ALASKA AIR GROUP, INC. quarterly report, Q2 FY2019

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Business context and reporting period

Alaska Air Group, Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2019. The company operates Alaska Airlines and Horizon Air, with regional flying also provided by third-party carriers. Unless noted otherwise, financial amounts below are in millions of dollars.

Financial performance and position

  • Second quarter: Operating revenue was $2,288, up 6% year over year. Operating income was $364 (15.9% operating margin), versus $271 (12.6%) a year earlier. Net income was $262, or $2.11 diluted EPS, compared with $193, or $1.56. Pretax income rose to $351 from $259.
  • Adjusted results: Excluding merger-related costs and mark-to-market fuel-hedge adjustments, Q2 adjusted net income was $270, or $2.17 per diluted share, versus $206, or $1.66. These are non-GAAP measures.
  • First six months: Revenue was $4,164, up 4%; operating income was $389 (9.3% margin), versus $300 (7.5%); and net income was $266, or $2.14 diluted EPS, versus $197, or $1.59. Adjusted net income was $291, or $2.34 per diluted share, versus $224, or $1.81.
  • Revenue and operations: Q2 passenger revenue grew 6%, supported by 4.6% higher yield and 1.1% higher traffic. Consolidated load factor was 86.2%, up 0.2 percentage points. Q2 RASM rose 5.2%; adjusted CASM excluding fuel and special items increased 2.3% to 8.33 cents.
  • Costs: Q2 fuel expense increased 6% to $502, while non-fuel expenses excluding special items rose 3% to $1,414. Merger-related costs fell to $8 from $39. For the first half, fuel expense was $922 and non-fuel expenses excluding special items were $2,819.
  • Cash flow: First-half operating cash flow was $1,033, investing cash outflow $530, and financing cash outflow $363. Capital expenditures were $333. Cash, cash equivalents and restricted cash ended at $254; cash and marketable securities were $1,627.
  • Debt and liquidity: Total debt was $1,826, including $288 current, down from $2,103 at year-end 2018. Operating lease liabilities were $1,697 following adoption of the new lease standard. Debt-to-capitalization including leases was 45%, versus 47% at year-end. The company reported $516 of credit-facility availability in the debt note; the MD&A liquidity discussion cites $400 of combined lines with no outstanding borrowings. The company was compliant with the $500 minimum unrestricted cash and marketable securities covenant.

Material changes versus the prior comparable period

  • Q2 pretax income increased $92, primarily reflecting $132 higher revenue, partly offset by $27 higher fuel expense and $12 higher non-fuel operating expense.
  • Regional operations moved from a Q2 pretax loss of $20 to profit of $12. Mainline Q2 pretax profit rose to $334 from $288; Horizon reported $10 in both periods.
  • First-half operating cash flow increased $307 year over year, with higher revenue, larger increases in air traffic liability and deferred revenue, and expense-payment timing cited as drivers.
  • Cash and marketable securities rose 32% from December 31, 2018. Debt declined, while capitalized operating lease assets and liabilities were recognized under the lease accounting standard adopted January 1, 2019; this affects balance-sheet comparability.

Outlook, commentary, risks and unusual items

  • Management’s long-term goal is 13%–15% pretax margins over the business cycle. It expects revenue initiatives and merger synergies to contribute an incremental $330 of revenue in 2019.
  • Expected network capacity growth is approximately 2.1% in 2019 and 3%–4% in 2020. Management expects third-quarter 2019 economic fuel cost per gallon to be about 5% below the prior-year quarter.
  • For full-year 2019, management expects wages and benefits to grow faster than capacity; maintenance expense to be 3%–4% above 2018; aircraft rent 5%–6% higher; depreciation and amortization 8%–9% higher; and contracted-services expense 9%–10% lower. Expected capital expenditures are $725 in 2019 and $775 in 2020.
  • Labor agreements are a cost consideration: the AMFA agreement was ratified in July; the IAM agreement was tentative, with voting expected to conclude in Q3. The agreements were expected to add approximately $50 annually once implemented. If IAM ratification occurred, management expected $24 of signing bonuses and $24 of wage-rate increases in the second half of 2019.
  • The FAA grounding of Boeing 737 MAX aircraft delayed deliveries. The company had commitments for 32 737 MAX 9 aircraft, with delivery timing revised, and reported one scheduled A321neo lease delivery for the remainder of 2019. It later canceled three scheduled 2021 SkyWest E175 deliveries.
  • A California wage-and-hour class-action judgment against Virgin America and Alaska Airlines was approximately $78. The company is appealing and recorded no loss accrual, citing its view of the merits and federal preemption arguments.
  • Other cited risks include fuel-price volatility, competition, labor relations and staffing, operational disruptions, economic conditions, revenue concentration in key markets, aircraft incidents, cybersecurity/automated systems, and regulatory changes. Management stated there were no material changes to the annual report’s risk factors.
  • Management reported effective disclosure controls and no material impairment charges in the periods presented. Seasonality and fuel-price volatility mean interim results are not necessarily indicative of full-year results.

Most important facts for investors to verify

  1. Whether revenue initiatives and merger synergies deliver the expected $330 of incremental 2019 revenue and support the stated margin objective.
  2. Whether labor contract ratification and implementation produce the expected costs, including the second-half charges described for the IAM agreement.
  3. The timing and financial effects of 737 MAX delivery delays, fleet plans, and the company’s substantial aircraft and lease commitments.
  4. The outcome and potential cash impact of the approximately $78 class-action judgment, for which no loss was accrued.
  5. How cash generation, capital spending, debt repayment, fuel hedges, and available credit facilities affect liquidity and compliance with the $500 covenant.