Alaska Air Group, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual filing; selected fourth-quarter results are also summarized below. Alaska Air Group operates Alaska Airlines, Horizon Air and McGee Air Services. Virgin America was legally merged into Alaska Airlines in July 2018.
Financial and operating performance
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Operating revenue | $8.264 billion | $7.894 billion | +4.7% |
| Operating income | $643 million | $1.208 billion | −46.8% |
| Operating margin | 7.8% | 15.3% | −7.5 percentage points |
| Net income | $437 million | $960 million | −54.5% |
| Diluted EPS | $3.52 | $7.75 | Down |
| Adjusted net income (non-GAAP) | $554 million | $791 million | Down 30% |
| Operating cash flow | $1.195 billion | $1.590 billion | Down $395 million |
| Capital expenditures | $960 million | $1.026 billion | Down $66 million |
Revenue growth reflected a 5.3% increase in capacity; passenger revenue rose 4.5%. Consolidated load factor fell 0.6 points to 83.7%, while RASM decreased 0.6% to 12.65 cents. CASMex, the company’s non-GAAP unit-cost measure excluding fuel and special items, increased 3.0% to 8.50 cents. Fuel expense rose 33.8% to $1.936 billion, driven by higher prices and 5% more gallons consumed. Wages and benefits increased 13.4% to $2.190 billion.
GAAP operating margin is calculated from reported operating income and revenue. Operating cash flow less capital expenditures was approximately $235 million; this is a simple derived measure, not company-reported free cash flow.
Fourth quarter: Revenue was $2.064 billion versus $1.942 billion; operating income was $46 million versus $137 million; net income was $23 million versus $315 million; and diluted EPS was $0.19 versus $2.55. The filing’s quarterly table reports these figures. The unusually high Q4 2017 net income included a substantial tax benefit associated with tax reform.
Balance sheet and liquidity at December 31, 2018: Cash and marketable securities totaled $1.236 billion, down from $1.621 billion. Total debt, including current maturities, was $2.103 billion, down from $2.569 billion; shareholders’ equity was $3.751 billion. Debt-to-capitalization, including the present value of aircraft operating leases, was 47%, compared with 53%. The company reported $400 million of unused credit lines for liquidity purposes; total facility availability was $516 million, with letters of credit secured against one facility. Management said cash, operating cash generation and other liquidity sources should cover operations and debt obligations for the foreseeable future. The company paid $158 million in dividends and repaid $807 million of debt in 2018.
Air Group reported three operating segments: Mainline, Regional and Horizon. Adjusted pretax results were $809 million for Mainline, a $100 million loss for Regional, and $27 million profit for Horizon. Regional’s result deteriorated from a $34 million profit in 2017, as higher capacity, aircraft ownership and fuel costs outpaced revenue growth.
Material changes versus the prior year
- GAAP net income fell to $437 million from $960 million, and adjusted net income declined to $554 million from $791 million. Higher fuel and non-fuel costs outweighed revenue growth.
- Fuel expense increased $489 million; non-fuel expenses excluding special items rose $430 million. Fuel cost per gallon and labor costs were significant drivers.
- Capacity grew 5.3%, while passengers increased 4.1%. Regional capacity expanded 19.9%, substantially faster than Mainline’s 3.9%.
- Cash and marketable securities declined $385 million, while total debt fell $466 million. The company made $807 million of debt payments and obtained $339 million of new secured financing.
- Virgin America integration reached approximately 95% of major milestones. Alaska and Virgin America received a single FAA operating certificate in January, adopted a single passenger-service system in April, and legally merged in July.
- Accounting comparisons reflect retrospective adoption of new revenue-recognition and retirement-benefit standards for 2017 and 2016. The company expected to recognize approximately $1.75–$1.85 billion of lease assets and liabilities upon adopting the new lease standard in 2019.
Outlook, risks and unusual items
- 2019 outlook: Management expected network capacity growth of approximately 2%, versus 5.3% in 2018, and full-year CASMex growth of 2%–2.5%. It expected jet-fuel price per gallon to decline approximately 4% year over year, while noting fuel-price uncertainty. Management anticipated wage and maintenance pressure, ongoing but lower merger costs, and higher costs in the first half from regional mix, maintenance timing and employee training.
- Revenue initiatives: Management estimated approximately $200 million of incremental 2019 revenue from Saver Fares (about $100 million), other initiatives (about $50 million), and higher checked-bag fees (about $50 million). These are expectations, not reported results.
- Integration and labor: Remaining work included Airbus cabin reconfiguration, combining Boeing and Airbus maintenance operations, system integration and reaching an agreement with aircraft technicians. Failure to complete integration smoothly or labor disputes could delay synergies and disrupt operations.
- Legal contingency: On February 4, 2019, a court entered an approximately $78 million judgment in a California wage-and-hour class action involving about 1,800 former Virgin America flight attendants. The company planned to appeal and recorded no loss accrual, citing its view of the claims and federal preemption arguments.
- Aircraft accident: An employee took a Horizon Q400 without authorization in August 2018; the aircraft crashed, killing the individual. The company said the aircraft loss was fully insured and expected insurance proceeds in the first half of 2019; the claim was still being finalized.
- Key business risks: Fuel-price volatility, intense fare and capacity competition, concentration in West Coast markets, high fixed costs and debt obligations, labor costs and shortages, weather and air-traffic disruption, reliance on aircraft and service vendors, cyber and technology risks, and possible goodwill impairment. Fuel hedging covered portions of expected consumption; the company cautioned that fuel costs remain difficult to forecast.
- Other items: 2018 special items included $87 million of merger costs, a $20 million maintenance-contract termination fee and $25 million of employee bonuses following tax reform. The financial statements received an unqualified audit opinion, and the auditor also reported effective internal control over financial reporting.
Important facts for investors to verify
- Whether capacity restraint, revenue initiatives and network maturation improve unit revenue and margins in 2019, and whether the projected $200 million of incremental revenue is achieved.
- Actual fuel prices, refining margins and hedge outcomes, alongside wage, maintenance and regional-flying cost trends.
- Progress on Airbus retrofits, operational integration, labor agreements and realization of merger synergies.
- Developments in the $78 million class-action judgment, including appeal outcomes, potential payment and any future accrual.
- Cash generation, debt repayments, credit availability and the effect of recognizing lease liabilities under the new lease standard.
- Insurance proceeds from the Q400 loss and any related costs or claims not covered by insurance.