UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2005.
2006.
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 1-8957
ALASKA AIR GROUP, INC.
(Exact name of registrant as specified in its charter)
| Delaware | 91-1292054 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
19300 International Boulevard, Seattle, Washington 98188
(Address of principal executive offices)
Registrant’s telephone number, including area code: (206) 392-5040
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, (as definedor a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). YesAct (Check one):
Large accelerated filer x NoAccelerated filer ¨
Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
The registrant has 27,603,11340,022,870 common shares, par value $1.00, outstanding at September 30, 2005.2006.
| PART I. FINANCIAL INFORMATION | ||||||
Item 1. | 3 | |||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | |||||
Item 3. | ||||||
Item 4. | ||||||
| PART II. OTHER INFORMATION | ||||||
Item 1. | ||||||
Item 1A. | 47 | |||||
Item 2. | ||||||
Item 3. | ||||||
Item 4. | ||||||
Item 5. | ||||||
Item 6. | 48 | |||||
Cautionary Note regarding Forward-Looking Statements
In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements withinsubject to the meaning ofsafe harbor protection provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act. Forward-lookingAct of 1934. These statements are those that predict or describerelate to future events or trends and involve known and unknown risks and uncertainties that do not relate solelymay cause actual outcomes to historical matters. You can generally identifybe materially different from those indicated by any forward-looking statements as statements containing the words “believe,” “expect,” “will,” “anticipate,” “intend,” “estimate,” “project,” “assume” or other similar expressions, although not all forward-looking statements contain these identifying words.statements. Some of the things that could cause our actual results to differ from our expectations are: the competitive environment and other trends in our industry; changes in our operating costs including fuel, which can be volatile; the competitive environment and other trends in our industry; our ability to meet our cost reduction goals; labor disputes;our inability to achieve or maintain profitability and fluctuations in our quarterly results; our significant indebtedness; the implementation of our growth strategy; the timing of the MD-80 fleet disposal and the amounts of potential lease termination payments with lessors and sublease payments from sublessees; compliance with our financial covenants; potential downgrades of our credit ratings and the availability of financing; the concentration of our revenue from a few key markets; general economic conditions; our reliance on automated systems; increasesconditions, as well as economic conditions in government fees and taxes;the geographic regions we serve; actual or threatened terrorist attacks,attacks; global instability and potential U.S. military actions or activities; insurance costs; changes in lawslabor disputes; our ability to attract and regulations;retain qualified personnel; an aircraft accident or incident; liability and other claims asserted against us; operational disruptions; compliance with financial covenants;increases in government fees and taxes; changes in laws and regulations; our ability to attractreliance on automated systems; and retain qualified personnel;our reliance on third-party vendors and partners; our significant indebtedness; and downgrades of our credit ratings and availability of financing.partners. For a discussion of these and other risk factors, see Item 71A, “Risk Factors” of the Company’sthis Form 10-Q and Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2004 on Form 10-K under the caption “Risk Factors.”2005. All of the forward-looking statements are qualified in their entirety by reference to the risk factors discussed therein. These risk factors may not be exhaustive. We operate in a continually changing business environment, and new risk factors emerge from time to time. Management cannot predict such new risk factors, nor can it assess the impact, if any, of such new risk factors on our business or events described in any forward-looking statements. We disclaim any obligation to publicly update or revise any forward-looking statements after the date of this report to conform them to actual results. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such differences might be significant and materially adverse.
PART I. FINANCIAL INFORMATION
| ITEM 1. | Condensed Consolidated Financial Statements |
CONSOLIDATED BALANCE SHEETS (unaudited)
Alaska Air Group, Inc.
(In Millions) | September 30, 2005 | December 31, 2004 | ||||
ASSETS | ||||||
Current Assets | ||||||
Cash and cash equivalents | $ | 26.7 | $ | 28.0 | ||
Marketable securities | 719.0 | 845.9 | ||||
Restricted securities lending collateral | 76.5 | — | ||||
Receivables - net | 130.1 | 99.4 | ||||
Inventories and supplies - net | 48.1 | 42.0 | ||||
Deferred income taxes | 61.8 | 74.7 | ||||
Fuel hedge contracts | 140.7 | 65.7 | ||||
Prepaid expenses and other current assets | 105.2 | 86.6 | ||||
Total Current Assets | 1,308.1 | 1,242.3 | ||||
Property and Equipment | ||||||
Aircraft and other flight equipment | 2,258.8 | 2,294.3 | ||||
Other property and equipment | 473.5 | 471.8 | ||||
Aircraft purchase deposits | 214.3 | 67.1 | ||||
| 2,946.6 | 2,833.2 | |||||
Less accumulated depreciation and amortization | 988.0 | 924.9 | ||||
Total Property and Equipment - Net | 1,958.6 | 1,908.3 | ||||
Intangible Assets | 38.6 | 38.6 | ||||
Fuel Hedge Contracts | 71.1 | 30.3 | ||||
Other Assets | 133.3 | 115.5 | ||||
Total Assets | $ | 3,509.7 | $ | 3,335.0 | ||
(In Millions) | September 30, 2006 | December 31, 2005 | ||||
ASSETS | ||||||
Current Assets | ||||||
Cash and cash equivalents | $ | 152.3 | $ | 73.6 | ||
Marketable securities | 955.4 | 909.0 | ||||
Securities lending collateral | 111.4 | 112.0 | ||||
Receivables - net | 145.8 | 124.2 | ||||
Inventories and supplies - net | 52.4 | 44.0 | ||||
Deferred income taxes | 122.9 | 91.8 | ||||
Fuel hedge contracts | 55.1 | 101.4 | ||||
Prepaid expenses and other current assets | 102.0 | 84.3 | ||||
Total Current Assets | 1,697.3 | 1,540.3 | ||||
Property and Equipment | ||||||
Aircraft and other flight equipment | 2,135.6 | 2,265.5 | ||||
Other property and equipment | 518.9 | 481.0 | ||||
Deposits for future flight equipment | 440.4 | 305.3 | ||||
| 3,094.9 | 3,051.8 | |||||
Less accumulated depreciation and amortization | 843.9 | 1,019.6 | ||||
Total Property and Equipment - Net | 2,251.0 | 2,032.2 | ||||
Intangible Assets Related to Additional Minimum Pension Liability | 33.6 | 33.6 | ||||
Fuel Hedge Contracts | 26.5 | 51.9 | ||||
Other Assets | 131.3 | 134.0 | ||||
Total Assets | $ | 4,139.7 | $ | 3,792.0 | ||
See accompanying notes to condensed consolidated financial statements.
CONSOLIDATED BALANCE SHEETS (unaudited)
Alaska Air Group, Inc.
(In Millions) | September 30, 2005 | December 31, 2004 | ||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Current Liabilities | ||||||||
Accounts payable | $ | 138.4 | $ | 143.8 | ||||
Accrued aircraft rent | 64.0 | 75.3 | ||||||
Accrued wages, vacation and payroll taxes | 93.9 | 133.0 | ||||||
Other accrued liabilities | 350.7 | 301.6 | ||||||
Air traffic liability | 320.5 | 250.2 | ||||||
Securities lending obligation | 76.5 | — | ||||||
Current portion of long-term debt and capital lease obligations | 57.6 | 53.4 | ||||||
Total Current Liabilities | 1,101.6 | 957.3 | ||||||
Long-Term Debt and Capital Lease Obligations | 970.0 | 989.6 | ||||||
Other Liabilities and Credits | ||||||||
Deferred income taxes | 176.3 | 173.6 | ||||||
Deferred revenue | 276.5 | 264.8 | ||||||
Other liabilities | 285.7 | 284.9 | ||||||
| 738.5 | 723.3 | |||||||
Commitments and Contingencies | ||||||||
Shareholders’ Equity | ||||||||
Preferred stock, $1 par value | ||||||||
Authorized: 5,000,000 shares, none issued or outstanding | — | — | ||||||
Common stock, $1 par value | ||||||||
Authorized: 100,000,000 shares | ||||||||
Issued: 2005 -30,130,917 shares | ||||||||
2004 - 29,777,388 shares | 30.1 | 29.8 | ||||||
Capital in excess of par value | 513.0 | 496.5 | ||||||
Treasury stock, at cost: 2005 - 2,527,804 shares | ||||||||
2004 - 2,651,368 shares | (57.7 | ) | (60.5 | ) | ||||
Deferred stock-based compensation | (9.2 | ) | (3.4 | ) | ||||
Accumulated other comprehensive loss | (87.7 | ) | (81.6 | ) | ||||
Retained earnings | 311.1 | 284.0 | ||||||
| 699.6 | 664.8 | |||||||
Total Liabilities and Shareholders’ Equity | $ | 3,509.7 | $ | 3,335.0 | ||||
(In Millions) | September 30, 2006 | December 31, 2005 | ||||||
LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
Current Liabilities | ||||||||
Accounts payable | $ | 89.9 | $ | 86.9 | ||||
Accrued aircraft rent | 50.3 | 71.8 | ||||||
Accrued wages, vacation and payroll taxes | 133.8 | 105.9 | ||||||
Other accrued liabilities | 433.3 | 383.7 | ||||||
Air traffic liability | 358.2 | 291.8 | ||||||
Securities lending obligation | 111.4 | 112.0 | ||||||
Current portion of long-term debt | 203.6 | 113.5 | ||||||
Total Current Liabilities | 1,380.5 | 1,165.6 | ||||||
Long-Term Debt, Net of Current Portion | 945.5 | 969.1 | ||||||
Other Liabilities and Credits | ||||||||
Deferred income taxes | 155.2 | 156.4 | ||||||
Deferred revenue | 317.7 | 291.1 | ||||||
Other liabilities | 375.8 | 382.2 | ||||||
| 848.7 | 829.7 | |||||||
Commitments and Contingencies | ||||||||
Shareholders’ Equity | ||||||||
Preferred stock, $1 par value | ||||||||
Authorized: 5,000,000 shares, none issued or outstanding | — | — | ||||||
Common stock, $1 par value | ||||||||
Authorized: 100,000,000 shares | ||||||||
Issued: 2006 - 42,336,784 shares | ||||||||
2005 - 35,932,925 shares | 42.3 | 35.9 | ||||||
Capital in excess of par value | 868.6 | 710.3 | ||||||
Treasury stock, at cost: 2006 - 2,313,914 shares | ||||||||
2005 - 2,478,779 shares | (52.8 | ) | (56.6 | ) | ||||
Deferred stock-based compensation | — | (8.1 | ) | |||||
Accumulated other comprehensive loss | (130.2 | ) | (132.0 | ) | ||||
Retained earnings | 237.1 | 278.1 | ||||||
| 965.0 | 827.6 | |||||||
Total Liabilities and Shareholders' Equity | $ | 4,139.7 | $ | 3,792.0 | ||||
See accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Alaska Air Group, Inc.
Three Months Ended September 30 (In Millions Except Per Share Amounts) | 2005 | 2004 | ||||||
Operating Revenues | ||||||||
Passenger | $ | 777.4 | $ | 706.0 | ||||
Freight and mail | 26.1 | 25.5 | ||||||
Other - net | 42.2 | 36.7 | ||||||
Total Operating Revenues | 845.7 | 768.2 | ||||||
Operating Expenses | ||||||||
Wages and benefits | 221.5 | 248.9 | ||||||
Contracted services | 30.8 | 19.7 | ||||||
Aircraft fuel | 204.1 | 148.4 | ||||||
Aircraft maintenance | 55.2 | 37.0 | ||||||
Aircraft rent | 46.9 | 46.7 | ||||||
Food and beverage service | 13.5 | 14.3 | ||||||
Selling expenses | 44.3 | 37.5 | ||||||
Depreciation and amortization | 36.3 | 35.7 | ||||||
Landing fees and other rentals | 52.4 | 49.3 | ||||||
Other | 51.9 | 46.4 | ||||||
Restructuring charges | (1.4 | ) | 27.5 | |||||
Total Operating Expenses | 755.5 | 711.4 | ||||||
Operating Income | 90.2 | 56.8 | ||||||
Nonoperating Income (Expense) | ||||||||
Interest income | 8.6 | 7.9 | ||||||
Interest expense | (16.1 | ) | (13.6 | ) | ||||
Interest capitalized | 2.8 | 0.5 | ||||||
Fuel hedging gains | 62.9 | 66.9 | ||||||
Other - net | (1.6 | ) | 0.7 | |||||
| 56.6 | 62.4 | |||||||
Income before income tax | 146.8 | 119.2 | ||||||
Income tax expense | 56.6 | 45.2 | ||||||
Net Income | $ | 90.2 | $ | 74.0 | ||||
Basic Earnings Per Share | $ | 3.28 | $ | 2.75 | ||||
Diluted Earnings Per Share | $ | 2.71 | $ | 2.29 | ||||
Pro Forma Results (assuming change in method of accounting was applied retrospectively): | ||||||||
Pro Forma Net Income | NA | $ | 84.1 | |||||
Pro Forma Basic Earnings Per Share | NA | $ | 3.13 | |||||
Pro Forma Diluted Earnings Per Share | NA | $ | 2.61 | |||||
Shares used for computation: | ||||||||
Basic | 27.502 | 26.862 | ||||||
Diluted | 33.857 | 32.631 | ||||||
See accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Alaska Air Group, Inc.
Nine Months Ended September 30 (In Millions Except Per Share Amounts) | 2005 | 2004 | ||||||
Operating Revenues | ||||||||
Passenger | $ | 2,061.9 | $ | 1,896.7 | ||||
Freight and mail | 71.3 | 68.3 | ||||||
Other - net | 111.5 | 102.5 | ||||||
Total Operating Revenues | 2,244.7 | 2,067.5 | ||||||
Operating Expenses | ||||||||
Wages and benefits | 693.5 | 737.1 | ||||||
Contracted services | 96.2 | 79.1 | ||||||
Aircraft fuel | 526.0 | 384.8 | ||||||
Aircraft maintenance | 174.6 | 137.9 | ||||||
Aircraft rent | 140.0 | 141.5 | ||||||
Food and beverage service | 37.1 | 39.5 | ||||||
Selling expenses | 119.5 | 111.5 | ||||||
Depreciation and amortization | 105.8 | 105.8 | ||||||
Landing fees and other rentals | 156.5 | 138.5 | ||||||
Other | 156.4 | 147.0 | ||||||
Restructuring charges | 20.7 | 27.5 | ||||||
Impairment of aircraft and related spare parts | — | 39.6 | ||||||
Total Operating Expenses | 2,226.3 | 2,089.8 | ||||||
Operating Income (Loss) | 18.4 | (22.3 | ) | |||||
Nonoperating Income (Expense) | ||||||||
Interest income | 21.6 | 18.6 | ||||||
Interest expense | (45.5 | ) | (38.9 | ) | ||||
Interest capitalized | 4.9 | 1.1 | ||||||
Fuel hedging gains | 198.6 | 93.3 | ||||||
Other - net | (4.5 | ) | 0.5 | |||||
| 175.1 | 74.6 | |||||||
Income before income tax and accounting change | 193.5 | 52.3 | ||||||
Income tax expense | 76.0 | 22.7 | ||||||
Income before accounting change | 117.5 | 29.6 | ||||||
Cumulative effect of accounting change, net of tax | (90.4 | ) | — | |||||
Net Income | $ | 27.1 | $ | 29.6 | ||||
Basic Earnings Per Share: | ||||||||
Income before accounting change | $ | 4.31 | $ | 1.10 | ||||
Cumulative effect of accounting change | (3.32 | ) | NA | |||||
Net Income Per Share | $ | 0.99 | $ | 1.10 | ||||
Diluted Earnings Per Share: | ||||||||
Income before accounting change | $ | 3.62 | $ | 0.98 | ||||
Cumulative effect of accounting change | (2.69 | ) | NA | |||||
Net Income Per Share | $ | 0.93 | $ | 0.98 | ||||
Pro Forma Results(assuming change in method of accounting was applied retrospectively): | ||||||||
Pro Forma Net Income | NA | $ | 45.8 | |||||
Pro Forma Basic Earnings Per Share | NA | $ | 1.71 | |||||
Pro Forma Diluted Earnings Per Share | NA | $ | 1.48 | |||||
Shares used for computation: | ||||||||
Basic | 27.274 | 26.820 | ||||||
Diluted | 33.523 | 32.691 | ||||||
| Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||||
(In Millions Except Per Share Amounts) | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Operating Revenues | ||||||||||||||||
Passenger | $ | 871.5 | $ | 777.4 | $ | 2,358.4 | $ | 2,061.9 | ||||||||
Freight and mail | 26.7 | 26.1 | 74.8 | 71.3 | ||||||||||||
Other - net | 37.5 | 42.2 | 110.9 | 111.5 | ||||||||||||
Total Operating Revenues | 935.7 | 845.7 | 2,544.1 | 2,244.7 | ||||||||||||
Operating Expenses | ||||||||||||||||
Wages and benefits | 238.6 | 218.1 | 696.2 | 683.0 | ||||||||||||
Variable incentive pay | 5.0 | 3.4 | 24.1 | 10.5 | ||||||||||||
Contracted services | 37.6 | 30.8 | 114.3 | 96.2 | ||||||||||||
Aircraft fuel, including hedging gains and losses | 290.8 | 141.2 | 653.7 | 327.4 | ||||||||||||
Aircraft maintenance | 49.6 | 55.2 | 168.6 | 174.6 | ||||||||||||
Aircraft rent | 43.9 | 46.9 | 136.6 | 140.0 | ||||||||||||
Food and beverage service | 13.5 | 13.7 | 38.3 | 37.9 | ||||||||||||
Selling expenses | 44.7 | 45.9 | 132.6 | 123.8 | ||||||||||||
Depreciation and amortization | 40.5 | 36.3 | 114.1 | 105.8 | ||||||||||||
Landing fees and other rentals | 52.9 | 50.8 | 152.4 | 152.2 | ||||||||||||
Other | 55.6 | 51.7 | 160.4 | 155.6 | ||||||||||||
Fleet transition costs | 58.4 | — | 189.5 | — | ||||||||||||
Restructuring charges and adjustments | 28.6 | (1.4 | ) | 32.4 | 20.7 | |||||||||||
Total Operating Expenses | 959.7 | 692.6 | 2,613.2 | 2,027.7 | ||||||||||||
Operating Income (Loss) | (24.0 | ) | 153.1 | (69.1 | ) | 217.0 | ||||||||||
Nonoperating Income (Expense) | ||||||||||||||||
Interest income | 14.2 | 8.6 | 39.4 | 21.6 | ||||||||||||
Interest expense | (20.4 | ) | (16.1 | ) | (57.6 | ) | (45.5 | ) | ||||||||
Interest capitalized | 7.1 | 2.8 | 17.6 | 4.9 | ||||||||||||
Other - net | 0.2 | (1.6 | ) | (1.5 | ) | (4.5 | ) | |||||||||
| 1.1 | (6.3 | ) | (2.1 | ) | (23.5 | ) | ||||||||||
Income (loss) before income tax and accounting change | (22.9 | ) | 146.8 | (71.2 | ) | 193.5 | ||||||||||
Income tax expense (benefit) | (5.5 | ) | 56.6 | (30.2 | ) | 76.0 | ||||||||||
Income (loss) before accounting change | (17.4 | ) | 90.2 | (41.0 | ) | 117.5 | ||||||||||
Cumulative effect of accounting change, net of tax | — | — | — | (90.4 | ) | |||||||||||
Net Income (Loss) | ($17.4 | ) | $ | 90.2 | $ | (41.0 | ) | $ | 27.1 | |||||||
Basic Earnings (Loss) Per Share: | ||||||||||||||||
Income (loss) before accounting change | $ | (0.44 | ) | $ | 3.28 | $ | (1.10 | ) | $ | 4.31 | ||||||
Cumulative effect of accounting change | NA | NA | NA | (3.32 | ) | |||||||||||
Net Income (Loss) Per Share | $ | (0.44 | ) | $ | 3.28 | $ | (1.10 | ) | $ | 0.99 | ||||||
Diluted Earnings (Loss) Per Share: | ||||||||||||||||
Income (loss) before accounting change | $ | (0.44 | ) | $ | 2.71 | $ | (1.10 | ) | $ | 3.62 | ||||||
Cumulative effect of accounting change | NA | NA | NA | (2.69 | ) | |||||||||||
Net Income (Loss) Per Share | $ | (0.44 | ) | $ | 2.71 | $ | (1.10 | ) | $ | 0.93 | ||||||
Shares used for computation: | ||||||||||||||||
Basic | 39.954 | 27.502 | 37.172 | 27.274 | ||||||||||||
Diluted | 39.954 | 33.857 | 37.172 | 33.523 | ||||||||||||
See accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (unaudited)
Alaska Air Group, Inc.
(In Millions) | Common Shares Outstanding | Common Stock | Capital in Excess of Par Value | Treasury at Cost | Deferred Stock-Based Compensation | Accumulated Other Comprehensive Income (Loss) | Retained Earnings | Total | |||||||||||||||||||
Balances at December 31, 2004: | 27.126 | $ | 29.8 | $ | 496.5 | $ | (60.5 | ) | $ | (3.4 | ) | $ | (81.6 | ) | $ | 284.0 | $ | 664.8 | |||||||||
Net income for the nine months ended September 30, 2005 | 27.1 | 27.1 | |||||||||||||||||||||||||
Other comprehensive income (loss): | |||||||||||||||||||||||||||
Related to marketable securities: | |||||||||||||||||||||||||||
Change in fair value | (2.2 | ) | |||||||||||||||||||||||||
Reclassification to earnings | 3.3 | ||||||||||||||||||||||||||
Income tax effect | (0.4 | ) | |||||||||||||||||||||||||
| 0.7 | 0.7 | ||||||||||||||||||||||||||
Related to fuel hedges: | |||||||||||||||||||||||||||
Reclassification to earnings | (10.8 | ) | |||||||||||||||||||||||||
Income tax effect | 4.0 | ||||||||||||||||||||||||||
| (6.8 | ) | (6.8 | ) | ||||||||||||||||||||||||
Total comprehensive loss | 21.0 | ||||||||||||||||||||||||||
Deferred stock-based compensation | 6.9 | (6.9 | ) | — | |||||||||||||||||||||||
Amortization of deferred stock-based compensation | 1.1 | 1.1 | |||||||||||||||||||||||||
Treasury stock sales, including $0.3 tax benefit | 0.123 | — | — | 2.8 | 2.8 | ||||||||||||||||||||||
Stock issued for employee stock purchase plan | 0.094 | 0.1 | 6.5 | — | 6.6 | ||||||||||||||||||||||
Stock issued under stock plans, including $0.9 tax benefit | 0.260 | 0.2 | 3.1 | — | 3.3 | ||||||||||||||||||||||
Balances at September 30, 2005 | 27.603 | $ | 30.1 | $ | 513.0 | $ | (57.7 | ) | $ | (9.2 | ) | $ | (87.7 | ) | $ | 311.1 | $ | 699.6 | |||||||||
(In Millions) | Common Shares Outstanding | Common Stock | Capital in Excess of Par Value | Treasury Stock, at Cost | Deferred Stock-Based Compensation | Accumulated Other Comprehensive Loss | Retained Earnings | Total | |||||||||||||||||||||
Balances at December 31, 2005 | 33.454 | $ | 35.9 | $ | 710.3 | $ | (56.6 | ) | $ | (8.1 | ) | $ | (132.0 | ) | $ | 278.1 | $ | 827.6 | |||||||||||
Net loss for the nine months ended September 30, 2006 | (41.0 | ) | (41.0 | ) | |||||||||||||||||||||||||
Other comprehensive income (loss): | |||||||||||||||||||||||||||||
Related to marketable securities: | |||||||||||||||||||||||||||||
Change in fair value | 3.4 | ||||||||||||||||||||||||||||
Reclassification to earnings | — | ||||||||||||||||||||||||||||
Income tax effect | (1.3 | ) | |||||||||||||||||||||||||||
| 2.1 | 2.1 | ||||||||||||||||||||||||||||
Related to fuel hedges: | |||||||||||||||||||||||||||||
Reclassification to earnings | (0.5 | ) | |||||||||||||||||||||||||||
Income tax effect | 0.2 | ||||||||||||||||||||||||||||
| (0.3 | ) | (0.3 | ) | ||||||||||||||||||||||||||
Total comprehensive loss | (39.2 | ) | |||||||||||||||||||||||||||
Implementation of SFAS 123R | (8.1 | ) | 8.1 | — | |||||||||||||||||||||||||
Stock-based compensation | 5.8 | 5.8 | |||||||||||||||||||||||||||
Treasury stock issued under stock plans | 0.165 | — | 3.8 | 3.8 | |||||||||||||||||||||||||
Stock issued for employee stock purchase plan | 0.069 | 0.1 | 1.8 | — | 1.9 | ||||||||||||||||||||||||
Stock issued under stock plans, including $3.0 tax benefit | 0.566 | 0.5 | 19.0 | — | 19.5 | ||||||||||||||||||||||||
Stock issued upon conversion of senior convertible notes, net of $4.4 million of unamortized issuance costs | 5.769 | 5.8 | 139.8 | 145.6 | |||||||||||||||||||||||||
Balances at September 30, 2006 | 40.023 | $ | 42.3 | $ | 868.6 | $ | (52.8 | ) | $ | 0.0 | $ | (130.2 | ) | $ | 237.1 | $ | 965.0 | ||||||||||||
See accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Alaska Air Group, Inc.
Nine Months Ended September 30 (In Millions) | 2005 | 2004 | ||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 27.1 | $ | 29.6 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Cumulative effect of accounting change, net of tax effect | 90.4 | — | ||||||
Restructuring charges | 20.7 | 27.5 | ||||||
Impairment of aircraft and related spare parts | — | 39.6 | ||||||
Depreciation and amortization | 105.8 | 105.8 | ||||||
Amortization of airframe and engine overhauls | — | 48.3 | ||||||
Stock-based compensation | 1.1 | — | ||||||
Changes in fair values of open fuel hedge contracts | (126.6 | ) | (80.4 | ) | ||||
Loss (gain) on sale of assets | 1.4 | (1.4 | ) | |||||
Changes in deferred income taxes | 68.7 | 28.4 | ||||||
(Increase) decrease in receivables - net | (30.7 | ) | 0.2 | |||||
Increase in prepaid expenses and other current assets | (28.4 | ) | (13.8 | ) | ||||
Increase in air traffic liability | 70.3 | 42.2 | ||||||
Increase (decrease) in other current liabilities | (12.8 | ) | 31.4 | |||||
Increase (decrease) in deferred revenue and other-net | (6.8 | ) | 26.1 | |||||
Net cash provided by operating activities | 180.2 | 283.5 | ||||||
Cash flows from investing activities: | ||||||||
Proceeds from disposition of assets | 5.4 | 11.1 | ||||||
Purchases of marketable securities | (908.7 | ) | (717.0 | ) | ||||
Sales and maturities of marketable securities | 1,036.7 | 615.9 | ||||||
Securities lending collateral | (76.5 | ) | — | |||||
Securities lending obligation | 76.5 | — | ||||||
Property and equipment additions: | ||||||||
Aircraft and aircraft purchase deposits | (253.6 | ) | (52.0 | ) | ||||
Capitalized overhauls | — | (44.1 | ) | |||||
Other flight equipment | (39.6 | ) | (22.0 | ) | ||||
Other property and equipment | (24.1 | ) | (25.7 | ) | ||||
Aircraft deposits returned | 7.5 | 19.2 | ||||||
Restricted deposits and other | (3.6 | ) | (4.5 | ) | ||||
Net cash used in investing activities | (180.0 | ) | (219.1 | ) | ||||
Cash flows from financing activities: | ||||||||
Proceeds from issuance of long-term debt, net | 20.0 | 94.6 | ||||||
Long-term debt and capital lease payments | (35.4 | ) | (193.2 | ) | ||||
Proceeds from issuance of common stock | 13.9 | 2.3 | ||||||
Net cash used in financing activities | (1.5 | ) | (96.3 | ) | ||||
Net change in cash and cash equivalents | (1.3 | ) | (31.9 | ) | ||||
Cash and cash equivalents at beginning of period | 28.0 | 158.8 | ||||||
Cash and cash equivalents at end of period | $ | 26.7 | $ | 126.9 | ||||
Supplemental disclosure of cash paid (refunded) during the period for: | ||||||||
Interest (net of amount capitalized) | $ | 35.5 | $ | 34.8 | ||||
Income taxes | (1.8 | ) | (39.6 | ) | ||||
Noncash investing and financing activities: | ||||||||
Assets acquired under long-term debt and capital leases | — | 44.7 | ||||||
Credit received for flight deposits deferred in other liabilities | 9.7 | — | ||||||
| Nine Months Ended September 30 | ||||||||
(In Millions) | 2006 | 2005 | ||||||
Cash flows from operating activities: | ||||||||
Net income | $ | (41.0 | ) | $ | 27.1 | |||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Cumulative effect of accounting change, net of tax effect | — | 90.4 | ||||||
Restructuring charges and adjustments | 32.4 | 20.7 | ||||||
Fleet transition costs | 189.5 | — | ||||||
Depreciation and amortization | 114.1 | 105.8 | ||||||
Stock-based compensation | 5.8 | 1.1 | ||||||
Changes in fair values of open fuel hedge contracts | 71.2 | (126.6 | ) | |||||
Loss (gain) on sale of assets | 0.1 | 1.4 | ||||||
Changes in deferred income taxes | (30.4 | ) | 68.7 | |||||
Tax benefit from stock option exercises | (3.0 | ) | (1.2 | ) | ||||
(Increase) decrease in receivables - net | (21.6 | ) | (30.7 | ) | ||||
Increase in prepaid expenses and other current assets | (33.6 | ) | (28.4 | ) | ||||
Increase in air traffic liability | 66.4 | 70.3 | ||||||
Increase (decrease) in other current liabilities | 35.7 | (12.8 | ) | |||||
Increase (decrease) in deferred revenue and other-net | 3.3 | (6.8 | ) | |||||
Net cash provided by operating activities | 388.9 | 179.0 | ||||||
Cash flows from investing activities: | ||||||||
Proceeds from disposition of assets | 0.6 | 5.4 | ||||||
Purchases of marketable securities | (591.6 | ) | (908.7 | ) | ||||
Sales and maturities of marketable securities | 549.2 | 1,036.7 | ||||||
Securities lending collateral | 0.6 | (76.5 | ) | |||||
Securities lending obligation | (0.6 | ) | 76.5 | |||||
Property and equipment additions: | ||||||||
Aircraft and aircraft purchase deposits | (456.5 | ) | (253.6 | ) | ||||
Other flight equipment | (27.6 | ) | (39.6 | ) | ||||
Other property and equipment | (32.4 | ) | (24.1 | ) | ||||
Aircraft deposits returned | — | 7.5 | ||||||
Restricted deposits and other | 19.3 | (3.6 | ) | |||||
Net cash used in investing activities | (539.0 | ) | (180.0 | ) | ||||
Cash flows from financing activities: | ||||||||
Proceeds from issuance of long-term debt, net | 245.0 | 20.0 | ||||||
Long-term debt and capital lease payments | (41.1 | ) | (35.4 | ) | ||||
Proceeds from issuance of common stock | 21.9 | 13.9 | ||||||
Tax benefit from stock option exercises | 3.0 | 1.2 | ||||||
Net cash provided by (used in) financing activities | 228.8 | (0.3 | ) | |||||
Net change in cash and cash equivalents | 78.7 | (1.3 | ) | |||||
Cash and cash equivalents at beginning of period | 73.6 | 28.0 | ||||||
Cash and cash equivalents at end of period | $ | 152.3 | $ | 26.7 | ||||
Supplemental disclosure of cash paid (refunded) during the period for: | ||||||||
Interest (net of amount capitalized) | $ | 34.5 | $ | 35.5 | ||||
Income taxes | 6.2 | (1.8 | ) | |||||
Noncash investing and financing activities: | ||||||||
Conversion of senior convertible notes to equity | 150.0 | — | ||||||
Debt assumed in purchase of MD-80 aircraft | 11.6 | — | ||||||
Net change in discounts and premiums on long-term debt | 1.0 | — | ||||||
Credit received for flight deposits deferred in other liabilities | — | 9.7 | ||||||
See accompanying notes to condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Alaska Air Group, Inc.
Note 1. Basis of Presentation and Significant Accounting Policies
Organization and Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of Alaska Air Group, Inc. (Air Group or the Company) include the accounts of the parent company, Alaska Air Group, Inc., and its principal subsidiaries, Alaska Airlines, Inc. (Alaska) and Horizon Air Industries, Inc. (Horizon), through which the Company conducts substantially all of its operations. These interim condensed consolidated financial statements are unaudited and should be read in conjunction with the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.2005. In the opinion of management, all adjustments have been made which are necessary to present fairly the Company’s financial position as of September 30, 2005,2006, as well as the results of operations for the three and nine months ended September 30, 20042006 and 2005. The adjustments made were of a normal recurring nature.
The Company’s condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). In preparing these condensed consolidated financial statements, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities, as well as the reported amounts of revenues and expenses. Significant estimates made include assumptions used to record liabilities, expenses and revenues associated with the Company’s Mileage Plan, amounts paid to lessors upon aircraft lease terminations, the fair market value of surplus or impaired aircraft, engines and parts, assumptions used in the calculations of pension expense in the Company’s defined benefit plans, and the amounts of certain accrued liabilities. Actual results may differ from the Company’s estimates.
Reclassifications
The Company has reclassified all of its fuel hedging gains and losses fromother nonoperating income (expense) toaircraft fuel, including hedging gains and losses,for all periods presented (see Note 4). Certain other reclassifications have been made to conform the prior year’s data to the current format.
Securities Lending
From time to time, theThe Company lends certain marketable securities to third parties for a time period of less than one year. During the time period in which these securities are loaned to the third parties, the Company requires cash collateral for 102% of the daily market value of the loaned securities. This cash collateral is restricted and is deposited with a lending agent and invested by that agent in accordance with the Company’s guidelines to generate additional income, which is shared with the lending agent. As of September 30, 2005,2006, the Company had $74.8$109.2 million of securities on loan under the program. These affected securities are included as marketable securities and included inunder current assets. The Company maintains full ownership rights to the securities loaned and continues to earn interest and appreciation on them. The Company has an indemnification agreement with the lending agent in the event a borrower becomes insolvent or fails to return securities. The cash collateral is classified in current assets as restricted securities lending collateral in our consolidated balance sheets and the related liability is classified in current liabilities as securities lending obligation.
Stock OptionsRecent Accounting Pronouncements
The Company applies the intrinsic value method in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations in accounting for stock options.
The following table represents the pro forma net income before accounting change and pro forma net income per share (EPS) had compensation cost for the Company’s stock options been determined in accordance with Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation.” In accordance with SFAS No. 123, the fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model and then amortized ratably over the vesting period (in millions, except per share amounts):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Income before accounting change as reported | $ | 90.2 | $ | 74.0 | $ | 117.5 | $ | 29.6 | ||||||||
Add: Total stock-based compensation expense recognized under the intrinsic value-based method, net of related tax | 0.3 | — | 0.7 | — | ||||||||||||
Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects | (1.2 | ) | (1.1 | ) | (3.5 | ) | (3.4 | ) | ||||||||
Pro forma income before accounting change | $ | 89.3 | $ | 72.9 | $ | 114.7 | $ | 26.2 | ||||||||
Net income as reported | $ | 90.2 | $ | 74.0 | $ | 27.1 | $ | 29.6 | ||||||||
Add: Total stock-based compensation expense recognized under the intrinsic value-based method, net of related tax | 0.3 | — | 0.7 | — | ||||||||||||
Deduct: Total stock-based compensation expense determined under fair value-based methods for all awards, net of related tax | (1.2 | ) | (1.1 | ) | (3.5 | ) | (3.4 | ) | ||||||||
Pro forma net income | $ | 89.3 | $ | 72.9 | $ | 24.3 | $ | 26.2 | ||||||||
Basic EPS before accounting change: | ||||||||||||||||
As reported | $ | 3.28 | $ | 2.75 | $ | 4.31 | $ | 1.10 | ||||||||
Pro forma | 3.25 | 2.71 | 4.21 | 0.98 | ||||||||||||
Basic EPS: | ||||||||||||||||
As reported | $ | 3.28 | $ | 2.75 | $ | 0.99 | $ | 1.10 | ||||||||
Pro forma | 3.25 | 2.71 | 0.89 | 0.98 | ||||||||||||
Diluted EPS before accounting change: | ||||||||||||||||
As reported | $ | 2.71 | $ | 2.29 | $ | 3.62 | $ | 0.98 | ||||||||
Pro forma | 2.68 | 2.26 | 3.54 | 0.88 | ||||||||||||
Diluted EPS: | ||||||||||||||||
As reported | $ | 2.71 | $ | 2.29 | $ | 0.93 | $ | 0.98 | ||||||||
Pro forma | 2.68 | 2.26 | 0.85 | 0.88 | ||||||||||||
During the fourth quarter of 2004,July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48), which clarifies the accounting and disclosure for uncertainty in tax positions, as defined in that statement. The purpose of FIN 48 is to clarify certain aspects of the recognition and measurement related to accounting for income tax uncertainties. This interpretation is effective for fiscal years beginning after December 15, 2006.
The Company does not believe this interpretation will have a material impact on its results from operations or financial position.
In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 expresses SEC staff views regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether those misstatements are material to the Company’s financial statements. SAB 108 is effective for fiscal years ending after November 15, 2006. Management is evaluating the impact of this interpretation and does expect to have an adjustment to shareholders’ equity, although the adjustment is not expected to be material.
In September 2006, the FASB issued Statement No. 158,Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (SFAS 158).SFAS 123R, “Share158 requires recognition of the overfunded or underfunded status of an entity’s defined benefit postretirement plan as an asset or liability in the financial statements, requires the measurement of defined benefit postretirement plan assets and obligations as of the end of the employer’s fiscal year, and requires recognition of the funded status of defined benefit postretirement plans in other comprehensive income. SFAS 158 is effective for fiscal years ending after December 15, 2006. Based Payment: An Amendmenton current assumptions, which are likely to change, the Company expects the impact on its shareholders’ equity to be in the range of $75 million to $100 million. The Company believes the adoption of this statement will not have a material impact on its results from operations or cash flows.
Note 2. Fleet Transition
In March 2006, the Company’s Board approved a plan to accelerate the retirement of its MD-80 fleet (15 owned and 11 leased aircraft) and remove those aircraft from service by the end of 2008, which is earlier than the original retirement schedule. The Company expects to use firm orders, options and additional purchase rights under its existing order of B737-800 aircraft to replace the capacity lost from the early retirement of the MD-80s.
As a result of this decision, the Company evaluated impairment as required by SFAS Nos. 123No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” and 95”. concluded that the carrying value of the MD-80 fleet was no longer recoverable when compared to the estimated remaining future cash flows. Accordingly, during the first quarter of 2006, the Company recorded an impairment charge totaling $131.1 million (pretax) to write down the fleet to its estimated fair market value.
The new standard requires companiesestimated fair value of the Company’s aircraft was derived using third-party appraisals and market data compiled by a third-party consultant, adjusted for certain factors deemed appropriate by management, such as the position of each aircraft in its maintenance cycle. During the third quarter, the Company received multiple offers to recognizepurchase the aircraft. This information did not indicate a need for further impairment as expenseof September 30, 2006. In conjunction with the fair value determination, the Company has reassessed the useful lives and residual values of stock optionsthe fleet and related spare equipment and will depreciate the remaining carrying values through the estimated date that each aircraft will be retired or sold. The estimate of residual salvage value is highly judgmental and is primarily based on the estimated selling price of the aircraft. Actual proceeds upon sale of the aircraft may differ materially from the fair value estimate used for the impairment analysis and the offers received to date.
During the third quarter, the Company purchased five MD-80 aircraft from lessors and, in conjunction with the purchases, terminated the leases for those five aircraft. The total purchase price for the five aircraft was $80.9 million, including assumed debt of $11.6 million. Immediately upon purchase of the aircraft, the Company evaluated impairment and concluded that the carrying value was not recoverable. Therefore, the Company recorded a $58.4 million charge in the third quarter for the impairment, including the write-off of $1.8 million of leasehold improvements related to those aircraft. The charge was offset by the reduction of $7.5 million of deferred rent associated with the acquired aircraft. Similar to the impairment analysis discussed above, the Company derived the estimated fair value of the five purchased aircraft using a letter of intent from a third-party to purchase the aircraft, third-party appraisals and other equity-based compensation issuedmarket data. The charge is recorded as fleet transition costs in the accompanying consolidated statement of operations.
The Company had signed a letter of intent with a prospective buyer for its 20 owned MD-80s, although the Company is uncertain as to employees aswhether this transaction will close. The Company is continuing to negotiate with other prospective buyers, but the timing of any sale of its MD-80 aircraft is uncertain at this time.
The Company leases six additional MD-80 aircraft. The current expiration dates on these leases range from January 2007 to October 2013. The Company expects to cease operation of four of these aircraft prior to the lease expiration date through lease buy-outs, lease agreement restructuring, subleasing of the grant date. This new standard will apply to both stock options thataircraft, or storing the Company grants to employees and the Employee Stock Purchase Plan, which features a look-back provision and allows employees to purchase stockaircraft at a 15% discount. Implementationlong-term storage facility. At such time as one of SFAS 123R will be effective January 1, 2006. Options are typically granted with ratable vesting provisions, andthese actions is taken on the Company intends to amortize compensation cost over the service period using the straight line method. The Company intends to use the “modified prospective method” upon adoption whereby previously awarded but unvested equity awards are accounted for in accordance with SFAS 123R and prospective amounts are recognized in the income statement instead of simply being disclosed. Once adopted,aircraft, the Company expects to have an associated charge that stock-based compensation expense, as measured under SFAS 123R, will be recorded in the consolidated statements of operations.
In the second quarter of 2004, the Company announced its intention to accelerate the retirement of Alaska’s B737-200 fleet and remove those aircraft from service. On July 7, 2006, the Company entered into a purchase and sale agreement to sell six B737-200 aircraft to a third party. The Company’s seventh (and remaining) B737-200 aircraft will be donated to an aviation museum in Alaska. The six aircraft will be sold and delivered at various intervals through April 2007. The total purchase price for the six aircraft exceeded their aggregate net book value as of September 30, 2006. One of the six aircraft was transferred to the buyer in the third quarter and there was an associated gain on the sale of approximately $6 million$0.4 million. The Company expects to $10 million per yearrecord similar gains as the remaining aircraft are transferred.
During the third quarter, Horizon signed a letter of intent with another carrier to sublease up to 16 of its Bombardier Q200 aircraft. Each aircraft will be subject to a separate sublease agreement and will leave Horizon’s operating fleet beginning in January 2007 through mid 2008 based on Horizon’s delivery schedule of the new Q400 aircraft on order. It is expected that the sublease will result in a pre-tax basis.loss for Horizon approximating the difference between the lease payments and the sublease receipts. The loss on each aircraft will be recorded when the specific aircraft leave Horizon’s fleet and the sublease arrangement begins. As of September 30, 2006, none of the aircraft have been delivered to the other carrier.
Note 2. Change in Accounting Principle
Effective January 1, 2005, the Company changed its method of accounting for major airframe and engine overhauls from thecapitalize and amortize method to thedirect expense method. Under the former method, these costs were capitalized and amortized to maintenance expense over the shorter of the life of the overhaul or the remaining lease term. Under thedirect expense method, overhaul costs are expensed as incurred. The Company believes that thedirect expense method is preferable because it eliminates the judgment and estimation needed to determine overhaul versus repair allocations in maintenance activities. Additionally, the Company’s approved maintenance program for the majority of its airframes now focuses more on shorter, but more frequent, maintenance visits. Management also believes that thedirect expense method is the predominant method used in the airline industry. Accordingly, effective January 1, 2005, the Company wrote off the net book value of its previously capitalized airframe and engine overhauls for all aircraft in a charge totaling $144.7 million pre-tax ($90.4 million after tax). The Company does not believe disclosing the effect of adopting thedirect expense method on net income for the period ended September 30, 2005 provides meaningful information because of changes in the Company’s maintenance program, including the execution of a “power by the hour” engine maintenance agreement with a third party in late 2004.
Note 3. Restructuring Charges
In July 2006, Alaska reached new four-year agreements with the approximately 3,700 clerical, office and passenger service employees and the ramp service and stores agents, all represented by the International Association of Machinists. These agreements included a signing bonus, in aggregate, of $1.9 million paid in July 2006, which is included in wages and benefits in our statement of operations and an immediate 2% wage increase. Additionally, the agreements included a severance package offered to employees in the
top four wage-scale steps that includes cash payments based on years of service, one year of medical coverage after the severance date, and continued travel privileges for a period of time. The total amount of the charge was $28.6 million and is recorded as restructuring charges in the statement of operations, which includes a $0.3 million pension curtailment loss resulting from the expected change in the number of participants in the pension plan.
A new four-year contract with the Association of Flight Attendants for Alaska’s approximately 2,500 flight attendants was ratified on April 26, 2006. Under this agreement, the Company paid a signing bonus, in aggregate, of $2.7 million in May 2006, which is included in wages and benefits in the statement of operations. The new agreement also included an immediate 3% pay increase. Additionally, Alaska offered a voluntary severance package to a number of flight attendants that included, among other things, a lump-sum payment of $2,000 per year of service up to a maximum of 25 years and continuing travel privileges. During the quarter ended June 30, 2006, the Company recorded a restructuring charge of $3.8 million related to the severance amounts, the majority of which was paid in the third quarter.
During the second quarter of 2005, Alaska contracted out ramp services at the Seattle-Tacoma International Airport. This event resulted in a reduction of approximately 475 employees in Seattle. Severance and related costs associated with this restructuring were originally estimated at $16.1 million, which was recorded in the second quarter.
During the third quarter of 2004, Alaska announced a management reorganization and the closure of its Oakland heavy maintenance base, contracting out of the Company’s fleet service and ground support
equipment and facility maintenance functions, as well as other initiatives. Restructuring charges totaling $53.4 million were recorded in 2004, with $38.7 million remaining accrued at December 31, 2004.
2005.
The following table displays the activity and balance of the severance and related costs components of the Company’s restructuring accrual as of and for the nine months ended September 30, 2006 and 2005. The restructuring charge adjustment in 2005 relates to our changeschange in estimated costs of medical coverage extended to impacted employees and a change($ in the number of employees affected since the original accrual was recorded. millions):
Accrual for Severance and Related Costs | 2006 | 2005 | ||||||
Balance at December 31, 2005 and 2004, respectively | $ | 3.1 | $ | 38.7 | ||||
Restructuring charges | 32.4 | 16.1 | ||||||
Restructuring adjustment | — | (3.4 | ) | |||||
Cash payments | (5.7 | ) | (44.3 | ) | ||||
Balance at September 30 | $ | 29.8 | $ | 7.1 | ||||
The Company expects to record additional adjustments in future quarters as the number of impacted employees that select the extended medical coverage becomes known.
Accrual for Severance and Related Costs
| Nine Months Ended September 30, | ||||||||
| 2005 | 2004 | |||||||
Balance at December 31, 2004 and 2003, respectively | $ | 38.7 | $ | — | ||||
Restructuring charges | 16.1 | 27.5 | ||||||
Restructuring charge adjustments | (3.4 | ) | — | |||||
Cash payments | (44.3 | ) | (1.2 | ) | ||||
Balance at September 30, 2005 and 2004, respectively | $ | 7.1 | $ | 26.3 | ||||
The Company will make the majority of the remaining cash payments induring the fourth quarter of 2005.2006 and the first quarter of 2007. The accrual for severance and related costs at September 30, 2005 is included in accrued wages, vacation and payroll taxes in the consolidated balance sheets.
During March 2005, the Company notified the Port of Oakland of its decision to terminate the lease for the Oakland hangar as part of its ongoing restructuring efforts. Accordingly, the Company recorded an impairment charge of $7.7 million in the first quarter of 2005 for the leasehold improvements that will bewere abandoned as a result of the lease termination. Additionally, the Company recorded a charge of $0.3 million for certain costs associated with the lease termination, which hashave been paid.
Note 4. Derivative Financial InstrumentsFuel Hedge Contracts
The Company’s operations are inherently dependent upon the price and availability of aircraft fuel. To manage economic risks associated with fluctuations in aircraft fuel prices, the Company periodically enters into call options, collar structures, and swap agreements for crude oil, among other initiatives.
The Company records all derivative instruments, all of which are currently fuel hedge contracts, on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in earnings.
The Company’s operations are inherently dependent upon the price and availability of aircraft fuel, which accounted for approximately 20% of all of 2004 and 24% of year-to-date 2005 operating expenses (excluding impairment and restructuring charges). To manage economic risks associated with fluctuations in aircraft fuel prices, the Company periodically enters into swap agreements and call options for crude oil.
Because of historical variations in the spread between the prices of West Texas Intermediate crude oil (the commodity the Company uses to hedge) and jet fuel, since the second quarter of 2004, the Company’s hedge contracts are not “highly correlated” to changes in prices of aircraft fuel, as defined in SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The impacts on the Company’s reported results are as follows:
Beginning January 1, 2006, the Company records all of its fuel hedging gains and losses inaircraft fuel, including hedging gains and losses.Prior to January 1, 2006, the majority of these fuel hedging gains and losses were recorded inother non-operatingnonoperating income (expense).
year format. The following table summarizes realizedGAAP and economic aircraft fuel hedging gainsexpense for the three and changes in fair value of hedging contracts outstanding as ofnine months ended September 30, 2006 and 2005 (in millions):
| Three Months Ended September 30 | ||||||||||||||||||||||||
| Alaska | Horizon | Consolidated | ||||||||||||||||||||||
| 2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||||||||||||||
Raw or “into-plane” fuel cost | $ | 218.9 | $ | 179.5 | $ | 33.9 | $ | 28.0 | $ | 252.8 | $ | 207.5 | ||||||||||||
Less: gains on settled hedges | (23.6 | ) | (37.8 | ) | (3.8 | ) | (5.7 | ) | (27.4 | ) | (43.5 | ) | ||||||||||||
Economic fuel expense | $ | 195.3 | $ | 141.7 | $ | 30.1 | $ | 22.3 | $ | 225.4 | $ | 164.0 | ||||||||||||
Mark-to-market (gains) or losses related to hedges that settle in future periods, net of the reclassification of previously recorded mark-to-market gains on settled hedges | 56.2 | (19.9 | ) | 9.2 | (2.9 | ) | 65.4 | (22.8 | ) | |||||||||||||||
Aircraft fuel expense, as reported | $ | 251.5 | $ | 121.8 | $ | 39.3 | $ | 19.4 | $ | 290.8 | $ | 141.2 | ||||||||||||
| Nine Months Ended September 30 | ||||||||||||||||||||||||
| Alaska | Horizon | Consolidated | ||||||||||||||||||||||
| 2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||||||||||||||
Raw or “into-plane” fuel cost | $ | 585.5 | $ | 465.2 | $ | 90.8 | $ | 71.6 | $ | 676.3 | $ | 536.8 | ||||||||||||
Less: gains on settled hedges | (79.0 | ) | (81.4 | ) | (12.8 | ) | (12.2 | ) | (91.8 | ) | (93.6 | ) | ||||||||||||
Economic fuel expense | $ | 506.5 | $ | 383.8 | $ | 78.0 | $ | 59.4 | $ | 584.5 | $ | 443.2 | ||||||||||||
Mark-to-market (gains) or losses related to hedges that settle in future periods, net of the reclassification of previously recorded mark-to-market gains on settled hedges | 60.7 | (100.2 | ) | 8.5 | (15.6 | ) | 69.2 | (115.8 | ) | |||||||||||||||
Aircraft fuel expense, as reported | $ | 567.2 | $ | 283.6 | $ | 86.5 | $ | 43.8 | $ | 653.7 | $ | 327.4 | ||||||||||||
The following table compares amounts as originally reported in 2005 to the current-year format for the three and 2004nine months ended September 30, 2005 (in millions):
| Three Months Ended September 30 | ||||||||||||||||
| Alaska Airlines | Horizon Air | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Fuel expense before hedge activities (“raw” or “into-plane” fuel cost) | $ | 179.5 | $ | 133.7 | $ | 28.0 | $ | 18.7 | ||||||||
Less: gains on settled hedges included in fuel expense | (2.9 | ) | (3.5 | ) | (0.5 | ) | (0.5 | ) | ||||||||
GAAP fuel expense | $ | 176.6 | $ | 130.2 | $ | 27.5 | $ | 18.2 | ||||||||
Less: gains on settled hedges included in nonoperating income (expense) | (34.9 | ) | (8.5 | ) | (5.2 | ) | (1.2 | ) | ||||||||
Economic fuel expense | $ | 141.7 | $ | 121.7 | $ | 22.3 | $ | 17.0 | ||||||||
Mark-to-market hedging gains included in nonoperating income (expense) related to hedges that settle in future periods, net of the reclassification of previously recorded mark-to-market gains togains on settled hedges included in nonoperating income (expense) | $ | 19.9 | $ | 50.3 | $ | 2.9 | $ | 6.9 | ||||||||
| Nine Months Ended September 30 | ||||||||||||||||
| Alaska Airlines | Horizon Air | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Fuel expense before hedge activities (“raw” or “into-plane” fuel cost) | $ | 465.2 | $ | 347.4 | $ | 71.6 | $ | 49.9 | ||||||||
Less: gains on settled hedges included in fuel expense | (9.5 | ) | (11.0 | ) | (1.3 | ) | (1.5 | ) | ||||||||
GAAP fuel expense | $ | 455.7 | $ | 336.4 | $ | 70.3 | $ | 48.4 | ||||||||
Less: gains on settled hedges included in nonoperating income (expense) | (71.9 | ) | (11.7 | ) | (10.9 | ) | (1.6 | ) | ||||||||
Economic fuel expense | $ | 383.8 | $ | 324.7 | $ | 59.4 | $ | 46.8 | ||||||||
Mark-to-market hedging gains included in nonoperating income (expense) related to hedges that settle in future periods, net of the reclassification of previously recorded mark-to-market gains togains on settled hedges included in nonoperating income (expense) | $ | 100.2 | $ | 70.4 | $ | 15.6 | $ | 9.6 | ||||||||
Aircraft fuel expense as originally reported Reclassification of fuel hedging gains Aircraft fuel expense Operating income as originally reported Reclassification of fuel hedging gains Operating income Nonoperating income (expense) as originally reported Reclassification of fuel hedging gains Nonoperating income (expense) Three Months Ended Sep. 30, 2005 Nine Months Ended Sep. 30, 2005 Alaska Horizon Consolidated Alaska Horizon Consolidated $ 176.6 $ 27.5 $ 204.1 $ 455.7 $ 70.3 $ 526.0 (54.8 ) (8.1 ) (62.9 ) (172.1 ) (26.5 ) (198.6 ) $ 121.8 $ 19.4 $ 141.2 $ 283.6 $ 43.8 $ 327.4 $ 80.4 $ 10.2 $ 90.2 $ 11.4 $ 9.3 $ 18.4 54.8 8.1 62.9 172.1 26.5 198.6 $ 135.2 $ 18.3 $ 153.1 $ 183.5 $ 35.8 $ 217.0 $ 52.6 $ 7.1 $ 56.6 $ 159.1 $ 23.7 $ 175.1 (54.8 ) (8.1 ) (62.9 ) (172.1 ) (26.5 ) (198.6 ) $ (2.2 ) $ (1.0 ) $ (6.3 ) $ (13.0 ) $ (2.8 ) $ (23.5 )
Outstanding fuel hedge positions as of September 30, 20052006 are as follows:
| Approximate % of Expected Fuel Requirements | Gallons Hedged (in millions) | Approximate Crude Oil Price per Barrel | ||||||
Fourth Quarter 2005 | 50 | % | 50.4 | $ | 31.85 | |||
First Quarter 2006 | 50 | % | 50.8 | $ | 35.70 | |||
Second Quarter 2006 | 50 | % | 53.5 | $ | 39.76 | |||
Third Quarter 2006 | 40 | % | 45.9 | $ | 41.58 | |||
Fourth Quarter 2006 | 30 | % | 31.2 | $ | 42.70 | |||
First Quarter 2007 | 20 | % | 20.9 | $ | 43.09 | |||
Second Quarter 2007 | 19 | % | 21.3 | $ | 45.11 | |||
Third Quarter 2007 | 22 | % | 26.0 | $ | 45.27 | |||
Fourth Quarter 2007 | 17 | % | 17.8 | $ | 47.89 | |||
First Quarter 2008 | 11 | % | 12.3 | $ | 50.44 | |||
Second Quarter 2008 | 6 | % | 7.1 | $ | 49.26 | |||
Third Quarter 2008 | 6 | % | 6.8 | $ | 48.97 | |||
Fourth Quarter 2008 | 5 | % | 5.5 | $ | 48.68 | |||
| Approximate % of Expected Fuel Requirements | Gallons Hedged (in millions) | Average Crude Oil Price per Barrel | ||||||
Fourth Quarter 2006 | 35 | % | 36.4 | $ | 46.10 | |||
First Quarter 2007 | 35 | % | 36.6 | $ | 56.63 | |||
Second Quarter 2007 | 29 | % | 32.3 | $ | 55.32 | |||
Third Quarter 2007 | 32 | % | 37.8 | $ | 54.08 | |||
Fourth Quarter 2007 | 22 | % | 23.2 | $ | 55.22 | |||
First Quarter 2008 | 18 | % | 19.2 | $ | 59.77 | |||
Second Quarter 2008 | 12 | % | 14.2 | $ | 62.56 | |||
Third Quarter 2008 | 11 | % | 13.5 | $ | 62.16 | |||
Fourth Quarter 2008 | 10 | % | 11.0 | $ | 61.77 | |||
The fair values of the Company’s fuel hedge positions for the period endedat September 30, 20052006 and December 31, 20042005 were $211.8$81.6 million and $96.0$153.3 million, respectively, and are presented as fuel hedge contracts as both current and non-current assets in the consolidated balance sheets.
Note 5. Change in Accounting Principle
Effective January 1, 2005, the Company changed its method of accounting for major airframe and engine overhauls from thecapitalize and amortize method to thedirect expense method. Under the former method, these costs were capitalized and amortized to maintenance expense over the shorter of the life of the overhaul or the remaining lease term. Under the direct expense method, overhaul costs are expensed as incurred. Accordingly, in the first quarter of 2005, the Company wrote off the net book value of its previously capitalized airframe and engine overhauls for all aircraft in a charge totaling $144.7 million pre-tax ($90.4 million after tax).
Note 6. Other Assets
At September 30, 2005 and December 31, 2004 , otherOther assets consisted of the following (in millions):
| September 30, 2005 | December 31, 2004 | |||||
Restricted deposits (primarily restricted investments) | $ | 95.1 | $ | 84.2 | ||
Deferred costs and other | 38.2 | 27.7 | ||||
Restricted cash for senior convertible notes | — | 3.6 | ||||
| $ | 133.3 | $ | 115.5 | |||
| September 30, 2006 | December 31, 2005 | |||||
Restricted deposits (primarily restricted investments) | $ | 87.0 | $ | 101.9 | ||
Deferred costs and other | 44.3 | 32.1 | ||||
| $ | 131.3 | $ | 134.0 | |||
Note 6.7. Mileage Plan
Alaska’s Mileage Plan deferrals and liabilities are included under the following balance sheet captions (in millions):
| September 30, 2005 | December 31, 2004 | |||||
Current Liabilities: | ||||||
Other accrued liabilities | $ | 159.0 | $ | 136.6 | ||
Other Liabilities and Credits (non-current): | ||||||
Deferred revenue | 265.9 | 252.9 | ||||
Other liabilities | 20.5 | 19.8 | ||||
Total | $ | 445.4 | $ | 409.3 | ||
| September 30, 2006 | December 31, 2005 | |||||
Current Liabilities: | ||||||
Other accrued liabilities | $ | 186.7 | $ | 165.0 | ||
Other Liabilities and Credits (non-current): | ||||||
Deferred revenue | 309.1 | 280.9 | ||||
Other liabilities | 21.0 | 20.9 | ||||
Total Mileage Plan deferrals and liabilities | $ | 516.8 | $ | 466.8 | ||
Note 7. Employee Benefit Plans
Pension Plans-Qualified Defined Benefit
Net pension expenseAlaska’s Mileage Plan revenue is included under the following statement of operations captions for the three and nine months ended September 30 included the following components (in millions):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Service cost | $ | 13.3 | $ | 13.5 | $ | 38.8 | $ | 40.9 | ||||||||
Interest cost | 12.9 | 11.8 | 38.7 | 35.8 | ||||||||||||
Expected return on assets | (12.5 | ) | (10.9 | ) | (37.5 | ) | (32.3 | ) | ||||||||
Amortization of prior service cost | 1.2 | 1.1 | 3.6 | 3.7 | ||||||||||||
Actuarial loss | 3.6 | 3.6 | 10.8 | 11.0 | ||||||||||||
SFAS No. 88 curtailment charge* | — | 1.0 | — | 1.0 | ||||||||||||
Net pension expense | $ | 18.5 | $ | 20.1 | $ | 54.4 | $ | 60.1 | ||||||||
Passenger revenues Other-net revenues Total Mileage Plan revenues Three Months Ended
September 30 Nine Months Ended
September 30 2006 2005 2006 2005 $ 24.0 $ 20.8 $ 75.3 $ 60.7 23.6 29.5 69.8 70.6 $ 47.6 $ 50.3 $ 145.1 $ 131.3
The Company made $30.7 million and $69.3 million in contributions during the three and nine months ended
Note 8. Long-term Debt
At September 30, 2006 and December 31, 2005, respectively. The Company made $16.5 million and $49.4 million in contributions to its defined benefit pension plans during the three and nine months ended September 30, 2004, respectively.
Pension Plans-Nonqualified Defined Benefit
Net pension expense for the unfunded, noncontributory defined benefit plans for certain elected officers of the Company for the three and nine months ended September 30 included the following componentslong-term debt obligations were as follows (in millions):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||
Service cost | $ | 0.6 | $ | 0.2 | $ | 1.2 | $ | 0.8 | ||||
Interest cost | 0.4 | 0.4 | 1.2 | 1.4 | ||||||||
Actuarial loss | 0.1 | 0.1 | 0.3 | 0.5 | ||||||||
Net pension expense | $ | 1.1 | $ | 0.7 | $ | 2.7 | $ | 2.7 | ||||
| September 30, 2006 | December 31, 2005 | |||||||
Fixed-rate notes payable due through 2020 | $ | 736.5 | $ | 607.3 | ||||
Variable-rate notes payable due through 2021 | 270.3 | 251.5 | ||||||
Pre-delivery payment facility expiring in 2009 | 142.3 | 73.8 | ||||||
Senior convertible notes converted April 2006 | — | 150.0 | ||||||
Long-term debt | 1,149.1 | 1,082.6 | ||||||
Less current portion | (203.6 | ) | (113.5 | ) | ||||
| $ | 945.5 | $ | 969.1 | |||||
Postretirement Medical Benefits
Net periodic benefit cost forDuring the postretirement medical plans for the three andfirst nine months ended September 30 includedof 2006, Alaska borrowed $159.5 million using fixed-rate and variable-rate debt secured by flight equipment and increased its borrowings on its pre-delivery payment facility by $68.5 million. Additionally, Alaska assumed $11.6 million of debt related to the following components (in millions):purchase of one of its leased MD-80 aircraft in the third quarter (See Note 2). Horizon borrowed $17.0 million using variable-rate debt secured by flight equipment.
During the first nine months of 2006, the Company exercised its option under certain existing variable-rate, long-term debt arrangements to fix the interest rates through maturity. The fixed rates on these affected debt arrangements range from 6.2% to 6.8%. These changes did not result in any gain or loss in the condensed consolidated statements of operations.
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Service cost | $ | 1.1 | $ | 0.6 | $ | 3.1 | $ | 3.0 | ||||||||
Interest cost | 1.1 | 0.7 | 3.3 | 3.3 | ||||||||||||
Amortization of prior service cost | (0.1 | ) | (0.1 | ) | (0.3 | ) | (0.3 | ) | ||||||||
Actuarial loss | 0.5 | 0.4 | 1.5 | 1.8 | ||||||||||||
Net periodic benefit cost | $ | 2.6 | $ | 1.6 | $ | 7.6 | $ | 7.8 | ||||||||
The Company’s $150.0 million senior convertible notes due in 2023 (Notes) became redeemable by the Company on March 21, 2006, the third anniversary of the issuance of the Notes. On March 29, 2006, the Company called for redemption all of the Notes and, in April, all of the Notes were converted by the holders into shares of the Company’s common stock. The conversion rate was approximately 38.5 shares per $1,000 of Notes at par, which equates to $26 per share. In total, this added 5.769 million common shares to the Company’s outstanding shares as of the end of April 2006. This resulted in $145.6 million of additional equity, which is net of $4.4 million of unamortized financing costs remaining from the original issuance of the Notes in 2003.
Note 8. Earnings Per Share9. Employee Benefit Plans
Pension Plans-Qualified Defined Benefit
Net pension expense for the three and nine months ended September 30 included the following components (in millions):
Income per share was calculated as follows (in millions except per share amounts).
| Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||||
| 2006 | 2005 | 2006 | 2005 | |||||||||||||
Service cost | $ | 14.1 | $ | 13.3 | $ | 38.7 | $ | 38.8 | ||||||||
Interest cost | 15.3 | 12.9 | 40.7 | 38.7 | ||||||||||||
Expected return on assets | (14.9 | ) | (12.5 | ) | (39.9 | ) | (37.5 | ) | ||||||||
Curtailment loss* | 0.3 | — | 0.3 | — | ||||||||||||
Amortization of prior service cost | 1.2 | 1.2 | 3.6 | 3.6 | ||||||||||||
Actuarial loss | 5.8 | 3.6 | 13.6 | 10.8 | ||||||||||||
Net pension expense | $ | 21.8 | $ | 18.5 | $ | 57.0 | $ | 54.4 | ||||||||
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||
| 2005 | 2004 | 2005 | 2004 | ||||||||||
Basic Earnings Per Share | |||||||||||||
Income before accounting change | $ | 90.2 | $ | 74.0 | $ | 117.5 | $ | 29.6 | |||||
Weighted average shares outstanding | 27.502 | 26.862 | 27.274 | 26.820 | |||||||||
Income per share before accounting change | $ | 3.28 | $ | 2.75 | $ | 4.31 | $ | 1.10 | |||||
Cumulative effect of accounting change, net of tax | NA | NA | $ | (90.4 | ) | NA | |||||||
Weighted average shares outstanding | NA | NA | 27.274 | NA | |||||||||
Per share cumulative effect of accounting change | NA | NA | $ | (3.32 | ) | NA | |||||||
Net income | $ | 90.2 | $ | 74.0 | $ | 27.1 | $ | 29.6 | |||||
Weighted average shares outstanding | 27.502 | 26.862 | 27.274 | 26.820 | |||||||||
Net income per share | $ | 3.28 | $ | 2.75 | $ | 0.99 | $ | 1.10 | |||||
Diluted Earnings Per Share | |||||||||||||
Income before accounting change | $ | 90.2 | $ | 74.0 | $ | 117.5 | $ | 29.6 | |||||
Interest on convertible notes, net of tax | 1.5 | 1.0 | 4.0 | 2.6 | |||||||||
Diluted income before accounting change | $ | 91.7 | $ | 75.0 | $ | 121.5 | $ | 32.2 | |||||
Weighted average diluted shares outstanding | 33.857 | 32.631 | 33.523 | 32.691 | |||||||||
Income per share before accounting change | $ | 2.71 | $ | 2.29 | $ | 3.62 | $ | 0.98 | |||||
Cumulative effect of accounting change, net of tax | NA | NA | $ | (90.4 | ) | NA | |||||||
Weighted average shares outstanding | NA | NA | 33.523 | NA | |||||||||
Per share cumulative effect of accounting change | NA | NA | $ | (2.69 | ) | NA | |||||||
Net income | $ | 90.2 | $ | 74.0 | $ | 27.1 | $ | 29.6 | |||||
Interest on convertible notes, net of tax | 1.5 | 1.0 | 4.0 | 2.6 | |||||||||
Diluted net income | $ | 91.7 | $ | 75.0 | $ | 31.1 | $ | 32.2 | |||||
Weighted average shares outstanding | 33.857 | 32.631 | 33.523 | 32.691 | |||||||||
Net income per share | $ | 2.71 | $ | 2.29 | $ | 0.93 | $ | 0.98 | |||||
| * | In connection with the reduction in employees as discussed in Note 3, the Company recorded curtailment charges. These charges are included in restructuring charges in the condensed consolidated financial statements. |
For
The Company made no contributions during the quarterthree-month period ended September 30, 2006 and $71.9 million in contributions during the nine months ended September 30, 2006. The Company made $30.7 million and $69.3 million in contributions during the three and nine months ended September 30, 2005, respectively.
Pension Plans-Nonqualified Defined Benefit
Net pension expense for the unfunded, noncontributory defined benefit plans for certain elected officers of the Company for the three and 2004,nine months ended September 30 included the dilutive impactfollowing components (in millions):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
| 2006 | 2005 | 2006 | 2005 | |||||||||
Service cost | $ | 0.4 | $ | 0.6 | $ | 1.2 | $ | 1.2 | ||||
Interest cost | 0.5 | 0.4 | 1.5 | 1.2 | ||||||||
Actuarial loss | 0.1 | 0.1 | 0.3 | 0.3 | ||||||||
Net pension expense | $ | 1.0 | $ | 1.1 | $ | 3.0 | $ | 2.7 | ||||
Postretirement Medical Benefits
Net periodic benefit cost for the postretirement medical plans for the three and nine months ended September 30 included the following components (in millions):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||
| 2006 | 2005 | 2006 | 2005 | |||||||||||
Service cost | $ | 1.3 | $ | 1.1 | $ | 4.0 | $ | 3.1 | ||||||
Interest cost | 1.1 | 1.1 | 3.2 | 3.3 | ||||||||||
Amortization of prior service cost | — | (0.1 | ) | 3.3 | (0.3 | ) | ||||||||
Actuarial loss | 0.4 | 0.5 | 1.2 | 1.5 | ||||||||||
Net periodic benefit cost | $ | 2.8 | $ | 2.6 | $ | 11.7 | $ | 7.6 | ||||||
Note 10. Stock Plans
The Company adopted Statement of commonFinancial Accounting Standards (SFAS) 123R, “Share-Based Payment: An Amendment of SFAS Nos. 123 and 95,” as of January 1, 2006. This new standard requires companies to recognize as expense the fair value of stock options and 5.8other equity-based compensation issued to employees as of the grant date. The standard applies to both stock options and restricted stock units that the Company grants to employees and the Company’s Employee Stock Purchase Plan (ESPP), which features a look-back provision and allows employees to purchase stock at a 15% discount. The Company is using the “modified prospective method,” which is explained below.
The adoption of SFAS 123R changes the accounting for stock options under the Company’s long-term incentive equity plans and changes the accounting for the Company’s ESPP. Accounting for the Company’s restricted stock awards did not change with the adoption of the standard. All stock-based compensation expense is recorded in wages and benefits in the condensed consolidated statements of operations.
Stock Options
SFAS 123R is effective for all stock options granted beginning January 1, 2006. For stock options granted prior to January 1, 2006, for which the vesting period is not complete, the “modified prospective method” for transition permitted by SFAS 123R was used. Under this method, the Company accounts for the unvested portion of these awards on a prospective basis, with expense recognized in the condensed consolidated statements of operations beginning January 1, 2006 using the grant-date fair values previously calculated for pro forma disclosures. The Company selected this method due to the relatively limited use of stock-based awards and the immaterial impact on the comparability between periods. The Company also elected to use the method available under FASB Staff Position FSP No. 123(R)-3Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards, which provides an alternative method for calculating historical excess tax benefits (the APIC pool) from the method described in FAS 123(R) for stock-based compensation awards. The standard also requires that tax benefits realized from stock award exercise gains in excess of stock-based compensation expense recognized for financial statement purposes be reported as cash flows from financing activities rather than as operating cash flows.
The Company has stock option awards outstanding under a number of long-term incentive equity plans, one of which continues to provide for the grant of stock options to purchase the Company’s common stock at market prices on the date of grant to directors, officers and employees of the Company and its subsidiaries. Under the various plans, options for 5,097,750 shares have been granted and, at September 30, 2006, 883,425 shares were available for future grant. Under all plans, the stock options granted have terms of up to ten years. The Company’s options are typically granted with graded vesting provisions, and compensation cost is amortized over the service period using the straight-line method. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model, which requires the Company to make several assumptions. The risk-free interest rate is based on the U.S. Treasury yield curve in effect for the term nearest the expected term of the option at the time of grant. The dividend yield is zero as the Company does not pay dividends and has no plans to do so in the immediate future. The market price volatility of the common stock is based on a combination of the historical volatility over a time period equal to the expected term of the option and management’s judgment of future volatility. The expected life of the options and the expected forfeiture rates are based on our historical experience for various homogenous employee groups.
The tables below summarize stock option activity for the nine months ended September 30, 2006:
| Shares | Weighted- Average Exercise Price Per Share | Weighted- Average Contractual Life (Years) | Aggregate Intrinsic Value (in millions) | ||||||||
Outstanding, December 31, 2005 | 3,376,015 | $ | 31.05 | ||||||||
Granted | 233,610 | 37.73 | |||||||||
Exercised | (731,195 | ) | 27.68 | ||||||||
Canceled | (98,920 | ) | 42.12 | ||||||||
Outstanding, September 30, 2006 | 2,779,510 | $ | 32.02 | 5.1 | $ | 19.0 | |||||
Exercisable at September 30, 2006 | 2,059,724 | $ | 32.40 | 4.0 | $ | 13.8 | |||||
During the three months ended September 30, 2006, the Company granted 225,935 options with a weighted-average exercise price of $37.99 per share and a weighted-average fair value of $18.51 per share. The fair value was derived using risk-free interest rates ranging from 4.8% to 5.2%, expected volatility ranging between 41.5% to 44.7%, and expected lives between 4.75 years and 6 years. During the nine months ended September 30, 2006, the Company granted 233,610 options with a weighted-average exercise price of $37.73 per share and a weighted-average fair value of $18.37 per share. The fair value was derived using risk-free interest rates ranging from 4.5% to 5.2%, expected volatility ranging between 41.5% to 44.7%, and expected lives between 4.75 years and 6 years.
The total intrinsic value of options exercised during the three and nine months ended September 30, 2006 was $1.3 million and $7.8 million, respectively. Cash received from option exercises during the three and nine months ended September 30, 2006 totaled $3.4 million and $20.1 million, respectively.
The following table summarizes stock options outstanding and exercisable at September 30, 2006 with their weighted-average exercise prices and remaining contractual lives:
Range of Exercise prices | Remaining Life (years) | Shares | Price Per Share | ||||
Outstanding: | |||||||
$10 to $20 | 5.9 | 218,555 | $ | 18.69 | |||
$21 to $28 | 5.9 | 660,340 | 26.15 | ||||
$29 to $34 | 5.3 | 1,007,093 | 31.63 | ||||
$35 to $45 | 4.6 | 724,122 | 38.28 | ||||
$46 to $58 | 1.6 | 169,400 | 47.75 | ||||
$10 to $58 | 5.1 | 2,779,510 | $ | 32.02 | |||
Range of Exercise prices | Shares | Price Per Share | |||||
Exercisable: | |||||||
$10 to $20 | 117,655 | $ | 18.67 | ||||
$21 to $28 | 513,985 | 26.22 | |||||
$29 to $34 | 762,897 | 31.35 | |||||
$35 to $45 | 495,787 | 38.42 | |||||
$46 to $58 | 169,400 | 47.75 | |||||
$10 to $58 | 2,059,724 | $ | 32.40 | ||||
Restricted Stock Awards
During the nine months ended September 30, 2006 and 2005, the Company awarded 120,465 and 211,975 restricted stock units (RSUs), respectively, to certain employees, with grant date fair values of $4.5 million and $6.8 million, respectively. These amounts reflect the value of the total RSU award at the grant date based on the closing price of the Company’s common shares thatstock. Compensation cost for RSUs is recognized over three years from the date of grant as the awards “cliff vest” after three years. As of September 30, 2006, 448,450 RSUs were outstanding, with an aggregate intrinsic value of $17.1 million.
Impact of Adoption of SFAS 123R
Stock-based compensation expense recognized under SFAS 123R for the three and nine months ended September 30, 2006 is as follows:
| Three Months Ended September 30, 2006 | |||||||||
Pre-tax (in millions) | After-tax (in millions) | Effect on Diluted EPS | |||||||
Stock Options | $ | 0.7 | $ | 0.4 | $ | .01 | |||
ESPP | 0.3 | 0.2 | .01 | ||||||
Restricted Stock Units | 0.9 | 0.6 | .01 | ||||||
Total | $ | 1.9 | $ | 1.2 | $ | .03 | |||
| Nine Months Ended September 30, 2006 | |||||||||
Pre-tax (in millions) | After-tax (in millions) | Effect on Diluted EPS | |||||||
Stock Options | $ | 2.4 | $ | 1.5 | $ | .04 | |||
ESPP | 0.8 | 0.5 | .01 | ||||||
Restricted Stock Units | 2.6 | 1.7 | .05 | ||||||
Total | $ | 5.8 | $ | 3.7 | $ | .10 | |||
As of September 30, 2006, $8.0 million and $9.8 million of compensation cost associated with unvested stock options and restricted stock awards, respectively, attributable to future service had not yet been recognized. These amounts will be recognized as expense over a weighted-average period of 1.6 years and 1.2 years for stock options and restricted stock awards, respectively.
Had compensation cost for the Company’s stock options and employee stock purchase plan been determined in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation,” net income for the three and nine months ended September 30, 2005 would have been outstanding upon conversion ofnegatively impacted by $0.9 million, or $0.03 per diluted share, and $2.8 million, or $0.08 per diluted share, respectively.
Note 11. Earnings Per Share
In April 2006, the senior convertible notes were converted into 5.769 million shares of common stock and are included in the calculations.calculation of the basic weighted-average shares outstanding for the three and nine months ended September 30, 2006. For the three and nine months ended September 30, 2006, all outstanding options to purchase common shares were excluded in the calculation for diluted earnings per share as the Company had a net loss. Outstanding options to purchase 0.9 million and 1.8
million common shares were excluded from the calculation for the quarterthree and nine months ended September 30, 2005, respectively, as the impact of those options would have been antidilutive. For the quarter and nine months ended September 30, 2004, options to purchase 3.3 million and 3.2 million common shares, respectively, were excluded from the computation of diluted loss per share in 2004 because the impact would have been antidilutive.
Basic Earnings (Loss) Per Share Income (loss) before accounting change Weighted average shares outstanding Income (loss) per share before accounting change Cumulative effect of accounting change, net of tax Weighted average shares outstanding Per share cumulative effect of accounting change Net income (loss) Weighted average shares outstanding Net income (loss) per shareNote 9. Operating Segment Information Three Months Ended
September 30, Nine Months Ended
September 30, 2006 2005 2006 2005 $ (17.4 ) $ 90.2 $ (41.0 ) $ 117.5 39.954 27.502 37.172 27.274 $ (0.44 ) $ 3.28 $ (1.10 ) $ 4.31 NA NA NA $ (90.4 ) NA NA NA 27.274 NA NA NA $ (3.32 ) $ (17.4 ) $ 90.2 $ (41.0 ) $ 27.1 39.954 27.502 37.172 27.274 $ (0.44 ) $ 3.28 $ (1.10 ) $ 0.99
Operating segment information for Alaska and Horizon for the three and nine month periods ended September 30 was as follows (in millions):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Operating revenues: | ||||||||||||||||
Alaska | $ | 689.3 | $ | 632.8 | $ | 1,828.9 | $ | 1,701.7 | ||||||||
Horizon | 153.7 | 139.3 | 415.5 | 374.3 | ||||||||||||
Other* | 0.3 | 0.2 | 0.8 | 0.5 | ||||||||||||
Elimination of intercompany revenues | 2.4 | (4.1 | ) | (0.5 | ) | (9.0 | ) | |||||||||
Consolidated | $ | 845.7 | $ | 768.2 | $ | 2,244.7 | $ | 2,067.5 | ||||||||
Income (loss) before income tax and accounting change: | ||||||||||||||||
Alaska | $ | 133.0 | $ | 97.9 | $ | 170.5 | $ | 41.9 | ||||||||
Horizon | 17.3 | 24.4 | 33.0 | 18.7 | ||||||||||||
Other* | (3.5 | ) | (3.1 | ) | (10.0 | ) | (8.3 | ) | ||||||||
Consolidated | $ | 146.8 | $ | 119.2 | $ | 193.5 | $ | 52.3 | ||||||||
Total assets at end of period: | ||||||||||||||||
Alaska | $ | 3,226.6 | $ | 3,161.1 | ||||||||||||
Horizon | 325.6 | 304.1 | ||||||||||||||
Other* | 872.2 | 882.2 | ||||||||||||||
Elimination of intercompany accounts | (914.7 | ) | (935.9 | ) | ||||||||||||
Consolidated | $ | 3,509.7 | $ | 3,411.5 | ||||||||||||
Note 10. Long-Term Debt and Capital Lease Obligations
At September 30, 2005 and December 31, 2004, long-term debt and capital lease obligations were as follows (in millions):
| September 30, 2005 | December 31, 2004 | |||||||
Fixed rate notes payable due through 2020 | $ | 589.5 | $ | 361.3 | ||||
Variable rate notes payable due through 2018 | 287.8 | 531.2 | ||||||
Senior convertible notes due through 2023 | 150.0 | 150.0 | ||||||
Long-term debt | 1,027.3 | 1,042.5 | ||||||
Capital lease obligations | 0.3 | 0.5 | ||||||
Less current portion | (57.6 | ) | (53.4 | ) | ||||
| $ | 970.0 | $ | 989.6 | |||||
During the first nine months of 2005, Horizon issued $20.0 million of debt secured by flight equipment, having a fixed interest rate of 6.07% and a fifteen-year term.
During 2004, Alaska repaid its $150 million credit facility and, on December 23, 2004, that facility expired. On March 25, 2005, Alaska finalized a $160 million variable rate credit facility with a syndicate of financial institutions that will expire in March 2008. The interest rate on the credit facility varies depending on certain financial ratios specified in the agreement with a minimum interest rate of LIBOR plus 200 basis points. Any borrowings will be secured by either aircraft or cash collateral. This credit facility contains contractual restrictions and requires maintenance of specific levels of net worth, maintenance of certain debt and leases to net worth, leverage and fixed charge coverage ratios, and limits on liens, asset dispositions, dividends, and certain other expenditures. Such provisions restrict Alaska Airlines from distributing any funds to Alaska Air Group in the form of dividends and limit the amount of funds Alaska Airlines can loan to Alaska Air Group. As of September 30, 2005, Alaska could loan up to $300.0 million to Air Group without violating the covenants in the credit facility. As of September 30, 2005, there are no outstanding borrowings on this credit facility.
In the second and third quarters of 2005, the Company exercised its option under several of its existing variable rate long-term debt arrangements to fix the interest rates through maturity. The fixed rates on these affected debt arrangements range from 5.2% to 6.5%. These changes did not result in any gain or loss in the consolidated statements of operations.
Subsequent to the end of the third quarter of 2005, Alaska finalized a pre-delivery payment facility to assist in its pre-delivery funding requirements on the purchase of B737-800 aircraft. See Note 13.
Note 11. Aircraft Commitments
Alaska entered into an aircraft purchase agreement during the second quarter of 2005 to acquire 35 B737-800 aircraft with deliveries beginning in January 2006 and continuing through April 2011. The purchase agreement also includes options to purchase an additional 15 aircraft. Concurrent with the execution of this purchase agreement, Alaska paid $110.9 million in aircraft purchase and option deposits using cash and a credit of $9.7 million received from the manufacturer. The $9.7 million credit has been deferred as other liabilities in the Company’s balance sheet and will be applied to the purchase price of future aircraft upon delivery.
As of Sep 30, 2005, the Company has firm purchase commitments for 43 aircraft requiring aggregate future payments of approximately $1.3 billion. In addition to the 15 options noted above, Horizon had options to purchase 11 Q400’s and 19 CRJ 700’s. However, these commitments and number of options for Horizon changed subsequent to the end of the quarter (See Note 13). Alaska and Horizon expect to finance the firm orders and, to the extent exercised, the option aircraft with leases, long-term debt or internally generated cash.
Note 12. Contingencies
The Company is a party to routine litigation incidental to its business and with respect to which no material liability is expected. Management believes the ultimate disposition of these matters is not likely to materially affect the Company’s financial position or results of operations. However, this belief is based on management’s current understanding of the relevant law and facts; it is subject to various contingencies, including the potential costs and risks associated with litigation and the actions of judges and juries.
In May 2005, the Air Line Pilots Association filed a lawsuit in federal district court in Seattle to overturn the current labor contract covering Alaska’s pilots as established by an arbitrator, which was effective May 1, 2005. On July 21, 2005, the Company filed a motion to dismiss the lawsuit. On October 28, 2005, the district court granted the Company’s motion to dismiss. This decision is subject to appeal.
In March 2005, the Company filed a claim against the International Association of Machinists (IAM) seeking to compel arbitration of the dispute regarding the subcontracting of the Company’s ramp service operation in Seattle. On May 10, 2005, the IAM filed a counter claim against the Company alleging that the Company violated the status quo and engaged in bad faith bargaining. On May 13, 2005, the Company announced that it had subcontracted the ramp service operation in Seattle, resulting in the immediate reduction of approximately 475 employees represented by the IAM. Shortly after this event, the IAM filed a motion for a preliminary injunction seeking to reverse the subcontracting by the Company. That motion was heard and denied by a federal court judge on June 2, 2005. The Company’s lawsuit is still pending in federal court and a September 2006 trial date has been set for the IAM’s counter claim. The Company has filed a motion to dismiss the IAM’s counter claim. At this time, the Company is not certain as to what the outcome will be.
Note 13. Subsequent Events
On October 19, 2005, Alaska finalized a $172 million variable rate revolving loan facility with a syndicate of lenders to provide a portion of the pre-delivery funding requirements of the Company’s purchase of up to 38 new Boeing 737-800 aircraft (23 of which are firm orders) under the current aircraft purchase agreement. The facility will expire on August 31, 2009. The interest rate is based on one-month LIBOR plus a specified margin. Any borrowings will be secured by the Company’s rights under the Boeing purchase agreement. The initial draw on the facility was $61.3 million, which was used to reimburse Alaska for the facility’s portion of the pre-delivery payments made to date.
Horizon entered into an aircraft purchase agreement in October 2005 to acquire 12 Q400 aircraft with deliveries beginning in December 2006 and continuing through July 2007. The purchase agreement also includes options to purchase an additional 20 aircraft. Concurrent with the execution of this purchase agreement, Bombardier agreed to provide certain remarketing assistance for up to 12 DHC-8 Series 200 aircraft previously leased by Horizon for a fee as set forth in the agreement. In association with the purchase of the 12 Q400 Aircraft, Horizon and the manufacturer have agreed to terminate firm orders for seven CRJ700 model aircraft.
Alaska Airlines Financial and Statistical Data (Unaudited)
| Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||||||||||
| 2005 | 2004 | % Change | 2005 | 2004 | % Change | |||||||||||||||||
Financial Data (in millions): | ||||||||||||||||||||||
Operating Revenues: | ||||||||||||||||||||||
Passenger | $ | 624.1 | $ | 576.6 | 8.2 | % | $ | 1,656.6 | $ | 1,545.8 | 7.2 | % | ||||||||||
Freight and mail | 25.2 | 24.5 | 2.9 | % | 68.4 | 65.3 | 4.7 | % | ||||||||||||||
Other - net | 40.0 | 31.7 | 26.2 | % | 103.9 | 90.6 | 14.7 | % | ||||||||||||||
Total Operating Revenues | 689.3 | 632.8 | 8.9 | % | 1,828.9 | 1,701.7 | 7.5 | % | ||||||||||||||
Operating Expenses: | ||||||||||||||||||||||
Wages and benefits | 174.5 | 207.3 | -15.8 | % | 556.2 | 611.8 | -9.1 | % | ||||||||||||||
Contracted services | 27.6 | 17.8 | 55.1 | % | 87.0 | 70.3 | 23.8 | % | ||||||||||||||
Aircraft fuel | 176.6 | 130.2 | 35.6 | % | 455.7 | 336.4 | 35.5 | % | ||||||||||||||
Aircraft maintenance | 43.2 | 27.1 | 59.4 | % | 143.5 | 111.3 | 28.9 | % | ||||||||||||||
Aircraft rent | 29.5 | 28.1 | 5.0 | % | 87.2 | 85.5 | 2.0 | % | ||||||||||||||
Food and beverage service | 12.8 | 13.7 | -6.6 | % | 35.2 | 37.9 | -7.1 | % | ||||||||||||||
Selling expenses | 34.0 | 35.9 | -5.3 | % | 97.9 | 101.1 | -3.2 | % | ||||||||||||||
Depreciation and amortization | 31.9 | 32.0 | -0.3 | % | 92.9 | 95.2 | -2.4 | % | ||||||||||||||
Landing fees and other rentals | 40.4 | 37.6 | 7.4 | % | 121.5 | 106.1 | 14.5 | % | ||||||||||||||
Other | 39.8 | 34.6 | 15.0 | % | 119.7 | 110.4 | 8.4 | % | ||||||||||||||
Restructuring charges | (1.4 | ) | 27.5 | NM | 20.7 | 27.5 | NM | |||||||||||||||
Impairment of aircraft and related spare parts | — | — | NM | — | 36.8 | NM | ||||||||||||||||
Total Operating Expenses | 608.9 | 591.8 | 2.9 | % | 1,817.5 | 1,730.3 | 5.0 | % | ||||||||||||||
Operating Income (Loss) | 80.4 | 41.0 | NM | 11.4 | (28.6 | ) | NM | |||||||||||||||
Interest income | 9.2 | 8.4 | 23.1 | 20.0 | ||||||||||||||||||
Interest expense | (13.0 | ) | (11.6 | ) | (36.9 | ) | (33.1 | ) | ||||||||||||||
Interest capitalized | 2.6 | 0.4 | 4.5 | 0.7 | ||||||||||||||||||
Fuel hedging gains | 54.8 | 58.8 | 172.1 | 82.1 | ||||||||||||||||||
Other - net | (1.0 | ) | 0.9 | (3.7 | ) | 0.8 | ||||||||||||||||
| 52.6 | 56.9 | 159.1 | 70.5 | |||||||||||||||||||
Income Before Income Tax and Accounting Change | $ | 133.0 | $ | 97.9 | NM | $ | 170.5 | $ | 41.9 | NM | ||||||||||||
Operating Statistics: | ||||||||||||||||||||||
Revenue passengers (000) | 4,632 | 4,589 | 0.9 | % | 12,715 | 12,296 | 3.4 | % | ||||||||||||||
RPMs (000,000) | 4,598 | 4,571 | 0.6 | % | 12,812 | 12,255 | 4.5 | % | ||||||||||||||
ASMs (000,000) | 5,822 | 6,012 | -3.2 | % | 16,735 | 16,825 | -0.5 | % | ||||||||||||||
Passenger load factor | 79.0 | % | 76.0 | % | 3.0 pts | 76.6 | % | 72.8 | % | 3.8 pts | ||||||||||||
Yield per passenger mile | 13.57 | ¢ | 12.62 | ¢ | 7.4 | % | 12.93 | ¢ | 12.61 | ¢ | 2.5 | % | ||||||||||
Operating revenue per ASM | 11.84 | ¢ | 10.53 | ¢ | 12.4 | % | 10.93 | ¢ | 10.11 | ¢ | 8.1 | % | ||||||||||
Operating expenses per ASM (a) | 10.46 | ¢ | 9.84 | ¢ | 6.1 | % | 10.86 | ¢ | 10.28 | ¢ | 5.6 | % | ||||||||||
Operating expense per ASM excluding fuel, navigation fee refund, restructuring and impairment charges(a) | 7.53 | ¢ | 7.35 | ¢ | 2.4 | % | 8.04 | ¢ | 7.95 | ¢ | 1.2 | % | ||||||||||
Raw fuel cost per gallon (a) | $ | 1.99 | $ | 1.40 | 41.8 | % | $ | 1.78 | $ | 1.30 | 37.4 | % | ||||||||||
GAAP fuel cost per gallon (a) | $ | 1.95 | $ | 1.36 | 43.3 | % | $ | 1.74 | $ | 1.26 | 38.6 | % | ||||||||||
Economic fuel cost per gallon (a) | $ | 1.56 | $ | 1.27 | 23.0 | % | $ | 1.46 | $ | 1.21 | 20.8 | % | ||||||||||
Fuel gallons (000,000) | 90.4 | 95.8 | -5.7 | % | 260.8 | 267.6 | -2.5 | % | ||||||||||||||
Average number of employees | 8,961 | 10,201 | -12.2 | % | 9,108 | 10,147 | -10.2 | % | ||||||||||||||
Aircraft utilization (blk hrs/day) | 10.9 | 11.8 | -7.6 | % | 10.8 | 11.1 | -2.7 | % | ||||||||||||||
Operating fleet at period-end | 110 | 107 | 2.8 | % | 110 | 107 | 2.8 | % | ||||||||||||||
NM = Not Meaningful
Horizon Air Financial and Statistical Data (Unaudited)
| Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||||||||||
| 2005 | 2004 | % Change | 2005 | 2004 | % Change | |||||||||||||||||
Financial Data (in millions): | ||||||||||||||||||||||
Operating Revenues: | ||||||||||||||||||||||
Passenger | $ | 151.2 | $ | 134.5 | 12.4 | % | $ | 405.8 | $ | 360.4 | 12.6 | % | ||||||||||
Freight and mail | 1.0 | 1.0 | 0.0 | % | 2.9 | 3.0 | -3.3 | % | ||||||||||||||
Other - net | 1.5 | 3.8 | -60.5 | % | 6.8 | 10.9 | -37.6 | % | ||||||||||||||
Total Operating Revenues | 153.7 | 139.3 | 10.3 | % | 415.5 | 374.3 | 11.0 | % | ||||||||||||||
Operating Expenses: | ||||||||||||||||||||||
Wages and benefits | 45.3 | 39.7 | 14.1 | % | 131.6 | 122.1 | 7.8 | % | ||||||||||||||
Contracted services | 6.1 | 5.0 | 22.0 | % | 17.7 | 15.4 | 14.9 | % | ||||||||||||||
Aircraft fuel | 27.5 | 18.2 | 51.1 | % | 70.3 | 48.4 | 45.2 | % | ||||||||||||||
Aircraft maintenance | 11.9 | 9.9 | 20.2 | % | 31.1 | 26.6 | 16.9 | % | ||||||||||||||
Aircraft rent | 17.5 | 18.6 | -5.9 | % | 52.8 | 56.0 | -5.7 | % | ||||||||||||||
Food and beverage service | 0.7 | 0.6 | 16.7 | % | 1.9 | 1.6 | 18.8 | % | ||||||||||||||
Selling expenses | 8.1 | 6.7 | 20.9 | % | 22.1 | 19.9 | 11.1 | % | ||||||||||||||
Depreciation and amortization | 4.1 | 3.4 | 20.6 | % | 12.0 | 9.7 | 23.7 | % | ||||||||||||||
Landing fees and other rentals | 12.2 | 11.0 | 10.9 | % | 35.7 | 31.2 | 14.4 | % | ||||||||||||||
Other | 10.1 | 9.4 | 7.4 | % | 31.0 | 31.2 | -0.6 | % | ||||||||||||||
Impairment of aircraft and spare parts | — | — | NM | — | 2.8 | NM | ||||||||||||||||
Total Operating Expenses | 143.5 | 122.5 | 17.1 | % | 406.2 | 364.9 | 11.3 | % | ||||||||||||||
Operating Income | 10.2 | 16.8 | NM | 9.3 | 9.4 | NM | ||||||||||||||||
Interest income | 0.3 | 0.3 | 1.0 | 0.9 | ||||||||||||||||||
Interest expense | (1.6 | ) | (0.9 | ) | (4.3 | ) | (3.2 | ) | ||||||||||||||
Interest capitalized | 0.2 | 0.1 | 0.4 | 0.4 | ||||||||||||||||||
Fuel hedging gains | 8.1 | 8.1 | 26.5 | 11.2 | ||||||||||||||||||
Other - net | 0.1 | — | 0.1 | — | ||||||||||||||||||
| 7.1 | 7.6 | 23.7 | 9.3 | |||||||||||||||||||
Income Before Income Tax and Accounting Change | $ | 17.3 | $ | 24.4 | NM | $ | 33.0 | $ | 18.7 | NM | ||||||||||||
Operating Statistics: | ||||||||||||||||||||||
Revenue passengers (000) | 1,755 | 1,641 | 6.9 | % | 4,868 | 4,362 | 11.6 | % | ||||||||||||||
RPMs (000,000) | 683 | 601 | 13.6 | % | 1,843 | 1,586 | 16.2 | % | ||||||||||||||
ASMs (000,000) | 911 | 830 | 9.8 | % | 2,542 | 2,314 | 9.9 | % | ||||||||||||||
Passenger load factor | 75.0 | % | 72.4 | % | 2.6 pts | 72.5 | % | 68.5 | % | 4.0 pts | ||||||||||||
Yield per passenger mile | 22.14 | ¢ | 22.38 | ¢ | -1.1 | % | 22.02 | ¢ | 22.73 | ¢ | -3.1 | % | ||||||||||
Operating revenue per ASM | 16.87 | ¢ | 16.78 | ¢ | 0.6 | % | 16.35 | ¢ | 16.18 | ¢ | 1.0 | % | ||||||||||
Operating expenses per ASM (a) | 15.75 | ¢ | 14.76 | ¢ | 6.7 | % | 15.98 | ¢ | 15.77 | ¢ | 1.3 | % | ||||||||||
Operating expense per ASM excluding fuel and impairment charges(a) | 12.73 | ¢ | 12.57 | ¢ | 1.3 | % | 13.21 | ¢ | 13.56 | ¢ | -2.6 | % | ||||||||||
Raw fuel cost per gallon (a) | $ | 2.04 | $ | 1.44 | 41.8 | % | $ | 1.85 | $ | 1.34 | 38.4 | % | ||||||||||
GAAP fuel cost per gallon (a) | $ | 2.00 | $ | 1.40 | 43.1 | % | $ | 1.82 | $ | 1.30 | 40.1 | % | ||||||||||
Economic fuel cost per gallon (a) | $ | 1.62 | $ | 1.31 | 23.9 | % | $ | 1.54 | $ | 1.26 | 22.1 | % | ||||||||||
Fuel gallons (000,000) | 13.7 | 13.0 | 5.4 | % | 38.6 | 37.2 | 3.8 | % | ||||||||||||||
Average number of employees | 3,508 | 3,439 | 2.0 | % | 3,428 | 3,399 | 0.9 | % | ||||||||||||||
Aircraft utilization (blk hrs/day) | 9.0 | 8.7 | 3.4 | % | 8.6 | 8.3 | 3.6 | % | ||||||||||||||
Operating fleet at period-end | 65 | 65 | 0.0 | % | 65 | 65 | 0.0 | % | ||||||||||||||
NM = Not Meaningful
Note A:
Pursuant to Item 10 of Regulation S-K, we are providing disclosure of the reconciliation of reported non-GAAP financial measures to their most directly comparable financial measures reported on a GAAP basis. The non-GAAP financial measures provide management the ability to measure and monitor performance both with and without the cost of aircraft fuel (including the gains and losses associated with our fuel hedging program where appropriate), the navigation fee refund, restructuring charges, and aircraft impairment charges. Because the cost and availability of aircraft fuel are subject to many economic and political factors beyond our control and we record changes in the fair value of our hedge portfolio in our income statement, it is our view that the measurement and monitoring of performance without fuel is important. In addition, we believe the disclosure of financial performance without the navigation fee refund and impairment and restructuring charges is useful to investors. Finally, these non-GAAP financial measures are also more comparable to financial measures reported to the Department of Transportation by other major network airlines.
The following tables reconcile our non-GAAP financial measures to the most directly comparable GAAP financial measures for both Alaska Airlines, Inc. and Horizon Air Industries, Inc.:
Alaska Airlines, Inc.:
($ in millions) | Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Unit cost reconciliations: | ||||||||||||||||
Operating expenses | $ | 608.9 | $ | 591.8 | $ | 1,817.5 | $ | 1,730.3 | ||||||||
ASMs (000,000) | 5,822 | 6,012 | 16,735 | 16,825 | ||||||||||||
Operating expenses per ASM | 10.46 | ¢ | 9.84 | ¢ | 10.86 | ¢ | 10.28 | ¢ | ||||||||
Operating expenses | $ | 608.9 | $ | 591.8 | $ | 1,817.5 | $ | 1,730.3 | ||||||||
Less: aircraft fuel | (176.6 | ) | (130.2 | ) | (455.7 | ) | (336.4 | ) | ||||||||
Less: restructuring charges | 1.4 | (27.5 | ) | (20.7 | ) | (27.5 | ) | |||||||||
Add: navigation fee refund | 4.7 | 7.7 | 4.7 | 7.7 | ||||||||||||
Less: impairment of aircraft and related spare parts | — | — | — | (36.8 | ) | |||||||||||
Operating expenses excluding fuel, navigation fee refund, restructuring and impairment charges | $ | 438.4 | $ | 441.8 | $ | 1,345.8 | $ | 1,337.3 | ||||||||
ASMs (000,000) | 5,822 | 6,012 | 16,735 | 16,825 | ||||||||||||
Operating expenses per ASM excluding fuel, navigation fee refund, restructuring and impairment charges | 7.53 | ¢ | 7.35 | ¢ | 8.04 | ¢ | 7.95 | ¢ | ||||||||
Reconciliation to GAAP income before taxes and accounting change: | ||||||||||||||||
Income before taxes and accounting change, excluding mark-to-market hedging gains, navigation fee refund, restructuring and impairment charges | $ | 106.0 | $ | 64.1 | $ | 85.3 | $ | 24.8 | ||||||||
Add: mark-to-market hedging gains included in nonoperating income (expense) | 19.9 | 50.3 | 100.2 | 70.4 | ||||||||||||
Less: restructuring charges | 1.4 | (27.5 | ) | (20.7 | ) | (27.5 | ) | |||||||||
Add: navigation fee refund and related interest received | 5.7 | 11.0 | 5.7 | 11.0 | ||||||||||||
Less: impairment of aircraft and related spare parts | — | — | — | (36.8 | ) | |||||||||||
GAAP income before taxes and accounting change as reported | $ | 133.0 | $ | 97.9 | $ | 170.5 | $ | 41.9 | ||||||||
Aircraft fuel reconciliations: | ||||||||||||||||
| Three Months Ended September 30, | ||||||||||||||||
| 2005 | 2004 | |||||||||||||||
| (in millions) | Cost/Gal | (in millions) | Cost/Gal | |||||||||||||
Fuel expense before hedge activities (“raw” or “into-plane” fuel cost) | $ | 179.5 | $ | 1.99 | $ | 133.7 | $ | 1.40 | ||||||||
Less: gains on settled hedges included in fuel expense | (2.9 | ) | (0.04 | ) | (3.5 | ) | (0.04 | ) | ||||||||
GAAP fuel expense | $ | 176.6 | $ | 1.95 | $ | 130.2 | $ | 1.36 | ||||||||
Less: gains on settled hedges included in nonoperating income (expense) | (34.9 | ) | (0.39 | ) | (8.5 | ) | (0.09 | ) | ||||||||
Economic fuel expense | $ | 141.7 | $ | 1.56 | $ | 121.7 | $ | 1.27 | ||||||||
Fuel gallons (000,000) | 90.4 | 95.8 | ||||||||||||||
Mark-to-market gains included in non-operating income (expense) related to hedges that settle in future periods, net of the reclassification of previously recorded mark-to-market gains togains on settled hedges included in nonoperating income (expense) | $ | 19.9 | $ | 50.3 | ||||||||||||
| Nine Months Ended September 30, | ||||||||||||||||
| 2005 | 2004 | |||||||||||||||
| (in millions) | Cost/Gal | (in millions) | Cost/Gal | |||||||||||||
Fuel expense before hedge activities (“raw” or “into-plane” fuel cost) | $ | 465.2 | $ | 1.78 | $ | 347.4 | $ | 1.30 | ||||||||
Less: gains on settled hedges included in fuel expense | (9.5 | ) | (0.04 | ) | (11.0 | ) | (0.04 | ) | ||||||||
GAAP fuel expense | $ | 455.7 | $ | 1.74 | $ | 336.4 | $ | 1.26 | ||||||||
Less: gains on settled hedges included in nonoperating income (expense) | (71.9 | ) | (0.28 | ) | (11.7 | ) | (0.05 | ) | ||||||||
Economic fuel expense | $ | 383.8 | $ | 1.46 | $ | 324.7 | $ | 1.21 | ||||||||
Fuel gallons (000,000) | 260.8 | 267.6 | ||||||||||||||
Mark-to-market gains included in non-operating income (expense) related to hedges that settle in future periods, net of the reclassification of previously recorded mark-to-market gains togains on settled hedges included in nonoperating income (expense) | $ | 100.2 | $ | 70.4 | ||||||||||||
Horizon Air Industries, Inc.
($ in millions) | Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Unit cost reconciliations: | ||||||||||||||||
Operating expenses | $ | 143.5 | $ | 122.5 | $ | 406.2 | $ | 364.9 | ||||||||
ASMs (000,000) | 911 | 830 | 2,542 | 2,314 | ||||||||||||
Operating expenses per ASM | 15.75 | ¢ | 14.76 | ¢ | 15.98 | ¢ | 15.77 | ¢ | ||||||||
Operating expenses | $ | 143.5 | $ | 122.5 | $ | 406.2 | $ | 364.9 | ||||||||
Less: aircraft fuel | (27.5 | ) | (18.2 | ) | (70.3 | ) | (48.4 | ) | ||||||||
Less: impairment of aircraft | — | — | — | (2.8 | ) | |||||||||||
Operating expense excluding fuel and impairment charge | $ | 116.0 | $ | 104.3 | $ | 335.9 | $ | 313.7 | ||||||||
ASMs (000,000) | 911 | 830 | 2,542 | 2,314 | ||||||||||||
Operating expense per ASM excluding fuel and impairment charge | 12.73 | ¢ | 12.57 | ¢ | 13.21 | ¢ | 13.56 | ¢ | ||||||||
Reconciliation to GAAP income before taxes and accounting change: | ||||||||||||||||
Income before taxes and accounting change, excluding mark-to-market hedging gains and impairment charge | $ | 14.4 | $ | 17.5 | $ | 17.4 | $ | 11.9 | ||||||||
Add: mark-to-market hedging gains included in nonoperating income (expense) | 2.9 | 6.9 | 15.6 | 9.6 | ||||||||||||
Less: impairment of aircraft and related spare parts | — | — | — | (2.8 | ) | |||||||||||
GAAP income before taxes and accounting change as reported | $ | 17.3 | $ | 24.4 | $ | 33.0 | $ | 18.7 | ||||||||
Aircraft fuel reconciliations: | ||||||||||||||||
| Three Months Ended September 30, | ||||||||||||||||
| 2005 | 2004 | |||||||||||||||
| (in millions) | Cost/Gal | (in millions) | Cost/Gal | |||||||||||||
Fuel expense before hedge activities (“raw” or “into-plane” fuel cost) | $ | 28.0 | $ | 2.04 | $ | 18.7 | $ | 1.44 | ||||||||
Less: gains on settled hedges included in fuel expense | (0.5 | ) | (0.04 | ) | (0.5 | ) | (0.04 | ) | ||||||||
GAAP fuel expense | $ | 27.5 | $ | 2.00 | $ | 18.2 | $ | 1.40 | ||||||||
Less: gains on settled hedges included in nonoperating income (expense) | (5.2 | ) | (0.38 | ) | (1.2 | ) | (0.09 | ) | ||||||||
Economic fuel expense | $ | 22.3 | $ | 1.62 | $ | 17.0 | $ | 1.31 | ||||||||
Fuel gallons (000,000) | 13.7 | 13.0 | ||||||||||||||
Mark-to-market gains included in non-operating income (expense) related to hedges that settle in future periods, net of the reclassification of previously recorded mark-to-market gains togains on settled hedges included in nonoperating income (expense) | $ | 2.9 | $ | 6.9 | ||||||||||||
| Nine Months Ended September 30, | ||||||||||||||||
| 2005 | 2004 | |||||||||||||||
| (in millions) | Cost/Gal | (in millions) | Cost/Gal | |||||||||||||
Fuel expense before hedge activities (“raw” or “into-plane” fuel cost) | $ | 71.6 | $ | 1.85 | $ | 49.9 | $ | 1.34 | ||||||||
Less: gains on settled hedges included in fuel expense | (1.3 | ) | (0.03 | ) | (1.5 | ) | (0.04 | ) | ||||||||
GAAP fuel expense | $ | 70.3 | $ | 1.82 | $ | 48.4 | $ | 1.30 | ||||||||
Less: gains on settled hedges included in nonoperating income (expense) | (10.9 | ) | (0.28 | ) | (1.6 | ) | (0.04 | ) | ||||||||
Economic fuel expense | $ | 59.4 | $ | 1.54 | $ | 46.8 | $ | 1.26 | ||||||||
Fuel gallons (000,000) | 38.6 | 37.2 | ||||||||||||||
Mark-to-market gains included in non-operating income (expense) related to hedges that settle in future periods, net of the reclassification of previously recorded mark-to-market gains togains on settled hedges included in nonoperating income (expense) | $ | 15.6 | $ | 9.6 | ||||||||||||
Diluted Earnings (Loss) Per Share Income (loss) before accounting change Interest on convertible notes, net of tax Diluted income (loss) before accounting change Weighted average diluted shares outstanding Income (loss) per share before accounting change Cumulative effect of accounting change, net of tax Weighted average shares outstanding Per share cumulative effect of accounting change Net income (loss) Interest on convertible notes, net of tax Diluted net income (loss) Weighted average shares outstanding Net income (loss) per share Three Months Ended
September 30, Nine Months Ended
September 30, 2006 2005 2006 2005 $ (17.4 ) $ 90.2 $ (41.0 ) $ 117.5 NA 1.5 NA 4.0 $ (17.4 ) $ 91.7 $ (41.0 ) $ 121.5 39.954 33.857 37.172 33.523 $ (0.44 ) $ 2.71 $ (1.10 ) $ 3.62 NA NA NA $ (90.4 ) NA NA NA 33.523 NA NA NA $ (2.69 ) $ (17.4 ) $ 90.2 $ (41.0 ) $ 27.1 NA 1.5 NA 4.0 $ (17.4 ) $ 91.7 $ (41.0 ) $ 31.1 39.954 33.857 37.172 33.523 $ (0.44 ) $ 2.71 $ (1.10 ) $0.93
The following discussion should be read in conjunction with our condensed consolidated financial statements and the related notes contained elsewhere in this quarterly report on Form 10-Q. All statements in the following discussion that are not reports of historical information or descriptions of current accounting policy are forward-looking statements. Please consider our forward-looking statements in light of the risks referred to in this report’s introductory cautionary note.
Air Group’s filings with the Securities and Exchange Commission, including its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are accessible free of charge at www.alaskaair.com. The information contained on our website is not a part of this quarterly report on Form 10-Q. As used in this Form 10-Q, the terms “Air Group,” “our,” “we” and the “Company” refer to Alaska Air Group, Inc. and its subsidiaries, unless the context indicates otherwise.
Third Quarter in Review and Current EventsNote 12. Operating Segment Information
In the third quarter, despite relatively flat passenger traffic at Alaska, revenues continued to improve due to higher ticket yields resulting from industry wide fare increases. The flat passenger traffic resulted from reduced capacity, in light of the operational difficulties described below, despite record load factors during the quarter. Horizon continued to see significant increases in passenger traffic, resulting in increased revenues, offset by slightly lower yield. Operating expenses per available seat mile increased 6.1% at Alaska to 10.46 cents and 6.7% at Horizon to 15.75 cents compared to the third quarter of 2004. Fuel is a major component of our operating costs and fuel prices reached record highs once again during the quarter. At Alaska, our unit costs excluding fuel, a navigation fee refund and restructuring charges during the third quarter of 2005 increased by 2.4% to 7.53 cents compared to the third quarter of 2004. This is primarily due to the capacity reduction during the summer. Compared to the third quarter of 2004, Horizon had a 1.3% increase in unit costs excluding fuel to 12.73 cents.
Although revenues and pre-tax income at Alaska have improved over the prior year, we faced several operational difficulties during much of the third quarter due to the combined effects of the recent labor and operational changes across our company. The result was operational performance that was well below our goal during much of the third quarter. Our operational performance, measured by on-time arrivals and departures, declined from the third quarter of 2004. However, in September, we began to see improvement in these metrics and expect the positive trend to continue through the remainder of the year. In order to improve our operational performance, we reduced our 2005 summer capacity from our original expectations through schedule reductions and the elimination of certain flights.
Labor Costs and Negotiations
Subsequent to the end of the third quarter, Alaska reached an agreement with the Aircraft Mechanics Fraternal Association (AMFA) resulting in a new four year contract covering Alaska’s approximately 700 aircraft technicians. This contract includes, among other items, a market-based wage increase of approximately 10% and a one-time $1,000 bonus to each of the employees covered under the contract.
Also, in October 2005, Horizon reached an agreement with the Transport Workers Union for a new three-year contract covering 21 dispatchers at Horizon. Additionally, Horizon has reached a tentative agreement with AMFA on a three-year contract covering Horizon’s more than 400 mechanics and fleet service agents. This tentative agreement is expected to be voted on by the union members in the fourth quarter of 2005.
We are pleased with the contracts that have been reached recently and we are continuing to negotiate with our other workgroups to reach agreement on contracts that would benefit both our employees and our shareholders. None of the contract negotiations is at an impasse or has reached the 30-day cooling off period required under the Railway Labor Act that would trigger self help. Therefore, we currently believe the risk of a work stoppage or other material service disruption in the near future is low.
Mark-to-Market Fuel Hedging Gains
Beginning in the second quarter of 2004, we lost the ability to defer, as a component of comprehensive income, recognition of any unrealized gain or loss on our fuel hedge contracts until the hedged fuel is consumed. We lost this ability because the price correlation between crude oil, the commodity we use to hedge, and West Coast jet fuel fell below required thresholds. For more discussion, see Note 4 to our condensed consolidated financial statements.
The implications of this change are twofold: First, our earnings can be more volatile as we mark our entire hedge portfolio to market each quarter-end and report the gain or loss in other non-operating income or expense, even though the actual consumption could take place in a future period. In times of rising fuel prices such as the third quarter of 2005, this will have the effect of increasing our reported net income or decreasing our reported net loss. Our mark-to-market gains recorded in the third quarter of 2005 for contracts that settle in future periods, net of the reclassification of previously recorded mark-to-market gains for settled hedges, were $22.8 million compared to $57.2 million in the third quarter of 2004. Second, to a large extent, the impact of our fuel hedge program will not be reflected in fuel expense. In the third quarter of 2005, we recorded gains from settled fuel hedges totaling $43.5 million, but only $3.4 million of that gain is reflected as an offset to fuel expense with the balance reported in other non-operating income. In the third quarter of 2004, gains of $4.0 million on settled hedges were recorded as an offset to fuel expense and gains of $9.7 million were recorded in non-operating income related to settled hedges.
We have providedsegment information on mark-to-market gains or losses, as well as calculations of our economic fuel cost per gallon on pages 22 and 23.
We believe that our fuel hedge program is an important part of our strategy to reduce our exposure to volatile fuel prices.
Restructuring Charges
During the third quarter of 2004, Alaska announced a management reorganization and the closure of its Oakland maintenance base, contracting out of the Alaska’s fleet service and ground support equipment and facility maintenance functions, as well as other initiatives. Severance and related costs associated with this restructuring during the third quarter of 2004 were $27.5 million. In the third quarter of 2005, we recorded a $1.4 million (pre-tax) positive adjustment to the restructuring accrual related to this and other initiatives as discussed in Note 3 to our condensed consolidated financial statements.
Other Events
In August 2005, Alaska recorded a net refund totaling $5.7 million ($3.6 million, net of tax) from the Mexican government related to navigation fees paid in 2004. Approximately $4.7 million of the refund was recorded as a reduction to operating expenses and $1.0 million was recorded as interest income in non-operating income. This is compared to an $11.0 million refund ($6.3 million, net of tax) recorded during the third quarter of 2004.
In October 2005, Horizon finalized an agreement to purchase twelve Bombardier Q400 aircraft with delivery dates beginning in December 2006 and continuing through July 2007. This agreement, in part, replaced firm orders for seven CRJ-700 aircraft that were to be delivered over the next several years. This agreement also provides for an option to purchase up to an additional 20 Q400 aircraft. In connection with the agreement, Bombardier agreed to provide certain remarketing assistance for up to twelve Q200 aircraft currently leased by Horizon for a fee as set forth in the agreement.
In October 2005, Alaska finalized a $172 million variable rate revolving loan facility to provide a portion of the pre-delivery funding requirements of Alaska’s purchase of up to 38 new Boeing 737-800 aircraft (23 of which are firm orders) under the current aircraft purchase agreement. The facility will expire on August 31, 2009 and the interest rate is based on one-month LIBOR plus a specified margin. Any borrowings will be secured by the Company’s rights under the Boeing purchase agreement. Upon closing, we drew $61.3 million on the facility.
We began daily non-stop service from Los Angeles to Mexico City in August 2005 and Seattle to Dallas/Fort Worth in September 2005.
Outlook
For the fourth quarter of 2005, Alaska and Horizon expect capacity to be up approximately 2% and 8%, respectively, compared to 2004 capacity.
Results of Operations
Comparison of Three Months Ended September 30, 2005 to Three Months Ended September 30, 2004
Our consolidated net income for the third quarter of 2005 was $90.2 million, or $2.71 per diluted share, versus $74.0 million, or $2.29 per diluted share, in the third quarter of 2004.
Our consolidated pre-tax income for the quarter was $146.8 million compared to $119.2 million for the third quarter of 2004. Both the 2005 and 2004 results include certain notable items that impact the comparability of the quarters. These items are discussed in the “Third Quarter in Review and Current Events” section beginning on page 24. Excluding those items, the quarter over quarter improvement can be characterized by higher revenues and slightly lower non-fuel operating costs, offset by significantly higher fuel costs. Wages and benefits declined significantly due to some of the recent initiatives and the new pilot contract at Alaska. However, these declines were largely offset by higher operating expenses in other areas such as contracted services and aircraft maintenance.
Financial and statistical data comparisons for Alaska and Horizon are shown on pages 20 and 21, respectively. On pages 22 and 23, we have included a reconciliation of reported non-GAAP financial measures to the most directly comparable GAAP financial measures.
Alaska Airlines Revenues
Operating revenues increased $56.5 million, or 8.9%, during the third quarter of 2005 as compared to 2004 due to a 12.4% increase in operating revenue per available seat mile (RASM) offset by reduced ASMs. The increase in RASM was driven by a 7.4% increase in ticket yields that resulted from increases in ticket prices designed to offset higher fuel prices and higher load factors. The capacity decrease is primarily a direct result of the reduction in our flight schedule that was announced in June 2005, offset by the addition of three B737-800s in the first nine months of 2005
Load factor increased 3.0 percentage points to 79.0% for the third quarter of 2005 due primarily to the nearly flat passenger traffic combined with fewer departures. We expect that load factors will continue to improvethree and that yields and passenger unit revenues will be higher in the fourth quarter of 2005 compared to 2004, although not to the extent that we had in the third quarter.
Freight and mail revenues increased by $0.7 million, or 2.9%, compared to the same period in 2004 as a result of a relatively new mail contract we have in the State of Alaska that began in the third quarter of 2004 and fuel surcharges added to our freight services during the third quarter of 2005, offset by lower freight volumes.
Other-net revenues increased $8.3 million, or 26.2%, primarily due to increases in Mileage Plan revenues resulting from higher award redemption on our partner airlines and an increase in cash receipts from miles sold, of which a portion is recognized immediately as other revenue.
Alaska Airlines Expenses
For the quarter, total operating expenses increased $17.1 million, or 2.9%, as compared to the same period in 2004, although operating expenses excluding fuel, the navigation fee refund and restructuring charges, decreased by $3.4 million, or 0.8%. Operating expenses per ASM increased 6.1% from 9.84 cents in the third quarter of 2004 to 10.46 cents in the third quarter of 2005. The increase in operating expenses is due largely to the significant increase in raw or “into-plane” fuel costs and increases in aircraft maintenance, contracted services, and landing fees and other rentals, offset by a decline in wages and benefits and selling expenses. Operating expenses per ASM excluding fuel, the navigation fee refund, and restructuring charges increased 2.4% as compared to the same period in 2004. Our estimates of costs per ASM, excluding the items noted above for the fourth quarter and full year of 2005, are 7.8 cents and 8.0 cents, respectively.
Explanations of significant period-over-period changes in the components of operating expenses are as follows:
During the second quarter of 2005, we entered into a fuel contract whereby the spread between crude oil prices and jet fuel prices is fixed for approximately one-third of our fuel consumption. This contract has resulted in approximately $6.0 million in savings for Air Group during the third quarter of 2005.
See page 22 for a table summarizing fuel cost per gallon realized by Alaska (the economic cost per gallon), the cost per gallon on a GAAP basis (including hedging gains recorded in aircraft fuel) and fuel cost per gallon excluding all hedging activities.
Horizon Air Revenues
For the third quarter, operating revenues increased $14.4 million, or 10.3% as compared to 2004. This increase is due largely to increased traffic, partially offset by a 1.1% decline in ticket yields.
For the three months ending September 30, 2005, capacity increased 9.8% and traffic was up 13.6%, compared to the same period in 2004 due primarily to the addition of one CRJ-700, four additional seats on each of our Q400’s and an increase in the average trip length. Passenger yield decreased 1.1% to 22.14 cents per passenger mile due primarily to an increase in average trip lengths across the native network, partially as a result of increased harmonization flying with Alaska. Passenger revenues increased by $16.7 million, or 12.4%, due primarily to the increase in traffic resulting from increased harmonization flying with Alaska and in our native network.
Horizon Air Expenses
Operating expenses for the third quarter of 2005 increased $21.0 million, or 17.1%, as compared to the same period in 2004 primarily due to increases in raw or “into-plane” fuel costs, wages and benefits and aircraft maintenance. Operating expenses per ASM increased 6.7% as compared to 2004. Operating expenses per ASM excluding fuel increased 1.3% as compared to the same period in 2004. Our estimates of costs per ASM, excluding fuel and any special charges, for the fourth quarter and full year of 2005 are 13.8 cents, and 13.4 cents, respectively.
Explanations of other significant period-over-period changes in the components of operating expenses are as follows:
During the second quarter of 2005, we entered into a fuel contract whereby the spread between crude oil prices and jet fuel prices is fixed for approximately one-third of our fuel consumption. This contract has resulted in approximately $6.0 million in savings for Air Group during the third quarter of 2005.
See page 23 for a table summarizing fuel cost per gallon realized by Horizon (the economic cost per gallon), the cost per gallon on a GAAP basis (including hedging gains recorded in aircraft fuel) and fuel cost per gallon excluding all hedging activities.
Consolidated Nonoperating Income (Expense)
Net nonoperating income was $56.6 million in the third quarter of 2005 compared to $62.4 million during the same period of 2004. Interest income increased $0.7 million due to a larger average marketable securities portfolio in the third quarter of 2005, offset by a larger interest payment in 2004 related to the navigation fee refund. Interest expense increased $2.5 million primarily due to interest rate increases on our variable rate debt and the changes to some of our variable rate debt agreements to slightly higher fixed rate arrangements. Capitalized interest increased $2.3 million from $0.5 million in the third quarter of 2004 to $2.8 million in the third quarter of 2005. This increase is due to the significant increase in deposits for future flight equipment resulting from our new aircraft purchase agreement for B737-800 aircraft.
Fuel hedging gains include $40.1 million in gains from fuel hedging contracts settled in the third quarter of 2005 compared to $9.7 million in 2004. In addition, fuel hedging gains include net mark-to-market gains on unsettled hedge contracts, net of the reclassification of previously recorded mark-to-market gains for settled hedges, of $22.8 million in 2005 and $57.2 million in 2004.
Comparison of Nine Months Ended September 30, 2005 to Nine Months Ended September 30, 2004
Our consolidated net income for the nine months ended September 30 2005 was $27.1 million, or $0.93 per diluted share, versus $29.6 million, or $0.98 per diluted share, duringas follows (in millions):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2006 | 2005 | 2006 | 2005 | |||||||||||||
Operating revenues: | ||||||||||||||||
Alaska | $ | 759.9 | $ | 689.3 | $ | 2,060.3 | $ | 1,828.9 | ||||||||
Horizon | 176.3 | 153.7 | 485.2 | 415.5 | ||||||||||||
Other* | 0.2 | 0.3 | 0.8 | 0.8 | ||||||||||||
Elimination of intercompany revenues | (0.7 | ) | 2.4 | (2.2 | ) | (0.5 | ) | |||||||||
Consolidated | $ | 935.7 | $ | 845.7 | $ | 2,544.1 | $ | 2,244.7 | ||||||||
Income (loss) before income tax and accounting change: | ||||||||||||||||
Alaska | $ | (27.9 | ) | $ | 133.0 | $ | (80.1 | ) | $ | 170.5 | ||||||
Horizon | 5.9 | 17.3 | 15.2 | 33.0 | ||||||||||||
Other* | (0.9 | ) | (3.5 | ) | (6.3 | ) | (10.0 | ) | ||||||||
Consolidated | $ | (22.9 | ) | $ | 146.8 | $ | (71.2 | ) | $ | 193.5 | ||||||
Total assets at end of period: Alaska Horizon Other* Elimination of intercompany accounts Consolidated September 30,
2006 December 31,
2005 $ 3,777.8 $ 3,511.9 415.7 311.8 983.5 1,012.1 (1,037.3 ) (1,043.8 ) $ 4,139.7 $ 3,792.0
| * | Includes the parent company, Alaska Air Group, Inc., including its investments in Alaska and Horizon, which are eliminated in consolidation. |
Note 13. Contingencies
In April 2006, the federal district court in Seattle granted voluntary dismissal of Alaska’s lawsuit against the International Association of Machinists (IAM) seeking to compel arbitration of dispute regarding the permissibility of subcontracting of Alaska’s ramp service operation in Seattle. At the same time, the court also dismissed a counterclaim by the IAM alleging that Alaska violated the Railway Labor Act status quo and engaged in bad faith bargaining. The appeal period of 2004.has expired and these matters are closed.
Our consolidated income before income tax andAdditionally, the accounting change forIAM filed a grievance against Alaska alleging that Alaska violated the nine months of 2005 was $193.5 million compared to $52.3 million for the first nine months of 2004. Both the 2005 and
2004 results include certain notable items as stated below that impact the comparability of the nine-month periods:
Financial and statistical data comparisons for Alaska and Horizon are shown on pages 20 and 21, respectively. On pages 22 and 23, we have included a reconciliation of reported non-GAAP financial measures to the most directly comparable GAAP financial measures. A discussion of the nine-month data follows.
Alaska Airlines Revenues
Operating revenues increased $127.2 million, or 7.5%, during 2005 as compared to 2004.
Yield per passenger mile increased 2.5% to 12.93 cents and passenger load factor increased 3.8 points during the first nine months of 2005 as compared to the same period in 2004. Increases in traffic and yield resulted in a 7.2% increase in passenger revenues in 2005.
Freight and mail revenues increased $3.1 million, or 4.7%, compared to the same period in 2004 because of a relatively new mail contract we have in the State of Alaska that began during the third quarter of 2004 and fuel surcharges added to our freight services during the third quarter of 2005, offset by lower freight volumes.
Other-net revenues increased $13.3 million, or 14.7%, due largely to an increase in Mileage Plan revenues, resulting from higher award redemption on our partner airlines and an increase in cash receipts from miles sold, of which a portion is recognized immediately as other revenue, offset by the termination of contract maintenance work that we were performing for third parties in the second quarter of 2004 and are no longer performing.
Alaska Airlines Expenses
For the nine months ended September 30, 2005, total operating expenses increased $87.2 million, or 5.0%, as compared to the same period in 2004. Operating expenses per ASM increased 5.6% in 2005 as compared to 2004. The increase in operating expenses is due largely to the significant increases in raw or “into-plane” fuel costs, aircraft maintenance, contracted services, and landing fees and other rentals, offset by a decline in wages and benefits, food and beverage service, selling expenses, depreciation and amortization and an impairment charge in 2004 related to our Boeing 737-200 fleet. Operating expense per ASM excluding fuel, the navigation fee refund, restructuring and impairment charges increased 1.2% as compared to the same period in 2004. As noted above, operating expenses per ASM was also negatively impacted by the summer capacity reductions.
Explanations of significant period-over-period changes in the components of operating expenses are as follows:
Aircraft fuel increased $119.3 million, or 35.5%, due to a 38.6% increase in the GAAP fuel cost per gallon, offset by a 2.5% decrease in fuel gallons consumed. During the first nine months of 2005, Alaska also realized $81.4 million of gains from settled hedges, the majority of which are recorded in other non-operating income (expense). The total gains from settled hedges of $81.4 million represents 47.7% of Alaska’s income before taxes and the accounting change.
|
See page 22 for a table summarizing fuel cost per gallon realized by Alaska (the economic cost per gallon), the cost per gallon on a GAAP basis (including hedging gains recorded in aircraft fuel) and fuel cost per gallon excluding all hedging activities.
Horizon Air Revenues
For the first nine months of 2005, operating revenues increased $41.2 million, or 11.0% as compared to 2004. This increase is due largely to increased traffic in the native network and the contract flying for Frontier Airlines, which began in January 2004, partially offset by a 3.1% decline in ticket yields.
For the nine months ended September 30, 2005, capacity increased 9.9% and traffic was up 16.2%, compared to the same period in 2004, due to an increase in contract flying with Frontier and harmonization flying with Alaska, the addition of one CRJ-700 in March 2005 and four additional seats on each of our Q400’s. Contract flying with Frontier represented approximately 9.1% of passenger revenues and 22.3% of capacity, during the first nine months of 2005 compared to 8.8% and 20.8%, respectively, in the first nine months of 2004. Passenger load factor increased 4.0 percentage points to 72.5%. Passenger yield decreased 3.1% to 22.02 cents, reflecting the inclusion of the Frontier contract flying, the yield for which is significantly lower than native network flying and an increase in average trip lengths across the native network, partially due to an increase in harmonization flying with Alaska. Passenger revenues increased by $45.4 million, or 12.6%, due primarily to the increase in traffic resulting from increased harmonization flying with Alaska and the increase in Frontier contract flying.
Horizon Air Expenses
Operating expenses for the first nine months of 2005 increased $41.3 million, or 11.3%, as compared to the same period in 2004, primarily due to increases in fuel costs, wages and benefits, aircraft maintenance and landing fees and other rentals, partially offset by a decline in aircraft rent. Operating expenses per ASM increased 1.3% as compared to 2004. Operating expenses per ASM excluding fuel and impairment charges decreased 2.6% as compared to the same period in 2004.
Explanations of other significant period-over-period changes in the components of operating expenses are as follows:
Aircraft fuel increased $21.9 million, or 45.2%, due to a 40.1% increase in the GAAP fuel cost per gallon from $1.30 in 2004 to $1.82 in 2005. During the first nine months of 2005, Horizon also realized $12.2 million of gains from settled hedges, the majority of which are recorded in other non-operating income (expense). The total gains from settled hedges of $12.2 million represents 37.0% of Horizon’s pre-tax income. After including all gains from settled hedges
|
See page 23 for a table summarizing fuel cost per gallon realized by Horizon (the economic cost per gallon), the cost per gallon on a GAAP basis (including hedging gains recorded in aircraft fuel) and fuel cost per gallon excluding all hedging activities.
Consolidated Nonoperating Income (Expense)
Net nonoperating income was $175.1 million in 2005 compared to $74.6 million in 2004. Interest income increased $3.0 million due to a larger average marketable securities portfolio in 2005, offset by a larger interest payment in 2004 related to the navigation fee refund. Interest expense increased $6.6 million due to interest rate increases on our variable rate debt and the changes to some of our variable rate debt agreements to slightly higher fixed rate agreements. Capitalized interest increased $3.8 million from $1.1 million in the first nine months of 2004 to $4.9 million in the first nine months of 2005. This increase is due to the significant increase in deposits for future flight equipment resulting from our new aircraft purchase agreement for B737-800 aircraft.
Fuel hedging gains include $82.8 million in gains from fuel hedging contracts settled in the first nine months of 2005 compared to $13.3 million in 2004. In addition, fuel hedging gains include net mark-to-market gains on unsettled hedge contracts, net of the reclassification of previously recorded mark-to-market gains for settled hedges, of $115.8 million in 2005 and $80.0 million in 2004.
Consolidated Income Tax Benefit
Accounting standards require us to provide for income taxes each quarter based on either our estimate of the effective tax rate for the full year or the actual year-to-date effective tax rate if it is our best estimate of our annual expectation. As the volatility of airfares and fuel prices and the seasonality of our business make it difficult to accurately forecast full-year pre-tax results, we use the actual year-to-date effective tax rate to provide for income taxes. In addition, a relatively small change in pre-tax results can cause a significant change in the effective tax rate due to the magnitude of nondeductible expenses, such as employee per diem costs, relative to pre-tax profit or loss. Our effective income tax rate on pre-tax income before the accounting change for the third quarter and first nine months of 2005 is 38.6% and 39.3%, respectively. We applied our 2005 year-to-date marginal rate of 37.5% for the cumulative effect of the accounting change. In arriving at these rates, we considered a variety of factors, including year-to-date pre-tax results, the U.S. federal rate of 35%, estimated year-to-date nondeductible expenses and estimated state income taxes. We evaluate our tax rate each quarter and make adjustments when necessary.
Change in Accounting Policy
Effective January 1, 2005, we changed our method of accounting for major airframe and engine overhauls from thecapitalize and amortize method to thedirect expense method. Under the former method, these costs were capitalized and amortized to maintenance expense over the shorter of the life of the overhaul or the remaining lease term. Under thedirect expense method, overhaul costs are expensed as incurred. We believe that thedirect expensemethod is preferable because it eliminates the judgment and estimation needed to determine overhaul versus repair allocations in maintenance activities. Additionally, our approved maintenance program for the majority of our airframes now focuses more on shorter, but more frequent, maintenance visits. We also believe that thedirect expense method is the predominant method used in the airline industry. Accordingly, effective January 1, 2005, we wrote off the net book value of our previously capitalized airframe and engine overhauls for all aircraft in a charge totaling $144.7 million pre-tax ($90.4 million after tax). We do not believe disclosing the effect of adopting thedirect expense method on net income for the period ended September 30, 2005 provides meaningful information because of changes in our maintenance program, including the execution of a “power by the hour” engine maintenance agreement with a third party in late 2004.
Critical Accounting Policies
For information on additional critical accounting policies, see Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2004.
Liquidity and Capital Resources
The table below presents the major indicators of financial condition and liquidity.
| September 30, 2005 | December 31, 2004 | Change | ||||||||
| (In millions, except per share and debt-to-capital amounts) | ||||||||||
Cash and marketable securities | $ | 745.7 | $ | 873.9 | $ | (128.2 | ) | |||
Working capital | 206.5 | 285.0 | (78.5 | ) | ||||||
Long-term debt and long-term capital lease obligations | 970.0 | 989.6 | (19.6 | ) | ||||||
Shareholders’ equity | 699.6 | 664.8 | 34.8 | |||||||
Book value per common share | $ | 25.34 | $ | 24.51 | $ | 0.83 | ||||
Long-term debt-to-capital | 58%:42% | 60%:40% | NA | |||||||
Long-term debt-to-capital assuming aircraft operating leases are capitalized at seven times annualized rent | 76%:24% | 78%:22% | NA | |||||||
During the nine months ended September 30, 2005, our cash and marketable securities decreased $128.2 million to $745.7 million at September 30, 2005. This decrease reflects cash used for property and equipment additions, net of aircraft deposit returns and proceeds from asset dispositions, of $304.4 million and cash used in financing activities of $1.5 million, partially offset by cash provided by operating activities of $180.2 million.
Cash Provided by Operating Activities
During the first nine months of 2005, net cash provided by operating activities was $180.2 million compared to $283.5 million during the first nine months of 2004. The decrease is due largely to the significant increases in the cost of fuel in the current year, cash payments made for severance, and a $42.7 million tax refund in 2004
Cash Used in Investing Activities
Cash used in investing activities was $180.0 million during the first nine months of 2005, compared to $219.1 million in 2004. We had net sales of $128.0 million of marketable securities and net purchases of $304.4 million for property and equipment additions, net of aircraft deposit returns and proceeds from asset dispositions. During the first nine months of 2005, our aircraft related capital expenditures net of aircraft deposit returns and proceeds from asset dispositions, increased $190.9 million as compared to 2004, primarily reflecting the net payment of $101.2 million related to the aircraft purchase commitment entered into during the second quarter of 2005 to acquire 35 B737-800 aircraft, as well as additional scheduled pre-delivery payments. As of January 1, 2005, we no longer have capital expenditures related to overhauls as those maintenance activities are expensed as incurred under our maintenance accounting policy adopted on that date. We expect capital expenditures to be approximately $450.0 million for the full year of 2005 and approximately $430 million (of which $400 million is expected to be aircraft related) in 2006 as we begin to take delivery of several aircraft.
Cash Provided by (Used in) Financing Activities
Net cash used in financing activities was $1.5 million during the first nine months of 2005 compared to $96.3 million during the same period in 2004. There was one debt issuance during the first nine months of 2005 of $20.0 million, which is secured by flight equipment. This note has a fixed interest rate of 6.07% and the payment term is 15 years. Additionally, we received $13.9 million in proceeds from issuances of common stock during the first nine months of 2005 compared to $2.3 million in the same period of 2004. Debt issuances and proceeds from common stock issuance during the period were offset by normal long-term debt payments of $35.4 million.
We plan to meet our capital and operating commitments through internally generated funds from operations and cash and marketable securities on hand at September 30, 2005 totaling $745.7 million, along with proceeds from our new pre-delivery payment facility used to provide assistance with our pre-delivery funding requirements on the purchase of new B737-800 aircraft, and additional debt financing. We also have restricted cash of $6.5 million, which is intended to collateralize interest payments due through March 2006 on our $150 million floating rate senior convertible notes due 2023 issued in 2003.
Bank Line of Credit Facility
During 2004, Alaska repaid its $150 million credit facility and, on December 23, 2004, that facility expired. On March 25, 2005, Alaska finalized a $160 million variable rate credit facility with a syndicate of financial institutions that will expire in March 2008. The interest rate on the credit facility varies depending on certain financial ratios specified in the agreement with a minimum interest rate of LIBOR plus 200 basis points. Any borrowings will be secured by either aircraft or cash collateral. This credit facility contains contractual restrictions and requires maintenance of specific levels of net worth, maintenance of certain debt and leases to net worth, leverage and fixed charge coverage ratios, and limits on liens, asset dispositions, dividends, and certain other expenditures. Such provisions restrict Alaska from distributing any funds to Air Group in the form of dividends and limit the amount of funds Alaska can loan to Air Group. As of September 30, 2005, Alaska could loan up to $300.0 million to Air Group without violating the covenants in the credit facility. As of September 30, 2005, there are no outstanding borrowings on this credit facility and the Company has no immediate plans to borrow using this credit facility.
Pre-delivery Payment Facility
On October 19, 2005, Alaska finalized a $172 million variable rate revolving loan facility with a syndicate of lenders to provide a portion of the pre-delivery funding requirements of Alaska’s purchase of up to 38 new Boeing 737-800 aircraft (23 of which are firm orders) under the current aircraft purchase agreement. The facility will expire on August 31, 2009. The interest rate is based on one-month LIBOR plus a specified margin. Any borrowings will be secured by Alaska’s rights under the Boeing purchase agreement. The initial draw on the facility was $61.3 million, which was used to reimburse Alaska for the facility’s portion of the pre-delivery payments made to date.
Supplemental Disclosure of Noncash Investing and Financing Activities
We received a $9.7 million credit toward our purchase deposits related to the aircraft purchase agreement entered into during the second quarter of 2005. This credit was recorded as additional purchase deposits and is included in other liabilities on our consolidated balance sheet and will be applied to future aircraft upon delivery.
Contractual Obligations, Commitments and Off-Balance Sheet Arrangements
Aircraft Purchase Commitments
In addition to the commitments below, Alaska has options to acquire 15 B737’s and purchase rights for 50 more. In October 2005, Horizon entered into a purchase agreement to acquire 12 Q400 aircraft with deliveries beginningarbitration in December 2006 and continuing through Julyinto 2007. The purchase agreement also includes options to purchase an additional 20 aircraft. Concurrent withCompany cannot predict the executionoutcome of this purchase agreement, Bombardier has agreedarbitration; however, management does not believe any unfavorable outcome would be material to provide certain remarketing assistance for upthe Company’s cash flows or financial position.
The Company is a party to 12 DHC-8 Series 200 aircraft previously leased by Horizon for a fee as set forth inroutine commercial and employment litigation incidental to its business and with respect to which no material liability is expected.
Management believes the agreement. In association withultimate disposition of these matters is not likely to materially affect the purchaseCompany’s financial position or results of operations. However, this belief is based on management’s current understanding of the 12 Q400 Aircraft, Horizonrelevant law and facts; it is subject to various contingencies, including the potential costs and risks associated with litigation and the manufacturer have agreed to terminate firm orders for 7 CRJ700 model aircraft.
Alaskaactions of judges and Horizon expect to finance the firm orders and to the extent exercised, the option aircraft with leases, long-term debt or internally generated cash. We are currently negotiating agreements for debt financing for 14 Boeing 737-800 aircraft to be delivered through May 2007. The following table summarizes aircraft commitments and payments by year as of September 30, 2005, adjusted for the subsequent Horizon agreement as discussed above:
Delivery Period - Firm Orders
Aircraft | October 1-December 31, 2005 | 2006 | 2007 | 2008 | 2009 | Beyond 2009 | Total | ||||||||||||||
Boeing 737-800 | — | 10 | 8 | 5 | 3 | 9 | 35 | ||||||||||||||
Bombardier Q-400 | — | 2 | 10 | — | — | — | 12 | ||||||||||||||
Bombardier CRJ700 | — | 1 | — | — | — | — | 1 | ||||||||||||||
Total | — | 13 | 18 | 5 | 3 | 9 | 48 | ||||||||||||||
Payments (Millions) | $ | 28.3 | $ | 397.2 | $ | 364.0 | $ | 169.5 | $ | 119.9 | $ | 261.2 | $ | 1,340.1 | |||||||
Contractual Obligations
The following table provides a summary of our principal payments under current and long-term debt obligations, capital lease obligations, operating lease commitments, aircraft purchase commitments and other obligations as of September 30, 2005, adjusted for the subsequent Horizon agreement as discussed above. This table excludes contributions to our various pension plans, which we expect to be approximately $60 million to $70 million per year through 2008.
(in millions) | October 1-December 31, 2005 | 2006 | 2007 | 2008 | 2009 | Beyond 2009* | Total | ||||||||||||||
Current and long-term debt and capital lease obligations* | $ | 20.4 | $ | 58.5 | $ | 61.6 | $ | 64.9 | $ | 68.2 | $ | 754.0 | $ | 1,027.6 | |||||||
Operating lease commitments | 47.3 | 247.0 | 219.8 | 210.4 | 193.7 | 986.0 | 1,904.2 | ||||||||||||||
Aircraft purchase commitments | 28.3 | 397.2 | 364.0 | 169.5 | 119.9 | 261.2 | 1,340.1 | ||||||||||||||
Interest obligations (1) | 16.3 | 52.7 | 51.5 | 49.7 | 47.2 | 159.9 | 377.3 | ||||||||||||||
Other purchase obligations (2) | 6.1 | 29.1 | 29.4 | 29.7 | 30.0 | 154.5 | 278.8 | ||||||||||||||
Total | $ | 118.4 | $ | 784.5 | $ | 726.3 | $ | 524.2 | $ | 459.0 | $ | 2,315.6 | $ | 4,928.0 | |||||||
New Accounting Standards
During the fourth quarter of 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123R, “Share Based Payment: An Amendment of SFAS Nos. 123 and 95”. The new standard requires companies to recognize as expense the fair value of stock options and other equity based compensation issued to employees as of the grant date. This new standard will apply to both stock options that we grant to employees and our Employee Stock Purchase Plan, which features a look-back provision and allows employees to purchase stock at a 15% discount. Our options are typically granted with ratable vesting provisions, and we intend to amortize compensation cost over the service period using the straight-line method. Due to a recent decision by the Securities and Exchange Commission, implementation of SFAS 123R will be effective January 1, 2006. We intend to use the “modified prospective method” upon adoption whereby previously awarded but unvested equity awards are accounted for in accordance with SFAS 123R and prospective amounts are recognized in the income statement instead of simply being disclosed. Once adopted, we expect our stock-based compensation expense, as measured under SFAS 123R, will be approximately $6 million to $10 million per year on a pre-tax basis.juries.
In March 2005, the FASB issued Interpretation No. 47 (FIN 47), “Accounting for Conditional Asset Retirement Obligations - an interpretation of FASB Statement No. 143.” FIN 47 clarifies that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. The FIN also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 is effective no later than the end of our fiscal year ending December 31, 2005. FIN 47 is not expected to have a significant impact on our financial position, results of operations or cash flows.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS No. 154”). SFAS No. 154 requires retrospective application as the required method for reporting a change in accounting principle, unless impracticable or a pronouncement includes specific transition provisions. SFAS No. 154 also requires that a change in depreciation, amortization or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. This statement carries forward the guidance in APB Opinion No. 20, “Accounting Changes,” for the reporting of the correction of an error and a change in accounting estimate. SFAS No. 154 is effective beginning January 1, 2006. SFAS No. 154 is not expected to have a significant impact on our financial position, results of operations or cash flows.
In June 2005, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 05-6, “Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination” (“EITF 05-6”). EITF 05-6 requires that leasehold improvements that are placed in service significantly after and not contemplated at or near the beginning of the lease term be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured at the date the leasehold improvements are purchased. EITF 05-6 is effective for our fourth quarter. We are currently evaluating the impact, if any, that EITF 05-6 will have on our financial position, results of operations or cash flows.
Effect of Inflation and Price Changes
Inflation and price changes other than for aircraft fuel do not have a significant effect on our operating revenues, operating expenses and operating income.
Risk Factors
Alaska and Horizon are parties to marketing agreements with certain domestic air carriers, including Northwest Airlines and Delta Air Lines. These agreements provide that certain flight segments operated by Alaska or Horizon are held out for sale as Northwest or Delta as “codeshare” flights. In addition, the agreements provide that members of Alaska’s Mileage Plan program can redeem miles for flights on Northwest or Delta.
In September 2005, Northwest and Delta filed for protection under Chapter 11 of the Bankruptcy Code. Either carrier could propose plans of reorganization that would seek to modify or terminate some or all of these agreements. However, the nature and extent of risk cannot be quantified at this time.
For a discussion of our other risk factors, see Item 7 of the Company’s Annual Report for the year ended December 31, 2004 on Form 10-K under the caption “Risk Factors.”
| ITEM 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion should be read in conjunction with our condensed consolidated financial statements and the related notes contained elsewhere in this quarterly report on Form 10-Q. All statements in the following discussion that are not reports of historical information or descriptions of current accounting policy are forward-looking statements. Please consider our forward-looking statements in light of the risks referred to in this report’s introductory cautionary note.
Air Group’s filings with the Securities and Exchange Commission, including its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are accessible free of charge atwww.alaskaair.com. The information contained on our website is not a part of this quarterly report on Form 10-Q. As used in this Form 10-Q, the terms “Air Group,” “our,” “we” and “Company” refer to Alaska Air Group, Inc. and its subsidiaries, unless the context indicates otherwise.
Third Quarter Highlights
In what is historically been our most profitable quarter, we reported a third-quarter net loss, driven principally by fleet transition costs, restructuring charges, and the downward mark-to-market adjustment of our fuel hedge portfolio as a result of declining oil prices. However, these items should not overshadow what we believe to be a very strong quarterly financial result. The quarter was characterized by strong revenue, offset by significantly higher economic fuel cost and a small increase in other operating expenses.
Fleet Transition
During the first quarter of this year, we announced our intention to retire our MD-80 fleet by the end of 2008, earlier than originally expected, as part of our move to an all Boeing 737 fleet. As part of this plan, we recognized a pre-tax impairment charge of $131.1 million during the first quarter related to 15 owned MD-80 aircraft. At that time, we also estimated that we would have significant additional charges resulting from actions taken on our 11 leased MD-80 aircraft. During the third quarter, we realized a portion of that expected charge as we purchased five of the leased MD-80s from the lessors for cash of $69.3 million and assumed debt of $11.6 million. Immediately upon purchase of the aircraft, we evaluated the aircraft for impairment and concluded that the carrying value was not recoverable. Therefore, we recorded a $58.4 million charge ($36.5 million after tax) in the third quarter for the impairment, including the write-off of $1.8 million of leasehold improvements related to those aircraft. The charge was offset by the reduction of $7.5 million of deferred rent associated with the acquired aircraft. We had signed a letter of intent with a prospective buyer for our 20 owned MD-80s, although we are uncertain as to whether this transaction will close. We are continuing to negotiate with other prospective buyers, but the timing of any sale of our MD-80s is uncertain at this time.
After taking into account the five aircraft purchased out of leases mentioned above, we have six remaining leased MD-80s. We expect to cease operation of four of these aircraft prior to the lease expiration date through lease buy-outs, lease agreement restructuring, subleasing of the aircraft, or storing the aircraft at a long-term storage facility. At such time as one of these actions is taken on the aircraft, we expect to have an associated charge that will be recorded in our consolidated statements of operations.
On July 7, 2006, we entered into a purchase and sale agreement to sell six B737-200 aircraft to a third party. Our seventh (and remaining) B737-200 aircraft will be donated to an aviation museum in Alaska. The six aircraft will be sold and delivered at various intervals through April 2007. One of the six aircraft was transferred to the buyer in the third quarter and there was a nominal gain on the sale.
During the third quarter, Horizon signed a letter of intent with another carrier to sublease up to 16 of its Bombardier Q200 aircraft. Each aircraft will be subject to a separate sublease agreement and will leave Horizon’s operating fleet beginning in January 2007 through mid 2008 based on Horizon’s delivery schedule of the new Q400 aircraft on order. It is expected that the sublease will result in a loss for Horizon approximating the difference between the lease payments and the sublease receipts. The loss on each aircraft will be recorded when the specific aircraft leave Horizon’s fleet and the sublease arrangement begins. As of September 30, 2006, none of the aircraft have been delivered to the other carrier.
Labor Costs and Negotiations
During the third quarter, we reached new four-year agreements with the approximately 3,700 clerical, office and passenger service employees and ramp service agents and stock clerks at Alaska, all represented by the International Association of Machinists. These agreements included a signing bonus, in aggregate, of $1.9 million in July 2006, which is included in wages and benefits in our statement of operations and an immediate 2% wage increase. Additionally, the agreements included a severance package offered to employees in the top four wage-scale steps that includes cash payments based on years of service, one year of medical coverage after the severance date, and continued travel privileges for a period of time. The total amount of the charge was $28.6 million ($17.9 million after tax) in the third quarter. This charge is management’s best estimate at this time and we will likely record adjustments related to this charge in the fourth quarter as more information becomes available.
In November 2006, Alaska will begin negotiations on a new collective bargaining agreement for Alaska’s pilots, all represented by the Air Line Pilots Association. Alaska’s pilots are currently under an arbitrated agreement that becomes amendable on May 1, 2007.
Mark-to-Market Fuel Hedging Gains
Beginning in the second quarter of 2004, we lost the ability to use hedge accounting because the price correlation between crude oil, the commodity we use to hedge, and West Coast jet fuel fell below required thresholds. As a result, our earnings are more volatile as we mark our entire hedge portfolio to market each period through earnings, even though the actual consumption and related cash settlement will take place in a future period.
Historically, we have reported these gains and losses in other nonoperating income and expense. Beginning in the first quarter of 2006, however, we report these gains and losses in aircraft fuel, including hedging gains and losses, in the condensed consolidated statements of operations. Prior
period amounts have been reclassified to conform to the current-year format. Because of the recent decline in world oil prices, we recorded a mark-to-market fuel hedging loss, including the reclassification of previously recorded mark-to-market gains on settled hedges, of $65.4 million ($40.9 million after tax) on our hedge portfolio, as its value declined during the quarter. This loss is compared to $22.8 million ($14.2 million after tax) of gains in the third quarter of 2005. Even though we had a loss in the value of our hedge portfolio in the third quarter, the portfolio will still provide benefit as the value of those contracts as of September 30, 2006 was $81.6 million. The vast majority of these contracts are call options, which effectively cap the crude oil price component of our fuel consumption. These types of contracts allow us to benefit from a reduction in oil prices and limit our exposure when prices increase. In the third quarters of 2006 and 2005, we recorded gains from settled fuel hedges totaling $27.4 million and $43.5 million, respectively, which are also recorded in aircraft fuel.
We have provided information on mark-to-market gains or losses, as well as calculations of our economic fuel cost per gallon on pages 28 and 29. For more discussion, see Note 4 to our condensed consolidated financial statements.
We continue to believe that our fuel hedge program is an important part of our strategy to reduce our exposure to volatile fuel prices. We began entering into hedge contracts again in the third quarter of 2006 after several quarters of no activity. We expect to continue to enter into these types of contracts into the future, although significant changes in market conditions could affect our decisions.
Frontier JetExpress
In the third quarter, we announced that Horizon would discontinue its contract flying with Frontier Airlines as Frontier JetExpress. We have nine CRJ700 aircraft dedicated to this program that will transition back into Horizon’s fleet over a period of approximately one year beginning in the first quarter of 2007. We anticipate that these aircraft will be used for productive and strategic redeployments throughout our native network and harmonization flying with Alaska. We do not anticipate the termination of this agreement and the redeployment of these aircraft to have a material impact on our results from operations.
Outlook
For 2006, Alaska and Horizon expect full-year capacity increases of approximately 4.5% and 7%, respectively, over 2005 capacity. The expected capacity increase at Alaska is due largely to an increase in scheduled departures after last year’s summer capacity reduction and the introduction of 12 new B737-800 aircraft in 2006, of which six will be delivered in the fourth quarter, offset by the retirement of four MD-80 aircraft. Horizon’s expected capacity increase is due to the annualization of increasing the capacity of the Q400 fleet from 70 to 74 seats and the addition of one CRJ700 and two Q400s in 2006. For the fourth quarter of 2006, we expect capacity increases of between 3.5% and 4% for Alaska and approximately 6% for Horizon.
SELECTED FINANCIAL AND STATISTICAL DATA
Alaska Airlines Financial and Statistical Data
| Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||||||||||
Financial Data (in millions): | 2006 | 2005 | % Change | 2006 | 2005 | % Change | ||||||||||||||||
Operating Revenues: | ||||||||||||||||||||||
Passenger | $ | 698.4 | $ | 624.1 | 11.9 | $ | 1,882.5 | $ | 1,656.6 | 13.6 | ||||||||||||
Freight and mail | 25.7 | 25.2 | 2.0 | 71.8 | 68.4 | 5.0 | ||||||||||||||||
Other - net | 35.8 | 40.0 | (10.5 | ) | 106.0 | 103.9 | 2.0 | |||||||||||||||
Total Operating Revenues | 759.9 | 689.3 | 10.2 | 2,060.3 | 1,828.9 | 12.7 | ||||||||||||||||
Operating Expenses: | ||||||||||||||||||||||
Wages and benefits | 190.3 | 171.7 | 10.8 | 552.9 | 548.7 | 0.8 | ||||||||||||||||
Variable incentive pay | 3.3 | 2.8 | 17.9 | 17.3 | 7.5 | 130.7 | ||||||||||||||||
Contracted services | 32.3 | 27.6 | 17.0 | 98.4 | 87.0 | 13.1 | ||||||||||||||||
Aircraft fuel, including hedging gains and losses | 251.5 | 121.8 | 106.5 | 567.2 | 283.6 | 100.0 | ||||||||||||||||
Aircraft maintenance | 32.4 | 43.2 | (25.0 | ) | 118.6 | 143.5 | (17.4 | ) | ||||||||||||||
Aircraft rent | 26.4 | 29.5 | (10.5 | ) | 84.6 | 87.2 | (3.0 | ) | ||||||||||||||
Food and beverage service | 12.6 | 13.0 | (3.1 | ) | 36.1 | 36.0 | 0.3 | |||||||||||||||
Selling expenses | 36.8 | 35.6 | 3.4 | 110.0 | 102.2 | 7.6 | ||||||||||||||||
Depreciation and amortization | 35.2 | 31.9 | 10.3 | 99.6 | 92.9 | 7.2 | ||||||||||||||||
Landing fees and other rentals | 40.5 | 38.8 | 4.4 | 117.9 | 117.2 | 0.6 | ||||||||||||||||
Other | 40.8 | 39.6 | 3.0 | 118.4 | 118.9 | (0.4 | ) | |||||||||||||||
Fleet transition costs | 58.4 | — | NM | 189.5 | — | NM | ||||||||||||||||
Restructuring charges and adjustments | 28.6 | (1.4 | ) | NM | 32.4 | 20.7 | NM | |||||||||||||||
Total Operating Expenses | 789.1 | 554.1 | 42.4 | 2,142.9 | 1,645.4 | 30.2 | ||||||||||||||||
Operating Income (Loss) | (29.2 | ) | 135.2 | NM | (82.6 | ) | 183.5 | NM | ||||||||||||||
Interest income | 14.6 | 9.2 | 58.7 | 41.2 | 23.1 | 78.4 | ||||||||||||||||
Interest expense | (19.9 | ) | (13.0 | ) | 53.1 | (53.5 | ) | (36.9 | ) | 45.0 | ||||||||||||
Interest capitalized | 6.1 | 2.6 | 134.6 | 15.5 | 4.5 | 244.4 | ||||||||||||||||
Other - net | 0.5 | (1.0 | ) | NM | (0.7 | ) | (3.7 | ) | NM | |||||||||||||
| 1.3 | (2.2 | ) | NM | 2.5 | (13.0 | ) | NM | |||||||||||||||
Income (Loss) Before Income Tax and Accounting Change | $ | (27.9 | ) | $ | 133.0 | NM | $ | (80.1 | ) | $ | 170.5 | NM | ||||||||||
Operating Statistics: | ||||||||||||||||||||||
Revenue passengers (000) | 4,710 | 4,632 | 1.7 | 13,058 | 12,715 | 2.7 | ||||||||||||||||
RPMs (000,000) “traffic” | 4,873 | 4,598 | 6.0 | 13,579 | 12,812 | 6.0 | ||||||||||||||||
ASMs (000,000) “capacity” | 6,150 | 5,822 | 5.6 | 17,523 | 16,735 | 4.7 | ||||||||||||||||
Passenger load factor | 79.2 | % | 79.0 | % | 0.2pts | 77.5 | % | 76.6 | % | 0.9pts | ||||||||||||
Yield per passenger mile | 14.33 | ¢ | 13.57 | ¢ | 5.6 | 13.86 | ¢ | 12.93 | ¢ | 7.2 | ||||||||||||
Operating revenue per ASM | 12.36 | ¢ | 11.84 | ¢ | 4.4 | 11.76 | ¢ | 10.93 | ¢ | 7.6 | ||||||||||||
Operating expenses per ASM (a) | 12.83 | ¢ | 9.52 | ¢ | 34.8 | 12.23 | ¢ | 9.83 | ¢ | 24.4 | ||||||||||||
Operating expense per ASM excluding fuel, fleet transition costs, and restructuring charges and adjustments(a) | 7.33 | ¢ | 7.53 | ¢ | (2.7 | ) | 7.73 | ¢ | 8.04 | ¢ | (3.9 | ) | ||||||||||
GAAP fuel cost per gallon (a) | $ | 2.68 | $ | 1.34 | 100.3 | $ | 2.12 | $ | 1.08 | 96.7 | ||||||||||||
Economic fuel cost per gallon (a) | $ | 2.08 | $ | 1.56 | 33.5 | $ | 1.90 | $ | 1.46 | 29.7 | ||||||||||||
Fuel gallons (000,000) | 93.9 | 90.4 | 3.9 | 267.2 | 260.8 | 2.5 | ||||||||||||||||
Average number of full-time equivalent employees | 9,467 | 8,961 | 5.6 | 9,267 | 9,108 | 1.7 | ||||||||||||||||
Aircraft utilization (blk hrs/day) | 11.4 | 10.9 | 4.6 | 11.1 | 10.8 | 2.8 | ||||||||||||||||
Average aircraft stage length (miles) | 920 | 887 | 3.7 | 921 | 895 | 2.9 | ||||||||||||||||
Operating fleet at period-end | 112 | 110 | 1.8 | 112 | 110 | 1.8 | ||||||||||||||||
NM = Not Meaningful
| (a) | See Note A on page 28. |
Horizon Air Financial and Statistical Data
| Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||||||||||
Financial Data (in millions): | 2006 | 2005 | % Change | 2006 | 2005 | % Change | ||||||||||||||||
Operating Revenues: | ||||||||||||||||||||||
Passenger | $ | 173.9 | $ | 151.2 | 15.0 | $ | 478.1 | $ | 405.8 | 17.8 | ||||||||||||
Freight and mail | 1.0 | 1.0 | 0.0 | 3.0 | 2.9 | 3.4 | ||||||||||||||||
Other - net | 1.4 | 1.5 | (6.7 | ) | 4.1 | 6.8 | (39.7 | ) | ||||||||||||||
Total Operating Revenues | 176.3 | 153.7 | 14.7 | 485.2 | 415.5 | 16.8 | ||||||||||||||||
Operating Expenses: | ||||||||||||||||||||||
Wages and benefits | 47.3 | 44.7 | 5.8 | 140.3 | 128.6 | 9.1 | ||||||||||||||||
Variable incentive pay | 1.7 | 0.6 | 183.3 | 6.8 | 3.0 | 126.7 | ||||||||||||||||
Contracted services | 6.7 | 6.1 | 9.8 | 20.1 | 17.7 | 13.6 | ||||||||||||||||
Aircraft fuel, including hedging gains and losses | 39.3 | 19.4 | 102.6 | 86.5 | 43.8 | 97.5 | ||||||||||||||||
Aircraft maintenance | 17.2 | 11.9 | 44.5 | 50.0 | 31.1 | 60.8 | ||||||||||||||||
Aircraft rent | 17.5 | 17.5 | 0.0 | 52.0 | 52.8 | (1.5 | ) | |||||||||||||||
Food and beverage service | 0.9 | 0.7 | 28.6 | 2.2 | 1.9 | 15.8 | ||||||||||||||||
Selling expenses | 8.8 | 8.1 | 8.6 | 25.2 | 22.1 | 14.0 | ||||||||||||||||
Depreciation and amortization | 4.9 | 4.1 | 19.5 | 13.6 | 12.0 | 13.3 | ||||||||||||||||
Landing fees and other rentals | 12.7 | 12.2 | 4.1 | 35.3 | 35.7 | (1.1 | ) | |||||||||||||||
Other | 13.6 | 10.1 | 34.7 | 37.0 | 31.0 | 19.4 | ||||||||||||||||
Total Operating Expenses | 170.6 | 135.4 | 26.0 | 469.0 | 379.7 | 23.5 | ||||||||||||||||
Operating Income | 5.7 | 18.3 | NM | 16.2 | 35.8 | NM | ||||||||||||||||
Interest income | 1.0 | 0.3 | 233.3 | 2.7 | 1.0 | 170.0 | ||||||||||||||||
Interest expense | (1.8 | ) | (1.6 | ) | 12.5 | (5.8 | ) | (4.3 | ) | 34.9 | ||||||||||||
Interest capitalized | 1.0 | 0.2 | 400.0 | 2.1 | 0.4 | 425.0 | ||||||||||||||||
Other - net | — | 0.1 | NM | 0.1 | NM | |||||||||||||||||
| 0.2 | (1.0 | ) | NM | (1.0 | ) | (2.8 | ) | NM | ||||||||||||||
Income Before Income Tax and Accounting Change | $ | 5.9 | $ | 17.3 | NM | $ | 15.2 | $ | 33.0 | NM | ||||||||||||
Operating Statistics: | ||||||||||||||||||||||
Revenue passengers (000) | 1,832 | 1,755 | 4.4 | 5,171 | 4,868 | 6.2 | ||||||||||||||||
RPMs (000,000) “traffic” | 722 | 683 | 5.7 | 2,032 | 1,843 | 10.3 | ||||||||||||||||
ASMs (000,000) “capacity” | 951 | 911 | 4.4 | 2,729 | 2,542 | 7.4 | ||||||||||||||||
Passenger load factor | 75.9 | % | 75.0 | % | 0.9pts | 74.5 | % | 72.5 | % | 2.0pts | ||||||||||||
Yield per passenger mile | 24.09 | ¢ | 22.14 | ¢ | 8.8 | 23.53 | ¢ | 22.02 | ¢ | 6.9 | ||||||||||||
Operating revenue per ASM | 18.54 | ¢ | 16.87 | ¢ | 9.9 | 17.78 | ¢ | 16.35 | ¢ | 8.8 | ||||||||||||
Operating expenses per ASM (a) | 17.94 | ¢ | 14.86 | ¢ | 20.7 | 17.19 | ¢ | 14.94 | ¢ | 15.1 | ||||||||||||
Operating expense per ASM excluding fuel (a) | 13.81 | ¢ | 12.73 | ¢ | 8.4 | 14.02 | ¢ | 13.21 | ¢ | 6.1 | ||||||||||||
GAAP fuel cost per gallon (a) | $ | 2.71 | $ | 1.41 | 92.8 | $ | 2.13 | $ | 1.13 | 88.6 | ||||||||||||
Economic fuel cost per gallon (a) | $ | 2.08 | $ | 1.62 | 28.3 | $ | 1.92 | $ | 1.54 | 24.8 | ||||||||||||
Fuel gallons (000,000) | 14.5 | 13.7 | 5.8 | 40.6 | 38.6 | 5.2 | ||||||||||||||||
Average number of full-time equivalent employees | 3,706 | 3,508 | 5.6 | 3,592 | 3,428 | 4.8 | ||||||||||||||||
Aircraft utilization (blk hrs/day) | 8.8 | 9.0 | (2.2 | ) | 8.8 | 8.6 | 2.3 | |||||||||||||||
Operating fleet at period-end | 69 | 65 | 6.2 | 69 | 65 | 6.2 | ||||||||||||||||
NM = Not Meaningful
| (a) | See Note A on page 28. |
Note A:
Pursuant to Item 10 of Regulation S-K, we are providing disclosure of the reconciliation of reported non-GAAP financial measures to their most directly comparable financial measures reported on a GAAP basis. The non-GAAP financial measures provide management the ability to measure and monitor performance both with and without the cost of aircraft fuel (including the gains and losses associated with our fuel hedging program where appropriate), fleet transition costs, and restructuring charges and adjustments. Because the cost and availability of aircraft fuel are subject to many economic and political factors beyond our control and we record changes in the fair value of our hedge portfolio in our income statement, it is our view that the measurement and monitoring of performance without fuel is important. In addition, we believe the disclosure of financial performance without fleet transition costs, restructuring charges, and the navigation fee refund is useful to investors. Finally, these non-GAAP financial measures are also more comparable to financial measures reported to the Department of Transportation by other major network airlines.
The following tables reconcile our non-GAAP financial measures to the most directly comparable GAAP financial measures for both Alaska Airlines, Inc. and Horizon Air Industries, Inc.:
Alaska Airlines, Inc.:
| Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||||
($ in millions) | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Unit cost reconciliations: | ||||||||||||||||
Operating expenses | $ | 789.1 | $ | 554.1 | $ | 2,142.9 | $ | 1,645.4 | ||||||||
ASMs (000,000) | 6,150 | 5,822 | 17,523 | 16,735 | ||||||||||||
Operating expenses per ASM | 12.83 | ¢ | 9.52 | ¢ | 12.23 | ¢ | 9.83 | ¢ | ||||||||
Operating expenses | $ | 789.1 | $ | 554.1 | $ | 2,142.9 | $ | 1,645.4 | ||||||||
Less: aircraft fuel | (251.5 | ) | (121.8 | ) | (567.2 | ) | (283.6 | ) | ||||||||
Less: fleet transition costs | (58.4 | ) | — | (189.5 | ) | — | ||||||||||
Add: navigation fee refund | — | 4.7 | — | 4.7 | ||||||||||||
Less: restructuring charges and adjustments | (28.6 | ) | 1.4 | (32.4 | ) | (20.7 | ) | |||||||||
Operating expenses excluding fuel, fleet transition costs, the navigation fee refund, and restructuring charges and adjustments | $ | 450.6 | $ | 438.4 | $ | 1,353.8 | $ | 1,345.8 | ||||||||
ASMs (000,000) | 6,150 | 5,822 | 17,523 | 16,735 | ||||||||||||
Operating expenses per ASM excluding fuel, fleet transition costs, the navigation fee refund, and restructuring charges and adjustments | 7.33 | ¢ | 7.53 | ¢ | 7.73 | ¢ | 8.04 | ¢ | ||||||||
Reconciliation to GAAP income (loss) before taxes and accounting change: | ||||||||||||||||
Income (loss) before taxes and accounting change, excluding mark-to-market hedging gains (losses), fleet transition costs, the navigation fee refund, and restructuring charges and adjustments | $ | 115.3 | $ | 106.0 | $ | 202.5 | $ | 85.3 | ||||||||
Mark-to-market hedging gains (losses) included in aircraft fuel | (56.2 | ) | 19.9 | (60.7 | ) | 100.2 | ||||||||||
Less: fleet transition costs | (58.4 | ) | — | (189.5 | ) | — | ||||||||||
Add: navigation fee refund and related interest received | — | 5.7 | — | 5.7 | ||||||||||||
Less: restructuring charges and adjustments | (28.6 | ) | 1.4 | (32.4 | ) | (20.7 | ) | |||||||||
GAAP income (loss) before taxes and accounting change as reported | $ | (27.9 | ) | $ | 133.0 | $ | (80.1 | ) | $ | 170.5 | ||||||
Aircraft fuel reconciliations:* | ||||||||||||||||
| Three Months Ended September 30 | ||||||||||||||||
($ in millions except per gallon amounts) | 2006 | 2005 | ||||||||||||||
| Cost/Gal | Cost/Gal | |||||||||||||||
Raw or “into-plane” fuel cost | $ | 218.9 | $ | 2.33 | $ | 179.5 | $ | 1.99 | ||||||||
Less: gains on settled hedges | (23.6 | ) | (0.25 | ) | (37.8 | ) | (0.43 | ) | ||||||||
Economic fuel expense* | $ | 195.3 | $ | 2.08 | $ | 141.7 | $ | 1.56 | ||||||||
Less: mark-to-market gains and losses related to hedges that settle in future periods and the reclassification of previously recorded mark-to-market gains on settled hedges | 56.2 | 0.60 | (19.9 | ) | (0.22 | ) | ||||||||||
GAAP fuel expense* | $ | 251.5 | $ | 2.68 | $ | 121.8 | $ | 1.34 | ||||||||
Fuel gallons (000,000) | 93.9 | 90.4 | ||||||||||||||
| Nine Months Ended September 30 | ||||||||||||||||
| 2006 | 2005 | |||||||||||||||
| Cost/Gal | Cost/Gal | |||||||||||||||
Raw or “into-plane” fuel cost | $ | 585.5 | $ | 2.19 | $ | 465.2 | $ | 1.78 | ||||||||
Less: gains on settled hedges | (79.0 | ) | (0.29 | ) | (81.4 | ) | (0.32 | ) | ||||||||
Economic fuel expense* | $ | 506.5 | $ | 1.90 | $ | 383.8 | $ | 1.46 | ||||||||
Less: mark-to-market gains and losses related to hedges that settle in future periods and the reclassification of previously recorded mark-to-market gains on settled hedges | 60.7 | 0.22 | (100.2 | ) | (0.38 | ) | ||||||||||
GAAP fuel expense* | $ | 567.2 | $ | 2.12 | $ | 283.6 | $ | 1.08 | ||||||||
Fuel gallons (000,000) | 267.2 | 260.8 | ||||||||||||||
Horizon Air Industries, Inc.
| Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||||
($ in millions) | 2006 | 2005 | 2006 | 2005 | ||||||||||||
Unit cost reconciliations: | ||||||||||||||||
Operating expenses | $ | 170.6 | $ | 135.4 | $ | 469.0 | $ | 379.7 | ||||||||
ASMs (000,000) | 951 | 911 | 2,729 | 2,542 | ||||||||||||
Operating expenses per ASM | 17.94 | ¢ | 14.86 | ¢ | 17.19 | ¢ | 14.94 | ¢ | ||||||||
Operating expenses | $ | 170.6 | $ | 135.4 | $ | 469.0 | $ | 379.7 | ||||||||
Less: aircraft fuel | (39.3 | ) | (19.4 | ) | (86.5 | ) | (43.8 | ) | ||||||||
Operating expenses excluding fuel | $ | 131.3 | $ | 116.0 | $ | 382.5 | $ | 335.9 | ||||||||
ASMs (000,000) | 951 | 911 | 2,729 | 2,542 | ||||||||||||
Operating expenses per ASM excluding fuel | 13.81 | ¢ | 12.73 | ¢ | 14.02 | ¢ | 13.21 | ¢ | ||||||||
Reconciliation to GAAP income before taxes and accounting change: | ||||||||||||||||
Income before taxes and accounting change, excluding mark-to-market hedging gains (losses) | $ | 15.1 | $ | 14.4 | $ | 23.7 | $ | 17.4 | ||||||||
Mark-to-market hedging gains (losses) included in aircraft fuel | (9.2 | ) | 2.9 | (8.5 | ) | 15.6 | ||||||||||
GAAP income before taxes and accounting change as reported | $ | 5.9 | $ | 17.3 | $ | 15.2 | $ | 33.0 | ||||||||
Aircraft fuel reconciliations:* | ||||||||||||||||
| Three Months Ended September 30 | ||||||||||||||||
($ in millions except per gallon amounts) | 2006 | 2005 | ||||||||||||||
| Cost/Gal | Cost/Gal | |||||||||||||||
Raw or “into-plane” fuel cost | $ | 33.9 | $ | 2.34 | $ | 28.0 | $ | 2.04 | ||||||||
Less: gains on settled hedges | (3.8 | ) | (0.26 | ) | (5.7 | ) | (0.42 | ) | ||||||||
Economic fuel expense* | $ | 30.1 | $ | 2.08 | $ | 22.3 | $ | 1.62 | ||||||||
Less: mark-to-market gains and losses related to hedges that settle in future periods and the reclassification of previously recorded mark-to-market gains on settled hedges | 9.2 | 0.63 | (2.9 | ) | (0.21 | ) | ||||||||||
GAAP fuel expense* | $ | 39.3 | $ | 2.71 | $ | 19.4 | $ | 1.41 | ||||||||
Fuel gallons (000,000) | 14.5 | 13.7 | ||||||||||||||
| Nine Months Ended September 30 | ||||||||||||||||
| 2006 | 2005 | |||||||||||||||
| Cost/Gal | Cost/Gal | |||||||||||||||
Raw or “into-plane” fuel cost | $ | 90.8 | $ | 2.24 | $ | 71.6 | $ | 1.85 | ||||||||
Less: gains on settled hedges | (12.8 | ) | (0.32 | ) | (12.2 | ) | (0.31 | ) | ||||||||
Economic fuel expense* | $ | 78.0 | $ | 1.92 | $ | 59.4 | $ | 1.54 | ||||||||
Less: mark-to-market gains and losses related to hedges that settle in future periods and the reclassification of previously recorded mark-to-market gains on settled hedges | 8.5 | 0.21 | (15.6 | ) | (0.41 | ) | ||||||||||
GAAP fuel expense* | $ | 86.5 | $ | 2.13 | $ | 43.8 | $ | 1.13 | ||||||||
Fuel gallons (000,000) | 40.6 | 38.6 | ||||||||||||||
| * | Beginning in the first quarter of 2006, the Company records all fuel hedging activity, including mark-to-market gains and losses, in aircraft fuel expense. Prior year amounts have been reclassified for consistency. |
RESULTS OF OPERATIONS
Comparison of Three Months Ended September 30, 2006 to Three Months Ended September 30, 2005
Our consolidated net loss for the third quarter of 2006 was $17.4 million, or $0.44 per diluted share, versus net income of $90.2 million, or $2.71 per diluted share, in the third quarter of 2005.
The 2006 results include certain significant items that impact the comparability to 2005. These items are discussed in the “Third Quarter Highlights” section beginning on page 23. Our 2005 results also include certain items that impact comparability, including $1.4 million ($0.9 million after tax) of favorable restructuring adjustments, $22.8 million ($14.2 million after tax) of mark-to-market fuel hedging gains, and a navigation fee refund of $5.7 million ($3.6 million after tax). Excluding these items, our consolidated net income would have been $77.9 million for the third quarter of 2006 compared to $71.5 million in the third quarter of 2005. Financial and statistical data comparisons for Alaska and Horizon are shown on pages 26 and 27, respectively. On pages 28 and 29, we have included a reconciliation of reported non-GAAP financial measures to the most directly comparable GAAP financial measures.
Alaska Airlines Revenues
Operating revenues increased $70.6 million, or 10.2%, during the third quarter of 2006 as compared to the same period in 2005 due to a 4.4% increase in operating revenue per available seat mile (RASM) and a 5.6% increase in capacity. The increase in RASM resulted from an increase in load factors and a 5.6% increase in ticket yields resulting largely from higher ticket prices, offset by a 10.5% decline in other-net revenue as explained below. The increase in capacity is primarily the result of having a fleet of 112 operating aircraft at September 30, 2006, compared to 110 at September 30, 2005, a longer average stage length this quarter compared to last year, the schedule reduction in the summer of 2005, and a larger average seat capacity on our aircraft.
Load factor increased slightly by 0.2 percentage points to 79.2% for the third quarter of 2006 due to a 6.0% increase in passenger traffic outpacing the 5.6% increase in capacity. Even though load factor was nearly flat for the quarter, we did experience a decline in load factor from prior year in the month of August. We believe this decline is due, in part, to the foiled terror plot in the United Kingdom and the resulting new security measures. Alaska has seen a softening revenue environment in the last few months and we expect a continuing trend of slower year-over-year growth into the fourth quarter when compared to the first half of 2006. This was evidenced by the trend in yields throughout the quarter. Our yields were up 7.7% in July, 6.8% in August and 1.4% in September.
Freight and mail revenues increased $0.5 million, or 2.0%, primarily due to higher mail and freight yields and fuel surcharges that we added to our freight services beginning in the third quarter of 2005, offset by lower volumes.
Other-net revenues decreased $4.2 million, or 10.5%, due to a decrease in Mileage Plan revenues, resulting from a higher deferral rate on cash received from miles sold, offset by higher cash
receipts compared to the prior year period. As yields have increased in 2006, our rate at which we defer the revenue related to sold miles has increased, resulting in a smaller percentage of those cash receipts recorded as revenue during the period.
Alaska Airlines Expenses
Total operating expenses increased $235.0 million, or 42.4%, as compared to the same period in 2005. The increase in operating expenses is largely due to fleet transition costs, a significant increase in aircraft fuel (including hedging gains and losses), and increases in wages and benefits, contracted services, depreciation and amortization, and restructuring charges, offset by a decline in aircraft maintenance, and aircraft rent. Operating expenses per ASM increased 34.8% from 9.52 cents in the third quarter of 2005 to 12.83 cents in the third quarter of 2006. Operating expense per ASM excluding fuel, fleet transition costs, restructuring charges and the navigation fee refund in 2005 decreased by 2.7% to 7.33 cents per ASM compared to 7.53 cents per ASM in 2005. Our estimates of costs per ASM excluding fuel and items noted above for the fourth-quarter and full-year targets for 2006 are 7.9 cents and between 7.75 cents and 8.0 cents, respectively.
Explanations of significant period-over-period changes in the components of operating expenses are as follows:
Aircraft fuel increased $129.7 million, or 106.5%, due primarily to losses on the value of our fuel hedge portfolio and, to a lesser extent, the significant rise in fuel prices compared to the same period in 2005. As mentioned earlier, we began recording all fuel hedging
gains and losses in aircraft fuel during the first quarter of 2006 and have reclassified prior periods to conform to the current-period format. For the third quarter of 2006, aircraft fuel includes $56.2 million of mark-to-market losses related to hedges that settle in future periods, including the reclassification of previously recorded mark-to-market gains on settled hedges, compared to $19.9 million of gains during the same period of 2005. Additionally, aircraft fuel expense includes $23.6 million and $37.8 million of gains from settled hedges during the third quarter of 2006 and 2005, respectively. After excluding mark-to-market gains and losses recorded during the quarters, our “economic,” or net, fuel expense increased $53.6 million, or 37.8%, over the same period in 2005, on a 3.9% increase in fuel consumption. Our economic fuel cost per gallon increased 33.5% over the third quarter of 2005 from $1.56 to $2.08. Even though fuel prices have declined recently, we expect a year-over-year increase in fuel cost in the fourth quarter of 2006. |
See page 28 for a table summarizing fuel cost per gallon realized by Alaska (the economic cost per gallon) and the cost per gallon on a GAAP basis (including all hedging gains and losses).
Horizon Air Revenues
For the third quarter of 2006, operating revenues increased $22.6 million, or 14.7%, compared to 2005. This increase reflects a 9.9% increase in RASM and a 4.4% increase in capacity.
The capacity increase is due to the addition of one CRJ700 in January 2006 and two Q400s that began operating in June and August 2006, offset by slightly less flying for Frontier. Revenue and capacity from the Frontier contract flying represented approximately 8% of passenger revenues and 21% of capacity during the third quarter of 2006. As noted above, we announced that we would end the contract flying with Frontier and transition the dedicated CRJ700 aircraft back into Horizon’s fleet beginning in the first quarter of 2007.
The overall RASM increase from the prior-year period comes from an 8.9% RASM increase in native network flying and a 5.1% increase in RASM from the Frontier contract flying. Passenger load factor increased 0.9 percentage points to 75.9% due to a 5.7% increase in traffic outpacing the 4.4% increase in capacity. Passenger yield increased 8.8% to 24.09 cents resulting largely from industry-wide fare increases.
Horizon Air Expenses
Operating expenses increased $35.2 million, or 26.0%, as compared to the same period in 2005. Operating expenses per ASM increased 20.7% from 14.86 cents in the third quarter of 2005 to 17.94 cents in the third quarter of 2006. Operating expenses per ASM excluding fuel increased 8.4% to 13.81 cents as compared to the same period in 2005. Our estimates of cost per ASM excluding fuel for the fourth quarter and full year 2006 are 14.7 cents and 14.2 cents, respectively.
Explanations of significant period-over-period changes in the components of operating expenses are as follows:
See page 29 for a table summarizing fuel cost per gallon realized by Horizon (the economic cost per gallon) and the cost per gallon on a GAAP basis (including all hedging gains and losses).
| ��� | Other operating expense increased $3.5 million, or 34.7%, primarily due to a sales and use tax assessment in Denver related to our contract flying with Frontier that we are contesting. Other factors contributing to the year-over-year increase are higher crew expenses and passenger remuneration costs. |
Consolidated Nonoperating Income (Expense)
Net nonoperating income (expense) was $1.1 million in the third quarter of 2006 compared to $(6.3) million during the same period of 2005. Interest income increased $5.6 million compared to the third quarter of 2005, primarily due to the higher average cash and marketable securities balance and higher average portfolio returns. Interest expense increased $4.3 million due to interest rate increases on our variable-rate debt, new debt arrangements in the first nine months of 2006, the increased balance on our pre-delivery payment facility, and the changes to some of our variable-rate debt arrangements to slightly higher fixed rates. The increase was offset by the conversion of our $150 million senior convertible notes to equity in the April 2006, which eliminated further interest expense on those notes. Capitalized interest increased $4.3 million from $2.8 million in the third quarter of 2005 to $7.1 million in the third quarter of 2006. This increase is due to the significant increase in deposits for future flight equipment resulting from our recent aircraft purchase agreements for B737-800 and Bombardier Q400 aircraft.
Consolidated Income Tax Expense (Benefit)
See discussion below under “Comparison of Nine Months Ended September 30, 2006 to Nine Months Ended September 30, 2005.”
Comparison of Nine Months Ended September 30, 2006 to Nine Months Ended September 30, 2005
Our consolidated net loss for the nine months ended September 30, 2006 was $41.0 million, or $1.10 per diluted share, versus net income of $27.1 million, or $0.93 per diluted share, during the same period of 2005.
Both the 2006 and 2005 results include certain significant items that impact the comparability of the nine-month periods:
Excluding these items, our consolidated net income would have been $141.1 million for the first nine months of 2006 compared to $54.4 million during the same period of 2005.
Financial and statistical data comparisons for Alaska and Horizon are shown on pages 26 and 27, respectively. On pages 28 and 29, we have included a reconciliation of reported non-GAAP financial measures to the most directly comparable GAAP financial measures. A discussion of the nine-month data follows.
Alaska Airlines Revenues
Operating revenues increased $231.4 million, or 12.7%, during the first nine months of 2006 as compared to the same period in 2005 due primarily to a 7.6% increase in operating revenue per available seat mile (RASM) and a 4.7% increase in capacity. The increase in RASM resulted from a slight increase in load factors and a 7.2% increase in ticket yields resulting largely from higher ticket prices, coupled with increases in freight and mail revenue and other-net revenue as explained below. The increase in capacity is primarily the result of having a fleet of 112 operating
aircraft at September 30, 2006 compared to 110 at September 30, 2005 and a longer average stage length this quarter compared to last year.
Load factor increased 0.9 percentage points to 77.5% during the first nine months of 2006 due primarily to a 6.0% increase in passenger traffic outpacing the 4.7% increase in capacity.
Freight and mail revenues increased $3.4 million, or 5.0%, compared to the same period in 2005 primarily due to higher mail and freight yields and fuel surcharges that we added to our freight services beginning in the third quarter of 2005, offset by lower volumes.
Other-net revenues increased slightly by $2.1 million, or 2.0%, due to an increase in Mileage Plan revenues, resulting from higher award redemption on our partner airlines and an increase in cash receipts from miles sold, of which a portion is recognized immediately. The increase was offset by an increase in the deferral rate on cash received from miles sold. As yields have increased in 2006, our rate at which we defer the revenue related to sold miles has increased, resulting in a smaller percentage of those cash receipts recorded as revenue during the period.
Alaska Airlines Expenses
Total operating expenses increased $497.5 million, or 30.2%, as compared to the same period in 2005. This increase is largely due to fleet transition costs during the first nine months of 2006, a significant increase in aircraft fuel (including hedging gains and losses), and increases in wages and benefits, variable incentive pay, contracted services, selling expenses, depreciation and amortization, and restructuring charges, offset by a decline in aircraft maintenance. Operating expenses per ASM increased 24.4% to 12.23 cents in the first nine months of 2006 from 9.83 cents during the same period in 2005. Operating expense per ASM excluding fuel, fleet transition costs, restructuring charges and a navigation fee refund in 2005 decreased 3.9% as compared to the same period in 2005.
Explanations of significant period-over-period changes in the components of operating expenses are as follows:
The increase over prior year was partially offset by the following:
See page 28 for a table summarizing fuel cost per gallon realized by Alaska (the economic cost per gallon) and the cost per gallon on a GAAP basis (including all hedging gains and losses).
Horizon Air Revenues
For the first nine months of 2006, operating revenues increased $69.7 million, or 16.8% compared to 2005. This increase reflects an 8.8% increase in RASM and a 7.4% increase in capacity.
The capacity increase is primarily due to the addition of one CRJ700 in January 2006, two Q400s that began operating in June and August 2006, increased capacity of the Q400 from 70 to 74 seats in the third quarter of 2005, and increased flying for Frontier. Revenue and capacity from the Frontier contract flying represented approximately 8% of passenger revenues and 23% of capacity during the first nine months of 2006, similar to the prior year. As mentioned above, Horizon will begin transitioning out of the Frontier contract flying in the first quarter of 2007.
The overall RASM increase from the prior-year period comes from a 10.3% RASM increase in our native network flying, offset by a 3.2% decline in RASM from the Frontier contract flying. The Frontier decline is a function of a 9.4% increase in capacity coupled with a fee arrangement based on certain metrics that do not correspond to capacity. As such, the per-unit revenues become diluted as more capacity is added. Passenger load factor increased 2.0 percentage points to 74.5% due to continued increase in demand. Passenger yield increased 6.9% to 23.53 cents, largely benefiting from industry-wide fare increases.
Horizon Air Expenses
Operating expenses for the first nine months of 2006 increased $89.3 million, or 23.5%, compared to the same period in 2005. Operating expenses per ASM increased 15.1% as compared to 2005. Operating expenses per ASM excluding fuel increased 6.1% as compared to the same period in 2005.
Explanations of other significant period-over-period changes in the components of operating expenses are as follows:
See page 29 for a table summarizing fuel cost per gallon realized by Horizon (the economic cost per gallon) and the cost per gallon on a GAAP basis (including all hedging gains and losses).
Consolidated Nonoperating Income (Expense)
Net nonoperating income (expense) was $(2.1) million in the first nine months of 2006 compared to $(23.5) million during the same period of 2005. Interest income increased $17.8 million compared to 2005, primarily due to higher average portfolio returns and a higher average cash and marketable securities balance. Interest expense increased $12.1 million primarily due to interest rate increases on our variable-rate debt, new debt arrangements in 2006, the increased balance on our pre-delivery payment facility, and the changes to some of our variable-rate debt arrangements to slightly higher fixed rates. This increase was offset by the conversion of our $150 million senior convertible notes to equity in April 2006, which eliminated further interest expense on those notes. Capitalized interest increased $12.7 million from $4.9 million in 2005 to $17.6 million during 2006. This is due to the significant increase in deposits for future flight equipment in connection with our recent aircraft purchase agreements for B737-800 and Bombardier Q400 aircraft.
Consolidated Income Tax Expense (Benefit)
Accounting standards require us to provide for income taxes each quarter based on either our estimate of the effective tax rate for the full year or the actual year-to-date effective tax rate if it is our best estimate of our annual expectation. For the first nine months of 2006, we used the estimate of the effective tax rate for the full year, as we believe it to be a better estimate than the actual year-to-date effective tax rate. Our effective income tax benefit rate on the pre-tax loss for the nine months ended September 30, 2006 was 42.4%. The nine months ended September 30, 2006 also includes $5.5 million of tax benefits associated with the reduction of certain tax contingency accruals for periods for which the statute of limitations expired in 2006. Excluding this benefit, our effective tax rate for the nine months ended September 30, 2006 would have been 34.7%, which is the estimated effective tax rate for the full year 2006. In arriving at this rate, we considered a variety of factors, including year-to-date pre-tax results, the U.S. federal rate of 35%, estimated year-to-date nondeductible expenses and estimated state income taxes. We evaluate our tax rate each quarter and make adjustments when necessary. Our final effective tax rate for the full year is highly dependent on the level of pre-tax income or loss and the magnitude of any nondeductible expenses in relation to that pre-tax amount.
Critical Accounting Estimates
For information on our critical accounting estimates, see Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2005.
Liquidity and Capital Resources
The table below presents the major indicators of financial condition and liquidity.
| September 30, 2006 | December 31, 2005 | Change | ||||||||
| (In millions, except per-share and debt- to-capital amounts) | ||||||||||
Cash and marketable securities | $ | 1,107.7 | $ | 982.6 | $ | 125.1 | ||||
Working capital | 316.8 | 374.7 | (57.9 | ) | ||||||
Long-term debt, net of current portion | 945.5 | 969.1 | (23.6 | ) | ||||||
Shareholders’ equity | 965.0 | 827.6 | 137.4 | |||||||
Book value per common share | $ | 24.11 | $ | 24.74 | $ | (0.63 | ) | |||
Long-term debt-to-capital | 50%:50% | 54%:46% | NA | |||||||
Long-term debt-to-capital assuming aircraft operating leases are capitalized at seven times annualized rent | 69%:31% | 73%:27% | NA | |||||||
Our debt-to-capital ratio decreased from December 31, 2005 primarily due to the conversion to equity of our senior convertible notes in April 2006, partially offset by a $41.0 million net loss for the nine months, and by an increase in our outstanding debt in connection with new aircraft-secured debt arrangements in the first nine months of 2006.
During the nine months ended September 30, 2006, our cash and marketable securities increased $125.1 million to just over $1.1 billion. The following discussion summarizes the primary drivers of the increase.
Cash Provided by (Used in) Operating Activities
During the first nine months of 2006, net cash provided by operating activities was $388.9 million, compared to $179.0 million during the same period of 2005. The improvement was driven by significantly higher operating revenues and a decline in cash payments made for severance compared to the prior year, offset by continued increases in fuel costs and $71.9 million in cash contributions to our defined benefit pension plan during the first nine months of 2006 compared to $69.3 million during the same period of 2005.
Cash Provided by (Used in) Investing Activities
Cash used in investing activities was $539.0 million during the first nine months of 2006, compared to $180.0 million during the same period of 2005. During the first nine months of 2006, we had net purchases of marketable securities of $42.4 million and used $515.9 million for property and equipment additions, net of proceeds from asset dispositions. During the nine months ended September 30, 2006, our aircraft-related capital expenditures, net of aircraft deposits returned and proceeds from asset dispositions, increased $211.5 million as compared to the same period of 2005, primarily as a result of the increase in pre-delivery payments made for future aircraft deliveries and the purchase of six B737-800s, five MD-80s out of leases, two Q400s and one CRJ700 in the first nine months of 2006, compared to three B737-800s in 2005. We expect capital expenditures to be approximately $630 million for the full year 2006 and $680 million in 2007.
Cash Provided by (Used in) Financing Activities
Net cash provided by financing activities was $228.8 million during the first nine months of 2006 compared to net cash used of $0.3 million during the same period of 2005. We obtained debt financing for five new B737-800 aircraft and one CRJ700 purchased in the first nine months of 2006. Additionally, there was a net increase of $68.5 million in our pre-delivery payment facility. Finally, we had $21.9 million in proceeds from the issuance of common stock through stock option exercises and our employee stock purchase plan, compared to $13.9 million during the same period of 2005. Offsetting these increases were normal long-term debt payments of $41.1 million during 2006.
We plan to meet our capital and operating commitments through internally generated funds from operations and cash and marketable securities on hand at September 30, 2006, along with additional debt financing and proceeds from our pre-delivery payment facility.
Noncash Investing and Financing Activities
In the second quarter of 2006, we called for redemption all of our $150 million senior convertible notes, and all of the notes were converted by the holders into shares of the Company’s common stock. Additionally, we assumed debt totaling $11.6 million in connection with the purchase of one of the MD-80 aircraft purchased from lessors during the third quarter.
Bank Line of Credit Facility
Alaska’s $160 million variable-rate credit facility restricts Alaska from distributing any funds to Air Group in the form of dividends and limits the amount of funds Alaska can loan to Air Group. As of September 30, 2006, there are no outstanding borrowings on this credit facility and we have no immediate plans to draw on the facility.
Contractual Obligations, Commitments and Off-Balance Sheet Arrangements
Aircraft Purchase Commitments
At September 30, 2006, we had firm orders for 54 aircraft requiring aggregate payments of approximately $1.2 billion, as set forth below. In addition, Alaska has options to acquire 28 additional B737-800s and purchase rights for 27 more. Alaska also has entered into operating lease agreements for two B737-800 aircraft to be delivered in late 2006. Horizon has options to acquire 19 Q400s and 15 CRJ700s. Alaska and Horizon expect to finance the firm orders and, to the extent exercised, the option aircraft through operating lease arrangements, long-term debt or internally generated cash.
During the first nine months of 2006, Alaska took delivery of six B737-800 aircraft, all of which were paid for with cash upon delivery and then five were financed with fixed-rate debt arrangements. The sixth B737-800 was financed in October. Horizon took delivery of two used
Q400 aircraft, both of which were acquired using cash on hand, and one CRJ700, which was financed with a variable-rate debt arrangement. Subsequent to the end of the quarter, Alaska took delivery of an additional B737-800 that was financed with variable-rate debt. During the third quarter, Alaska executed an agreement to sell six B737-200 aircraft. Title to each aircraft will be transferred as each of the aircraft leaves our fleet over the next several months, with the last aircraft expected to leave our fleet in April 2007. The first one was sold during the quarter and another was sold in October.
The following table summarizes aircraft purchase commitments as of September 30, 2006 and payments by year:
| Delivery Period - Firm Orders | ||||||||||||||||||||||
| October 1 – December 31 | Beyond | |||||||||||||||||||||
Aircraft | 2006 | 2007 | 2008 | 2009 | 2010 | 2010 | Total | |||||||||||||||
Boeing 737-800 | 6 | * | 14 | 8 | 4 | 6 | 3 | 41 | ||||||||||||||
Bombardier Q400 | 2 | 11 | — | — | — | — | 13 | |||||||||||||||
Total | 8 | 25 | 8 | 4 | 6 | 3 | 54 | |||||||||||||||
Payments (Millions) | $ | 136.1 | $ | 495.2 | $ | 227.6 | $ | 159.9 | $ | 146.0 | $ | 44.9 | $ | 1,209.7 | ||||||||
| * | Excludes operating lease agreements for two aircraft to be delivered in late 2006. |
As noted, Alaska announced a plan to transition to a single Boeing 737 fleet type by the end of 2008, which includes the accelerated retirement of our MD-80 fleet. As a result, we expect to exercise additional options and purchase rights on our Boeing 737-800 order in the future in addition to the firm deliveries that are identified in the contractual table above.
Giving consideration to this fleet transition plan, the following table displays the currently anticipated fleet count for Alaska as of December 31, 2006, 2007 and 2008:
| 2006 | 2007 | 2008 | ||||
737-200 | 2 | 0 | 0 | |||
MD80 | 22 | 15 | 0 | |||
737-400 | 37 | 35 | 35 | |||
737-400F | 1 | 1 | 1 | |||
737-400C | 2 | 4 | 4 | |||
737-700 | 22 | 20 | 20 | |||
737-800* | 15 | 29 | 42 | |||
737-900 | 12 | 12 | 12 | |||
Totals | 113 | 116 | 114 | |||
| * | Includes options for three aircraft in 2008, which have not yet been exercised. The total also assumes we will identify one airplane for delivery in 2008 for which we have not yet secured a delivery position. |
Contractual Obligations
The following table provides a summary of our principal payments under current and long-term debt obligations, operating lease commitments, aircraft purchase commitments and other obligations as of September 30, 2006. This table excludes contributions to our various pension plans, which we expect to be approximately $55 million to $80 million per year through 2010.
| October 1 – December 31 | Beyond | ||||||||||||||||||||
(in millions) | 2006 | 2007 | 2008 | 2009 | 2010 | 2010 | Total | ||||||||||||||
Current and long-term debt | |||||||||||||||||||||
Obligations | 21.0 | 73.3 | 76.9 | 80.9 | 86.7 | 668.0 | $ | 1,006.8 | |||||||||||||
Current and long-term portions of the pre-delivery payment facility | 50.2 | 92.1 | — | — | �� | — | — | 142.3 | |||||||||||||
Operating lease commitments (1) | 42.8 | 265.0 | 253.3 | 233.7 | 223.2 | 849.7 | 1,867.7 | ||||||||||||||
Aircraft purchase commitments | 136.1 | 495.2 | 227.6 | 159.9 | 146.0 | 44.9 | 1,209.7 | ||||||||||||||
Interest obligations (2) | 20.5 | 67.5 | 62.4 | 55.4 | 49.7 | 157.5 | 413.0 | ||||||||||||||
Other purchase obligations (3) | 5.6 | 29.4 | 29.7 | 30.0 | 30.3 | 124.2 | 249.2 | ||||||||||||||
Total | $ | 276.2 | $ | 1,022.5 | $ | 649.9 | $ | 559.9 | $ | 535.9 | $ | 1,844.3 | $ | 4,888.7 | |||||||
| (1) | Operating lease commitments generally include aircraft operating leases, airport property and hangar leases, office space leases, and other equipment operating leases. Specifically, the line item includes two aircraft lease agreements for B737-800 aircraft that will be delivered in late 2006. Also includes contractual lease obligations for six leased MD-80 aircraft, four of which we intend to retire earlier than expected. |
| (2) | For variable-rate debt, future obligations are shown above using interest rates in effect as of September 30, 2006. |
| (3) | Includes obligations under our long-term power-by-the-hour maintenance agreement. |
Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48), which clarifies the accounting and disclosure for uncertainty in tax positions, as defined in that statement. The purpose of FIN 48 is to clarify certain aspects of the recognition and measurement related to accounting for income tax uncertainties. This interpretation is effective for fiscal years beginning after December 15, 2006. We do not believe this interpretation will have a material impact on our results from operations or financial position.
In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 expresses SEC staff views regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether those misstatements are material to our financial statements. SAB 108 is effective for fiscal years ending after November 15, 2006. We are evaluating the impact of this interpretation and expect to have an adjustment to shareholders’ equity, although the adjustment is not expected to be material.
In September 2006, the FASB issued Statement No. 158,Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (SFAS 158). SFAS 158 requires recognition of the overfunded or underfunded status of an entity’s defined benefit postretirement plan as an asset or liability in the financial statements, requires the measurement of defined benefit postretirement plan assets and obligations as of the end of the employer’s fiscal year, and requires recognition of the funded status of defined benefit postretirement plans in other comprehensive income. SFAS 158 is effective for fiscal years ending after December 15, 2006. We expect the impact on shareholders’ equity from the adoption of SFAS 158 and certain assumption changes to be in the range of $75 million to $100 million. We believe the adoption of this statement will not have a material impact on our results from operations or cash flows.
Effect of Inflation - Inflation and price changes other than for aircraft fuel and passenger fares do not have a significant effect on our operating revenues, operating expenses and operating income.
| Quantitative and Qualitative Disclosures about Market Risk |
There have been no material changes in market risk from the information provided in Item 7A “Quantitative and Qualitative Disclosure About Market Risk” in our 2004 10KAnnual Report on Form 10-K for the year ended December 31, 2005 except as follows:
Market Risk – Aircraft Fuel Prices
We purchase jet fuel at prevailing market prices, and seek to manage the risk of price fluctuations through execution of structured pricing purchase agreements and a documented hedging strategy. Wealmost exclusively utilize derivative financial instrumentscrude oil call options as hedges to decrease our exposure to the volatility of jet fuel prices. At September 30, 2005,Call options effectively cap our pricing on the crude oil component of fuel prices allowing us to limit our exposure to increasing fuel prices. With these call option contracts, we hadstill benefit from the decline in crude oil prices as there is no downward exposure other than the premiums that we pay to enter into the contracts. We also use collar structures in limited instances for fuel hedge contractshedging purposes. We believe there is risk in place to hedge 50.4 million gallonsnot hedging against the possibility of fuel price increases. See Note 4 in the condensed consolidated financial statements for a summary of our expected jet fuel usage during the remainder of 2005, 181.4 million gallons in 2006, 86.0 million gallons in 2007 and 31.7 million gallons in 2008. This represents 50%, 42%, 20% and 7% of our anticipated fuel consumption in 2005, 2006, 2007 and 2008, respectively. Prices of these agreements range from $32 to $50 per crude oil barrel.hedge positions. We estimate that a 10% increase or decrease in crude oil prices as of September 30, 20052006 would impact hedging positionsincrease or decrease the fair value of our hedge portfolio by approximately $41.0$21.4 million and $40.1$20.0 million, respectively.
AsAdditionally, we have entered into fuel purchase contracts that fix the refining margin we pay for approximately 45% and 36% of September 30, 2005 and December 31, 2004, the fair values of ourAlaska’s fuel hedge positions were $211.8 million and $96.0 million, respectively. Of these amounts, $140.7 million of the 2005 fair value amounts and $65.7 million of the 2004 fair value amounts were included in current assetsconsumption in the consolidated balance sheets based on the settlement dates for the underlying contracts. The remaining $71.1 million 2005 fair value and $30.3 million 2004 fair value is reflected as a non-current asset in the consolidated balance sheets.
During the secondfourth quarter of 2005, we entered into a fuel contract whereby the spread between crude oil prices2006 and jet fuel prices is fixed for approximately one-third of our fuel consumption. This contract has resulted in approximately $6.0 million in savings for Air Group during the thirdfirst quarter of 2005.
2007, respectively.
Please refer to pages 2226 and 23,27, as well as to Note 4 in the condensed consolidated financial statements, for company specificcompany-specific data on the results of our fuel hedgingfuel-hedging program.
Financial Market Risk
During the first nine months of 2005, we issued $20.0 million of debt secured by flight equipment, having an interest rate of 6.07% and a payment term of 15 years.
In the second and third quarters of 2005, the Company exercised its option under several of its existing variable rate long-term debt arrangements to fix the interest rates through maturity. The fixed rates on these recently affected debt arrangements range from 5.2% to 6.5%. These changes did not result in any gain or loss in the consolidated statements of operations.
Subsequent to the end of the third quarter, as noted above, we finalized a $172 million purchase deposit facility to assist with our pre-delivery funding requirements on the firm B737-800 aircraft. The initial draw on the facility was $61.3 million.
Our pension obligation is highly sensitive to changes in the interest rate environment and our estimated return on assets. Our preliminary assessment of our projected pension benefit obligation, accumulated benefit obligation, and expected return on plan assets, assuming a consistent discount rate from the prior year, would result in a tax effected charge to equity as of December 31, 2005 of approximately $20 million. However, due to the sensitivity of the obligation to changes in the discount rate used, a 25-basis point downward shift in the discount rate used to value our pension obligation would result in an additional tax affected charge to equity of approximately $20 million.
| ITEM 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
As of September 30, 2005,2006, an evaluation was performed under the supervision and with the participation of our management, including our chief executive officer and chief financial officer (collectively, our “certifying officers”), of the effectiveness of the design and operation of our disclosure controls and procedures. These disclosure controls and procedures are designed to ensure that the information required to be disclosed by us in our current and periodic reports filed with or submitted to the Securities and Exchange Commission (the SEC) is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms, and that the information is accumulated and communicated to our management, including our certifying officers, on a timely basis.
Our certifying officers concluded, based on their evaluation, that disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
We madeDuring the third quarter of 2006, the separate accounting and payroll departments of Alaska and Horizon were combined into one Air Group accounting and payroll function in an attempt to improve economies of scale and standardize processes across the two companies. Additionally, during the third quarter, Horizon implemented a new maintenance and inventory system. There were no changes in ourthe Company’s internal controlscontrol over financial reporting, including the changes described above, identified in management’s evaluation during the fiscalthird quarter ended September 30, 2005,of 2006 that our certifying officers concludedhave materially affected, or are reasonably likely to materially affect, ourthe Company’s internal control over financial reporting.
We intend to regularly review and evaluate the design and effectiveness of our disclosure controls and procedures and internal controlscontrol over financial reporting on an ongoing basis and to improve these controls and procedures over time and to correct any deficiencies that we may discover in the future. While we believe the present design of our disclosure controls and procedures and internal controlscontrol over financial reporting are effective, future events affecting our business may cause us to modify our these controls and procedures in the future.
procedures.
PART II.II OTHER INFORMATION
| ITEM 1. | Legal Proceedings |
In May 2005,April 2006, the Air Line Pilots Association filed a lawsuit in federal district court in Seattle to overturn the current labor contract coveringgranted voluntary dismissal of Alaska’s pilots as established by an arbitrator, which was effective May 1, 2005. On July 21, 2005, the Company filed a motion to dismiss the lawsuit. On October 28, 2005, the district court granted the Company’s motion to dismiss. This decision is subject to appeal.
In March 2005, the Company filed a claimlawsuit against the International Association of Machinists (IAM) seeking to compel arbitration of the dispute regarding the permissibility of subcontracting of the Company’sAlaska’s ramp service operation in Seattle. On May 10, 2005,At the same time, the court also dismissed a counterclaim by the IAM filed a counter claim against the Company alleging that the CompanyAlaska violated the Railway Labor Act status quo and engaged in bad faith bargaining. On May 13, 2005,The appeal period has expired and these matters are closed.
Additionally, the Company announcedIAM filed a grievance against Alaska alleging that it had subcontractedAlaska violated the collective bargaining agreement by, among other things, subcontracting the ramp service operation in Seattle resultingwhen the parties could not reach agreement on an acceptable labor contract. This matter is scheduled for arbitration in the immediate reduction of approximately 475 employees represented by the IAM. Shortly after this event, the IAM filed a motion for a preliminary injunction seeking to reverse the subcontracting by the Company. That motion was heardDecember 2006 and denied by a federal court judge on June 2, 2005. The Company’s lawsuit is still pending in federal court and a September 2006 trial date has been set for the IAM’s counterclaim. The Company has filed a motion to dismiss the IAM’ counterclaim. At this time, the Company is not certain as to whatinto 2007. We cannot predict the outcome will be.
of this arbitration; however, we do not believe any unfavorable outcome would be material to our cash flows or results of operations.
We are a party to ordinary routine litigation incidental to our business and with respect to which no material liability is expected.
Management believes the ultimate disposition of these matters is not likely to materially affect our financial position or results of operations. This forward-looking statement is based on management’s current understanding of the relevant law and facts;facts, and it is subject to various contingencies, including the potential costs and risks associated with litigation and the actions of judges and juries.
| ITEM 1A. | Risk Factors |
We expect to implement a number of new an important operational and financial systems over the next 18 months. As such, we have modified one of the risk factors from our 2005 Form 10-K as follows.
We rely heavily on automated systems to operate our business and any failure of these systems could harm our business.
We depend on automated systems to operate our business, including our computerized airline reservation system, our telecommunication systems, our website, our maintenance systems, and other systems. We also issue a substantial number of our tickets to passengers as electronic tickets. We depend on our computerized reservation system to be able to issue, track and accept these electronic tickets. In order for our operations to work efficiently, our website and reservation system must be able to accommodate a high volume of traffic and deliver important flight information. Substantial or repeated website, reservations system or telecommunication systems failures could reduce the attractiveness of our services and cause our customers to purchase tickets from another airline. In addition, we rely on other automated systems for crew scheduling, flight dispatch, maintenance tracking, and other operational needs. Any disruption in or changes to these systems could result in the loss of important data, increase our expenses and possibly cause us to temporarily cease our operations.
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we
currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
| ITEM 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
NoneNone.
| ITEM 3. |
NoneNone.
| ITEM 4. | Submission of Matters to a Vote of Security Holders |
NoneNone.
| ITEM 5. | Other Information |
No changes have been made to the procedures by which security holders may recommend nominees to our Board of Directors since the filing of our definitive proxy statement for our 2005 annual meeting of shareholders.None.
| ITEM 6. | Exhibits |
See Exhibit Index on page 47.
49.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ALASKA AIR GROUP, INC. | ||
Registrant | ||
Date: November | ||
| By: | /s/ Brandon S. Pedersen | |
Brandon S. Pedersen | ||
Staff Vice President/Finance and Controller | ||
| By: | /s/ Bradley D. Tilden | |
Bradley D. Tilden | ||
| Executive Vice President/Finance and Chief Financial Officer | ||
Pursuant to Item 601(a)(2) of Regulation S-K, this Exhibit Index immediately precedes the exhibits.
The following exhibits are numbered in accordance with Item 601 of Regulation S-K.
| Exhibit No. | Description | |
| 10.1 (1) | Alaska Air Group, Inc. Performance Based Pay Plan, Amended and Restated September 14, 2006 (Exhibit 10.1 to Form 8-K filed September 18, 2006) | |
| As adopted pursuant to Section | ||
| As adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Certification of Chief Financial Officer | ||
| Filed previously. |
| (2) | Filed herewith. |
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