ALASKA AIR GROUP, INC. quarterly report, Q2 FY2012

Business context and reporting period

Alaska Air Group, Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2012. The company operates Alaska Airlines and Horizon Air, with mainline, regional, and Horizon operations. Seasonal travel demand and volatile fuel prices mean interim results may not indicate full-year performance.

Financial performance and position

Metric	Q2 2012	Q2 2011	Six months 2012	Six months 2011
Operating revenue	$1,213.2 million	$1,110.2 million	$2,252.5 million	$2,075.4 million
Operating income	$115.8 million	$57.8 million	$188.2 million	$191.6 million
Net income	$67.5 million	$28.8 million	$108.3 million	$103.0 million
Diluted EPS	$0.93	$0.39	$1.50	$1.40
Operating margin	9.5%	5.2%	8.4%	9.2%

Q2 revenue rose 9.3%, while operating expenses rose 4.3%. Passenger revenue increased 10.2%; management attributed the improvement primarily to capacity growth and stronger unit revenue.
Q2 consolidated capacity rose 6.3%, load factor was 86.5% versus 84.3%, and revenue per available seat mile (RASM) increased 2.8%.
Fuel expense was $431.8 million in Q2, up 8.6%; for the first half it was $750.6 million, up 26.8%. First-half non-fuel expenses rose 1.7%. Q2 adjusted diluted EPS, excluding fuel-hedge mark-to-market adjustments and 2011 fleet-transition costs, was $1.53 versus $1.22. These are non-GAAP measures.
First-half cash from operations was $455.7 million, versus $368.7 million. Investing activities used $410.7 million and financing activities used $111.8 million. Cash and cash equivalents declined $66.8 million to $35.4 million; cash and marketable securities together totaled $1,185.4 million.
At June 30, total debt was $1,140.5 million, including $183.4 million current, compared with $1,306.9 million at December 31, 2011. Shareholders’ equity was $1,283.0 million. The company had no borrowings under its two $100 million credit facilities and met their $500 million minimum liquidity covenant.
Current assets were $1,698.4 million and current liabilities $1,664.3 million. The company reported $1,185.4 million in cash and marketable securities, but only $35.4 million of that amount was cash and cash equivalents.

Material changes versus comparable periods

Q2 pretax income rose to $109.1 million from $47.0 million, mainly on $103.0 million higher revenue; higher fuel and other operating costs partly offset the gain. The prior-year quarter included $26.8 million of Horizon fleet-transition expense, absent in 2012.
First-half net income increased modestly, although operating income declined. Fuel-hedge mark-to-market effects were losses of $49.7 million in first-half 2012 versus gains of $11.1 million in 2011; 2011 also included $36.9 million of fleet-transition costs. Adjusted first-half net income was $139.1 million versus $119.0 million, as defined by the company.
Fuel-hedge accounting materially affects reported earnings: Q2 included net mark-to-market losses of $69.6 million, compared with $70.9 million in Q2 2011. Economic fuel cost per gallon, a non-GAAP cash-oriented measure, was $3.40 in Q2 versus $3.28.
The company reclassified ancillary revenues, including baggage and ticket-change fees, from passenger revenue to “Other—net” for current and prior periods. This changed revenue categories but not total revenue.
A two-for-one stock split was distributed in March 2012. During the first half, the company repurchased $26.3 million of shares under a new $50 million authorization.

Outlook, commentary, and risks

Management expected Q3 capacity growth of about 6.5% year over year and consolidated non-fuel CASM of 8.20–8.30 cents, up 0.5%–1.5%. Full-year capacity was projected to grow about 6%; full-year non-fuel CASM was projected at 8.50–8.55 cents, approximately flat year over year.
Advance bookings indicated flat August load factor and a half-point decline in September versus 2011, on planned Q3 capacity growth of 6.5%. July load factor was 88.3%, up half a point. Management expected Q3 economic fuel cost per gallon to be approximately 5% lower year over year, but said fuel costs remained difficult to forecast.
Projected 2012 capital expenditures were $470 million. The company expected 2012 cash taxes of $75–$125 million and pension contributions of $10–$15 million in the remainder of the year; it had already contributed $23.6 million in the first half.
Contractual obligations totaled $3,333.7 million, including $1,140.5 million of debt, $921.4 million of operating leases and $812.8 million of aircraft purchase commitments. The company had firm orders for 25 aircraft and options for additional aircraft.
Fuel-price volatility, fuel-hedge valuation, economic conditions, competition, labor negotiations, operational disruptions, indebtedness and reliance on key markets were identified risks. Alaska and Horizon were negotiating with flight-attendant unions; ramp and stores agents had ratified a six-year agreement. Credit-card agreements could require reserves under specified credit-rating or liquidity conditions. Routine litigation was not expected by management to materially affect results.
Management said liquidity was sufficient for the foreseeable future; Standard & Poor’s had changed its outlook to positive. These statements are forward-looking and subject to the risks described in the filing.

Important facts for investors to verify

Separate underlying operating performance from volatile fuel-hedge mark-to-market impacts; review the company’s non-GAAP adjustments and reconciliations.
Monitor fuel prices, hedge coverage, settlement costs, and their effect on reported versus economic fuel expense.
Assess whether revenue and load-factor growth can support planned capacity increases while controlling non-fuel unit costs.
Review cash availability, debt maturities, aircraft commitments, lease obligations, and the credit-card reserve triggers alongside the headline liquidity balance.
Track pension costs and contributions, cash-tax expectations, labor negotiations, and execution of aircraft and capital-investment plans.