Alaska Air Group, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context and comparability
Air Group operates Alaska Airlines, Virgin America and Horizon Air. Virgin America was acquired on December 14, 2016, so Q1 2017 results include its operations but Q1 2016 reported results do not. The filing also presents selected “Combined Comparative” figures, combining historical Alaska Air Group and Virgin America data for Q1 2016; these are not pro forma results.
Financial and operating performance
| Metric | Q1 2017 | Q1 2016 reported |
|---|---|---|
| Operating revenue | $1,749 | $1,347 |
| Operating income | $166 | $290 |
| Net income | $99 | $184 |
| Diluted EPS | $0.79 | $1.46 |
| Operating cash flow | $470 | $525 |
| Capital expenditures | $216 | $119 |
GAAP operating margin was approximately 9.5% versus 21.5%; net margin was approximately 5.7% versus 13.7%. The reported-period comparisons are substantially affected by Virgin America’s inclusion in 2017.
- Management said pretax income fell $140 million, primarily reflecting $354 million more non-fuel expense and $172 million more fuel expense, partly offset by $402 million higher revenue.
- On a combined comparative basis, revenue increased 2%, while operating expense increased 14%. Combined-comparative PRASM fell 3.3%, RASM fell 2.6%, and CASM excluding fuel and special items rose 0.1%.
- Q1 merger-related costs were $40 million, primarily severance and retention. Excluding merger costs and fuel-hedge mark-to-market adjustments, adjusted net income was $130 million, or $1.05 per diluted share; this is a non-GAAP measure.
- Combined-comparative fuel expense rose 42%, with higher raw fuel prices the principal driver. GAAP fuel expense also included a $10 million mark-to-market hedge loss.
Balance sheet, liquidity and cash flow
- Cash and marketable securities totaled $1.710 billion at March 31, up from $1.580 billion at year-end. Cash and cash equivalents alone were $183 million.
- Total debt was $2.863 billion, including $332 million current and $2.531 billion long-term; debt payments were $101 million during the quarter. Long-term debt-to-capital including aircraft operating leases was 58%.
- Operating activities provided $470 million; investing used $488 million and financing used $127 million. Cash and cash equivalents declined $145 million to $183 million.
- Credit facilities total $302 million; the filing also describes $250 million of combined bank lines in its liquidity discussion. The facilities require at least $500 million of unrestricted cash and marketable securities; the company reported compliance. A $52 million facility was secured by letters of credit.
- Contractual obligations totaled $11.199 billion, including $3.337 billion of aircraft purchase commitments and $2.833 billion of operating lease commitments. The company forecast $1.155 billion of 2017 property and equipment additions.
Guidance, management commentary and risks
- For 2017, management expected combined network capacity growth of approximately 8.5%. Full-year capacity guidance was 62.8–63.0 billion ASMs; CASM excluding fuel and special items was forecast at 8.00–8.05 cents, approximately flat year over year. Q2 guidance was 15.625–15.675 billion ASMs and CASM of 7.88–7.93 cents, about 3% higher year over year.
- Management expected to continue Virgin America integration and targeted a single operating certificate in early 2018; the Alaska name and logo were expected to replace Virgin America’s in 2019. Management said merger costs would continue during 2017.
- Winter weather disrupted operations; on-time performance was 78.4% for Alaska, 64.7% for Virgin America and 70.9% for Horizon. Management identified improved operational performance as a focus.
- In April, Horizon reached a tentative pilot contract agreement that included higher pay and an approximately $10 million ratification bonus.
- Key exposures include fuel-price volatility, competition and capacity growth, operational disruptions, labor and staffing, integration and synergy execution, and concentration in key markets. Credit-card agreements could require reserves if cash and marketable securities fell below $500 million or specified credit-rating triggers were met; no reserve was then required.
- A certified class action alleges wage-and-hour violations by Virgin America flight attendants. The company disputed the claims and intended to defend the case; management did not expect litigation matters to materially affect results. The filing reported no material change to previously disclosed risk factors.
- The company expected adoption of the new revenue standard in 2018 to increase its frequent-flyer liability by approximately $350–$450 million and change classification of certain revenues. Lease accounting changes effective in 2019 are expected to recognize right-of-use assets and lease liabilities.
Important facts for investors to verify
- Compare results using the filing’s combined-comparative data as well as reported GAAP figures, accounting for the acquisition-related scope difference.
- Track integration costs, realization of expected synergies, operating reliability and progress toward the single operating certificate.
- Monitor fuel costs and hedges, unit revenue trends, capacity growth and non-fuel unit-cost performance against guidance.
- Assess liquidity against aircraft purchases, debt maturities, lease commitments and the $500 million cash-and-securities covenant/credit-card thresholds.
- Review the final Virgin America purchase-price allocation, the flight-attendant litigation and the expected frequent-flyer accounting transition impact.