ALK

Business Context and Reporting Period

Company: Alaska Air Group, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2009
Business Overview: The Company operates two primary airlines: Alaska Airlines, Inc. (mainline jet service) and Horizon Air Industries, Inc. (regional service). The reporting period reflects operations during a severe economic recession, characterized by reduced passenger demand and significant capacity reductions.

Key Financial Metrics

Note: Operating income for the six-month period includes a $35.8 million charge for new pilot contract transition costs.

Material Changes vs. Prior Comparable Period

• Revenue Decline: Total operating revenues decreased 9.3% in Q2 2009 compared to Q2 2008, driven by a 6.2% drop in passenger traffic and a 2.5% decline in unit operating revenues due to the economic recession.
• Fuel Cost Reduction: Aircraft fuel expense decreased significantly. Economic fuel cost per gallon dropped 43.2% year-over-year in Q2 2009 ($1.84 vs. $3.24), resulting in a $169.1 million reduction in economic fuel expense compared to the prior year quarter.
• Special Charges:
  • 2009: Incurred $35.8 million in "New pilot contract transition costs" (one-time bonus and sick-leave payout program) following the ratification of a new pilot contract.
  • 2008: Incurred $32.1 million in fleet transition costs related to the retirement of MD-80 and CRJ-700 aircraft.
• Profitability: Net income for Q2 2009 was $29.1 million, down from $63.1 million in Q2 2008. The decline was primarily due to lower revenues and the new pilot contract charge, partially offset by lower fuel costs and the absence of 2008 fleet transition charges.

Guidance, Outlook, and Risks

• Outlook: Management expects advance booked load factors to be slightly up for August 2009 but down for September. Capacity is expected to decline by 5% for Alaska mainline and 10% for Horizon in Q3 2009.
• Revenue Initiatives:
  • Implementation of a $15 first checked bag fee (effective July 7, 2009), expected to generate at least $70 million annually.
  • Revised Mileage Plan affinity card agreement expected to generate an additional $15 million in revenue for the second half of 2009.
• Cost Guidance: Mainline costs per ASM (excluding fuel and special items) are forecast to be up 9-11% in Q3 2009 and 8% for the full year 2009 compared to 2008.
• Liquidity: The Company maintains a strong liquidity position with $1.1 billion in cash and marketable securities. It has completed sale-leaseback transactions and secured financing for new aircraft.
• Risks:
  • Economic Conditions: Continued recession impacting travel demand.
  • Fuel Volatility: Exposure to crude oil price fluctuations, though mitigated by hedging.
  • Labor: Ongoing negotiations with the International Association of Machinists (IAM); other unions have ratified new contracts.
  • Fleet Transition: Delays in remarketing CRJ-700 aircraft due to market conditions; potential for additional exit charges.

Investor Verification Checklist

• Debt Covenants: Verify compliance with financial covenants given the significant indebtedness ($1.8 billion total debt).
• Fuel Hedge Portfolio: Review the fair value of fuel hedge contracts ($75.2 million net asset) and the impact of mark-to-market accounting on reported earnings.
• Pilot Contract Impact: Assess the long-term cost implications of the new pilot contract, including the $23 million expected increase in wages and benefits for 2009.
• Asset Impairment: Monitor the status of the 18 CRJ-700 aircraft and potential future impairment charges as remarketing efforts continue.
• First Bag Fee Revenue: Track the actual revenue generated from the new first checked bag fee starting in Q3 2009 against the $30 million H2 2009 estimate.