Alaska Air Group, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Amounts are in U.S. dollars; financial statement figures are in millions except per-share data. Virgin America, acquired in December 2016, is included in 2017 results but not in the reported 2016 comparisons.
Business context and key financial results
Air Group operates Alaska Airlines, Virgin America and Horizon Air. The acquisition makes reported year-over-year growth difficult to compare; where available, management’s “Combined Comparative” figures include Virgin America in the prior-year baseline.
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Operating revenue | $2,102 | $1,494 | $3,851 | $2,841 |
| Operating income | $493 | $418 | $659 | $708 |
| Net income | $296 | $260 | $395 | $444 |
| Diluted EPS | $2.38 | $2.10 | $3.17 | $3.56 |
| Operating cash flow | Not provided by quarter | Not provided by quarter | $1,084 | $899 |
On a Combined Comparative basis, Q2 revenue rose 10% and operating expenses rose 13%; for the first six months, revenue rose 6% and expenses rose 13%. Reported Q2 revenue increased 41%, largely reflecting Virgin America’s inclusion. Six-month reported operating income and net income declined despite higher reported revenue.
- Q2 margins and costs: GAAP operating margin was approximately 23.5% (versus 28.0% in Q2 2016). Consolidated CASM excluding fuel and special items was 7.94 cents, up 2.1% reported; Combined Comparative CASMex was up 3.3%.
- Fuel: Q2 GAAP fuel expense was $344, up $143 reported and $66 (24%) on a Combined Comparative basis. Economic fuel cost was $1.71 per gallon versus $1.54 on the combined prior-year basis.
- Cash flow and investment: First-half operating cash flow was $1,084; capital expenditures were $512, implying approximately $572 of operating cash flow less capital expenditures. Investing cash outflow was $971, and financing cash outflow was $243.
- Liquidity and debt: Cash and marketable securities totaled $1,922 at June 30, 2017, versus $1,580 at year-end 2016. Gross debt was $2,806, including $337 current; long-term debt net of current portion was $2,469. Debt-to-capital including the present value of aircraft operating leases was 55%, down from 59%.
- Shareholder returns: Dividends paid in the first half totaled $74 ($0.60 per share); share repurchases were $22. The company resumed its $1 billion repurchase program during Q2.
Material changes and notable items
- Virgin America materially expanded the reported business and contributed to higher revenue, expenses, staffing and aircraft fleet. Combined Comparative results offer a more informative trend than reported totals.
- Q2 merger-related costs were $24; first-half costs were $64, primarily severance and retention. The company expects further integration costs through 2019.
- First-half operating cash flow increased $185 from the prior-year period, driven in part by a larger increase in air traffic liability and Virgin America’s addition; net income was lower.
- Higher fuel prices, labor costs, maintenance activity and irregular-operation costs pressured results. First-half adjusted net income, excluding specified merger and fuel-hedge items, was $443 versus $445 in 2016.
Outlook, risks and contingencies
- Capacity and unit-cost outlook: Management expected 2017 combined network capacity growth of approximately 8%. Q3 guidance was 16,310–16,360 million ASMs and CASM excluding fuel and special items of 8.00–8.05 cents. Full-year guidance was 62,455–62,610 million ASMs and CASM excluding fuel and special items of 8.07–8.11 cents. Full-year fuel-price guidance was not provided because of volatility.
- Integration: The company expected a single operating certificate in early 2018 and a single reservations system in Q2 2018, which management expected to bring forward approximately $20 million of revenue synergies into 2018. Alaska’s brand was expected to replace Virgin America’s in 2019.
- Labor: Pilot contract talks proceeded to arbitration, with a decision expected in Q4 2017. Management estimated the contract could add approximately $140 million to annual wages and benefits; that increase was not included in current unit-cost guidance. Horizon’s pilot agreement included a $9 million ratification bonus, recognized in Q2 expense.
- Operations: Q2 on-time performance was 82.4% for Alaska, 67.1% for Virgin America and 82.6% for Horizon. Air traffic control issues, runway construction and Horizon pilot shortages were cited as causes.
- Liquidity commitments: The company reported $3,017 of non-cancelable aircraft purchase commitments and $2,253 of aircraft lease commitments, in addition to debt and other contractual obligations. Credit-card agreements could require reserves if specified credit-rating or liquidity thresholds are breached; no reserve was then required. The company was in compliance with the $500 minimum unrestricted cash and securities covenant.
- Legal and other risks: A certified class action alleges wage-and-hour violations by Virgin America flight attendants; the company intends to defend the case and said it did not expect litigation to materially affect results. Key stated risks include fuel-price volatility, competition, operational disruption, labor matters, and successful Virgin America integration and synergy realization. Management reported disclosure controls were effective and no material risk-factor changes.
Important facts for investors to verify
- Use Combined Comparative results when assessing underlying year-over-year performance; reported comparisons exclude Virgin America in 2016.
- Track whether integration milestones and the expected $20 million of 2018 revenue synergies are achieved, and monitor continuing merger costs.
- Reassess unit-cost guidance after the pilot arbitration decision and compare actual fuel prices and operating costs with management’s expectations.
- Monitor operating reliability, particularly Virgin America on-time performance and Horizon pilot staffing, alongside planned capacity growth.
- Review aircraft commitments, lease obligations, debt maturities and credit-card liquidity covenants against cash generation and available liquidity.