ALK 10-Q3 2013


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

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

For the quarterly period ended September 30, 2013
 
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 69,536,989 common shares, par value $1.00, outstanding at October 31, 2013.



ALASKA AIR GROUP, INC.
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2013

 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, 2012. 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)
September 30,
2013
 
December 31,
2012
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
41

 
$
122

Marketable securities
1,404

 
1,130

Total cash and marketable securities
1,445

 
1,252

Receivables - net
182

 
130

Inventories and supplies - net
60

 
58

Deferred income taxes
123

 
148

Fuel hedge contracts
20

 
26

Prepaid expenses and other current assets
105

 
123

Total Current Assets
1,935

 
1,737

 
 
 
 
Property and Equipment
 

 
 

Aircraft and other flight equipment
4,419

 
4,248

Other property and equipment
857

 
855

Deposits for future flight equipment
550

 
369

 
5,826

 
5,472

Less accumulated depreciation and amortization
2,034

 
1,863

Total Property and Equipment - Net
3,792

 
3,609

 
 
 
 
Fuel Hedge Contracts
9

 
39

 
 
 
 
Other Assets
126

 
120

 
 
 
 
Total Assets
$
5,862

 
$
5,505


See accompanying notes to condensed consolidated financial statements.


4

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(in millions, except share amounts)
September 30,
2013
 
December 31,
2012
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
60

 
$
65

Accrued wages, vacation and payroll taxes
176

 
184

Other accrued liabilities
676

 
557

Air traffic liability
627

 
534

Current portion of long-term debt
111

 
161

Total Current Liabilities
1,650

 
1,501

 
 
 
 
Long-Term Debt, Net of Current Portion
782

 
871

Other Liabilities and Credits
 

 
 

Deferred income taxes
554

 
446

Deferred revenue
295

 
443

Obligation for pension and postretirement medical benefits
461

 
489

Other liabilities
318

 
334

 
1,628

 
1,712

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: 2013 - 69,991,221 shares; 2012 - 70,376,543 shares, Outstanding: 2013 - 69,650,542; 2012 - 70,376,543
70

 
70

Capital in excess of par value
625

 
660

Treasury stock (common), at cost: 2013 - 340,679 shares; 2012 - 0 shares
(21
)
 
—

Accumulated other comprehensive loss
(414
)
 
(436
)
Retained earnings
1,542

 
1,127

 
1,802

 
1,421

Total Liabilities and Shareholders' Equity
$
5,862

 
$
5,505


See accompanying notes to condensed consolidated financial statements.


5

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions, except per share amounts)
2013
 
2012
 
2013
 
2012
Operating Revenues
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
Mainline
$
960

 
$
905

 
$
2,651

 
$
2,491

Regional
208

 
198

 
582

 
559

Total passenger revenue
1,168

 
1,103

 
3,233

 
3,050

Freight and mail
32

 
30

 
88

 
85

Other - net
165

 
139

 
433

 
390

Special mileage plan revenue
192

 
—

 
192

 
—

Total Operating Revenues
1,557

 
1,272

 
3,946

 
3,525

 
 
 
 
 
 
 
 
Operating Expenses
 
 
 
 
 

 
 

Wages and benefits
285

 
255

 
806

 
771

Variable incentive pay
26

 
24

 
68

 
61

Aircraft fuel, including hedging gains and losses
363

 
337

 
1,115

 
1,087

Aircraft maintenance
54

 
56

 
187

 
160

Aircraft rent
29

 
29

 
89

 
86

Landing fees and other rentals
71

 
61

 
207

 
185

Contracted services
54

 
50

 
161

 
149

Selling expenses
47

 
46

 
137

 
131

Depreciation and amortization
67

 
66

 
203

 
195

Food and beverage service
22

 
20

 
63

 
58

Other
69

 
59

 
202

 
184

Total Operating Expenses
1,087

 
1,003

 
3,238

 
3,067

Operating Income
470

 
269

 
708

 
458

 
 
 
 
 
 
 
 
Nonoperating Income (Expense)
 
 
 
 
 

 
 

Interest income
5

 
5

 
14

 
15

Interest expense
(13
)
 
(15
)
 
(42
)
 
(49
)
Interest capitalized
6

 
4

 
15

 
12

Other - net
(5
)
 
2

 
(4
)
 
6

 
(7
)
 
(4
)
 
(17
)
 
(16
)
Income before income tax
463

 
265

 
691

 
442

Income tax expense
174

 
102

 
261

 
170

Net Income
$
289

 
$
163

 
$
430

 
$
272

 
 
 
 
 
 
 
 
Basic Earnings Per Share:
$
4.13

 
$
2.30

 
$
6.12

 
$
3.83

Diluted Earnings Per Share:
$
4.08

 
$
2.27

 
$
6.04

 
$
3.77

 
 
 
 
 
 
 
 
Shares used for computation:
 
 
 
 
 
 
 

Basic
69.780

 
70.963

 
70.152

 
70.852

Diluted
70.692

 
71.883

 
71.106

 
72.059

 
 
 
 
 
 
 
 
Cash dividend declared per share:
$
0.20

 
—

 
$
0.20

 
—


See accompanying notes to condensed consolidated financial statements.

6

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS (unaudited)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions)
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Net Income
$
289

 
$
163

 
$
430

 
$
272

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

 
5

 
(8
)
 
10

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

 
(2
)
 
(2
)
 
(5
)
Income tax effect
(1
)
 
(1
)
 
4

 
(2
)
Total
3

 
2

 
(6
)
 
3

 
 
 
 
 
 
 
 
Related to employee benefit plans:
 
 
 
 
 
 
 
Reclassification of (gains) losses into net income (within Wages and benefits)
11

 
10

 
32

 
30

Income tax effect
(5
)
 
(4
)
 
(12
)
 
(11
)
Total
6

 
6

 
20

 
19

 
 
 
 
 
 
 
 
Related to interest rate derivative instruments:
 
 
 
 
 
 
 
Unrealized holding gains (losses) arising during the period
(1
)
 
(4
)
 
9

 
(9
)
Reclassification of (gains) losses into net income (within Aircraft rent)
1

 
2

 
4

 
4

Income tax effect
1

 
1

 
(5
)
 
(1
)
Total
1

 
(1
)
 
8

 
(6
)
 
 
 
 
 
 
 
 
Other comprehensive income
10

 
7

 
22

 
16

 
 
 
 
 
 
 
 
Comprehensive income
$
299

 
$
170

 
$
452

 
$
288


See accompanying notes to condensed consolidated financial statements.


7

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
 
Nine Months Ended September 30,
(in millions)
2013
 
2012
Cash flows from operating activities:
 
 
 
Net income
$
430

 
$
272

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

 
 

Depreciation and amortization
203

 
195

Stock-based compensation and other
26

 
8

Changes in certain assets and liabilities:
 
 
 
Changes in fair values of open fuel hedge contracts
35

 
28

Changes in deferred income taxes
121

 
101

Increase in air traffic liability
93

 
94

Increase (decrease) in deferred revenue
(147
)
 
13

Other - net
61

 
(73
)
Net cash provided by operating activities
822

 
638

 
 
 
 
Cash flows from investing activities:
 

 
 

Property and equipment additions:
 

 
 

Aircraft and aircraft purchase deposits
(353
)
 
(298
)
Other flight equipment
(16
)
 
(13
)
Other property and equipment
(26
)
 
(29
)
Total property and equipment additions
(395
)
 
(340
)
Assets constructed for others (Terminal 6 at LAX)
—

 
(65
)
Purchases of marketable securities
(994
)
 
(811
)
Sales and maturities of marketable securities
712

 
701

Proceeds from disposition of assets and changes in restricted deposits
(3
)
 
1

Net cash used in investing activities
(680
)
 
(514
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Long-term debt payments
(139
)
 
(240
)
Proceeds from sale-leaseback transactions
—

 
49

Common stock repurchases
(83
)
 
(52
)
Dividends paid
(14
)
 
—

Proceeds and tax benefit from issuance of common stock
20

 
23

Other financing activities
(7
)
 
21

Net cash used in financing activities
(223
)
 
(199
)
Net decrease in cash and cash equivalents
(81
)
 
(75
)
Cash and cash equivalents at beginning of year
122

 
102

Cash and cash equivalents at end of the period
$
41

 
$
27

 
 
 
 
Supplemental disclosure:
 

 
 

Cash paid (received) during the period for:
 
 
 
Interest (net of amount capitalized)
$
31

 
$
40

Income taxes
100

 
49

Non-cash transactions:
 
 
 
Assets constructed related to Terminal 6 at LAX
—

 
2

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, 2012. In the opinion of management, all adjustments have been made that are necessary to present fairly the Company’s financial position as of September 30, 2013, as well as the results of operations for the three and nine months ended September 30, 2013 and 2012. 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 and other factors, operating results for the three and nine months ended September 30, 2013, are not necessarily indicative of operating results for the entire year.

NOTE 2. MODIFIED AFFINITY CARD AGREEMENT

Multiple-Deliverable Revenue Arrangements

Alaska operates a frequent flyer program (“Mileage Plan”) that provides travel awards to members based on accumulated mileage. Members can accumulate miles either by (i) flying on Alaska or on the Company's airline partners, or (ii) earning miles based on the amount spent with the affinity credit cards and the Company's other non-airline partners, such as hotels and car rental agencies. For miles earned by flying, the estimated cost of providing award travel is recognized as a selling expense and accrued as a liability as miles are earned and accumulated. For miles earned based on spend, the Company defers a portion of the amount sold to our non-airline partners representing deferred travel, and recognizes revenue for the services provided to the non-airline partners during the period.

Historically, the Company deferred the portion of the sales proceeds that represented the estimated selling price of the award transportation by looking to the sales prices of comparable paid travel and recognized that amount as Passenger Revenue when the award transportation was provided by Alaska or as Other - net revenue when the awards were redeemed and flown on other airlines. The residual portion of the sales proceeds not deferred was recognized as revenue in the period that the miles were sold and included in Other - net revenue.

On July 2, 2013, the Company modified it's Affinity Card Agreement (Agreement) with Bank of America Corporation (BAC), through which the Company sells miles and other items to BAC and the Company's loyalty program members accrue frequent flyer miles based on purchases using credit cards issued by BAC. The Agreement materially modifies the previously existing agreement between BAC and Alaska. As a result of the execution of the Agreement, consideration received as part of this agreement is subject to Accounting Standards Update 2009-13, "Multiple-Deliverable Revenue Arrangements - a consensus of the FASB Emerging Issues Task Force" (ASU 2009-13).

The modified Agreement has the same four deliverables as the previous agreement which are: award transportation; certificates for discounted companion travel; use of the Alaska Airlines brand and access to frequent flyer member lists; and advertising. Under the previous residual method of accounting, sales consideration was allocated to: award transportation and all other deliverables. Upon the adoption of ASU 2009-13, consideration is being allocated to each of the four deliverables based on the relative selling price of each deliverable.

Significant management judgment was used to estimate the selling price of each of the deliverables. The objective was to determine the price at which we would transact a sale if the product or service was sold on a stand-alone basis. We determined our best estimate of selling price by considering multiple inputs and methods including, but not limited to, the estimated selling price of comparable travel, discounted cash flows, brand value, published selling prices, number of miles awarded and the

9


number of miles redeemed. The Company estimated the selling prices and volumes over the term of the Agreement in order to determine the allocation of proceeds to each of the multiple deliverables.

The Company records passenger revenue related to air transportation and certificates for discounted companion travel when the transportation is delivered. The other elements are recognized as Other - net revenue when earned.

Absent a new or material modification to an existing agreement, other non-airline partners who participate in the loyalty program to which we sell miles remain subject to our historical residual accounting method and are immaterial to the overall program.

Special mileage plan revenue
The Company followed the rollforward transition approach of ASU 2009-13, which required that the Company's existing deferred revenue balance be adjusted to reflect the value, on a relative selling price basis, of any undelivered element remaining at the date of contract modification as if the Company had been applying ASU 2009-13 since inception of the Agreement. The relative selling price of the undelivered element (air transportation) is lower than the rate at which it had been deferred under the previous contract and the Company recorded a one-time, non-cash adjustment to decrease frequent flyer deferred revenue and increase Special mileage plan revenue. The impact on earnings are as follows:

Three Months Ended September 30, 2013
Nine Months Ended September 30, 2013
Special mileage plan revenue (in millions)
$
192

$
192

 
 
 
Per basic share
$
1.72

$
1.71

Per diluted share
$
1.70

$
1.69


During the third quarter of 2013, as part of the Company's ongoing evaluation of Mileage Plan program assumptions, the Company performed a statistical analysis on historical data, which refined its estimate of the amount of breakage in the mileage population. This new data enables the Company to better identify historical differences between certain of its mileage breakage estimates and the amounts that have actually been experienced. As a result, the Company increased its estimate of the number of frequent flyer miles expected to expire unused from 12.0% to 17.4%. Included in the Special mileage plan revenue item above is $44 million of additional revenue related to the effect of the change on the deferred revenue balance as of July 1, 2013.

NOTE 3. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES

Components for cash, cash equivalents and marketable securities (in millions):
September 30, 2013
Cost Basis
 
Unrealized
Gains
 
Unrealized Losses
 
Fair Value
Cash
$
3

 
$
—

 
$
—

 
$
3

Cash equivalents
38

 
—

 
—

 
38

Cash and cash equivalents
41

 
—

 
—

 
41

U.S. government and agency securities
393

 
1

 
(1
)
 
393

Foreign government bonds
24

 
—

 
—

 
24

Asset-back securities
129

 
—

 
—

 
129

Mortgage-back securities
134

 
—

 
(1
)
 
133

Corporate notes and bonds
693

 
5

 
(3
)
 
695

Municipal securities
30

 
—

 
—

 
30

Marketable securities
1,403

 
6

 
(5
)
 
1,404

Total
$
1,444

 
$
6

 
$
(5
)
 
$
1,445



10


December 31, 2012
Cost Basis
 
Unrealized
Gains
 
Unrealized Losses
 
Fair Value
Cash
$
28

 
$
—

 
$
—

 
$
28

Cash equivalents
94

 
—

 
—

 
94

Cash and cash equivalents
122

 
—

 
—

 
122

U.S. government and agency securities
271

 
1

 
—

 
272

Foreign government bonds
50

 
1

 
—

 
51

Asset-back securities
61

 
1

 
—

 
62

Mortgage-back securities
137

 
1

 
(1
)
 
137

Corporate notes and bonds
577

 
8

 
—

 
585

Municipal securities
23

 
—

 
—

 
23

Marketable securities
1,119

 
12

 
(1
)
 
1,130

Total
$
1,241

 
$
12

 
$
(1
)
 
$
1,252


Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence as of September 30, 2013.

Activity for marketable securities (in millions):  
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Proceeds from sales and maturities
$
247

 
$
271

 
$
712

 
$
701

Gross realized gains
—

 
2

 
3

 
6

Gross realized losses
—

 
—

 
(1
)
 
(1
)
 
Marketable securities maturities (in millions):
September 30, 2013
Cost Basis
 
Fair Value
Due in one year or less
$
198

 
$
199

Due after one year through five years
1,187

 
1,187

Due after five years through 10 years
18

 
18

Total
$
1,403

 
$
1,404


NOTE 4. 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 September 30, 2013, the Company had fuel hedge contracts outstanding covering 360 million gallons of crude oil that will be settled from October 2013 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.

11



Fair Values of Derivative Instruments

Fair values of derivative instruments on the consolidated balance sheet (in millions):
 
September 30,
2013
 
December 31,
2012
Derivative Instruments Not Designated as Hedges
 
 
 
Fuel hedge contracts
 
 
 
Fuel hedge contracts, current assets
$
20

 
$
26

Fuel hedge contracts, noncurrent assets
9

 
39

Fuel hedge contracts, current liabilities
(1
)
 
(1
)
 
 
 
 
Derivative Instruments Designated as Hedges
 
 
 
Interest rate swaps
 
 
 
Other accrued liabilities
(6
)
 
(6
)
Other liabilities
(13
)
 
(27
)
Losses in accumulated other comprehensive loss (AOCL)
(19
)
 
(33
)

The net cash received (paid) for new positions and settlements was $6 million and $4 million during the three months ended September 30, 2013 and 2012, respectively. The net cash received (paid) for new positions and settlements was $(3) million and $(13) million during the nine months ended September 30, 2013 and 2012, respectively.

Pretax effect of derivative instruments on earnings (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Derivative Instruments Not Designated as Hedges
 
 
 
 
 
 
 
Fuel hedge contracts
 
 
 
 
 
 
 
Gains (losses) recognized in aircraft fuel expense
$
10

 
$
22

 
$
(39
)
 
$
(41
)
 
 
 
 
 
 
 
 
Derivative Instruments Designated as Hedges
 
 
 
 
 
 
 
Interest rate swaps
 
 
 
 
 
 
 
Losses recognized in aircraft rent
(1
)
 
(2
)
 
(4
)
 
(4
)
Gains (losses) recognized in other comprehensive income (OCI)
(1
)
 
(4
)
 
9

 
(9
)

The amounts shown as recognized in aircraft rent for cash flow hedges (interest rate swaps) represent the realized losses transferred out of AOCL to aircraft rent. The amounts shown as recognized in OCI are prior to the losses recognized in aircraft rent during the period. The Company expects $6 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.


12


The Company posted collateral of $8 million and $15 million as of September 30, 2013 and December 31, 2012, respectively. The collateral was provided to one counterparty associated with the net liability position of the interest rate swap agreements, offset by the net asset position of the fuel hedge contracts under a master netting arrangement.

NOTE 5. FAIR VALUE MEASUREMENTS

Fair Value of Financial Instruments on a Recurring Basis

Fair values of financial instruments on the consolidated balance sheet (in millions):
September 30, 2013
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
393

 
$
—

 
$
393

Foreign government bonds
—

 
24

 
24

Asset-back securities
—

 
129

 
129

Mortgage-back securities
—

 
133

 
133

Corporate notes and bonds
—

 
695

 
695

Municipal securities
—

 
30

 
30

Derivative instruments
 
 
 
 
 
Call options
—

 
29

 
29

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Fuel hedge contracts
—

 
(1
)
 
(1
)
Interest rate swap agreements
—

 
(19
)
 
(19
)

December 31, 2012
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
272

 
$
—

 
$
272

Foreign government bonds
—

 
51

 
51

Asset-back securities
—

 
62

 
62

Mortgage-back securities
—

 
137

 
137

Corporate notes and bonds
—

 
585

 
585

Municipal securities
—

 
23

 
23

Derivative instruments
 
 
 
 
 
Call options
—

 
65

 
65

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Fuel hedge contracts
—

 
(1
)
 
(1
)
Interest rate swap agreements
—

 
(33
)
 
(33
)

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's 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

13


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

The Company has no financial assets that are measured at fair value on a nonrecurring basis at September 30, 2013.

Fair Value of Other Financial Instruments

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

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

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

Fixed-rate debt that is not carried at fair value on the consolidated balance sheet and the estimated fair value of long-term fixed-rate debt (in millions):
 
September 30,
2013
 
December 31,
2012
Carrying amount
$
721

 
$
844

Fair value
781

 
915


NOTE 6. MILEAGE PLAN

Refer to Note 2 for items impacting comparability between periods due to the application of ASU 2009-13. Alaska's Mileage Plan liabilities and deferrals on the consolidated balance sheets (in millions):
 
September 30,
2013
 
December 31,
2012
Current Liabilities:
 
 
 
Other accrued liabilities
$
342

 
$
285

Other Liabilities and Credits:
 
 
 
Deferred revenue
283

 
428

Other liabilities
17

 
17

Total
$
642

 
$
730

 
Alaska's Mileage Plan revenue included in the consolidated statements of operations (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Passenger revenues
$
54

 
$
47

 
$
150

 
$
137

Other - net revenues
74

 
55

 
184

 
158

Special mileage plan revenue
192

 
—

 
192

 
—

Total
$
320

 
$
102

 
$
526

 
$
295



14


NOTE 7. LONG-TERM DEBT
 
Long-term debt obligations on the consolidated balance sheet (in millions):
 
September 30,
2013
 
December 31,
2012
Fixed-rate notes payable due through 2024
$
721

 
$
844

Variable-rate notes payable due through 2023
172

 
188

Long-term debt
893

 
1,032

Less current portion
111

 
161

Total
$
782

 
$
871

 
 
 
 
Weighted-average fixed-interest rate
5.7
%
 
5.8
%
Weighted-average variable-interest rate
1.7
%
 
2.0
%

During the nine months ended September 30, 2013, the Company made debt payments of $139 million.

At September 30, 2013, long-term debt principal payments for the next five years and thereafter are as follows (in millions):
 
Total
Remainder of 2013
$
22

2014
117

2015
113

2016
111

2017
116

Thereafter
414

Total
$
893

 
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 September 30, 2013.

NOTE 8. EMPLOYEE BENEFIT PLANS

Net periodic benefit costs recognized included the following components for the three months ended September 30, 2013 (in millions): 
 
Three Months Ended September 30,
 
Qualified
 
Nonqualified
 
Postretirement Medical
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
Service cost
$
11

 
$
9

 
$
—

 
$
—

 
$
1

 
$
1

Interest cost
19

 
18

 
—

 
1

 
1

 
2

Expected return on assets
(27
)
 
(23
)
 
—

 
—

 
—

 
—

Amortization of prior service cost
(1
)
 
—

 
—

 
—

 
—

 
—

Recognized actuarial loss
11

 
10

 
—

 
—

 
—

 
—

Total
$
13

 
$
14

 
$
—

 
$
1

 
$
2

 
$
3



15


Net periodic benefit costs recognized included the following components for the nine months ended September 30, 2013 (in millions):
 
Nine Months Ended September 30,
 
Qualified
 
Nonqualified
 
Postretirement Medical
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
Service cost
$
34

 
$
29

 
$
1

 
$
1

 
$
3

 
$
3

Interest cost
55

 
55

 
1

 
2

 
3

 
5

Expected return on assets
(82
)
 
(70
)
 
—

 
—

 
—

 
—

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

 
—

 
—

 
—

Recognized actuarial loss
32

 
30

 
—

 
—

 
—

 
—

Total
$
38

 
$
43

 
$
2

 
$
3

 
$
6

 
$
8


NOTE 9. COMMITMENTS

Future minimum fixed payments for commitments (in millions):
September 30, 2013
Aircraft Leases
 
Facility Leases
 
Aircraft Commitments
 
Capacity Purchase Agreements
 
Engine Maintenance
Remainder of 2013
$
17

 
$
12

 
$
117

 
$
9

 
$
3

2014
127

 
45

 
448

 
38

 
10

2015
105

 
35

 
328

 
31

 
11

2016
82

 
27

 
279

 
18

 
—

2017
51

 
21

 
338

 
19

 
—

Thereafter
79

 
148

 
1,450

 
8

 
—

Total
$
461

 
$
288

 
$
2,960

 
$
123

 
$
24


Lease Commitments

At September 30, 2013, the Company had lease contracts for 63 aircraft, which have remaining noncancelable lease terms ranging from 2013 to 2021. Of these aircraft, 14 are non-operating (i.e. not in the Company's fleet) with 11 that are subleased to third-party carriers. The majority of airport and terminal facilities are also leased. Rent expense was $75 million and $69 million for the three months ended September 30, 2013 and 2012, respectively and $228 million and $207 million for the nine months ended September 30, 2013 and 2012, respectively.

During the third quarter, the Company had three subleased Bombardier CRJ-700 aircrafts returned. In connection with these aircraft the Company incurred costs to deliver the aircraft to SkyWest Airlines, whom will sublease and operate the aircraft under a Capacity Purchase Agreement (CPA).

Aircraft Commitments
 
As of September 30, 2013, the Company is committed to purchasing 72 B737 aircraft (35 B737-900ER aircraft and 37 B737 MAX aircraft) and three Q400 aircraft, with deliveries in 2013 through 2022. In addition, the Company has options to purchase an additional 64 B737 aircraft and seven Q400 aircraft.

Capacity Purchase Agreements (CPAs)
 
At September 30, 2013, 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 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 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.

16



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 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 10. SHAREHOLDERS' EQUITY

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 by the end of December 2014. In February 2012, the Board of Directors authorized a $50 million share repurchase program, which was completed in September 2012. In June 2011, the Board of Directors authorized a $50 million share repurchase program, which was completed in January 2012.
Share repurchase activity (in millions, except share amounts):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
2012 Repurchase Program - $250 million
537,008

 
$
32

 
—

 
$
—

 
1,454,790

 
$
83

 
—

 
$
—

2012 Repurchase Program - $50 million
—

 
—

 
728,101

 
26

 
—

 
—

 
1,437,101

 
50

2011 Repurchase Program - $50 million
—

 
—

 
—

 
—

 
—

 
—

 
46,340

 
2

Total
537,008

 
$
32

 
728,101

 
$
26

 
1,454,790

 
$
83

 
1,483,441

 
$
52

 
Accumulated Other Comprehensive Loss
 
Components of accumulated other comprehensive income (loss) (in millions):
 
September 30,
2013
 
December 31,
2012
Marketable securities
$
1

 
$
7

Employee benefit plans
(403
)
 
(423
)
Interest rate derivatives
(12
)
 
(20
)
Total
$
(414
)
 
$
(436
)

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 and nine months ended September 30, 2013 and 2012, anti-dilutive shares excluded from the calculation of EPS were not material.


17


NOTE 11. 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 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 and 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):
 
Three Months Ended September 30, 2013
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Consolidating
 
Air Group Adjusted(a)
 
Special Items(b)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
960

 
$
—

 
$
—

 
$
—

 
$
960

 
$
—

 
$
960

Regional


 
208

 
—

 
—

 
208

 
—

 
208

Total passenger revenues
960

 
208

 
—

 
—

 
1,168

 
—

 
1,168

CPA revenues
—

 
—

 
88

 
(88
)
 
—

 
—

 
—

Freight and mail
31

 
1

 
—

 
—

 
32

 
—

 
32

Other - net
145

 
19

 
1

 
—

 
165

 
192

 
357

Total operating revenues
1,136

 
228

 
89

 
(88
)
 
1,365

 
192

 
1,557

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
588

 
144

 
80

 
(88
)
 
724

 
—

 
724

Economic fuel
337

 
46

 
—

 
—

 
383

 
(20
)
 
363

Total operating expenses
925

 
190

 
80

 
(88
)
 
1,107

 
(20
)
 
1,087

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
5

 
—

 
—

 
—

 
5

 
—

 
5

Interest expense
(9
)
 
—

 
(4
)
 
—

 
(13
)
 
—

 
(13
)
Other
8

 
(8
)
 
1

 
—

 
1

 
—

 
1

 
4

 
(8
)
 
(3
)
 
—

 
(7
)
 
—

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

 
$
30

 
$
6

 
$
—

 
$
251

 
$
212

 
$
463



18


 
Three Months Ended September 30, 2012
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Consolidating
 
Air Group Adjusted(a)
 
Special Items(b)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
905

 
$
—

 
$
—

 
$
—

 
$
905

 
$
—

 
$
905

Regional
—

 
198

 
—

 
—

 
198

 
—

 
198

Total passenger revenues
905

 
198

 
—

 
—

 
1,103

 
—

 
1,103

CPA revenues
—

 
—

 
96

 
(96
)
 
—

 
—

 
—

Freight and mail
28

 
2

 
—

 
—

 
30

 
—

 
30

Other - net
121

 
16

 
2

 
—

 
139

 
—

 
139

Total operating revenues
1,054

 
216

 
98

 
(96
)
 
1,272

 
—

 
1,272

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
532

 
145

 
86

 
(97
)
 
666

 
—

 
666

Economic fuel
312

 
46

 
—

 
—

 
358

 
(21
)
 
337

Total operating expenses
844

 
191

 
86

 
(97
)
 
1,024

 
(21
)
 
1,003

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
5

 
—

 
—

 
—

 
5

 
—

 
5

Interest expense
(11
)
 
—

 
(4
)
 
—

 
(15
)
 
—

 
(15
)
Other
6

 
—

 
—

 
—

 
6

 
—

 
6

 
—

 
—

 
(4
)
 
—

 
(4
)
 
—

 
(4
)
Income (loss) before income tax
$
210

 
$
25

 
$
8

 
$
1

 
$
244

 
$
21

 
$
265


 
Nine Months Ended September 30, 2013
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Consolidating
 
Air Group Adjusted(a)
 
Special Items(b)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
2,651

 
$
—

 
$
—

 
$
—

 
$
2,651

 
$
—

 
$
2,651

Regional
—

 
582

 
—

 
—

 
582