Document


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

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

For the quarterly period ended June 30, 2016
 
OR

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

 For the transition period from                      to                      

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes T No £
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer   T
Accelerated filer  £ 
Non-accelerated filer   £
Smaller reporting company   £
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes £ No T
 
The registrant has 123,089,982 common shares, par value $0.01, outstanding at July 31, 2016.



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

 TABLE OF CONTENTS

 

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

2



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

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

You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Our forward-looking statements are based on the information currently available to us and speak only as of the date on which this report was filed with the SEC. We expressly disclaim any obligation to issue any updates or revisions to our forward-looking statements, even if subsequent events cause our expectations to change regarding the matters discussed in those statements. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such differences might be significant and materially adverse to our shareholders. For a discussion of these and other risk factors, see Item 1A. "Risk Factors” of the Company’s annual report on Form 10-K for the year ended December 31, 2015, 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)
June 30,
2016
 
December 31,
2015
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
81

 
$
73

Marketable securities
1,526

 
1,255

Total cash and marketable securities
1,607

 
1,328

Receivables - net
254

 
212

Inventories and supplies - net
45

 
51

Prepaid expenses and other current assets
97

 
72

Total Current Assets
2,003

 
1,663

 
 
 
 
Property and Equipment
 

 
 

Aircraft and other flight equipment
6,198

 
5,690

Other property and equipment
994

 
955

Deposits for future flight equipment
551

 
771

 
7,743

 
7,416

Less accumulated depreciation and amortization
2,784

 
2,614

Total Property and Equipment - Net
4,959

 
4,802

 
 
 
 
Other Assets
73

 
65

 
 
 
 
Total Assets
$
7,035

 
$
6,530


See accompanying notes to condensed consolidated financial statements.


4

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(in millions, except share amounts)
June 30,
2016
 
December 31,
2015
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
78

 
$
63

Accrued wages, vacation and payroll taxes
239

 
298

Air traffic liability
870

 
669

Other accrued liabilities
757

 
661

Current portion of long-term debt
117

 
114

Total Current Liabilities
2,061

 
1,805

 
 
 
 
Long-Term Debt, Net of Current Portion
509

 
569

Other Liabilities and Credits
 

 
 

Deferred income taxes
721

 
682

Deferred revenue
480

 
431

Obligation for pension and postretirement medical benefits
271

 
270

Other liabilities
366

 
362

 
1,838

 
1,745

Commitments and Contingencies


 


Shareholders' Equity
 

 
 

Preferred stock, $0.01 par value, Authorized: 5,000,000 shares, none issued or outstanding
—

 
—

Common stock, $0.01 par value, Authorized: 200,000,000 shares, Issued: 2016 - 128,941,102 shares; 2015 - 128,442,099 shares, Outstanding: 2016 - 123,079,519 shares; 2015 - 125,175,325 shares
1

 
1

Capital in excess of par value
91

 
73

Treasury stock (common), at cost: 2016 - 5,861,583 shares; 2015 - 3,266,774 shares
(444
)
 
(250
)
Accumulated other comprehensive loss
(287
)
 
(303
)
Retained earnings
3,266

 
2,890

 
2,627

 
2,411

Total Liabilities and Shareholders' Equity
$
7,035

 
$
6,530


See accompanying notes to condensed consolidated financial statements.


5

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in millions, except per share amounts)
2016
 
2015
 
2016
 
2015
Operating Revenues
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
Mainline
$
1,036

 
$
1,019

 
$
1,963

 
$
1,920

Regional
227

 
212

 
433

 
398

Total passenger revenue
1,263

 
1,231

 
2,396

 
2,318

Freight and mail
27

 
30

 
51

 
53

Other - net
204

 
176

 
394

 
335

Total Operating Revenues
1,494

 
1,437

 
2,841

 
2,706

 
 
 
 
 
 
 
 
Operating Expenses
 
 
 
 
 

 
 

Wages and benefits
332

 
305

 
668

 
611

Variable incentive pay
32

 
32

 
64

 
58

Aircraft fuel, including hedging gains and losses
201

 
261

 
368

 
496

Aircraft maintenance
65

 
52

 
133

 
115

Aircraft rent
26

 
26

 
55

 
52

Landing fees and other rentals
63

 
66

 
143

 
137

Contracted services
60

 
51

 
120

 
102

Selling expenses
55

 
54

 
104

 
107

Depreciation and amortization
92

 
79

 
180

 
155

Food and beverage service
31

 
28

 
62

 
53

Third-party regional carrier expense
24

 
17

 
47

 
33

Other
81

 
94

 
175

 
177

Special items - merger costs
14

 
—

 
14

 
—

Total Operating Expenses
1,076

 
1,065

 
2,133

 
2,096

Operating Income
418

 
372

 
708

 
610

 
 
 
 
 
 
 
 
Nonoperating Income (Expense)
 
 
 
 
 

 
 

Interest income
7

 
6

 
13

 
11

Interest expense
(9
)
 
(11
)
 
(22
)
 
(22
)
Interest capitalized
7

 
8

 
15

 
16

Other - net
(3
)
 
1

 
(2
)
 
1

 
2

 
4

 
4

 
6

Income before income tax
420

 
376

 
712

 
616

Income tax expense
160

 
142

 
268

 
233

Net Income
$
260

 
$
234

 
$
444

 
$
383

 
 
 
 
 
 
 
 
Basic Earnings Per Share:
$
2.11

 
$
1.80

 
$
3.58

 
$
2.93

Diluted Earnings Per Share:
$
2.10

 
$
1.79

 
$
3.56

 
$
2.91

 
 
 
 
 
 
 
 
Shares used for computation:
 
 
 
 
 
 
 

Basic
123.250

 
129.236

 
123.900

 
130.173

Diluted
123.988

 
130.255

 
124.715

 
131.271

 
 
 
 
 
 
 
 
Cash dividend declared per share:
$
0.275

 
$
0.20

 
$
0.550

 
$
0.40

See accompanying notes to condensed consolidated financial statements.

6

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS (unaudited)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in millions)
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Net Income
$
260

 
$
234

 
$
444

 
$
383

 
 
 
 
 
 
 
 
Other Comprehensive Income (Loss):
 
 
 
 
 
 
 
Related to marketable securities:
 
 
 
 
 
 
 
Unrealized holding gains (losses) arising during the period
7

 
(5
)
 
19

 
2

Reclassification of (gains) losses into Other-net nonoperating income (expense)
(1
)
 
—

 
(1
)
 
—

Income tax effect
(2
)
 
2

 
(6
)
 
(1
)
Total
4

 
(3
)
 
12

 
1

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

 
5

 
10

 
8

Income tax effect
(2
)
 
(2
)
 
(4
)
 
(3
)
Total
3

 
3

 
6

 
5

 
 
 
 
 
 
 
 
Related to interest rate derivative instruments:
 
 
 
 
 
 
 
Unrealized holding gains (losses) arising during the period
(2
)
 
1

 
(7
)
 
(3
)
Reclassification of (gains) losses into Aircraft rent
2

 
1

 
3

 
3

Income tax effect
—

 
(1
)
 
2

 
—

Total
—

 
1

 
(2
)
 
—

 
 
 
 
 
 
 
 
Other Comprehensive Income
7

 
1

 
16

 
6

 
 
 
 
 
 
 
 
Comprehensive Income
$
267

 
$
235

 
$
460

 
$
389


See accompanying notes to condensed consolidated financial statements.


7

ALASKA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
 
Six Months Ended June 30,
(in millions)
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
444

 
$
383

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

 
 

Depreciation and amortization
180

 
155

Stock-based compensation and other
13

 
14

Changes in certain assets and liabilities:
 
 
 
Changes in deferred tax provision
41

 
(44
)
Increase (decrease) in air traffic liability
201

 
209

Increase (decrease) in deferred revenue
48

 
27

Other - net
(28
)
 
145

Net cash provided by operating activities
899

 
889

 
 
 
 
Cash flows from investing activities:
 

 
 

Property and equipment additions:
 

 
 

Aircraft and aircraft purchase deposits
(268
)
 
(490
)
Other flight equipment
(31
)
 
(43
)
Other property and equipment
(41
)
 
(26
)
Total property and equipment additions, including capitalized interest
(340
)
 
(559
)
Purchases of marketable securities
(610
)
 
(711
)
Sales and maturities of marketable securities
357

 
676

Proceeds from disposition of assets and changes in restricted deposits
3

 
—

Net cash used in investing activities
(590
)
 
(594
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Long-term debt payments
(57
)
 
(58
)
Common stock repurchases
(193
)
 
(262
)
Dividends paid
(68
)
 
(52
)
Other financing activities
17

 
15

Net cash used in financing activities
(301
)
 
(357
)
Net increase (decrease) in cash and cash equivalents
8

 
(62
)
Cash and cash equivalents at beginning of year
73

 
107

Cash and cash equivalents at end of the period
$
81

 
$
45

 
 
 
 
Supplemental disclosure:
 

 
 

Cash paid during the period for:
 
 
 
Interest (net of amount capitalized)
$
8

 
$
8

Income taxes paid (received)
182

 
108

See accompanying notes to condensed consolidated financial statements.

8


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

NOTE 1. GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Basis of Presentation
 
The interim condensed consolidated financial statements include the accounts of Alaska Air Group, Inc. (Air Group or the Company) and its primary subsidiaries, Alaska Airlines, Inc. (Alaska) and Horizon Air Industries, Inc. (Horizon), through which the Company conducts substantially all of its operations. All intercompany balances and transactions have been eliminated. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information. Consistent with these requirements, this Form 10-Q does not include all the information required by GAAP for complete financial statements. As a result, this Form 10-Q should be read in conjunction with the Consolidated Financial Statements and accompanying Notes in the Form 10-K for the year ended December 31, 2015. In the opinion of management, all adjustments have been made that are necessary to present fairly the Company’s financial position as of June 30, 2016, as well as the results of operations for the three and six months ended June 30, 2016 and 2015. The adjustments made were of a normal recurring nature.

In preparing these statements, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities, as well as the reported amounts of revenues and expenses. Due to seasonal variations in the demand for air travel, the volatility of aircraft fuel prices, changes in global economic conditions, changes in the competitive environment, and other factors, operating results for the three and six months ended June 30, 2016 are not necessarily indicative of operating results for the entire year.

Certain reclassifications have been made to prior year financial statements to conform with classifications used in the current year.

Recently Issued Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update 2014-09, "Revenue from Contracts with Customers" (ASU 2014-09), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on January 1, 2018. The standard permits the use of either the retrospective or cumulative effect transition method. At this time, the Company believes the most significant impact to the financial statements will be in Mileage Plan revenues and liabilities. The Company currently uses the incremental cost approach for miles earned through travel. This standard eliminates that option and the Company will be required to increase its liability for earned miles through a relative selling price model. The Company has not evaluated the full impact of the standard, although application is expected to result in a material increase to Deferred Revenue. The Company has not yet selected a transition method.

In April 2015, the FASB issued ASU 2015-03, "Interest - Imputation of Interest" (Subtopic 835-30), which requires debt issuance costs related to a debt liability be presented as a direct deduction from the carrying value of the debt liability. The amendment was adopted as of January 1, 2016. Prior period debt balances have been adjusted to reflect the adoption of ASU 2015-03. The adoption of the ASU had no impact on the Statements of Operations or retained earnings.

In February 2016, the FASB issued ASU 2016-02, "Leases" (Topic 842), which requires lessees to recognize assets and liabilities for leases currently classified as operating leases. Under the new standard a lessee will recognize a liability on the balance sheet representing the lease payments owed, and a right-of-use-asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election not to recognize lease assets and lease liabilities. The new standard is effective for the Company on January 1, 2019. Early adoption of the standard is permitted. The Company is evaluating the effect that ASU 2016-02 will have on its financial statements and related disclosures. The Company has not yet determined whether it will early adopt the standard.

In March 2016, the FASB issued ASU 2016-08, "Revenue from Contracts with Customers" (Topic 606), Principal versus Agent Considerations. The proposed standard provides guidance when a revenue transaction involves a third party in providing goods or services to a customer in determining whether the Company is considered the principal or the agent in the transaction. When an entity is engaged to provide the underlying good or service, such entity is classified as the principal in the transaction. When an entity is engaged to arrange for a third party to provide the goods or services, such entity is classified as the agent in the transaction. This ASU has the same effective date as the new revenue standard. Entities are required to adopt this ASU using

9


the same transition method they use to adopt the new revenue accounting standard. The Company is evaluating the effect that ASU 2016-08 will have on its consolidated financial statements and related disclosures. The Company has not yet elected a transition method nor has it determined whether it will early adopt.

In March 2016, the FASB issued ASU 2016-09, "Compensation - Stock Compensation" (Topic 718). The proposed standard simplifies several aspects of accounting for employee share-based payment awards, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The Company is evaluating the effect of ASU 2016-09 on the consolidated financial statements and related disclosures. The ASU is effective for the Company beginning January 1, 2017. Early adoption is permitted. The Company has not yet elected a transition method.

NOTE 2. PROPOSED ACQUISITION OF VIRGIN AMERICA INC.

On April 1, 2016 the Company entered into an agreement to acquire Virgin America. The Company has agreed to pay Virgin America shareholders $57 per share, or approximately $2.6 billion, in cash for the outstanding common stock of Virgin America. In addition, the Company expects to assume Virgin America's debt and lease obligations, other than related party debt, on the date of acquisition. The merger has been approved by Virgin America's shareholders and is subject to final approval by various regulatory bodies. We currently expect the transaction will close in the fourth quarter of 2016.

As of June 30, 2016 the Company has incurred merger costs of $14 million. These costs are classified as special items within the Statement of Operations. The Company expects to continue to incur merger costs in the future if the transaction closes.

NOTE 3. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES

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

 
$
—

 
$
—

 
$
—

Cash equivalents
81

 
—

 
—

 
81

Cash and cash equivalents
81

 
—

 
—

 
81

U.S. government and agency securities
430

 
3

 
—

 
433

Foreign government bonds
32

 
—

 
—

 
32

Asset-backed securities
160

 
1

 
—

 
161

Mortgage-backed securities
112

 
1

 
—

 
113

Corporate notes and bonds
762

 
9

 
(1
)
 
770

Municipal securities
17

 
—

 
—

 
17

Marketable securities
1,513

 
14

 
(1
)
 
1,526

Total
$
1,594

 
$
14

 
$
(1
)
 
$
1,607


December 31, 2015
Cost Basis
 
Unrealized
Gains
 
Unrealized Losses
 
Fair Value
Cash
$
4

 
$
—

 
$
—

 
$
4

Cash equivalents
69

 
—

 
—

 
69

Cash and cash equivalents
73

 
—

 
—

 
73

U.S. government and agency securities
254

 
—

 
(1
)
 
253

Foreign government bonds
31

 
—

 
—

 
31

Asset-backed securities
130

 
—

 
—

 
130

Mortgage-backed securities
117

 
—

 
(1
)
 
116

Corporate notes and bonds
711

 
1

 
(4
)
 
708

Municipal securities
17

 
—

 
—

 
17

Marketable securities
1,260

 
1

 
(6
)
 
1,255

Total
$
1,333

 
$
1

 
$
(6
)
 
$
1,328



10


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 June 30, 2016.

Activity for marketable securities (in millions):  
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Proceeds from sales and maturities
$
217

 
$
417

 
$
357

 
$
676

Gross realized gains
2

 
1

 
2

 
2

Gross realized losses
(1
)
 
(1
)
 
(1
)
 
(2
)
 
Maturities for marketable securities (in millions):
June 30, 2016
Cost Basis
 
Fair Value
Due in one year or less
$
363

 
$
363

Due after one year through five years
1,134

 
1,147

Due after five years through 10 years
16

 
16

Due after 10 years
—

 
—

Total
$
1,513

 
$
1,526


NOTE 4. FAIR VALUE MEASUREMENTS

In determining fair value, there is a three-level hierarchy based on the reliability of the inputs used. Level 1 refers to fair values based on quoted prices in active markets for identical assets or liabilities, Level 2 refers to fair values estimated using significant other observable inputs and Level 3 refers to fair values estimated using significant unobservable inputs.

Fair Value of Financial Instruments on a Recurring Basis

Fair values of financial instruments on the consolidated balance sheet (in millions):
June 30, 2016
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
433

 
$
—

 
$
433

Foreign government bonds
—

 
32

 
32

Asset-backed securities
—

 
161

 
161

Mortgage-backed securities
—

 
113

 
113

Corporate notes and bonds
—

 
770

 
770

Municipal securities
—

 
17

 
17

Total Marketable securities
433

 
1,093

 
1,526

Derivative instruments
 
 
 
 
 
Fuel hedge call options
—

 
19

 
19

Total Assets
433

 
1,112

 
1,545

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Interest rate swap agreements
—

 
(22
)
 
(22
)
Total Liabilities
—

 
(22
)
 
(22
)


11


December 31, 2015
Level 1
 
Level 2
 
Total
Assets
 
 
 
 
 
Marketable securities
 
 
 
 
 
U.S. government and agency securities
$
253

 
$
—

 
$
253

Foreign government bonds
—

 
31

 
31

Asset-backed securities
—

 
130

 
130

Mortgage-backed securities
—

 
116

 
116

Corporate notes and bonds
—

 
708

 
708

Municipal securities
—

 
17

 
17

Total Marketable securities
253

 
1,002

 
1,255

Derivative instruments
 
 
 
 
 
Fuel hedge call options
—

 
4

 
4

Total Assets
253

 
1,006

 
1,259

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Derivative instruments
 
 
 
 
 
Interest rate swap agreements
—

 
(18
)
 
(18
)
Total Liabilities
—

 
(18
)
 
(18
)

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

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

The Company has no financial assets that are measured at fair value on a nonrecurring basis at June 30, 2016.

Fair Value of Other Financial Instruments

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

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

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

Fixed-rate debt 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) is as follows:
 
June 30,
2016
 
December 31,
2015
Carrying amount
$
474

 
$
520

Fair value
509

 
557




12


NOTE 5. MILEAGE PLAN

Alaska's Mileage Plan liabilities and deferrals on the consolidated balance sheets (in millions):
 
June 30,
2016
 
December 31,
2015
Current Liabilities:
 
 
 
Other accrued liabilities
$
391

 
$
368

Other Liabilities and Credits:
 
 
 
Deferred revenue
477

 
427

Other liabilities
19

 
19

Total
$
887

 
$
814

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

 
$
69

 
$
143

 
$
134

Other - net revenues
108

 
82

 
211

 
159

Total
$
181

 
$
151

 
$
354

 
$
293


NOTE 6. LONG-TERM DEBT
 
Long-term debt obligations on the consolidated balance sheet (in millions):
 
June 30,
2016
 
December 31,
2015
Fixed-rate notes payable due through 2024
$
474

 
$
520

Variable-rate notes payable due through 2025
155

 
166

Less debt issuance costs
(3
)
 
(3
)
Total debt
626

 
683

Less current portion
117

 
114

Long-term debt, less current portion
$
509

 
$
569

 
 
 
 
Weighted-average fixed-interest rate
5.7
%
 
5.7
%
Weighted-average variable-interest rate
2.1
%
 
1.8
%

During the six months ended June 30, 2016, the Company made debt payments of $57 million. As discussed in Note 1, the Company adopted ASU 2015-03 which resulted in a reclassification of debt issuance costs as an offset to debt in the consolidated balance sheet.

At June 30, 2016, long-term debt principal payments for the next five years and thereafter are as follows (in millions):
 
Total
Remainder of 2016
$
58

2017
121

2018
151

2019
114

2020
116

Thereafter
69

Total
$
629

 
Bank Lines of Credit
 

13


The Company has two $100 million credit facilities and one $52 million credit facility. All three facilities have variable interest rates based on LIBOR plus a specified margin. One of the $100 million facilities, which expires in September 2017, is secured by aircraft. The other $100 million facility, which expires in March 2017, is secured by certain accounts receivable, spare engines, spare parts and ground service equipment. The $52 million facility expires in October 2016 with a mechanism for annual renewal and is secured by two 737-800 aircraft. The Company has no immediate plans to borrow using any of these facilities. All three credit facilities have a requirement to maintain a minimum unrestricted cash and marketable securities balance of $500 million. The Company is in compliance with this covenant at June 30, 2016.

NOTE 7. EMPLOYEE BENEFIT PLANS

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

 
$
10

 
$
18


$
20

Interest cost
19

 
21

 
37


42

Expected return on assets
(27
)
 
(30
)
 
(54
)

(61
)
Recognized actuarial loss (gain)
6

 
6

 
12


13

Total
$
7

 
$
7

 
$
13


$
14



NOTE 8. COMMITMENTS

Future minimum fixed payments for commitments (in millions):
June 30, 2016
Aircraft Leases
 
Facility Leases
 
Aircraft Purchase Commitments
 
Capacity Purchase Agreements (a)
Remainder of 2016
$
39

 
$
47

 
$
305

 
$
34

2017
99

 
90

 
931

 
78

2018
90

 
42

 
725

 
81

2019
82

 
41

 
648

 
86

2020
73

 
40

 
337

 
92

Thereafter
400

 
142

 
400

 
745

Total
$
783

 
$
402

 
$
3,346

 
$
1,116

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

Lease Commitments

At June 30, 2016, the Company’s fleet includes lease contracts for 21 B737 aircraft and 15 Q400s. Additionally, the fleet includes 15 lease commitments under the CPA with SkyWest, comprising 6 CRJ-700s and 9 E175s. All lease contracts have remaining noncancelable lease terms ranging from 2016 to 2029. The Company has the option to increase capacity flown by SkyWest with 8 additional E175 aircraft with 2017 and 2018 delivery dates.

The majority of airport and terminal facilities are also leased. Rent expense for aircraft and facility leases was $63 million and $67 million for the three months ended June 30, 2016 and 2015, respectively. Rent expense for aircraft and facility leases was $144 million and $140 million for the six months ended June 30, 2016 and 2015, respectively.

Aircraft Purchase Commitments
 
As of June 30, 2016, the Company is committed to purchasing 56 B737 aircraft (19 737-900ER aircraft and 37 737 MAX aircraft), 33 E175 aircraft and 2 Q400 aircraft, with deliveries in 2016 through 2022. As of June 30, 2016 we do not intend to

14


take delivery of the 2 Q400 aircraft that are currently contracted. In addition, the Company has options to purchase 46 B737 aircraft, 30 E175 aircraft and 5 Q400 aircraft, which are not reflected in the commitments table above.

Capacity Purchase Agreements (CPAs)
 
At June 30, 2016, Alaska had CPAs with three carriers, including the Company's wholly-owned subsidiary, Horizon. Horizon sells 100% of its capacity under a CPA with Alaska. In addition, Alaska has CPAs with SkyWest to fly certain routes and PenAir to fly certain routes in the state of Alaska. Under these agreements, Alaska pays the carriers an amount which is based on a determination of their cost of operating those flights and other factors intended to approximate market rates for those services. Future payments (excluding Horizon) are based on minimum levels of flying by the third-party carriers, which could differ materially due to variable payments based on actual levels of flying and certain costs associated with operating flights such as fuel.

Contingencies

The Company is a party to routine litigation matters incidental to its business and with respect to which no material liability is expected. Management believes the ultimate disposition of these matters is not likely to materially affect the Company's financial position or results of operations. This forward-looking statement is based on management's current understanding of the relevant law and facts, and it is subject to various contingencies, including the potential costs and risks associated with litigation and the actions of arbitrators, judges and juries.

NOTE 9. SHAREHOLDERS' EQUITY

Dividends

During the three months ended June 30, 2016, the Company declared and paid cash dividends of $0.275 per share, or $34 million. During the six months ended June 30, 2016, the Company declared and paid cash dividends of $0.550 per share, or $68 million.

Common Stock Repurchase

In May 2014, the Board of Directors authorized a $650 million share repurchase program, which was completed in October 2015. In August 2015, the Board of Directors authorized a $1 billion share repurchase program. In the second quarter the Company paused the share repurchase program in advance of the pending acquisition of Virgin America.
Share repurchase activity (in millions, except share amounts):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
2015 Repurchase Program - $1 billion
873,396

 
$
67

 
—

 
$
—

 
2,594,809

 
$
193

 
—


$
—

2014 Repurchase Program - $650 million
—

 
$
—

 
2,480,807

 
$
160

 
—

 
$
—

 
4,061,554

 
$
262

Total
873,396

 
$
67

 
2,480,807

 
$
160

 
2,594,809

 
$
193

 
4,061,554

 
$
262

 
Accumulated Other Comprehensive Loss
 
Components of accumulated other comprehensive income (loss), net of tax (in millions):
 
June 30,
2016
 
December 31,
2015
Marketable securities
$
9

 
$
(3
)
Employee benefit plans
(282
)
 
(288
)
Interest rate derivatives
(14
)
 
(12
)
Total
$
(287
)
 
$
(303
)


15




NOTE 10. OPERATING SEGMENT INFORMATION
 
Air Group has two operating airlines - Alaska and Horizon. Each is a regulated airline with separate management teams. To manage the two operating airlines and the revenues and expenses associated with the CPAs, management views the business in three operating segments:
Alaska Mainline - The Boeing 737 part of Alaska's business.
Alaska Regional - Alaska's shorter distance network. In this segment, Alaska Regional records actual on board passenger revenue, less costs such as fuel, distribution costs, and payments made to Horizon, SkyWest and PenAir under CPAs. Additionally, Alaska Regional includes a small allocation of corporate overhead such as IT, finance and other administrative costs incurred by Alaska and on behalf of the regional operations.
Horizon - Horizon operates regional aircraft. All of Horizon's capacity is sold to Alaska under a CPA. Expenses include those typically borne by regional airlines such as crew costs, ownership costs, station handling costs, and maintenance costs.

16


Additionally, the following table reports “Air Group adjusted,” which is not a measure determined in accordance with GAAP. The Company's chief operating decision-makers and others in management use this measure to evaluate operational performance and determine resource allocations. Adjustments are further explained below in a reconciliation to consolidated GAAP results.

Operating segment information is as follows (in millions):
 
Three Months Ended June 30, 2016
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Parent & Consolidating(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
1,036

 
$
—

 
$
—

 
$
—

 
$
1,036

 
$
—

 
$
1,036

Regional
—

 
227

 
—

 
—

 
227

 
—

 
227

Total passenger revenues
1,036

 
227

 
—

 
—

 
1,263

 
—

 
1,263

CPA revenues
—

 
—

 
110

 
(110
)
 
—

 
—

 
—

Freight and mail
26

 
1

 
—

 
—

 
27

 
—

 
27

Other - net
184

 
19

 
1

 
—

 
204

 
—

 
204

Total operating revenues
1,246

 
247

 
111

 
(110
)
 
1,494

 
—

 
1,494

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
679

 
192

 
101

 
(111
)
 
861

 
14

 
875

Economic fuel
180

 
31

 
—

 
—

 
211

 
(10
)
 
201

Total operating expenses
859

 
223

 
101

 
(111
)
 
1,072

 
4

 
1,076

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
6

 
—

 
1

 
—

 
7

 
—

 
7

Interest expense
(4
)
 
—

 
(4
)
 
(1
)
 
(9
)
 
—

 
(9
)
Other
3

 
—

 
—

 
1

 
4

 
—

 
4

 
5

 
—

 
(3
)
 
—

 
2

 
—

 
2

Income (loss) before income tax
$
392

 
$
24

 
$
7

 
$
1

 
$
424

 
$
(4
)
 
$
420


17


 
Three Months Ended June 30, 2015
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Parent & Consolidating(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
1,019

 
$
—

 
$
—

 
$
—

 
$
1,019

 
$
—

 
$
1,019

Regional
—

 
212

 
—

 
—

 
212

 
—

 
212

Total passenger revenues
1,019

 
212

 
—

 
—

 
1,231

 
—

 
1,231

CPA revenues
—

 
—

 
99

 
(99
)
 
—

 
—

 
—

Freight and mail
28

 
2

 
—

 
—

 
30

 
—

 
30

Other - net
156

 
19

 
1

 
—

 
176

 
—

 
176

Total operating revenues
1,203

 
233

 
100

 
(99
)
 
1,437

 
—

 
1,437

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses, excluding fuel
645

 
169

 
90

 
(100
)
 
804

 
—

 
804

Economic fuel
232

 
35

 
—

 
—

 
267

 
(6
)
 
261

Total operating expenses
877

 
204

 
90

 
(100
)
 
1,071

 
(6
)
 
1,065

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nonoperating income (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
5

 
—

 
—

 
1

 
6

 
—

 
6

Interest expense
(7
)
 
—

 
(1
)
 
(3
)
 
(11
)
 
—

 
(11
)
Other
7

 
—

 
(1
)
 
3

 
9

 
—

 
9

 
5

 
—

 
(2
)
 
1

 
4

 
—

 
4

Income (loss) before income tax
$
331

 
$
29

 
$
8

 
$
2

 
$
370

 
$
6

 
$
376

 
Six Months Ended June 30, 2016
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Parent & Consolidating(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
1,963


—


$
—


$
—


$
1,963


$
—


$
1,963

Regional
—


433


—


—


433


—


433

Total passenger revenues
1,963


433


—


—


2,396


—


2,396

CPA revenues
—


—


213


(213
)

—


—


—

Freight and mail
49


2


—


—


51


—


51

Other - net
356


36


2


—


394


—


394

Total operating revenues
2,368


471


215


(213
)

2,841


—


2,841

 




















Operating expenses




















Operating expenses, excluding fuel
1,380


378


206


(213
)

1,751


14


1,765

Economic fuel
324


56


—


—


380


(12
)

368

Total operating expenses
1,704


434


206


(213
)

2,131


2


2,133

 




















Nonoperating income (expense)



















Interest income
12


—


1


—


13


—


13

Interest expense
(16
)

—


(5
)

(1
)

(22
)

—


(22
)
Other
10


—


—


3


13


—


13

 
6


—


(4
)

2


4


—


4

Income (loss) before income tax
$
670


$
37


$
5


$
2


$
714


$
(2
)

$
712



18


 
Six Months Ended June 30, 2015
 
Alaska
 
 
 
 
 
 
 
 
 
 
 
Mainline
 
Regional
 
Horizon
 
Parent & Consolidating(a)
 
Air Group Adjusted(b)
 
Special Items(c)
 
Consolidated
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
 
 
 
 
 
 
Mainline
$
1,920

 
$
—

 
$
—

 
$
—

 
$
1,920

 
$
—

 
$
1,920

Regional
—

 
398

 
—

 
—

 
398

 
—

 
398

Total passenger revenues
1,920