Business Context and Reporting Period
Company: Alaska Air Group, Inc. (Alaska Air Group)
Reporting Period: Fiscal year ended December 31, 2002
Business Overview: Alaska Air Group is a holding company with two principal airline subsidiaries: Alaska Airlines (major carrier, all-jet fleet) and Horizon Air (regional carrier, jet and turboprop fleet). The company operates primarily in the U.S. West Coast, Alaska, Canada, and Mexico. The 2002 operating environment was characterized by weak economic conditions, reduced corporate travel, and the lingering effects of the September 11, 2001 terrorist attacks, which led to industry-wide capacity reductions and bankruptcies among competitors.
Key Financial Metrics
| Metric | 2002 (in millions) | 2001 (in millions) |
|---|---|---|
| Operating Revenues | $2,224.1 | $2,152.8 |
| Operating Expenses | $2,313.0 | $2,279.1 |
| Operating Loss | $(88.9) | $(126.3) |
| Net Loss | $(118.6) | $(43.4) |
| Net Loss Before Accounting Change | $(67.2) | $(43.4) |
| Cash and Cash Equivalents | $269.0 | $490.8 |
| Working Capital | $198.4 | $167.0 |
| Long-term Debt & Capital Leases | $856.7 | $852.2 |
| Shareholders' Equity | $655.7 | $851.3 |
Key Ratios & Statistics:
- Debt-to-Capital Ratio: 57% (Debt) to 43% (Equity) as of Dec 31, 2002.
- Fuel Costs: Represented 13.1% of total operating expenses in 2002.
- Labor Costs: Represented approximately 37% of total operating expenses in 2002.
- Operating Fleet: 102 aircraft (Alaska) and 63 aircraft (Horizon) as of Dec 31, 2002.
Material Changes vs. Prior Period
- Operating Performance: The operating loss improved by $37.4 million (29.6%) compared to 2001, driven by a 3.7% increase in passenger revenue and a 4.6% decrease in aircraft fuel expenses. However, the company continued to report annual losses for the third consecutive year.
- Accounting Changes: The 2002 Net Loss includes a one-time, non-cash charge of $51.4 million for the write-off of all goodwill due to the adoption of SFAS No. 142. Additionally, a non-cash charge of $87.2 million (net of tax) was recorded to equity related to defined benefit pension plans due to lower investment returns and reduced discount rates.
- Government Compensation: Nonoperating income decreased significantly due to the reduction in U.S. government compensation related to the September 11 attacks. The company recognized $0.5 million in 2002 compared to $81.4 million in 2001.
- Revenue Mix: Passenger revenue increased 3.7% due to higher traffic (7.6% increase in RPMs) despite a 3.6% decrease in yield per passenger mile. Freight and mail revenue decreased 7.8% due to post-9/11 security measures.
- Cost Structure: Wages and benefits increased 9.7% due to wage increases and higher benefit costs. Commission expenses decreased 24.8% following the elimination of travel agent base commissions.
Guidance, Outlook, and Risks
Liquidity and Outlook: Management believes current cash resources ($635.8 million in cash and marketable securities) and internally generated funds will be sufficient to fund operations through 2003. The company anticipates continued industry losses and weak demand in 2003.
Key Risks and Contingencies:
- Flight 261 Litigation: The company is a defendant in lawsuits regarding the January 2000 crash of Flight 261. While 48 cases have been settled, trials for remaining cases are set for July 2003. Management does not expect a material impact on financial position.
- Fuel Price Volatility: A one-cent increase in fuel price per gallon affects annual costs by approximately $3.8 million. The company has hedged approximately 35% of its 2003 expected jet fuel requirements.
- Labor Relations: 83% of Alaska's and 46% of Horizon's employees are unionized. Several contracts are amendable or in negotiation, posing a risk of increased costs or work stoppages.
- Insurance Costs: War risk and liability insurance costs have increased significantly post-9/11. The company relies on government-provided war risk insurance, which is renewable only until August 31, 2003.
- Debt Covenants: The company must comply with financial covenants in its credit facilities. Failure to comply could result in an event of default and acceleration of debt repayment.
Investor Verification Checklist
- Goodwill Impairment: Verify the $51.4 million non-cash goodwill write-off and its impact on the reported net loss versus operating performance.
- Pension Liability: Review the $87.2 million non-cash charge to equity regarding pension underfunding and the assumptions used for discount rates and expected returns.
- Liquidity Position: Confirm the sufficiency of the $635.8 million cash and marketable securities balance to cover operations and debt service through 2003.
- Flight 261 Exposure: Monitor the status of the remaining litigation cases scheduled for trial in July 2003 and potential settlement costs.
- Fuel Hedging Effectiveness: Assess the performance of fuel hedge contracts and the exposure to rising fuel prices for the 65% of 2003 requirements not hedged.
- Debt Covenant Compliance: Verify continued compliance with financial covenants in the $150 million revolving credit facility and other debt agreements.