ALASKA AIR GROUP, INC. annual report, FY2013

Alaska Air Group, Inc. — FY 2013 Form 10-K

Reporting period: Fiscal year ended December 31, 2013. The filing also reports fourth-quarter results. Alaska Air Group operates Alaska Airlines and Horizon Air, with regional capacity from partner carriers, serving nearly 100 cities. Figures are in U.S. dollars unless noted.

Financial and operating performance

Metric	FY 2013	FY 2012
Operating revenue	$5.156 billion	$4.657 billion
Operating income	$838 million	$532 million
Income before tax	$816 million	$514 million
Net income / diluted EPS	$508 million / $7.16	$316 million / $4.40
Adjusted net income / diluted EPS (non-GAAP)	$383 million / $5.40	$339 million / $4.73
Net cash from operating activities	$981 million	$753 million
Capital expenditures	$566 million	$518 million

• Revenue increased 11%; passenger revenue rose 6%, while other-net revenue increased 13%. Traffic grew 6.8% and capacity 7.1%; load factor was 85.6%, down 0.3 percentage points. Yield declined 0.8%.
• Reported operating expenses increased 5% to $4.318 billion. Fuel expense was $1.467 billion, or 34% of operating expenses; non-fuel CASM, excluding fuel and fleet-transition costs, declined 0.1% to 8.47 cents.
• Year-end cash and marketable securities were $1.330 billion, versus $1.252 billion. Long-term debt including current maturities was $871 million, down from $1.032 billion. Adjusted debt-to-capital was 35%, compared with 48% in 2012.
• Qualified defined-benefit pensions were 104% funded, with a $60 million surplus, versus 82% funded and a $335 million deficit in 2012. Shareholders’ equity rose to $2.029 billion from $1.421 billion.
• Air Group repurchased $159 million of shares and paid $28 million in dividends; the 2013 declared dividend was $0.40 per share.

Fourth-quarter snapshot

Fourth-quarter 2013 operating revenue was $1.210 billion, operating income $130 million, and net income $78 million, compared with $1.132 billion, $74 million, and $44 million, respectively, in fourth-quarter 2012.

Material changes and unusual items

• 2013 GAAP results included a $192 million one-time, non-cash Mileage Plan revenue adjustment, primarily from modified accounting for the Bank of America affinity-card agreement and revised mileage breakage estimates. The item contributed $120 million after tax, or $1.70 per diluted share; adjusted earnings exclude it.
• Adjusted net income increased to $383 million from $339 million. This measure also excludes fuel-hedge mark-to-market effects; 2013 recorded an after-tax hedge gain adjustment of $5 million, compared with an after-tax loss adjustment of $23 million in 2012.
• Passenger revenue increased $237 million, but lower ticket yields partly offset traffic growth. Increased competition in Alaska and on the West Coast pressured mainline yield and load factor.
• Operating cash flow increased by $228 million, according to management, reflecting revenue and Mileage Plan cash-receipt growth, among other factors. Investing cash outflow was $698 million and financing cash outflow was $325 million.
• The company adopted ASU 2009-13 following the July 2013 modification of its affinity-card agreement, changing allocation of consideration among program deliverables. Management also increased its estimate of miles expected to expire unused from 12% to 17.4%.

Outlook, commentary and risks

• Management forecast 2014 consolidated capacity growth of about 5.5% for the full year and consolidated non-fuel cost per ASM, excluding fuel and special items, of 8.52–8.57 cents, about 1% higher year over year. No full-year earnings guidance was provided.
• For Q1 2014, management forecast consolidated capacity growth of about 4.5% and non-fuel cost per ASM of 9.00–9.05 cents, about 4.5% higher year over year. January load factor was down 0.3 points year over year; advance bookings indicated expected declines of 1 point in February and 3 points in March.
• Management identified increased competition, particularly Delta’s planned growth in Seattle, as its primary concern. It expected unit-revenue pressure, while forecasting passenger revenue growth, and planned to defend markets through schedule, loyalty-program and marketing actions.
• Planned investment includes cabin upgrades, brand refresh spending and fleet modernization. The company reported firm commitments for 69 Boeing aircraft through 2022 and options for additional aircraft. Forecast 2014 property and equipment additions were $525 million.
• Principal risks include volatile jet-fuel prices, fare and capacity competition, dependence on Seattle and other key markets, economic weakness, adverse weather and operational disruptions, labor costs and negotiations, aircraft/engine supplier concentration, vendor and IT/cybersecurity failures, regulation, and substantial fleet and other capital commitments. A $1-per-barrel oil-price increase was estimated to add about $11 million of annual fuel cost.
• Management said current liquidity and expected operating cash flows should fund operations for the foreseeable future. The company had $200 million of revolving credit facilities undrawn and was required to maintain at least $500 million of unrestricted cash and marketable securities under facility covenants.
• Management expected higher cash tax payments in 2014, but timing and amount were uncertain. Routine litigation was not expected to materially affect results. The filing reports no known FAA or TSA enforcement proceedings expected to materially affect the company’s position or operating authority.

Important facts for investors to verify

• How much of reported 2013 earnings growth is sustainable after excluding the $192 million non-cash Mileage Plan adjustment and fuel-hedge mark-to-market effects.
• Whether passenger yields and load factors stabilize amid planned capacity growth and increased competition, especially in Seattle and Alaska.
• Actual fuel prices, hedge settlements and cash effects, including the company’s reduced hedge horizon and exposure on unhedged fuel consumption.
• Whether operating cash flow can support aircraft commitments, forecast capital spending, dividends and repurchases while preserving liquidity.
• Whether labor agreements, maintenance costs, pension assumptions and Mileage Plan estimates develop in line with management expectations.