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ALK > SEC Filings for ALK > Form 10-Q on 7-Aug-2013All Recent SEC Filings

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Form 10-Q for ALASKA AIR GROUP, INC.


7-Aug-2013

Quarterly Report


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, 2012. This overview summarizes the MD&A, which includes the following sections:

• Second Quarter Review-highlights from the second quarter of 2013 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 and six months ended June 30, 2013. To the extent material to the understanding of segment profitability we more fully describe the segment expenses per financial statement line-item. Financial and statistical data is also included here. This section includes forward-looking statements regarding our view of the remainder of 2013.

• Liquidity and Capital Resources-an overview of our financial position, analysis of cash flows, and contractual obligations and commitments.

SECOND QUARTER REVIEW

Our consolidated pretax income was $169 million during the second quarter of 2013, compared to $109 million in the second quarter of 2012. The increase of $60 million was primarily due to decreased aircraft fuel expense of $61 million and increased revenues of $42 million, partially offset by increased non-fuel operating expenses of $45 million. The decrease in fuel costs was due to an unrealized mark-to-market fuel hedge loss of $70 million in the prior period, partially offset by a 6.6% increase in consumption. The improvement in revenues was primarily due to increased passenger revenues of $37 million on a 7.5% increase in traffic, partially offset by 3.7% lower ticket yields.

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

Operations Performance

During the second quarter, both Alaska and Horizon continued their strong on-time performance, reporting 88.0% and 89.8% of their flights arrived on time, respectively. For the twelve months ended May 2013, Alaska held the top spot among the 10 largest U.S. airlines for on-time performance, according the U.S. Department of Transportation.

Additionally, our employees earned two awards this past quarter and ratified two long-term labor agreements in July. Each of these can be tied to one our Five Focus Areas. First, as part of our focus on safety and compliance, 100% of our Alaska aircraft technicians completed the requirements for the FAA's "Diamond Certificate of Excellence" award for the 12th consecutive year and our Horizon aircraft technicians completed the requirements for the 12th time in the last 14 years. Second, in regards to our People Focus, we reached a five-year agreement with Alaska's pilots and a five-year agreement with Horizon's flight attendants, providing us with long-term certainty and allowing us to focus on running a great operation. Third, we believe our Hassle-Free initiative, and Low-cost, Low-fare and Network Growth initiative led to the improvement in our J.D. Power and Associates™ scores and thus earning the "Highest in Customer Satisfaction Among Traditional Network Carriers" for the sixth year in a row. With the improvements we're making to the onboard experience with new Recaro seats, inflight entertainment and power at every seat, among other initiates, we hope to improve our scores even further in 2014.


Cabin Investment Program

On April 23, 2013, we announced our cabin investment program that will improve our customers' onboard experience and make us more competitive. We will modify all of our 737-800s and -900s to include the same Recaro seats installed on our 737-900ERs; have power at every seat, including our -900ERs; and provide enhanced inflight entertainment. The slimmer Recaro seat and other cabin reconfigurations enable Alaska to add six seats to our 737-800s and nine seats to our -900s without sacrificing personal space. When complete, we will increase our seats by approximately 2.4%. We will be the only domestic airline to offer 110-volt and USB power at every seat and the outlets will be easily accessible rather than located beneath the seat. Modifications will start later in 2013 and continue through most of 2014.

Mileage Plan Affinity Card Agreement

On July 2, 2013, we extended our co-branded credit card agreement with BAC. We are pleased with the terms in the amended agreement and the new service levels it will provide to holders of our co-branded credit cards. For the remainder of 2013, the company expects to receive $55 million in additional cash flows, assuming credit card and spending volumes remain consistent.

Increases to Baggage and Change Fees

On July 9, 2013, we announced modifications to our baggage and change fees policies. Passengers who book travel after October 30, 2013, on Alaska, including flights operated by our CPA carriers, will pay $25 each for the first and second checked bags and $75 for additional bags. That compares with the flat $20 for each of the first three bags that Alaska currently charges. The fee to change tickets will increase to $125. Currently, Alaska charges $75 if the change is made online and $100 if the change is made through a call center. Passengers who change tickets 60 or more days from the day of travel will not incur any fee. We expect the changes above to result in additional revenue of approximately $50 million annually once implemented.

Update on Labor Negotiations

On May 2, 2013, Alaska Airlines flight attendants, represented by the Association of Flight Attendants (AFA), filed for mediation with the National Mediation Board (NMB). Negotiations started in November 2011, before the amendable date of May 1, 2012, and have been ongoing for the past 18 months.

On July 10, 2013, Alaska Airlines' pilots approved a new, five-year contract. With nearly 94% of eligible voters
casting a ballot, 67% voted in favor of the agreement. The agreement increases pay by nearly 20 percent over the life of the agreement and contains job security and work rule improvements.

On July 18, 2013, Horizon's flight attendants approved a new, five-year contract. Approximately 81% of eligible flight attendants participated, and 75% of those voted in favor of the agreement. The agreement includes pay raises, quality of life improvements and more flexible scheduling for Horizon's more than 500 flight attendants.

Additionally, Horizon is in negotiations with the International Association of Machinists and Aerospace Workers (IAM) who represent Horizon's maintenance store employees. Alaska is in negotiations with a different unit of International Association of Machinists and Aerospace Workers (IAM) who represent Alaska's clerical, operations, and passenger services employees, whose contract becomes amendable January 1, 2014.


New Markets

New routes launched in the first half of 2013 and announced in the second
quarter are as follows:
New Non-Stop Routes launched in 2013 New Non-Stop Routes (Launch Date)
Portland to Fairbanks                Anchorage to Fairbanks (3/3/14) - Horizon
San Diego to Boston                  Anchorage to Kodiak (3/3/14) - Horizon
San Diego to Lihue                   Anchorage to Las Vegas (12/19)
Seattle to Salt Lake City            Anchorage to Phoenix (12/18)
                                     Portland to Boise (11/1) - SkyWest
                                     Portland to Reno (11/8)
                                     Portland to Tucson (11/1)
                                     San Diego to Boise (11/1)
                                     San Diego to Mammoth Lakes (12/19)
                                     Seattle to Colorado Springs (11/1)
                                     Seattle to Omaha (11/7)
                                     Seattle to Steamboat Springs (12/18)

Capital Allocation

During the second quarter of 2013, we repurchased 544,597 shares of our common stock for $32 million under our $250 million repurchase program authorized by our Board of Directors in September 2012. Since 2007, we have repurchased 19 million shares of common stock under such programs for $372 million for an average price of $19 per share. During the month of July we repurchased 188,333 shares of our common stock for $11 million, resulting in 69.869 million shares outstanding at July 31, 2013.

On July 11, 2013, we announced that our Board of Directors approved a quarterly cash dividend of $0.20 per share to be paid August 22, 2013, to all shareholders of record as of August 6, 2013. We believe the dividend is the next logical step in our balanced approach to capital allocation that has been in place for a number of years.

Outlook

Our advance bookings suggest our load factors will be down half a point in August and down a point in September compared to the same periods in 2012 on an expected 7.0% increase in capacity in the third quarter of 2013. However, many of the factors that caused second quarter unit revenues to be negative, such as increased competitive capacity between the lower 48 and the state of Alaska and along the West Coast, will still exist in the third quarter. As a result, we expect unit revenues to decline again in the third quarter on a year-over-year basis.

Our current expectations for capacity and CASM excluding fuel and special items are summarized below:

                              Forecast      Change       Forecast        Change
                               Q3 2013       Y-O-Y    Full Year 2013      Y-O-Y
Consolidated:
ASMs (000,000) "capacity"   8,850 - 8,900     7.0 %   33,650 - 33,750      7.0  %

CASM excluding fuel (cents) 8.25˘ - 8.30˘ 3.0 % ~ 8.45˘ (0.5 )%

Mainline:
ASMs (000,000) "capacity" 8,000 - 8,050 8.0 % 30,350 - 30,450 8.0 % CASM excluding fuel (cents) 7.45˘ - 7.50˘ 4.5 % ~ 7.56˘ ~ flat


RESULTS OF OPERATIONS

COMPARISON OF THREE MONTHS ENDED JUNE 30, 2013 COMPARED TO THREE MONTHS ENDED
JUNE 30, 2012

Our consolidated net income for the second quarter of 2013 was $104 million, or $1.47 per diluted share, compared to net income of $68 million, or $0.93 per diluted share, in the second quarter of 2012. Both periods include adjustments to reflect the timing of unrealized mark-to-market adjustments related to our fuel hedge positions. For the second quarter of 2013, we recognized mark-to-market unrealized losses of $1 million compared to unrealized losses of $70 million ($43 million after tax, or $0.60 per share) in the second quarter of 2012.

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

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

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

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

• CASM excluding fuel and certain special items is one of the most important measures used by management and by the Air Group Board of Directors in assessing quarterly and annual cost performance;

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

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

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

Excluding the impact of mark-to-market fuel hedge adjustments, our adjusted consolidated net income for the second quarter of 2013 was $105 million, or $1.47 per diluted share, compared to an adjusted consolidated net income of $111 million, or $1.53 per share, in the second quarter of 2012.

                                                          Three Months Ended June 30,
                                                     2013                                2012
(in millions, except per share
amounts)                                  Dollars           Diluted EPS        Dollars        Diluted EPS
Net income and diluted EPS as
reported                             $       104          $        1.47     $        68     $        0.93
Mark-to-market fuel hedge
adjustments, net of tax                        1                      -              43              0.60
Non-GAAP adjusted income and per
share amounts                        $       105          $        1.47     $       111     $        1.53


Our operating costs per ASM are summarized below:

                                                       Three Months Ended June 30,
(in cents)                                             2013           2012     % Change
Consolidated:
CASM                                                      12.66 ˘    13.82 ˘      (8.4 )
Less the following components:
Aircraft fuel, including hedging gains and losses          4.35       5.44       (20.0 )
CASM excluding fuel                                        8.31 ˘     8.38 ˘      (0.8 )

Mainline:
CASM                                                      11.58 ˘    12.89 ˘     (10.2 )
Less the following components:
Aircraft fuel, including hedging gains and losses          4.23       5.43       (22.1 )
CASM excluding fuel                                        7.35 ˘     7.46 ˘      (1.6 )


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