Alaska Air Group, Inc. — 2010 Q2 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2010; it was filed August 5, 2010. Air Group operates Alaska Airlines and Horizon Air. Comparisons below are against the corresponding 2009 periods unless stated otherwise. Financial amounts are in millions except per-share data.
Key financial results
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Operating revenue | $976.4 | $843.9 | $1,806.3 | $1,586.3 |
| Operating income | $109.9 | $66.7 | $135.9 | $54.8 |
| Operating margin | 11.3% | 7.9% | 7.5% | 3.5% |
| Net income | $58.6 | $29.1 | $63.9 | $9.9 |
| Diluted EPS | $1.60 | $0.79 | $1.74 | $0.27 |
| Operating cash flow | Not stated separately for Q2 | $333.6 | $123.2 |
- Q2 revenue grew 15.7%; operating income rose 64.8%. Net income increased 101.4%. For the first half, revenue rose 13.9% and net income increased $54.0.
- Passenger revenue was $881.5 in Q2, up from $757.2. Management cited improved load factors and passenger unit revenue; checked-bag fees contributed to the increase.
- Fuel was a major cost pressure: reported aircraft fuel expense rose to $255.0 in Q2 from $128.4 and to $462.3 for the first half from $286.1. Q2 economic fuel averaged $2.31 per gallon company-wide, versus $1.84 in 2009, according to management.
- Six-month operating cash flow improved to $333.6, partly reflecting higher earnings and increased advance ticket-sale cash inflows. The air traffic liability rose $162.7 in the period, an important working-capital contributor.
- At June 30, cash and marketable securities totaled $1,272.7, compared with $1,192.1 at year-end 2009. Total debt was $1,724.3, including $154.3 current and $1,570.0 long-term; total debt was down $130.9 from year-end. Shareholders’ equity was $939.9.
- Current assets were $1,739.2 and current liabilities $1,440.7. The company reported $200 of revolving credit facilities, no immediate borrowing plans, and compliance with the facilities’ $500 minimum unrestricted cash and marketable-securities covenant.
- Investing cash outflow was $239.9 in the first half, versus $462.6 in 2009; capital expenditures were $111.8. Financing cash outflow was $149.8, including $130.9 of debt payments and $26.3 of share repurchases.
Material changes and operating performance
- Management attributed the Q2 pretax-income increase, to $94.0 from $47.7, primarily to $132.5 higher operating revenue and the absence of the prior-year $35.8 pilot-contract transition charge, partly offset by higher fuel expense.
- Air Group’s reported results include volatile fuel-hedge mark-to-market effects. Q2 included a $37.6 net mark-to-market loss, versus a $39.8 gain in 2009. First-half results included a $50.1 loss, versus a $49.8 gain.
- Excluding hedge mark-to-market effects and identified transition charges, management presented non-GAAP adjusted net income of $84.0, or $2.29 diluted EPS, for Q2 2010 versus $26.5, or $0.72, in Q2 2009. For the first half, adjusted net income was $97.1, or $2.65 diluted EPS, versus $1.1, or $0.03. These are company-defined non-GAAP measures and are not substitutes for reported results.
- Alaska earned $96.5 pretax in Q2; Horizon recorded a $1.2 pretax loss. Horizon’s first-half pretax loss was $7.4. Higher fuel costs contributed to Horizon’s weaker reported Q2 result.
- Alaska’s Q2 mainline load factor improved to 83.0% from 78.8%; passenger revenue per available seat mile increased 11.6%. Alaska’s mainline cost per available seat mile excluding fuel and specified transition costs fell 5.2%. Horizon’s corresponding Q2 measure fell 2.2% excluding fuel and CRJ-700 transition costs.
Outlook, risks and unusual items
- Management expressed a positive outlook for the second half of 2010, citing advance bookings above prior-year levels for August through October and a strong summer season. It forecast Alaska mainline CASM excluding fuel and specified items down about 3%–4% for Q3 and full-year 2010. Horizon’s comparable CASM was forecast up 5% in Q3 and flat to down 1% for the full year.
- Management expected economic fuel costs to remain higher than in 2009. Fuel prices and hedge valuations are volatile; the company hedged approximately 50% of expected fuel requirements in Q3 and Q4 2010, with hedge coverage declining in later periods.
- Horizon’s transition toward an all-Q400 fleet is delayed by weak regional-aircraft resale and sublease markets. The company recorded a $3.4 CRJ-700 transition charge in Q2 and expected another $7–$9 in Q3 for four additional aircraft. Further costs related to the remaining CRJ-700 fleet and Q200 subleases could not be estimated.
- Horizon planned to outsource remaining heavy-maintenance functions, expecting annual savings of about $3, with a Q3 severance and continuing-benefits charge estimated below $3. Other potential Horizon restructuring, fleet, labor and operating-model changes could produce additional costs that management could not yet estimate.
- Air Group had firm orders for 21 aircraft with aggregate future payments of approximately $571, plus options for additional aircraft. It forecast 2010 gross capital expenditures of about $210. Pension contributions were expected to be approximately $45 in 2010; the filing notes annual contributions could range from $45 to $75 based on historical practice.
- Management said current liquidity and expected cash flows should be adequate for operations, capital commitments and debt obligations for at least 12 months. It planned to reduce cash and marketable securities from 35% of trailing revenue to 25%–30% over two years, using some cash for debt repayment, share repurchases and pension funding.
- Key disclosed risks include economic weakness and travel demand, fuel-price volatility, substantial indebtedness, competition, cost-reduction execution, labor matters, operational disruptions, market concentration, safety incidents, security threats, reliance on systems and third parties, and regulatory changes. Routine litigation was not expected by management to materially affect financial position or results.
- The company repurchased 645,748 shares for $26.3 under its prior authorization during the first half. A new $50 share-repurchase authorization was approved in June; no purchases under that program had occurred by June 30. Management reported purchases beginning in July.
Important facts for investors to verify
- How much of the reported earnings improvement reflects stronger underlying fares, load factors and cost control versus fuel-hedge mark-to-market timing and prior-year transition charges.
- Whether passenger demand and advance bookings remain strong, and whether fee revenue and fare levels can offset higher fuel and airport costs.
- Actual fuel prices, hedge settlements and hedge coverage, including the effect of hedge premiums and refining-margin swaps on future cash costs.
- Horizon’s CRJ-700 and Q200 disposition costs, projected savings from maintenance outsourcing, and progress toward sustained profitability.
- Cash generation after changes in advance ticket sales and other working capital, and the planned balance between debt reduction, pension contributions, capital spending and share repurchases.
- Aircraft purchase commitments, lease obligations and pension funding needs, alongside the company’s liquidity and debt covenant compliance.