,942

 
1,934

Other assets
84

 
84

Total assets
3,433

 
3,426

 

 
 
Accounts payable
22

 
22

Accrued wages, vacation and payroll taxes
50

 
51

Air traffic liabilities
172

 
172

Other accrued liabilities
198

 
196

Current portion of long-term debt
125

 
125

Long-term debt, net of current portion
360

 
360

Deferred income taxes
(308
)
 
(304
)
Deferred revenue
126

 
126

Other liabilities
92

 
82

Total liabilities
837

 
830

 

 
 
Total purchase price
$
2,596

 
$
2,596


NOTE 3. 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.

11



Fair Value of Financial Instruments on a Recurring Basis

As of March 31, 2017, total cost basis for all marketable securities was $1,529 million. There were no significant differences between the cost basis and fair value of any individual class of marketable securities. Fair values of financial instruments on the consolidated balance sheet (in millions):
March 31, 2017
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
416

 
$
—

 
$
416

Foreign government bonds
—

 
38

 
38

Asset-backed securities
—

 
194

 
194

Mortgage-backed securities
—

 
88

 
88

Corporate notes and bonds
—

 
780

 
780

Municipal securities
—

 
11

 
11

Total Marketable securities
416

 
1,111

 
1,527

Derivative instruments
 
 
 
 
 
Fuel hedge call options
—

 
10

 
10

Interest rate swap agreements
—

 
9

 
9

Total Assets
416

 
1,130

 
1,546

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Interest rate swap agreements
—

 
(12
)
 
(12
)
Total Liabilities
—

 
(12
)
 
(12
)

December 31, 2016
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
287

 
$
—

 
$
287

Foreign government bonds
—

 
36

 
36

Asset-backed securities
—

 
138

 
138

Mortgage-backed securities
—

 
89

 
89

Corporate notes and bonds
—

 
691

 
691

Municipal securities
—

 
11

 
11

Total Marketable securities
287

 
965

 
1,252

Derivative instruments
 
 
 
 
 
Fuel hedge call options
—

 
20

 
20

Total Assets
287

 
985

 
1,272

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Interest rate swap agreements
—

 
(5
)
 
(5
)
Total Liabilities
—

 
(5
)
 
(5
)

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.


12


The Company uses the market approach and the income approach to determine the fair value of derivative instruments. The fair value for fuel hedge call options is determined utilizing an option pricing model based on inputs that are readily available in active markets or can be derived from information available in active markets. In addition, the fair value considers the exposure to credit losses in the event of non-performance by counterparties. Interest rate swap agreements are Level 2 as the fair value of these contracts is determined based on the difference between the fixed interest rate in the agreements and the observable LIBOR-based interest forward rates at period end multiplied by the total notional value.

Activity and Maturities for Marketable Securities

Activity for marketable securities (in millions):  
 
Three Months Ended March 31,
 
2017
 
2016
Proceeds from sales and maturities
$
285

 
$
140

Gross realized gains
1

 
—

Gross realized losses
(1
)
 
—

Gross unrealized gains
3

 
10

Gross unrealized losses
(5
)
 
(2
)
 
Maturities for marketable securities (in millions):
March 31, 2017
Cost Basis
 
Fair Value
Due in one year or less
$
236

 
$
236

Due after one year through five years
1,281

 
1,278

Due after five years through 10 years
12

 
13

Due after 10 years
—

 
—

Total
$
1,529

 
$
1,527


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 its evaluation of available information as of March 31, 2017.

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 value. For fixed-rate debt, the Company uses the income approach to determine the estimated fair value, calculated as the sum of future cash flows discounted at 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 is as follows (in millions):
 
March 31, 2017
 
December 31, 2016
Carrying amount
$
1,116

 
$
1,179

Fair value
1,130

 
1,199


Assets and Liabilities Measured at Fair Value on Nonrecurring Basis

Certain assets and liabilities are recognized or disclosed at fair value on a nonrecurring basis, including property, plant and equipment, goodwill, and intangible assets. These assets are subject to fair valuation when there is evidence of impairment. No impairment was recognized in the three months ended March 31, 2017.

13



NOTE 4. FREQUENT FLYER PROGRAMS

Frequent flyer program deferred revenue and liabilities included in the consolidated balance sheets (in millions):
 
March 31, 2017
 
December 31, 2016
Current Liabilities:
 
 
 
Other accrued liabilities
$
498

 
$
484

Other Liabilities and Credits:
 
 
 
Deferred revenue
641

 
638

Other liabilities
22

 
21

Total
$
1,161

 
$
1,143

 
Frequent flyer program revenue included in the consolidated statements of operations (in millions):
 
Three Months Ended March 31,
 
2017
 
2016
Passenger revenues
$
86

 
$
69

Other—net revenues
119

 
103

Total
$
205

 
$
172


NOTE 5. LONG-TERM DEBT
 
Long-term debt obligations on the consolidated balance sheet (in millions):
 
March 31, 2017
 
December 31, 2016
Fixed-rate notes payable due through 2028
$
1,116

 
$
1,179

Variable-rate notes payable due through 2028
1,764

 
1,803

Less debt issuance costs
(17
)
 
(18
)
Total debt
2,863

 
2,964

Less current portion
332

 
319

Long-term debt, less current portion
$
2,531

 
$
2,645

 
 
 
 
Weighted-average fixed-interest rate
4.4
%
 
4.4
%
Weighted-average variable-interest rate
2.5
%
 
2.4
%

During the three months ended March 31, 2017, the Company made debt payments of $101 million.

At March 31, 2017, long-term debt principal payments for the next five years and thereafter were as follows (in millions):
 
Total
Remainder of 2017
$
219

2018
350

2019
422

2020
449

2021
422

Thereafter
1,015

Total
$
2,877

 
Bank Lines of Credit
 
The Company has three credit facilities totaling $302 million. All three facilities have variable interest rates based on LIBOR plus a specified margin. One credit facility is for $100 million, expires in September 2017 and is secured by aircraft. The second credit facility is for $52 million, expires in October 2017 with a mechanism for annual renewal and is secured by

14


aircraft. The third credit facility was renegotiated in March 2017 and increased from $100 million to $150 million. It expires in March 2022 and is secured by certain accounts receivable, spare engines, spare parts and ground service equipment. The Company has secured letters of credit against the $52 million facility, but has no plans to borrow using either of the two remaining facilities. All three credit facilities have a requirement to maintain a minimum unrestricted cash and marketable securities balance of $500 million. The Company is in compliance with this covenant at March 31, 2017.

NOTE 6. EMPLOYEE BENEFIT PLANS

Net periodic benefit costs for the qualified defined-benefit plans included the following components for the three months ended March 31, 2017 (in millions): 
 
Three Months Ended March 31,
 
2017
 
2016
Service cost
$
10

 
$
9

Interest cost
18

 
18

Expected return on assets
(27
)
 
(27
)
Recognized actuarial loss
7

 
6

Total
$
8

 
$
6


NOTE 7. COMMITMENTS AND CONTINGENCIES

Future minimum payments for commitments (in millions) as of March 31, 2017:
 
Aircraft Leases
 
Facility Leases
 
Aircraft Purchase Commitments
 
Capacity Purchase Agreements (a)
 
Aircraft Maintenance Deposits
 
Aircraft Maintenance and Parts Management
Remainder of 2017
$
227

 
$
91

 
$
758

 
$
58

 
$
44

 
$
23

2018
318

 
73

 
876

 
80

 
61

 
32

2019
306

 
64

 
730

 
85

 
65

 
35

2020
279

 
57

 
337

 
90

 
68

 
37

2021
242

 
50

 
275

 
94

 
63

 
40

Thereafter
953

 
173

 
361

 
676

 
90

 
—

Total
$
2,325

 
$
508

 
$
3,337

 
$
1,083

 
$
391

 
$
167

(a)
Includes all non-aircraft lease costs associated with capacity purchase agreements.

Lease Commitments

Aircraft lease commitments include future obligations for all of the Company's operating airlines—Alaska, Virgin America and Horizon, as well as aircraft leases operated by third-parties. At March 31, 2017, the Company had lease contracts for 14 Boeing 737 ("B737") aircraft, 53 Airbus aircraft, 15 Bombardier Q400 aircraft and 20 Embraer E175s with SkyWest Airlines, Inc. ("SkyWest"). The Company has 10 scheduled lease deliveries of A321neo aircraft from 2017 through 2018, one of which was delivered subsequent to March 31, 2017. All lease contracts have remaining non-cancelable lease terms ranging from 2017 to 2030. The Company has the option to increase capacity flown by SkyWest with eight additional E175 aircraft deliveries in 2019. Options to lease are not reflected in the commitments table above.

Facility lease commitments primarily include airport and terminal facilities and building leases. Total rent expense for aircraft and facility leases was $138 million and $81 million for the three months ended March 31, 2017 and 2016.

Aircraft Purchase Commitments
 
Aircraft purchase commitments include non-cancelable contractual commitments for aircraft and engines. As of March 31, 2017, the Company had commitments to purchase 51 B737 aircraft (19 B737 NextGen aircraft and 32 B737 MAX aircraft, with deliveries in 2017 through 2023) and 32 E175 aircraft with deliveries in 2017 through 2019. The Company also has an order for 30 Airbus A320neo aircraft with deliveries from 2020 through 2022 with an option to cancel up to a certain period in

15


advance of delivery in groups of five aircraft. In addition, the Company has options to purchase 41 B737 aircraft and 30 E175 aircraft. Option payments are not reflected in the table above.

Capacity Purchase Agreements ("CPAs")
 
At March 31, 2017, 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 Canada and with Peninsula Airways, Inc. ("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.

Aircraft Maintenance Deposits

Through its acquisition of Virgin America, the Company is contractually required to make maintenance deposit payments to aircraft lessors, which represent maintenance reserves made solely to collateralize the lessor for future maintenance events should the Company not perform required maintenance. Under most leases, the lease agreements provide that maintenance reserves are reimbursable upon completion of the major maintenance event in an amount equal to the lesser of (i) the amount qualified for reimbursement from maintenance reserves held by the lessor associated with the specific major maintenance event or (ii) the qualifying costs related to the specific major maintenance event.

Aircraft Maintenance and Parts Management

The Company has a separate maintenance-cost-per-hour contract for management and repair of certain rotable parts to support airframe and engine maintenance and repair. This agreement requires monthly payments based upon utilization, such as flight hours, cycles and age of the aircraft, and, in turn, the agreement transfers certain risks to the third-party service provider. There are minimum payments under this agreement, which are reflected in the table above. Accordingly, payments could differ materially based on actual aircraft utilization.

Contingencies

The Company is a party to routine litigation matters incidental to its business and with respect to which no material liability is expected. Liabilities for litigation related contingencies are recorded when a loss is determined to be probable and estimable.

In 2015, three flight attendants filed a class action lawsuit seeking to represent all Virgin America flight attendants for damages based on alleged violations of California and City of San Francisco wage and hour laws.  Plaintiffs received class certification in November 2016. Virgin America filed a motion for summary judgment seeking to dismiss all claims on various federal preemption grounds.  In January 2017, the Court denied in part and granted in part Virgin America’s motion. The Company believes the claims in this case are without factual and legal merit and intends to defend this lawsuit.

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

NOTE 8. SHAREHOLDERS' EQUITY

Dividends

During the three months ended March 31, 2017, the Company declared and paid cash dividends of $0.30 per share, or $37 million.

Common Stock Repurchase

In August 2015, the Board of Directors authorized a $1 billion share repurchase program. As of March 31, 2017, the Company repurchased 4,112,086 shares for $313 million under this program. The program was paused in the second quarter of 2016 in anticipation of the acquisition of Virgin America. No shares were repurchased during the three months ended March 31, 2017.

16


Subsequent to March 31, 2017, the Company resumed the share repurchase program and repurchased 129,040 shares for $11 million through April 28, 2017.
Accumulated Other Comprehensive Loss
 
Components of accumulated other comprehensive loss, net of tax (in millions):
 
March 31, 2017
 
December 31, 2016
Marketable securities
$
(1
)
 
$
(3
)
Employee benefit plans
(295
)
 
(299
)
Interest rate derivatives
(3
)
 
(3
)
Total
$
(299
)
 
$
(305
)

Earnings Per Share ("EPS")

Diluted EPS is calculated by dividing net income by the average number of common shares outstanding plus the number of additional common shares that would have been outstanding assuming the exercise of in-the-money stock options and restricted stock units, using the treasury-stock method. For the three months ended March 31, 2017 and 2016, anti-dilutive shares excluded from the calculation of EPS were not material.

NOTE 9. OPERATING SEGMENT INFORMATION
 
Alaska Air Group has three operating airlines—Alaska, Virgin America and Horizon. Each is regulated by the U.S. Department of Transportation’s Federal Aviation Administration. Alaska has CPAs for regional capacity with Horizon, as well as with third-party carriers SkyWest and PenAir, under which Alaska receives all passenger revenues.

Under U.S. GAAP, operating segments are defined as components of a business for which there is discrete financial information that is regularly assessed by the Chief Operating Decision Maker ("CODM") in making resource allocation decisions. Financial performance for the operating airlines and CPAs is managed and reviewed by the Company's CODM as part of three reportable operating segments:
 
•
Mainline - includes Alaska's and Virgin America’s scheduled air transportation for passengers and cargo throughout the U.S., and in parts of Canada, Mexico, Costa Rica and Cuba.
•
Regional - includes Horizon's and other third-party carriers’ scheduled air transportation for passengers across a shorter distance network within the U.S. under CPAs. This segment includes the actual revenues and expenses associated with regional flying, as well as an allocation of corporate overhead incurred by Air Group on behalf of the regional operations.
•
Horizon - includes the capacity sold to Alaska under CPA. Expenses include those typically borne by regional airlines such as crew costs, ownership costs and maintenance costs.

The CODM makes resource allocation decisions for these reporting segments based on flight profitability data, aircraft type, route economics and other financial information.

The "Consolidating and Other" column reflects parent company activity, consolidating entries and other immaterial business units of the company. The “Air Group Adjusted” column represents a non-GAAP measure that is used by the Company CODM to evaluate performance and allocate resources. Adjustments are further explained below in reconciling to consolidated GAAP results.

17


Operating segment information is as follows (in millions):
 
Three Months Ended March 31, 2017
 
Mainline
 
Regional
 
Horizon
 
Consolidating & Other(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
1,272

 
$
—

 
$
—

 
$
—

 
$
1,272

 
$
—

 
$
1,272

Regional
—

 
212

 
—

 
—

 
212

 
—

 
212

Total passenger revenues
1,272

 
212

 
—

 
—

 
1,484

 
—

 
1,484

CPA revenues
—

 
—

 
97

 
(97
)
 
—

 
—

 
—

Freight and mail
23

 
1

 
—

 
—

 
24

 
—

 
24

Other—net
222

 
17

 
1

 
1

 
241

 
—

 
241

Total operating revenues
1,517

 
230

 
98

 
(96
)
 
1,749

 
—

 
1,749

Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
998

 
200

 
103

 
(97
)
 
1,204

 
40

 
1,244

Economic fuel
292

 
36

 
—

 
1

 
329

 
10

 
339

Total operating expenses
1,290

 
236

 
103

 
(96
)
 
1,533

 
50

 
1,583

Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
7

 
—

 
—

 
—

 
7

 
—

 
7

Interest expense
(22
)
 
—

 
(2
)
 
(1
)
 
(25
)
 
—

 
(25
)
Other
3

 
—

 
—

 
1

 
4

 
—

 
4

 
(12
)
 
—

 
(2
)
 
—

 
(14
)
 
—

 
(14
)
Income (loss) before income tax
$
215

 
$
(6
)
 
$
(7
)
 
$
—

 
$
202

 
$
(50
)
 
$
152

 
Three Months Ended March 31, 2016
 
Mainline
 
Regional
 
Horizon
 
Consolidating & Other(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
927

 
$
—

 
$
—

 
$
—

 
$
927

 
$
—

 
$
927

Regional
—

 
206

 
—

 
—

 
206

 
—

 
206

Total passenger revenues
927

 
206

 
—

 
—

 
1,133

 
—

 
1,133

CPA revenues
—

 
—

 
103

 
(103
)
 
—

 
—

 
—

Freight and mail
23

 
1

 
—

 
—

 
24

 
—

 
24

Other—net
172

 
17

 
1

 
—

 
190

 
—

 
190

Total operating revenues
1,122

 
224

 
104

 
(103
)
 
1,347

 
—

 
1,347

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
701

 
186

 
105

 
(102
)
 
890

 
—

 
890

Economic fuel
144

 
25

 
—

 
—

 
169

 
(2
)
 
167

Total operating expenses
845

 
211

 
105

 
(102
)
 
1,059

 
(2
)
 
1,057

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
6

 
—

 
—

 
—

 
6

 
—

 
6

Interest expense
(12
)
 
—

 
(1
)
 
—

 
(13
)
 
—

 
(13
)
Other
7

 
—

 
—

 
2

 
9

 
—

 
9

 
1

 
—

 
(1
)
 
2

 
2

 
—

 
2

Income (loss) before income tax
$
278

 
$
13

 
$
(2
)
 
$
1

 
$
290

 
$
2

 
$
292

(a)
Includes consolidating entries, Parent Company and other immaterial business units.
(b)
The Air Group Adjusted column represents the financial information that is reviewed by management to assess performance of operations and determine capital allocations and does not include certain income and charges.
(c)
Includes merger-related costs and mark-to-market fuel-hedge accounting charges.

18



Total assets were as follows (in millions):
 
March 31, 2017
 
December 31, 2016
Mainline
$
15,735

 
$
15,260

Horizon
719

 
690

Consolidating & Other
(6,152
)
 
(5,988
)
Consolidated
$
10,302

 
$
9,962


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, 2016. This overview summarizes the MD&A, which includes the following sections:
 
•
First Quarter Review—highlights from the first quarter of 2017 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, 2017. 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. As Virgin America was acquired on December 14, 2016, its financial and operational results are reflected in the three months ended March 31, 2017 but not in the comparative prior period. However, for comparability purposes, we have added "Combined Comparative" information for the prior year, which is more fully described below. This section includes forward-looking statements regarding our view of the remainder of 2017. 
  
•
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 2017, compared to $292 million in the first quarter of 2016. The decrease in pretax income of $140 million was primarily driven by a $354 million increase in non-fuel expense and $172 million increase in fuel expense, partially offset by an increase in revenues of $402 million.

As we completed the acquisition of Virgin America on December 14, 2016, our results of operations for the three months ended March 31, 2017 include those of Virgin America and the impact of purchase accounting. Our results of operations for the three months ended March 31, 2016 do not include those of Virgin America.

See “Results of Operations” below for further discussion of changes in revenues and operating expenses and our reconciliation of non-GAAP measures to the most directly comparable GAAP measure.

Operations Performance

During the first quarter of 2017, winter weather posed significant challenges to our operations resulting in on-time performance of 78.4% for Alaska, 64.7% for Virgin America and 70.9% for Horizon. These results are not in line with our standards, and our operational teams are focused on improving our on-time performance.


19


New Markets

In March 2017 we announced 13 new nonstop markets from San Francisco and San Jose as part of our strategy to grow our presence in the Bay Area. The routes mark the single largest new market announcement in our history. We also announced seven new nonstop markets from San Diego. In total, we have announced 37 new markets since the acquisition of Virgin America.

Shareholder Return

During the first quarter of 2017, we paid cash dividends of $37 million. In connection with our acquisition of Virgin America, we paused our share repurchases starting in the second quarter of 2016 with no shares repurchased during the three months ended March 31, 2017. Subsequent to March 31, 2017, we resumed the share repurchase program and repurchased 129,040 shares for $11 million through April 28, 2017.

Outlook

We completed the acquisition of Virgin America on December 14, 2016, positioning us as the fifth largest airline in the U.S. with an unparalleled ability to serve West Coast travelers. The acquisition of Virgin America provides a platform for growth of our low-fare, premium product, a powerful West Coast network for our guests and enhanced international partnerships. Additionally, Virgin America provides access to constrained gates, particularly on the East Coast, creating increased utility for our guests.

In 2017 and beyond, we are focused on the successful integration of Virgin America, while continuing to work towards obtaining a Single Operating Certificate ("SOC"). We currently expect to receive an SOC in early 2018. Our priority throughout the integration process is to run three great airlines and maintain a safe and compliant operation, while providing a great experience for our guests. The combined Company will adopt Alaska’s name and logo, retiring the Virgin America name sometime in 2019. Over the next few years we will focus on enhancing our guest experience and will adopt certain aspects of Virgin America’s brand elements, including enhanced inflight entertainment content, mood lighting, music and the relentless desire to make flying a different experience for guests. We will continue to enhance our fresh, healthy, West Coast-inspired onboard food and beverage menus. This year, Alaska First Class guests will be able to pre-select meals before they fly. Alaska’s main cabin guests will also be able to pre-pay for their meals in advance by early 2018, with Airbus flights soon to follow. Our onboard Free Chat service and free entertainment will be added to Airbus flights in August 2017. We also plan to expand the premium class offering on our Airbus fleet beginning in 2018 and have our entire fleet equipped with high-speed satellite Wi-Fi by the end of 2019. 

In 2018, Alaska Mileage Plan™ will become our sole loyalty program, offering guests more rewards, an expansive global partner network and the only major airline loyalty program that still rewards a mile flown with a mile earned on Alaska and Virgin America flights. 

We intend to minimize any disruption to our guests during the integration efforts by being transparent about the progress we are making and how the changes may affect them. Employee engagement throughout the integration will remain a top priority as well, ensuring that employees remain engaged, informed and excited about the new Air Group. We will remain focused on capturing the value and synergies created by combining these two great companies.

In April 2017, we reached a tentative agreement with the International Brotherhood of Teamsters to amend the eight-year contract with Horizon's pilots, which will provide Horizon the ability to attract and retain the best pilots in the regional industry. The agreement contains several provisions, including a ratification bonus of approximately $10 million and higher pay rates and is included in the cost guidance noted below.

Currently, we expect to grow our combined network capacity in 2017 by approximately 8.5%. The growth rate compares 2017 system-wide capacity to historical Air Group and Virgin America combined capacity in 2016. This compares to a 10.2% combined growth in 2016 on the same basis. Current schedules indicate competitive capacity will increase by approximately 1% in the second quarter of 2017 compared to the prior year. We believe that our product, our operation, our engaged employees, our award-winning service, and our award-winning Mileage Plan™ and Elevate® programs, combined with our strong balance sheet, give us the ability to compete vigorously in our markets.


20


Our current expectations for capacity and CASM excluding fuel and special items are summarized below. These expectations are from a "Combined Comparative" perspective, calculated as the sum of historical results for Alaska Air Group and Virgin America for the three months ended March 31, 2016:
 
Forecast
Q2 2017
 
Change
Y-O-Y
 
Forecast
Full Year 2017
 
Change
Y-O-Y
Consolidated:
 
 
 
 
 
 
 
Capacity (ASMs in millions)
15,625 - 15,675
 
~ 6.0%
 
62,800 - 63,000
 
~ 8.5%
Cost per ASM excluding fuel and special items (cents)
7.88¢ - 7.93¢
 
~ 3.0%
 
8.00¢ - 8.05¢
 
flat

RESULTS OF OPERATIONS
 
COMPARISON OF THREE MONTHS ENDED MARCH 31, 2017 COMPARED TO THREE MONTHS ENDED MARCH 31, 2016

Our consolidated net income for the first quarter of 2017 was $99 million, or $0.79 per diluted share, compared to net income of $184 million, or $1.46 per diluted share, in the first quarter of 2016.

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

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

•
By eliminating fuel expense and certain special items (including merger-related costs) from our unit metrics, we believe that we have better visibility into the results of operations and our non-fuel cost-reduction initiatives. Our industry is highly competitive and is characterized by high fixed costs, so even a small reduction in non-fuel operating costs can lead to a significant improvement in operating results. In addition, we believe that all domestic carriers are similarly impacted by changes in jet fuel costs over the long run, so it is important for management (and thus investors) to understand the impact of (and trends in) company-specific cost drivers, such as labor rates and productivity, airport costs, maintenance costs, etc., which are more controllable by management.

•
Cost per ASM ("CASM") excluding fuel and certain special items, such as merger-related costs, is one of the most important measures used by management and by the Air Group Board of Directors in assessing quarterly and annual cost performance.

•
Adjusted income before income tax and CASM excluding fuel (and other items as specified in our plan documents) are important metrics for the employee incentive plan, which covers the majority of Air Group employees.

•
CASM excluding fuel and certain special items is a measure commonly used by industry analysts and we believe it is the basis by which they compare our airlines to others in the industry. The measure is also the subject of frequent questions from investors.

•
Disclosure of the individual impact of certain noted items provides investors the ability to measure and monitor performance both with and without these special items. We believe that disclosing the impact of certain items, such as merger-related costs and mark-to-market hedging adjustments, is important because it provides information on significant items that are not necessarily indicative of future performance. Industry analysts and investors consistently measure our performance without these items for better comparability between periods and among other airlines.

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

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

21



Excluding the impact of merger-related costs and mark-to-market fuel hedge adjustments, our adjusted consolidated net income for the first quarter of 2017 was $130 million, or $1.05 per diluted share, compared to an adjusted consolidated net income of $183 million, or $1.45 per diluted share, in the first quarter of 2016. The following tables reconcile our adjusted net income and earnings per diluted share ("EPS") during the three months ended March 31, 2017 and 2016 to amounts as reported in accordance with GAAP:
 
Three Months Ended March 31,
 
2017
 
2016
(in millions, except per share amounts)
Dollars
 
Diluted EPS
 
Dollars
 
Diluted EPS
Reported GAAP net income
$
99

 
$
0.79

 
$
184

 
$
1.46

Mark-to-market fuel hedge adjustments
10

 
0.08

 
(2
)
 
(0.02
)
Special items—merger-related costs
40

 
0.33

 
—

 
—

Income tax effect on special items and fuel hedge adjustments
(19
)
 
(0.15
)
 
1

 
0.01

Non-GAAP adjusted income and per-share amounts
$
130

 
$
1.05

 
$
183

 
$
1.45


CASM reconciliation is summarized below:
 
Three Months Ended March 31,
(in cents)
2017
 
2016
 
% Change
Consolidated:
 
 
 
 
 
CASM

11.00
¢
 

10.11
¢
 
8.8
 %
Less the following components:
 
 
 

 
 
Aircraft fuel, including hedging gains and losses
2.36

 
1.60

 
47.5
 %
Special items—merger-related costs
0.27

 
—

 
NM

CASM excluding fuel and special items

8.37
¢
 

8.51
¢
 
(1.6
)%
 
 
 
 
 
 
Mainline:
 
 
 
 
 
CASM

10.11
¢
 

9.01
¢
 
12.2
 %
Less the following components:
 
 
 

 
 
Aircraft fuel, including hedging gains and losses
2.28

 
1.52

 
50.0
 %
Special items—merger-related costs
0.30

 
—

 
NM

CASM excluding fuel and special items

7.53
¢
 

7.49
¢
 
0.5
 %


22


OPERATING STATISTICS SUMMARY (unaudited)

Below are statistics we use to measure operating performance. As the acquisition closed on December 14, 2016, Consolidated and Mainline amounts presented below include Virgin America results for the three months ended March 31, 2017 and not for the comparative prior period. We often refer to CASM excluding fuel and special items, which is a non-GAAP measures.
 
Three Months Ended March 31,
 
2017
 
2016
 
Change
Consolidated Operating Statistics:(a)
 
 
 
 
 
Revenue passengers (000)
10,018
 
7,835
 
27.9%
RPMs (000,000) "traffic"
11,708
 
8,571
 
36.6%
ASMs (000,000) "capacity"
14,394
 
10,453
 
37.7%
Load factor
81.3%
 
82.0%
 
(0.7) pts
Yield
12.68¢
 
13.22¢
 
(4.1)%
PRASM
10.31¢
 
10.84¢
 
(4.9)%
RASM
12.15¢
 
12.88¢
 
(5.7)%
CASM excluding fuel and special items(b)
8.37¢
 
8.51¢
 
(1.6)%
Economic fuel cost per gallon(b)
$1.78
 
$1.29
 
38.0%
Fuel gallons (000,000)
184
 
132
 
39.4%
ASMs per fuel gallon
78.2
 
79.2
 
(1.3%)
Average full-time equivalent employees (FTEs)
18,682
 
14,357
 
30.1%
 
 
 
 
 
 
Mainline Operating Statistics:
 
 
 
 
 
Revenue passengers (000)
7,783
 
5,642
 
37.9%
RPMs (000,000) "traffic"
10,827
 
7,716
 
40.3%
ASMs (000,000) "capacity"
13,260
 
9,354
 
41.8%
Load factor
81.7%
 
82.5%
 
(0.8) pts
Yield
11.75¢
 
12.01¢
 
(2.2)%
PRASM
9.59¢
 
9.91¢
 
(3.2)%
RASM
11.44¢
 
11.99¢
 
(4.6)%
CASM excluding fuel and special items(b)
7.53¢
 
7.49¢
 
0.5%
Economic fuel cost per gallon(b)
$1.78
 
$1.28
 
39.1%
Fuel gallons (000,000)
164
 
113
 
45.1%
ASMs per fuel gallon
80.8
 
82.8
 
(2.4%)
Average FTEs
15,007
 
11,123
 
34.9%
Aircraft utilization
10.8
 
10.6
 
1.9%
Average aircraft stage length
1,245
 
1,237
 
0.6%
Operating fleet
217
 
152
 
65 a/c
 
 
 
 
 
 
Regional Operating Statistics:(c)
 
 
 
 
 
Revenue passengers (000)
2,234
 
2,192
 
1.9%
RPMs (000,000) "traffic"
880
 
855
 
2.9%
ASMs (000,000) "capacity"
1,134
 
1,100
 
3.1%
Load factor
77.6%
 
77.7%
 
(0.1 pts)
Yield
24.13¢
 
24.09¢
 
0.2%
PRASM
18.73¢
 
18.72¢
 
0.1%
Operating fleet
73
 
67
 
6 a/c
(a)
Except for FTEs, data includes information related to third-party regional capacity purchase flying arrangements.
(b)
See reconciliation of this measure to the most directly related GAAP measure in the accompanying pages.
(c)
Data presented includes information related to flights operated by Horizon and third-party carriers.



23


We believe that analysis of specific financial and operational results on a combined basis provides more meaningful year-over-year comparisons. The discussion below includes "Combined Comparative" results for the three months ended March 31, 2016, determined as the sum of the historical consolidated results of Air Group and of Virgin America. Virgin America's financial information has been conformed to reflect Air Group's historical financial statement presentation. This information does not purport to reflect what our financial and operational results would have been had the acquisition been consummated at the beginning of the periods presented.

COMBINED COMPARATIVE OPERATING STATISTICS
 
Three Months Ended March 31,
 
2017
 
2016 as Reported
 
2016 Virgin America
 
2016 Combined
 
Change
Consolidated:
 
 
 
 
 
 
 
 
 
Revenue passengers (in 000)
10,018
 
7,835
 
1,767
 
9,602
 
4.3
 %
RPMs (in 000,000)
11,708
 
8,571
 
2,615
 
11,186
 
4.7
 %
ASMs (in 000,000)
14,394
 
10,453
 
3,266
 
13,719
 
4.9
 %
Load Factor
81.3%
 
82.0%
 
(a)
 
81.5%
 
(0.2) pts

PRASM
10.31¢
 
10.84¢
 
(a)
 
10.66¢
 
(3.3
)%
RASM
12.15¢
 
12.88¢
 
(a)
 
12.47¢
 
(2.6
)%
CASMex
8.37¢
 
8.51¢
 
(a)
 
8.36¢
 
0.1
 %
FTEs
18,682
 
14,357
 
2,686
 
17,043
 
9.6
 %
 
 
 
 
 
 
 
 
 
 
Mainline:
 
 
 
 
 
 
 
 
 
RPMs (in 000,000)
10,827
 
7,716
 
2,615
 
10,331
 
4.8%
ASMs (in 000,000)
13,260
 
9,354
 
3,266
 
12,620
 
5.1%
Load Factor
81.7%
 
82.5%
 
(a)
 
81.9%
 
(0.2) pts
PRASM
9.59¢
 
9.91¢
 
(a)
 
9.95¢
 
(3.6)%
(a)
2016 Combined operating statistics have been recalculated using the combined results.

COMBINED COMPARATIVE OPERATING REVENUES

Total operating revenues increased $402 million, or 30%, during the first quarter of 2017 compared to the same period in 2016. On a Combined Comparative basis, total operating revenues increased $39 million or 2%. The changes, including the reconciliation of the impact of Virgin America on the comparative results, are summarized in the following table:
 
Three Months Ended March 31,
 
Change
(in millions)
2017
 
2016 as Reported
 
2016 Virgin America
 
2016 Combined
 
$ Combined
 
% Combined
Passenger
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
1,272

 
$
927

 
$
329

 
$
1,256

 
$
16

 
1
%
Regional
212

 
206

 
—

 
206

 
6

 
3
%
Total passenger revenue
1,484

 
1,133

 
329

 
1,462

 
22

 
2
%
Freight and mail
24

 
24

 
—

 
24

 
—

 
—
%
Other—net
241

 
190

 
34

 
224

 
17

 
8
%
Total operating revenues
$
1,749

 
$
1,347

 
$
363

 
$
1,710

 
$
39

 
2
%

Passenger Revenue—Mainline

On a consolidated basis, Mainline passenger revenue for the first quarter of 2017 increased by $345 million, or 37%. Overall, Mainline capacity increased 41.8%, while unit revenues declined 3.2%. On a Combined Comparative basis, mainline passenger revenue for the first quarter of 2017 remained relatively flat. Increase in capacity of 5.1% was partially offset by a 3.6% decrease in unit revenues compared to the combined first quarter of 2016. The increase in capacity was driven primarily by new routes and aircraft added to our fleet since the first quarter of 2016. The decrease in PRASM was driven by lower ticket yields primarily due to increased competitive capacity in the markets we serve and our own growth.

24



Passenger Revenue—Regional

Regional passenger revenue increased 3% compared to the first quarter of 2016 primarily, driven by a 3.1% increase in capacity on flat PRASM.

Other—Net

Other—net revenue increased $51 million, or 27%, from the first quarter of 2016. On a Combined Comparative basis other—net revenue increased $17 million, or 8%. Mileage Plan revenue contributed $13 million of the increase, primarily driven by more miles sold and other cash receipts, including bag fee revenue, from our affinity credit card partner and higher rates paid by our other airline partners.

COMBINED COMPARATIVE OPERATING EXPENSES

Total operating expenses increased $526 million, or 50%, compared to the first quarter of 2016. On a Combined Comparative basis, total operating expenses increased $195 million, or 14%. 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,
 
Change
(in millions)
2017
 
2016 as Reported
 
2016 Virgin America
 
2016 Combined
 
$ Combined
 
% Combined
Fuel expense
$
339

 
$
167

 
$
71

 
$
238

 
$
101

 
42
%
Non-fuel expenses
1,244

 
890

 
260

 
1,150

 
94

 
8
%
Total operating expenses
$
1,583

 
$
1,057

 
$
331

 
$
1,388

 
$
195

 
14
%

The table below provides the reconciliation of the impact of Virgin America on the comparative results for each of our non-fuel operating expenses. Significant operating expense variances from 2016 are more fully described below.
 
Three Months Ended March 31,
 
Change
(in millions)
2017
 
2016 as Reported
 
2016 Virgin America
 
2016 Combined
 
$ Combined
 
% Combined
Wages and benefits
$
448

 
$
336

 
$
72

 
$
408

 
$
40

 
10
 %
Variable incentive pay
31

 
32

 
6

 
38

 
(7
)
 
(18
)%
Aircraft maintenance
87

 
68

 
17

 
85

 
2

 
2
 %
Aircraft rent
65