NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Basis of Presentation
The consolidated financial statements include the accounts of Air Group, or the Company, and its primary subsidiaries, Alaska, Horizon, and Virgin America. Our consolidated financial statements also include McGee Air Services, a subsidiary of Alaska. The Company conducts substantially all of its operations through these subsidiaries. All significant intercompany balances and transactions have been eliminated. These financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and their preparation requires the use of management’s estimates. Actual results may differ from these estimates.
Certain reclassifications have been made to prior year financial statements to conform to classifications used in the current year.
Cash and Cash Equivalents
Cash equivalents consist of highly liquid investments with original maturities of three months or less, such as money market funds, commercial paper and certificates of deposit. They are carried at cost, which approximates market value. The Company reduces cash balances when funds are disbursed. Due to the time delay in funds clearing the banks, the Company normally maintains a negative balance in its cash disbursement accounts, which is reported as a current liability. The amount of the negative cash balance was
$10 million
and
$15 million
at
December 31, 2017
and
2016
respectively, and is included in accounts payable, with the change in the balance during the year included in other financing activities in the consolidated statements of cash flows.
The Company's restricted cash balances are primarily used to guarantee various letters of credit, self-insurance programs or other contractual rights. Restricted cash consists of highly liquid securities with original maturities of three months or less. They are carried at cost, which approximates fair value.
Marketable Securities
Investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. All cash equivalents and short-term investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in market value, excluding other-than-temporary impairments, are reflected in accumulated other comprehensive loss (AOCL).
Investments are considered to be impaired when a decline in fair value is judged to be other-than-temporary. The Company uses a systematic methodology that considers available quantitative and qualitative evidence in evaluating potential impairment. If the cost of an investment exceeds its fair value, management evaluates, among other factors, general market conditions, credit quality of debt instrument issuers, the duration and extent to which the fair value is less than cost, the Company's intent and ability to hold, or plans to sell, the investment. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded to Other—net in the consolidated statements of operations and a new cost basis in the investment is established.
Inventories and Supplies—net
Expendable aircraft parts, materials and supplies are stated at average cost and are included in inventories and supplies
—
net. An obsolescence allowance for expendable parts is accrued based on estimated lives of the corresponding fleet type and salvage values. The allowance for expendable inventories was $
38 million
and
$36 million
at
December 31, 2017
and
2016
, respectively. Inventory and supplies
—
net also includes fuel inventory of $
23 million
and
$16 million
at
December 31, 2017
and
2016
, respectively. Repairable and rotable aircraft parts inventories are included in flight equipment.
Property, Equipment and Depreciation
Property and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives less an estimated salvage value, which are as follows:
|
|
|
|
|
Estimated Useful Life
|
Estimated Salvage Value
|
Aircraft and other flight equipment:
|
|
|
Boeing 737, Airbus A319/320, and E175 aircraft
|
20-25 years
|
10%
|
Bombardier Q400 aircraft
|
15 years
|
10%
|
Buildings
|
25 - 30 years
|
—%
|
Minor building and land improvements
|
10 years
|
—%
|
Capitalized leases and leasehold improvements
|
Generally shorter of lease term or
estimated useful life
|
0-10%
|
Computer hardware and software
|
3-10 years
|
—%
|
Other furniture and equipment
|
5-10 years
|
—%
|
Near the end of an asset's estimated useful life, management updates the salvage value estimates based on current market conditions and expected use of the asset. Repairable and rotable aircraft parts are included in Aircraft and other flight equipment, and are depreciated over the associated fleet life.
In 2016, the Company changed its accounting estimate for the expected useful life of the B737 NextGen aircraft, which includes the B737-700, -800, -900, -900ER aircraft and the related parts, from
20
years to
25
years. The change in estimate was precipitated by management's annual accounting policy review, which considered market studies, asset performance and intended use, as well as industry benchmarking. The change in estimate was applied prospectively effective October 1, 2016.
Capitalized interest, based on the Company’s weighted-average borrowing rate, is added to the cost of the related asset, and is depreciated over the estimated useful life of the asset.
Maintenance and repairs, other than engine maintenance on B737-800 engines, are expensed when incurred. Major modifications that extend the life or improve the usefulness of aircraft are capitalized and depreciated over their estimated period of use. Maintenance on B737-800 engines is covered under a power-by-the-hour agreement with a third party beginning in the fourth quarter of 2017, whereby the Company pays a determinable amount, and transfers risk, to a third party. The Company expenses the contract amounts based on engine usage.
The Company evaluates long-lived assets to be held and used for impairment whenever events or changes in circumstances indicate that the total carrying amount of an asset or asset group may not be recoverable. The Company groups assets for purposes of such reviews at the lowest level, at which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. An impairment loss is considered when estimated future undiscounted cash flows expected to result from the use of the asset or asset group and its eventual disposition are less than its carrying amount. If the asset or asset group is not considered recoverable, a write-down equal to the excess of the carrying amount over the fair value will be recorded.
Goodwill
Goodwill represents the excess of purchase price over the fair value of the related net assets acquired in the Company's acquisition of Virgin America and is not amortized. As of
December 31, 2017
the goodwill balance was
$1.9 billion
, and is associated with the Mainline reporting unit. The Company reviews goodwill for impairment annually in Q4, or more frequently if events or circumstances indicate than an impairment may exist. If fair value of the reporting unit does not exceed the carrying amount, an impairment charge may be recorded. In
2017
, the fair value of the reporting unit with goodwill substantially exceeded its carrying value.
Intangible Assets
Intangible assets recorded in conjunction with the acquisition of Virgin America consist primarily of indefinite-lived airport slots, finite-lived airport gates and finite-lived customer relationships. Finite-lived intangibles are amortized over their estimated useful lives. Indefinite-lived intangibles are not amortized but are tested at least annually for impairment using a similar methodology to property, equipment and goodwill as described above.
Deferred Revenue
Deferred revenue results primarily from the sale of Mileage Plan™ miles to third-parties. It also includes Virgin America's Elevate® flown points outstanding at the acquisition date that were recorded at their estimated fair value as part of purchase price accounting. Recognition of this deferred revenue occurs when award transportation is provided or over the term of the applicable agreement.
Operating Leases
The Company leases aircraft, airport and terminal facilities, office space and other equipment under operating leases. Airport and terminal facility leases are variable based on volumes and expensed as incurred. Some of these lease agreements contain rent escalation clauses or rent holidays. For scheduled rent escalation clauses during the lease terms or for rental payments commencing at a date other than the date of initial occupancy, the Company records minimum rental expenses on a straight-line basis over the terms of the leases in the consolidated statements of operations.
Leased Aircraft Return Costs
Cash payments associated with returning leased aircraft are accrued when it is probable that a cash payment will be made and that amount is reasonably estimable, usually no sooner than after the last scheduled maintenance event prior to lease return. Any accrual is based on the time remaining on the lease, planned aircraft usage and the provisions included in the lease agreement, although the actual amount due to any lessor upon return may not be known with certainty until lease termination.
As leased aircraft are returned, any payments are charged against the established accrual. The accrual is part of other current and long-term liabilities and was
not material
as of
December 31, 2017
and
December 31, 2016
. The expense is included in Aircraft maintenance in the consolidated statements of operations.
Revenue Recognition
Passenger revenue is recognized when the passenger travels. Tickets sold but not yet used are reported as air traffic liability until travel or date of expiration. Air traffic liability includes approximately
$106 million
and
$62 million
related to credits for future travel, as of
December 31, 2017
and
December 31, 2016
, respectively. These credits are recognized into revenue either when the passenger travels or at the date of expiration, which is twelve months from issuance. Commissions to travel agents and related fees are expensed when the related revenue is recognized. Passenger traffic commissions and related fees not yet recognized are recorded as a prepaid expense. Taxes collected from passengers, including transportation excise taxes, airport and security fees and other fees, are recorded on a net basis within passenger revenue in the consolidated statements of operations. Due to complex pricing structures, refund and exchange policies, and interline agreements with other airlines, certain amounts are recognized as revenue using estimates regarding both the timing of the revenue recognition and the amount of revenue to be recognized. These estimates are based on the Company’s historical data.
Freight and mail revenues are recognized when the related services are provided.
Other—net revenues are primarily related to the Mileage Plan™ program. They are recognized as described in the “Mileage Plan” paragraph below. Other—net also includes certain ancillary or non-ticket revenues, such as checked-bag fees, reservations fees, ticket change fees, on-board food and beverage sales, and, to a much lesser extent, commissions from car and hotel vendors and sales of travel insurance. These items are recognized as revenue when the related services are provided. Airport lounge memberships are recognized as revenue over the membership period.
Frequent Flyer Programs
Alaska operates the Mileage Plan™ frequent flyer program, and Virgin America operated the Elevate frequent flyer program for the duration of 2017. Both programs provide travel awards to members based on accumulated mileage or points. For miles earned by flying on the Company's airlines, and through airline partners, the estimated cost of providing award travel is recognized as a selling expense and accrued as a liability, as miles are earned and accumulated.
Alaska and Virgin America also sell services, including miles or points for transportation, to non-airline partners, such as hotels, car rental agencies and major banks that offer Alaska's affinity credit card. The Company defers revenue related to air transportation and certificates for discounted companion travel until the transportation is delivered. The deferred proceeds are recognized as passenger revenue for awards redeemed and flown on the Company's airlines and as Other—net revenue for
awards redeemed and flown on other airlines (less the cost paid to the other airlines based on contractual agreements). The elements that represent use of the Alaska and Virgin America brands and access to frequent flyer member lists and advertising are recognized as commission income in the period that those elements are sold and included in Other—net revenue in the consolidated statements of operations.
Frequent flyer program deferred revenue and liabilities included in the consolidated balance sheets (in millions):
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
Current Liabilities:
|
|
|
|
Other accrued liabilities
|
$
|
519
|
|
|
$
|
484
|
|
Other Liabilities and Credits:
|
|
|
|
|
|
Deferred revenue
|
699
|
|
|
638
|
|
Other liabilities
|
26
|
|
|
21
|
|
Total
|
$
|
1,244
|
|
|
$
|
1,143
|
|
The amounts recorded in other accrued liabilities relate primarily to deferred revenue expected to be realized within one year, which includes Mileage Plan™ awards that have been issued but not yet flown for $
47 million
and
$43 million
at
December 31, 2017
and
2016
.
Frequent flyer program revenue included in the consolidated statements of operations (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Passenger revenues
|
$
|
380
|
|
|
$
|
293
|
|
|
$
|
267
|
|
Other
—
net revenues
|
482
|
|
|
429
|
|
|
329
|
|
Total frequent flyer program revenues
|
$
|
862
|
|
|
$
|
722
|
|
|
$
|
596
|
|
Other
—
net revenue includes commission revenues of
$396 million
,
$329 million
, and
$280 million
in
2017
,
2016
, and
2015
.
Selling Expenses
Selling expenses include credit card fees, global distribution systems charges, the estimated cost of frequent flyer travel awards earned through air travel, advertising, promotional costs, commissions and incentives. Advertising production costs are expensed as incurred. Advertising expense was $
91 million
,
$61 million
, and
$55 million
during the years ended
December 31, 2017
,
2016
, and
2015
.
Derivative Financial Instruments
The Company's operations are significantly impacted by changes in aircraft fuel prices and interest rates. In an effort to manage exposure to these risks, the Company periodically enters into fuel and interest rate derivative instruments. These derivative instruments are recognized at fair value on the balance sheet and changes in the fair value are recognized in AOCL or in the consolidated statements of operations, depending on the nature of the instrument.
The Company does not apply hedge accounting to its derivative fuel hedge contracts nor does it hold or issue them for trading purposes. For cash flow hedges related to interest rate swaps, the effective portion of the derivative represents the change in fair value of the hedge that offsets the change in fair value of the hedged item. To the extent the change in the fair value of the hedge does not perfectly offset the change in the fair value of the hedged item, the ineffective portion of the hedge is immediately recognized in interest expense.
Fair Value Measurements
Accounting standards define fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The standards also establish a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:
Level 1
- Quoted prices in active markets for identical assets or liabilities.
Level 2
- Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3
- Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The Company has elected not to use the fair value option provided in the accounting standards for non-financial instruments. Accordingly, those assets and liabilities are carried at amortized cost. For financial instruments, the assets and liabilities are carried at fair value, which is determined based on the market approach or income approach, depending upon the level of inputs used.
Assets and liabilities recognized or disclosed at fair value on a nonrecurring basis include items such as property, plant and equipment, goodwill, intangible assets and certain other assets and liabilities. The Company determines the fair value of these items using Level 3 inputs, as described in
Note 2
and
Note 4
.
Income Taxes
The Company uses the asset and liability approach for accounting for and reporting income taxes. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities, and their respective tax bases and for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. A valuation allowance would be established, if necessary, for the amount of any tax benefits that, based on available evidence, are not expected to be realized. As of
December 31, 2017
, there is no valuation allowance against net deferred tax assets. The Company accounts for unrecognized tax benefits in accordance with the applicable accounting standards.
Virgin America has substantial federal and state net operating losses (NOLs) for income tax purposes. The Company's ability to utilize Virgin America's NOLs could be limited if Virgin America had an “ownership change,” as defined in Section 382 of the Internal Revenue Code and similar state provisions. In general terms, an ownership change can occur whenever there is a collective shift in the ownership of a company by more than 50% by one or more “5% stockholders” within a three-year period. The occurrence of such a change generally limits the amount of NOL carryforwards a company could utilize in a given year to the aggregate fair market value of the company's common stock immediately prior to the ownership change, multiplied by the long-term tax-exempt interest rate in effect for the month of the ownership change. The acquisition constituted an ownership change and the potential for further limitations following the acquisition. See
Note 6
to the consolidated financial statements for more discussion of the calculation.
Stock-Based Compensation
Accounting standards require companies to recognize as expense the fair value of stock options and other equity-based compensation issued to employees as of the grant date. These standards apply to all stock awards that the Company grants to employees as well as the Company’s Employee Stock Purchase Plan (ESPP), which features a look-back provision and allows employees to purchase stock at a
15%
discount. All stock-based compensation expense is recorded in wages and benefits in the consolidated statements of operations.
Earnings Per Share (EPS)
Diluted EPS is calculated by dividing net income by the average common shares outstanding plus additional common shares that would have been outstanding assuming the exercise of in-the-money stock options and restricted stock units, using the treasury-stock method. In
2017
,
2016
, and
2015
, antidilutive stock options excluded from the calculation of EPS were not material.
Recently Issued Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, "Revenue from Contracts with Customers"(Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This comprehensive new standard will
replace most existing revenue recognition guidance in U.S. GAAP. In March 2016, the FASB issued ASU 2016-08, "Revenue from Contracts with Customers (Topic 606), Principal versus Agent Considerations" to clarify the guidance on determining whether the Company is considered the principal or the agent in a revenue transaction where a third party is providing goods or services to a customer. Entities are permitted to use either a full retrospective or cumulative effect transition method, and are required to adopt all parts of the new revenue standard using the same transition method. The new standard became effective for the Company on January 1, 2018.
Under the new standard, the Company estimates a net increase to Mileage Plan™ deferred revenues of approximately
$345 million
to
$365 million
as of the beginning of the retroactive reporting period (January 1, 2016) at the time of adoption. Additionally, the Company estimates the change in ticket breakage methodology will not have a significant impact on the statements of operations, but will decrease air traffic liability by approximately
$70 million
to
$80 million
at adoption of the standard. The overall impact to equity as of the beginning of the retroactive reporting period, including these, as well as other less material changes, is expected to be between
$165 million
and
$175 million
.
In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments—Overall (Subtopic 825-10)." This standard makes several changes, including the elimination of the available-for-sale classification of equity investments, and requires equity investments with readily determinable fair values to be measured at fair value with changes in fair value recognized in net income. It is effective for the Company beginning January 1, 2018. The Company does not expect the adoption of ASU 2016-01 to have a material impact on its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, "Leases" (Topic 842), which requires lessees to recognize assets and liabilities for leases currently classified as operating leases. Under the new standard a lessee will recognize a liability on the balance sheet representing the lease payments owed, and a right-of-use-asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election not to recognize lease assets and lease liabilities. At this time, the Company believes the most significant impact to the financial statements will relate to the recording of a right of use asset associated with leased aircraft. Other leases, including airports and real estate, equipment, software and other miscellaneous leases continue to be assessed for impact as it relates to the ASU. The new standard is effective for the Company on January 1, 2019. The Company will not early adopt the standard.
In March 2016, the FASB issued ASU 2016-09, "Compensation—Stock Compensation" (Topic 718), which simplifies several aspects of accounting for employee share-based payment awards, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. The ASU was adopted prospectively as of January 1, 2017. Prior periods have not been adjusted. The adoption of the standard did not have a material impact on the Company's statements of operations or financial position.
In January 2017, the FASB issued ASU 2017-04, "Intangibles—Goodwill and Other" (Topic 350), which eliminates step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. The ASU is effective for the Company beginning January 1, 2019. Early adoption of the standard is permitted. In 2017, the Company performed an impairment test for goodwill arising from its acquisition of Virgin America and adopted the standard effective January 1, 2017.
In March 2017, the FASB issued ASU 2017-07, "Compensation—Retirement Benefits" (Topic 715), which will require the Company to present the service cost component of net periodic benefit cost as Wages and benefits in the statements of operations. All other components of net periodic benefit cost will be required to be presented in Nonoperating income (expense) in the statements of operations. These components will not be eligible for capitalization. The ASU is effective for the Company beginning January 1, 2018. Changes to the statements of operations under the ASU are applicable retrospectively. The adoption of this standard will have no impact on Income before income tax or Net income for the periods subject to retrospective reclassification. See Note 7 for the current components of the Company's net periodic benefit costs.
In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." The ASU expands the activities that qualify for hedge accounting and simplifies the rules for reporting hedging relationships. The ASU is effective for the Company beginning January 1, 2019. The Company will not early adopt the standard.
NOTE 2. ACQUISITION OF VIRGIN AMERICA INC.
Virgin America
On
December 14, 2016
, the Company acquired
100%
of the outstanding common shares and voting interest of Virgin America for
$57
per share, or total cash consideration of
$2.6 billion
.
Fair values of the assets acquired and the liabilities assumed
The transaction was accounted for as a business combination using the acquisition method of accounting, which requires, among other things, that assets acquired and liabilities assumed be recognized on the balance sheet at their fair values as of the acquisition date. The fair values of the assets acquired and liabilities assumed were determined using the market, income and cost approaches. There were no significant fair value adjustments made during the
twelve
months ended
December 31, 2017
.
Fair values of the assets acquired and the liabilities assumed as of the acquisition date,
December 14, 2016
, at
December 31, 2017
and
December 31, 2016
were as follows (in millions):
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
|
December 31, 2016
|
Cash and cash equivalents
|
$
|
645
|
|
|
$
|
645
|
|
Receivables
|
53
|
|
|
44
|
|
Prepaid expenses and other current assets
|
18
|
|
|
16
|
|
Property and equipment
|
571
|
|
|
560
|
|
Intangible assets
|
141
|
|
|
143
|
|
Goodwill
|
1,943
|
|
|
1,934
|
|
Other assets
|
89
|
|
|
84
|
|
Total assets
|
3,460
|
|
|
3,426
|
|
|
|
|
|
Accounts payable
|
22
|
|
|
22
|
|
Accrued wages, vacation and payroll taxes
|
54
|
|
|
51
|
|
Air traffic liabilities
|
172
|
|
|
172
|
|
Other accrued liabilities
|
198
|
|
|
196
|
|
Current portion of long-term debt
|
125
|
|
|
125
|
|
Long-term debt, net of current portion
|
360
|
|
|
360
|
|
Deferred income taxes
|
(300
|
)
|
|
(304
|
)
|
Deferred revenue
|
126
|
|
|
126
|
|
Other liabilities
|
107
|
|
|
82
|
|
Total liabilities
|
864
|
|
|
830
|
|
|
|
|
|
Total purchase price
|
$
|
2,596
|
|
|
$
|
2,596
|
|
Intangible Assets
Of the
$141 million
of acquired intangible assets,
$89 million
represents airport slots. Airport slots are rights to take-off or land at a slot-controlled airport during a specific time period and are a means by which the FAA manages airspace/airport congestion. The Company acquired slots at three such airports—John F. Kennedy International, LaGuardia and Ronald Reagan Washington National. These slots either have no expiration dates or are expected to be renewed indefinitely in line with the FAA's past practice. They require no maintenance and do not have an established residual value. As the demand for air travel at these airports has remained very strong, the Company expects to use these slots in perpetuity and has determined these airport slots to be indefinite-lived intangible assets. They will not be amortized but rather tested for impairment annually, or more frequently when events and circumstances indicate that impairment may exist.
Of the remaining
$52 million
,
$37 million
represents customer relationships, subject to amortization on a straight-line basis over the estimated economic life of
seven
years,
$1 million
represents credit card agreements amortized on a straight-line basis over
one
year, and
$14 million
represents airport gates to be amortized on a straight-line basis over the remaining lease term of
eleven
years.
The Company considered examples of intangible assets that the FASB believes meet the criteria for recognition apart from goodwill, as well as any other intangible assets common to the airline industry, and did not identify any other such intangible assets acquired in the transaction.
Goodwill
Goodwill of
$1.9 billion
represents the excess of the purchase price over the fair value of the underlying net assets acquired and largely results from expected future synergies from combining operations as well as an assembled workforce, which does not qualify for separate recognition. Goodwill is not amortized to earnings, but instead is reviewed for impairment at least annually, absent any indicators of impairment.
Merger-related costs
The Company incurred pretax merger-related costs of
$118 million
and
$117 million
for the
twelve
months ended
December 31, 2017
and
2016
, respectively. Costs classified as merger-related are directly attributable to merger activities and are recorded as "Special items—merger-related costs" within the Statements of Operations. Refer to
Note 10
for further information on special items. The Company expects to continue to incur merger-related costs in the future as the integration continues.
Pro forma impact of the acquisition
The unaudited pro forma financial information presented below represents a summary of the consolidated results of operations for the Company including Virgin America as if the acquisition of Virgin America had been consummated as of January 1, 2015. The pro forma results do not include any anticipated synergies, or other expected benefits of the acquisition. Accordingly, the unaudited pro forma financial information below is not necessarily indicative of either future results of operations or results that might have been achieved had the acquisition been consummated as of January 1, 2015.
|
|
|
|
|
|
|
|
|
(in millions, except per share amounts)
|
Years Ended December 31,
|
|
2016
|
|
2015
|
Revenue
|
$
|
7,511
|
|
|
$
|
7,111
|
|
Net Income
|
1,008
|
|
|
914
|
|
NOTE 3. DERIVATIVE INSTRUMENTS AND RISK MANAGEMENT
Fuel 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 for crude oil.
As of
December 31, 2017
, the Company had outstanding fuel hedge contracts covering
434 million
gallons of crude oil that will be settled from
January 2018
to
June 2019
.
Interest Rate Swap Agreements
The Company is exposed to market risk from adverse changes in variable interest rates on long term debt and certain aircraft lease agreements. To manage this risk, the Company periodically enters into interest rate swap agreements. As of
December 31, 2017
, the Company has outstanding interest rate swap agreements with a third party designed to hedge the volatility of the underlying variable interest rates on lease agreements for
six
B737-800 aircraft, as well as
two
interest rate swap agreements with third parties designed to hedge the volatility of the underlying variable interest rates on
$265 million
of the debt obtained in 2016. All of the interest rate swap agreements stipulate that the Company pay a fixed interest rate and receive a floating interest rate over the term of the underlying contracts. The interest rate swap agreements expire from
February 2020
through
March 2021
to coincide with the lease termination dates, and
October 2022
through
September 2026
to coincide with the debt maturity dates. All significant terms of the swap agreements match the terms of the underlying hedged items, and have been designated as qualifying hedging instruments, which are accounted for as cash flow hedges.
As qualifying cash flow hedges, the interest rate swaps are recognized at fair value on the balance sheet, and changes in the fair value are recognized in accumulated other comprehensive income (loss). The effective portion of the derivative represents the change in fair value of the hedge that offsets the change in fair value of the hedged item. To the extent the change in fair value of the hedge does not perfectly offset the change in the fair value of the hedged item, the ineffective portion of the hedge is recognized in interest expense, if material.
Fair Values of Derivative Instruments
Fair values of derivative instruments on the consolidated balance sheet (in millions):
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
Fuel hedge contracts (not designated as hedges)
|
|
|
|
Prepaid expenses and other current assets
|
$
|
19
|
|
|
$
|
17
|
|
Other assets
|
3
|
|
|
3
|
|
Interest rate swaps (designated as hedges)
|
|
|
|
Prepaid expenses and other current assets
|
1
|
|
|
—
|
|
Other noncurrent assets
|
8
|
|
|
—
|
|
Other accrued liabilities
|
(3
|
)
|
|
(5
|
)
|
Other liabilities
|
(5
|
)
|
|
—
|
|
Losses in accumulated other comprehensive loss (AOCL)
|
(2
|
)
|
|
(5
|
)
|
The net cash paid for new fuel hedge positions and received from settlements was
$12 million
,
$19 million
and
$17 million
during
2017
,
2016
, and
2015
, respectively.
Pretax effect of derivative instruments on earnings and AOCL (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Fuel hedge contracts (not designated as hedges)
|
|
|
|
|
|
Gains (losses) recognized in Aircraft fuel
|
$
|
(6
|
)
|
|
$
|
(3
|
)
|
|
$
|
(19
|
)
|
Interest rate swaps (designated as hedges)
|
|
|
|
|
|
Gains (losses) recognized in Aircraft rent
|
(5
|
)
|
|
(6
|
)
|
|
(6
|
)
|
Gains (losses) recognized in other comprehensive income (OCI)
|
1
|
|
|
8
|
|
|
(5
|
)
|
The amounts shown as recognized in aircraft rent for cash flow hedges (interest rate swaps) represent the realized losses transferred out of AOCL to aircraft rent. No gains or losses related to interest rate swaps on variable rate debt have been recognized in interest expense during
2017
. The amounts shown as recognized in OCI are prior to the losses recognized in aircraft rent during the period. The Company expects
$3 million
to be reclassified from OCI to aircraft rent and
$1 million
to interest
income
within the next twelve months.
NOTE 4. FAIR VALUE MEASUREMENTS
Fair Value of Financial Instruments on a Recurring Basis
As of
December 31, 2017
, the total cost basis for marketable securities was
$1.4 billion
. There were no significant differences between the cost basis and fair value of any individual class of marketable securities.
Fair values of financial instruments on the consolidated balance sheet (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
Level 1
|
|
Level 2
|
|
Total
|
Assets
|
|
|
|
|
|
Marketable securities
|
|
|
|
|
|
U.S. government and agency securities
|
$
|
328
|
|
|
$
|
—
|
|
|
$
|
328
|
|
Foreign government bonds
|
—
|
|
|
43
|
|
|
43
|
|
Asset-backed securities
|
—
|
|
|
209
|
|
|
209
|
|
Mortgage-backed securities
|
—
|
|
|
99
|
|
|
99
|
|
Corporate notes and bonds
|
—
|
|
|
726
|
|
|
726
|
|
Municipal securities
|
—
|
|
|
22
|
|
|
22
|
|
Derivative instruments
|
|
|
|
|
|
Fuel hedge contracts—call options
|
—
|
|
|
22
|
|
|
22
|
|
Interest rate swap agreements
|
—
|
|
|
9
|
|
|
9
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
Derivative instruments
|
|
|
|
|
|
Interest rate swap agreements
|
—
|
|
|
(8
|
)
|
|
(8
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
Level 1
|
|
Level 2
|
|
Total
|
Assets
|
|
|
|
|
|
Marketable securities
|
|
|
|
|
|
U.S. government and agency securities
|
$
|
287
|
|
|
$
|
—
|
|
|
$
|
287
|
|
Foreign government bonds
|
—
|
|
|
36
|
|
|
36
|
|
Asset-backed securities
|
—
|
|
|
138
|
|
|
138
|
|
Mortgage-backed securities
|
—
|
|
|
89
|
|
|
89
|
|
Corporate notes and bonds
|
—
|
|
|
691
|
|
|
691
|
|
Municipal securities
|
—
|
|
|
11
|
|
|
11
|
|
Derivative instruments
|
|
|
|
|
|
Fuel hedge contracts—call options
|
—
|
|
|
20
|
|
|
20
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
Derivative instruments
|
|
|
|
|
|
Interest rate swap agreements
|
—
|
|
|
(5
|
)
|
|
(5
|
)
|
The Company uses the market and income approach to determine the fair value of marketable securities. U.S. government securities are Level 1 as the fair value is based on quoted prices in active markets. Foreign government bonds, asset-backed securities, mortgage-backed securities, corporate notes and bonds, and municipal securities are Level 2 as the fair value is based on standard valuation models that are calculated based on observable inputs such as quoted interest rates, yield curves, credit ratings of the security and other observable market information.
The Company uses the market and income approaches to determine the fair value of derivative instruments. The fair value for fuel hedge call options is determined utilizing an option pricing model based on inputs that are readily available in active markets or can be derived from information available in active markets. In addition, the fair value considers the exposure to
credit losses in the event of non-performance by counterparties. Interest rate swap agreements are Level 2 as the fair value of these contracts is determined based on the difference between the fixed interest rate in the agreements and the observable LIBOR-based interest forward rates at period end, multiplied by the total notional value.
The Company has no other financial assets that are measured at fair value on a nonrecurring basis at
December 31, 2017
.
Activity and Maturities for Marketable Securities
Unrealized losses from marketable securities are primarily attributable to changes in interest rates. Management does not believe any remaining losses represent other-than-temporary impairments based on the Company's evaluation of available evidence as of December 31, 2017.
Activity for marketable securities (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Proceeds from sales and maturities
|
$
|
1,388
|
|
|
$
|
962
|
|
|
$
|
1,175
|
|
Maturities for marketable securities (in millions):
|
|
|
|
|
|
|
|
|
December 31, 2017
|
Cost Basis
|
|
Fair Value
|
Due in one year or less
|
$
|
113
|
|
|
$
|
113
|
|
Due after one year through five years
|
1,272
|
|
|
1,264
|
|
Due after five years through 10 years
|
50
|
|
|
50
|
|
Total
|
$
|
1,435
|
|
|
$
|
1,427
|
|
Fair Value of Other Financial Instruments
The Company used the following methods and assumptions to determine the fair value of financial instruments that are not recognized at fair value as described below.
Cash and Cash Equivalents
: Carried at amortized costs which approximate fair value.
Debt
: Debt assumed in the acquisition of Virgin America was subject to a non-recurring fair valuation adjustment as part of purchase price accounting. The adjustment is amortized over the life of the associated debt. All other fixed-rate debt is carried at cost. To estimate the fair value of all fixed-rate as of December 31, 2017, the Company uses the income approach by discounting cash flows using borrowing rates for comparable debt over the weighted life of the outstanding debt. The estimated fair value of the fixed-rate debt is Level 3 as certain inputs used are unobservable.
Fixed-rate debt on the consolidated balance sheet and the estimated fair value of long-term fixed-rate debt (in millions):
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
Fixed rate debt at cost
|
$
|
956
|
|
|
$
|
1,175
|
|
Non-recurring purchase price accounting fair value adjustment
|
3
|
|
|
4
|
|
Total fixed rate debt
|
$
|
959
|
|
|
$
|
1,179
|
|
|
|
|
|
December 31, 2017 estimated fair value
|
$
|
959
|
|
|
$
|
1,199
|
|
NOTE 5. LONG-TERM DEBT
Long-term debt obligations (in millions):
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
Fixed-rate notes payable due through 2028
|
$
|
959
|
|
|
$
|
1,179
|
|
Variable-rate notes payable due through 2028
|
1,625
|
|
|
1,803
|
|
Less debt issuance costs
|
(15
|
)
|
|
(18
|
)
|
Total debt
|
2,569
|
|
|
2,964
|
|
Less current portion
|
307
|
|
|
319
|
|
Long-term debt, less current portion
|
$
|
2,262
|
|
|
$
|
2,645
|
|
|
|
|
|
Weighted-average fixed-interest rate
|
4.2
|
%
|
|
4.4
|
%
|
Weighted-average variable-interest rate
|
2.8
|
%
|
|
2.4
|
%
|
During
2017
, the Company's total debt
decreased
$395 million
, primarily due to payments of
$397 million
in
2017
, including the prepayment of
$74 million
of debt. Approximately
$2.2 billion
of the loans are secured by a total of
113
aircraft and
two
spare engines. An additional
$392 million
is secured by Air Group's interest in certain aircraft purchase deposits.
The Company's variable-rate debt bears interest at a floating rate per annum equal to a margin plus the three or six-month LIBOR in effect at the commencement of each semi-annual or three-month period, as applicable. As of
December 31, 2017
, none of the Company's borrowings were restricted by financial covenants.
Long-term debt principal payments for the next five years and thereafter (in millions):
|
|
|
|
|
|
Total
|
2018
|
$
|
310
|
|
2019
|
393
|
|
2020
|
449
|
|
2021
|
414
|
|
2022
|
247
|
|
Thereafter
|
768
|
|
Total principal payments
|
$
|
2,581
|
|
Bank Line of Credit
The Company has
three
credit facilities with availability totaling
$475 million
. All
three
facilities have variable interest rates based on LIBOR plus a specified margin.
One
credit facility increased from
$100 million
to
$250 million
in
June 2017
. It expires in
June 2021
and is secured by aircraft. A second credit facility increased from
$52 million
to
$75 million
in
September 2017
. It expires in
September 2018
, has a mechanism for annual renewal, and is secured by aircraft. A third credit facility increased from
$100 million
to
$150 million
in
March 2017
. It expires in
March 2022
and is secured by certain accounts receivable, spare engines, spare parts and ground service equipment. The Company has secured letters of credit against the
$75 million
facility, but has no plans to borrow using either of the
two
other facilities. All
three
credit facilities have a requirement to maintain a minimum unrestricted cash and marketable securities balance of
$500 million
. The Company was in compliance with this covenant at
December 31, 2017
.
NOTE 6. INCOME TAXES
Deferred Income Taxes
Deferred income taxes reflect the impact of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and such amounts for tax purposes. The Company has a net deferred tax liability, primarily due to differences in depreciation rates for federal income tax purposes and for financial reporting purposes.
Deferred tax (assets) and liabilities comprise the following (in millions):
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
Excess of tax over book depreciation
|
$
|
964
|
|
|
$
|
1,282
|
|
Intangibles—net
|
14
|
|
|
39
|
|
Other—net
|
43
|
|
|
26
|
|
Gross deferred tax liabilities
|
1,021
|
|
|
1,347
|
|
|
|
|
|
Mileage Plan™
|
(208
|
)
|
|
(310
|
)
|
Inventory obsolescence
|
(16
|
)
|
|
(23
|
)
|
Deferred gains
|
(5
|
)
|
|
(8
|
)
|
Employee benefits
|
(154
|
)
|
|
(196
|
)
|
Acquired net operating losses
|
(127
|
)
|
|
(289
|
)
|
Other—net
|
(57
|
)
|
|
(62
|
)
|
Gross deferred tax assets
|
(567
|
)
|
|
(888
|
)
|
Valuation allowance
|
—
|
|
|
4
|
|
Net deferred tax (assets) liabilities
|
$
|
454
|
|
|
$
|
463
|
|
On December 22, 2017, the Tax Cuts and Jobs Act was signed into law. The Tax Cuts and Jobs Act changed many aspects of the U.S. corporate income taxation, including but not limited to, a reduction in the corporate income tax rate from 35% to 21% and accelerated depreciation that will allow for full expensing of qualified property. ASC 740 requires a company to record the effects of a tax law change in the period of enactment.
The Company evaluated the impact of the Tax Cuts and Jobs Act and other law changes and recorded a discrete adjustment in our 2017 income tax expense of
$280 million
. The Company will continue to evaluate the impact of the new law and future guidance as issued.
At
December 31, 2017
, the Company had federal NOLs of approximately $
525 million
that expire beginning in
2029
and continuing through
2036
, and state NOLs of approximately $
254 million
that expire beginning in
2028
and continuing through
2035
.
Virgin America experienced multiple “ownership changes” as defined in Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), the most recent being its acquisition by the Company. Section 382 of the Code imposes an annual limitation on the utilization of pre-ownership change NOLs. Any unused annual limitation may, subject to certain limits, be carried over to later years. The combined Company’s ability to use the NOLs will also depend on the amount of taxable income generated in future periods.
Valuation allowances are provided to reduce the related deferred income tax assets to an amount which will, more likely than not, be realized. As a result of the Company’s assessment of the realization of deferred income tax assets, the Company concluded that it is more likely than not that all of its federal and state deferred income tax assets will be realized and thus no valuation allowance is necessary. The change from 2016 to 2017 was due to the reversal of the valuation allowance related to state NOL carryforwards. The Company reassesses the need for a valuation allowance each reporting period.
Components of Income Tax Expense
The components of income tax expense were as follows (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Current income tax expense:
|
|
|
|
|
|
Federal
|
$
|
127
|
|
|
$
|
392
|
|
|
$
|
397
|
|
State
|
35
|
|
|
48
|
|
|
30
|
|
Total current income tax expense
|
162
|
|
|
440
|
|
|
427
|
|
|
|
|
|
|
|
Deferred income tax expense (benefit):
|
|
|
|
|
|
|
|
|
Federal
|
(30
|
)
|
|
77
|
|
|
60
|
|
State
|
41
|
|
|
14
|
|
|
(23
|
)
|
Total deferred income tax expense (benefit)
|
11
|
|
|
91
|
|
|
37
|
|
Income tax expense
|
$
|
173
|
|
|
$
|
531
|
|
|
$
|
464
|
|
Income Tax Rate Reconciliation
Income tax expense reconciles to the amount computed by applying the U.S. federal rate of
35%
to income before income tax and the 2018 US federal rate of
21%
for deferred taxes as follows (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Income before income tax
|
$
|
1,207
|
|
|
$
|
1,345
|
|
|
$
|
1,312
|
|
|
|
|
|
|
|
Expected tax expense
|
422
|
|
|
471
|
|
|
459
|
|
Nondeductible expenses
|
5
|
|
|
20
|
|
|
4
|
|
State income taxes
|
29
|
|
|
28
|
|
|
19
|
|
State income sourcing
|
9
|
|
|
13
|
|
|
(15
|
)
|
Tax law changes
|
(280
|
)
|
|
—
|
|
|
—
|
|
Other—net
|
(12
|
)
|
|
(1
|
)
|
|
(3
|
)
|
Actual tax expense
|
$
|
173
|
|
|
$
|
531
|
|
|
$
|
464
|
|
|
|
|
|
|
|
Effective tax rate
|
14.3
|
%
|
|
39.5
|
%
|
|
35.4
|
%
|
As a result of tax changes signed into law during 2017, the Company recorded a deferred tax benefit of
$280 million
as a result of the reduction in future corporate income tax rate and other state law changes.
The Company incurred
$39 million
of acquisition-related costs that are not deductible under U.S. federal tax law in
2016
. These expenses are included in Special items—merger-related costs and other on the Company’s consolidated statement of operations and are reflected as a permanent unfavorable adjustment for the year ended December 31, 2016, in the table above.
In the fourth quarter of 2015, the Company filed amended state tax returns for the years 2010 through 2013 to change the Company’s position on income sourcing in various states. These positions were also taken on 2014 and subsequent filings, unless guidance or rules changed. In
2017
, adjustments were made to the Company's position on income sourcing in various states due to updated guidance from state taxing authorities. The impact of this guidance is reflected as an increase in income tax expense of approximately
$9 million
for the year ended
December 31, 2017
.
Uncertain Tax Positions
The Company has identified its federal tax return and its state tax returns in Alaska, Oregon and California as “major” tax jurisdictions. A summary of the Company's jurisdictions and the periods that are subject to examination are as follows:
|
|
|
Jurisdiction
|
Period
|
Federal
|
2007 to 2016
(a)(b)
|
Alaska
|
2012 to 2016
|
California
|
2006 to 2016
(a)
|
Oregon
|
2003 to 2016
(a)
|
|
|
(a)
|
The 2007-2012 Federal and California Virgin America tax returns are subject to examination only to the extent of net operating loss carryforwards from those years that were utilized in 2012 and later years. The 2003, 2004, 2008-2010 and 2011 Oregon tax returns are subject to examination only to the extent of net operating loss carryforwards from those years that were utilized in 2010 and later years.
|
|
|
(b)
|
Income tax years 2012 and 2013 are currently under exam by the Internal Revenue Service.
|
Changes in the liability for gross unrecognized tax benefits during
2017
,
2016
and
2015
are as follows (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Balance at January 1,
|
$
|
40
|
|
|
$
|
32
|
|
|
$
|
3
|
|
Additions related to prior years
|
16
|
|
|
—
|
|
|
29
|
|
Releases related to prior years
|
(2
|
)
|
|
—
|
|
|
—
|
|
Additions related to current year activity
|
2
|
|
|
—
|
|
|
—
|
|
Additions from acquisitions
|
—
|
|
|
8
|
|
|
—
|
|
Releases due to settlements
|
(11
|
)
|
|
—
|
|
|
—
|
|
Releases due to lapse of statute of limitations
|
(2
|
)
|
|
—
|
|
|
—
|
|
Balance at December 31,
|
$
|
43
|
|
|
$
|
40
|
|
|
$
|
32
|
|
As of
December 31, 2017
, the Company had
$43 million
of accrued tax contingencies, of which
$36 million
, if fully recognized, would decrease the effective tax rate. As of
December 31, 2017
,
2016
and
2015
, the Company has accrued interest and penalties, net of federal income tax benefit, of
$5 million
,
$3 million
, and
zero
. In
2017
,
2016
, and
2015
, the Company recognized an expense of
$2 million
,
$3 million
, and
zero
for interest and penalties, net of federal income tax benefit. At December 31, 2017, the Company has unrecognized tax benefits recorded as a liability and some reducing deferred tax assets. The Company added
$3 million
of reserves for uncertain tax positions in 2017, primarily due to changes in income sourcing for state income taxes. These uncertain tax positions could change as a result of the Company's ongoing audits, settlement of issues, new audits and status of other taxpayer court cases. The Company cannot predict the timing of these actions. Due to the positions being taken in various jurisdictions, the amounts currently accrued are the Company's best estimate as of December 31, 2017.
NOTE 7. EMPLOYEE BENEFIT PLANS
Four
qualified defined-benefit plans,
one
non-qualified defined-benefit plan, and
seven
defined-contribution retirement plans cover various employee groups of Alaska, Virgin America, McGee Air Services and Horizon.
The defined-benefit plans provide benefits based on an employee’s term of service and average compensation for a specified period of time before retirement. The qualified defined-benefit pension plans are closed to new entrants.
Accounting standards require recognition of the overfunded or underfunded status of an entity’s defined-benefit pension and other postretirement plan as an asset or liability in the consolidated financial statements and requires recognition of the funded status in AOCL.
Qualified Defined-Benefit Pension Plans
The Company’s
four
qualified defined-benefit pension plans are funded as required by the Employee Retirement Income Security Act of 1974. The defined-benefit plan assets consist primarily of marketable equity and fixed-income securities. The work groups covered by qualified defined-benefit pension plans include salaried employees, pilots, clerical, office, and
passenger service employees, and mechanics and related craft employees. The Company uses a December 31 measurement date for these plans.
Weighted average assumptions used to determine benefit obligations:
The rates below vary by plan and related work group.
|
|
|
|
|
|
2017
|
|
2016
|
Discount rates
|
3.69% to 3.78%
|
|
4.29% to 4.50%
|
Rate of compensation increases
|
2.11% to 3.00%
|
|
2.12% to 2.59%
|
Weighted average assumptions used to determine net periodic benefit cost:
The rates below vary by plan and related work group.
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Discount rates
|
4.29% to 4.50%
|
|
4.55% to 4.69%
|
|
4.20%
|
Expected return on plan assets
|
5.50% to 6.00%
|
|
6.00% to 6.50%
|
|
6.50%
|
Rate of compensation increases
|
2.12% to 2.59%
|
|
2.06% to 2.65%
|
|
2.85% to 3.91%
|
The discount rates are determined using current interest rates earned on high-quality, long-term bonds with maturities that correspond with the estimated cash distributions from the pension plans. At
December 31, 2017
, the Company selected discount rates for each of the plans using a pool of higher-yielding bonds estimated to be more reflective of settlement rates, as management has taken steps to ultimately terminate or settle plans that are frozen and move toward freezing benefits in active plans in the future. In determining the expected return on plan assets, the Company assesses the current level of expected returns on risk-free investments (primarily government bonds), the historical level of the risk premium associated with the other asset classes in which the portfolio is invested and the expectations for future returns of each asset class. The expected return for each asset class is then weighted based on the target asset allocation to develop the expected long-term rate of return on assets assumption for the portfolio.
Plan assets are invested in common commingled trust funds invested in equity and fixed income securities and in certain real estate assets. The target and actual asset allocation of the funds in the qualified defined-benefit plans, by asset category, are as follows:
|
|
|
|
|
|
|
|
|
|
Target
|
|
2017
|
|
2016
|
Asset category:
|
|
|
|
|
|
Domestic equity securities
|
5% - 33%
|
|
25
|
%
|
|
30
|
%
|
Non-U.S. equity securities
|
1% - 16%
|
|
11
|
%
|
|
12
|
%
|
Fixed income securities
|
48% - 95%
|
|
59
|
%
|
|
53
|
%
|
Real estate
|
2% - 8%
|
|
4
|
%
|
|
5
|
%
|
Cash equivalents
|
0%
|
|
1
|
%
|
|
—
|
%
|
Plan assets
|
|
|
100
|
%
|
|
100
|
%
|
The Company’s investment policy focuses on achieving maximum returns at a reasonable risk for pension assets over a full market cycle. The Company determines the strategic allocation between equities, fixed income and real estate based on current funded status and other characteristics of the plans. As the funded status improves, the Company increases the fixed income allocation of the portfolio and decreases the equity allocation. Actual asset allocations are reviewed regularly and periodically rebalanced as appropriate.
Plan assets invested in common commingled trust funds are fair valued using the net asset values of these funds to determine fair value as allowed using the practical expediency method outlined in the accounting standards. Fair value estimates for real estate are calculated using the present value of expected future cash flows based on independent appraisals, local market conditions and current and projected operating performance.
Plan asset by fund category (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
Fair Value Hierarchy
|
Fund type:
|
|
|
|
|
|
U.S. equity market fund
|
$
|
515
|
|
|
$
|
545
|
|
|
1
|
Non-U.S. equity fund
|
226
|
|
|
218
|
|
|
1
|
Credit bond index fund
|
1,232
|
|
|
989
|
|
|
1
|
Plan assets in common commingled trusts
|
$
|
1,973
|
|
|
$
|
1,752
|
|
|
|
Real estate
|
97
|
|
|
91
|
|
|
(a)
|
Cash equivalents
|
13
|
|
|
3
|
|
|
1
|
Total plan assets
|
$
|
2,083
|
|
|
$
|
1,846
|
|
|
|
|
|
(a)
|
In accordance with Subtopic 820-10, certain investments that are measured at net asset value per share (or its equivalent) have not been classified in the fair value hierarchy.
|
The following table sets forth the status of the qualified defined-benefit pension plans (in millions):
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
Projected benefit obligation (PBO)
|
|
|
|
Beginning of year
|
$
|
2,043
|
|
|
$
|
1,898
|
|
Service cost
|
39
|
|
|
37
|
|
Interest cost
|
74
|
|
|
73
|
|
Actuarial loss
|
300
|
|
|
104
|
|
Benefits paid
|
(69
|
)
|
|
(69
|
)
|
End of year
|
$
|
2,387
|
|
|
$
|
2,043
|
|
|
|
|
|
Plan assets at fair value
|
|
|
|
|
|
Beginning of year
|
$
|
1,846
|
|
|
$
|
1,737
|
|
Actual return on plan assets
|
291
|
|
|
178
|
|
Employer contributions
|
15
|
|
|
—
|
|
Benefits paid
|
(69
|
)
|
|
(69
|
)
|
End of year
|
$
|
2,083
|
|
|
$
|
1,846
|
|
Unfunded status
|
$
|
(304
|
)
|
|
$
|
(197
|
)
|
|
|
|
|
Percent funded
|
87
|
%
|
|
90
|
%
|
The accumulated benefit obligation for the combined qualified defined-benefit pension plans was
$2.2 billion
and
$1.9 billion
at
December 31, 2017
and
2016
.
The amounts recognized in the consolidated balance sheets (in millions):
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
Accrued benefit liability-long term
|
$
|
335
|
|
|
$
|
225
|
|
Plan assets-long term (within Other noncurrent assets)
|
(31
|
)
|
|
(28
|
)
|
Total liability recognized
|
$
|
304
|
|
|
$
|
197
|
|
The amounts not yet reflected in net periodic benefit cost and included in AOCL (in millions):
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
Prior service credit
|
$
|
(9
|
)
|
|
$
|
(10
|
)
|
Net loss
|
597
|
|
|
509
|
|
Amount recognized in AOCL (pretax)
|
$
|
588
|
|
|
$
|
499
|
|
The expected amortization of prior service credit and net loss from AOCL in
2018
is
$1 million
and
$31 million
, respectively, for the qualified defined-benefit pension plans.
Net pension expense for the qualified defined-benefit plans included the following components (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Service cost
|
$
|
39
|
|
|
$
|
37
|
|
|
$
|
41
|
|
Interest cost
|
74
|
|
|
73
|
|
|
84
|
|
Expected return on assets
|
(106
|
)
|
|
(108
|
)
|
|
(122
|
)
|
Amortization of prior service credit
|
(1
|
)
|
|
(1
|
)
|
|
(1
|
)
|
Recognized actuarial loss
|
26
|
|
|
25
|
|
|
26
|
|
Settlement expense
(special item)
|
—
|
|
|
—
|
|
|
14
|
|
Net pension expense
|
$
|
32
|
|
|
$
|
26
|
|
|
$
|
42
|
|
In 2015, the Company recognized a settlement charge of
$14 million
related to lump sum settlements offered to terminated, vested plan participants. The result was a reduction in the projected benefit obligation of
$62 million
. The settlement charge reflects the remaining unamortized actuarial loss in AOCL associated with the settled obligation.
There are no current statutory funding requirements for the Company’s plans in
2018
.
Future benefits expected to be paid over the next ten years under the qualified defined-benefit pension plans from the assets of those plans (in millions):
|
|
|
|
|
|
Total
|
2018
|
$
|
97
|
|
2019
|
101
|
|
2020
|
116
|
|
2021
|
116
|
|
2022
|
130
|
|
2023– 2027
|
723
|
|
Nonqualified Defined-Benefit Pension Plan
Alaska also maintains an unfunded, noncontributory defined-benefit plan for certain elected officers. This plan uses a December 31 measurement date. The assumptions used to determine benefit obligations and the net period benefit cost for the nonqualified defined-benefit pension plan are similar to those used to calculate the qualified defined-benefit pension plan. The plan's unfunded status, PBO and accumulated benefit obligation are immaterial. The net pension expense in prior year and expected future expense is also immaterial.
Postretirement Medical Benefits
The Company allows certain retirees to continue their medical, dental and vision benefits by paying all or a portion of the active employee plan premium until eligible for Medicare, currently age 65. This results in a subsidy to retirees, because the premiums received by the Company are less than the actual cost of the retirees’ claims. The accumulated postretirement benefit obligation for this subsidy is unfunded. The accumulated postretirement benefit obligation was
$85 million
and
$76 million
at
December 31, 2017
and
2016
, respectively. The net periodic benefit cost was not material in
2017
or
2016
.
Defined-Contribution Plans
The
seven
defined-contribution plans are deferred compensation plans under section 401(k) of the Internal Revenue Code. All of these plans require Company contributions. Total expense for the defined-contribution plans was
$103 million
,
$67 million
and
$60 million
in
2017
,
2016
, and
2015
, respectively.
The Company also has a noncontributory, unfunded defined-contribution plan for certain elected officers of the Company who are ineligible for the nonqualified defined-benefit pension plan. Amounts recorded as liabilities under the plan are not material to the consolidated balance sheets at
December 31, 2017
and
2016
.
Pilot Long-term Disability Benefits
Alaska maintains a long-term disability plan for its pilots. The long-term disability plan does not have a service requirement. Therefore, the liability is calculated based on estimated future benefit payments associated with pilots that were assumed to be disabled on a long-term basis as of
December 31, 2017
and does not include any assumptions for future disability. The liability includes the discounted expected future benefit payments and medical costs. The total liability was
$28 million
and
$25 million
, which was recorded net of a prefunded trust account of
$3 million
and
$3 million
, and included in long-term other liabilities on the consolidated balance sheets as of
December 31, 2017
and
December 31, 2016
, respectively.
Employee Incentive-Pay Plans
The Company has employee incentive plans that pay employees based on certain financial and operational metrics. These metrics are set and approved annually by the Compensation Committee of the Board of Directors. The aggregate expense under these plans in
2017
,
2016
and
2015
was
$135 million
,
$127 million
and
$120 million
. The Air Group plans are summarized below.
|
|
•
|
Performance-Based Pay
(PBP) is a program that rewards the majority of Air Group employees. The program is based on six separate metrics related to Air Group profitability, safety, loyalty Mileage Plan™ and credit card growth, achievement of unit-cost goals and employee engagement as measured by customer satisfaction.
|
|
|
•
|
The
Operational Performance Rewards Program
entitles the majority of Air Group employees to quarterly payouts of up to
$300
per person if certain operational and customer service objectives are met.
|
NOTE 8. COMMITMENTS AND CONTINGENCIES
Future minimum payments for commitments as of
December 31, 2017
(in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Aircraft Leases
|
|
Facility Leases
|
|
Aircraft Purchase Commitments
|
|
Capacity Purchase Agreements
(a)
|
|
Aircraft Maintenance Deposits
|
|
Aircraft Maintenance and Parts Management
|
2018
|
$
|
354
|
|
|
$
|
77
|
|
|
$
|
955
|
|
|
$
|
129
|
|
|
$
|
61
|
|
|
$
|
98
|
|
2019
|
356
|
|
|
67
|
|
|
816
|
|
|
151
|
|
|
65
|
|
|
102
|
|
2020
|
330
|
|
|
61
|
|
|
377
|
|
|
159
|
|
|
68
|
|
|
105
|
|
2021
|
285
|
|
|
53
|
|
|
268
|
|
|
165
|
|
|
64
|
|
|
121
|
|
2022
|
262
|
|
|
34
|
|
|
193
|
|
|
173
|
|
|
52
|
|
|
76
|
|
Thereafter
|
1,021
|
|
|
142
|
|
|
145
|
|
|
1,079
|
|
|
39
|
|
|
80
|
|
Total
|
$
|
2,608
|
|
|
$
|
434
|
|
|
$
|
2,754
|
|
|
$
|
1,856
|
|
|
$
|
349
|
|
|
$
|
582
|
|
|
|
(a)
|
Includes all non-aircraft lease costs associated with capacity purchase agreements.
|
Lease Commitments
Aircraft lease commitments include future obligations for all of the Company's operating airlines—Alaska, Virgin America and Horizon, as well as aircraft leases operated by third parties. At
December 31, 2017
, the Company had lease contracts for
10
B737 (B737) aircraft,
57
Airbus aircraft,
15
Bombardier Q400 aircraft, and
23
Embraer 175 (E175) aircraft with SkyWest Airlines, Inc. (SkyWest). The Company has an additional
six
scheduled lease deliveries of A321neo aircraft through
2018
, as well as
12
scheduled lease deliveries of E175 aircraft through
2018
to be operated by SkyWest. All lease contracts have remaining non-cancelable lease terms ranging from
2018
to
2030
. The Company has the option to increase capacity flown by SkyWest with
eight
additional E175 aircraft with deliveries in
2020
. Options to lease are not reflected in the commitments table above.
Facility lease commitments primarily include airport and terminal facilities and building leases. Total rent expense for aircraft and facility leases was
$552 million
,
$315 million
and
$295 million
, in
2017
,
2016
and
2015
.
Aircraft Purchase Commitments
Aircraft purchase commitments include non-cancelable contractual commitments for aircrafts and engines. As of
December 31, 2017
, the Company had commitments to purchase
44
B737 aircraft (
12
B737 NextGen aircraft and
32
B737 MAX aircraft, with deliveries in
2018
through
2023
) and
23
E175 aircraft with deliveries in
2018
through
2019
. The Company also has cancelable purchase commitments for
30
Airbus A320neo aircraft with deliveries from
2020
through
2022
. In addition, the Company has options to purchase
37
B737 aircraft and
30
E175 aircraft. The cancelable purchase commitments and option payments are not reflected in the table above.
The Company expects to defer certain purchase commitments in 2019 and beyond, which is not currently reflected in the contractual aircraft purchase commitments above.
Capacity Purchase Agreements (CPAs)
At
December 31, 2017
, Alaska had CPAs with
three
carriers, including the Company's wholly-owned subsidiary, Horizon. Horizon sells
100%
of its capacity under a CPA with Alaska. In addition, Alaska has CPAs with SkyWest to fly certain routes in the Lower 48 and Canada and with Peninsula Airways, Inc. (PenAir) to fly certain routes in the state of Alaska. Under these agreements, Alaska pays the carriers an amount which is based on a determination of their cost of operating those flights and other factors intended to approximate market rates for those services. Future payments (excluding Horizon) are based on minimum levels of flying by the third-party carriers, which could differ materially due to variable payments based on actual levels of flying and certain costs associated with operating flights such as fuel.
Aircraft Maintenance Deposits
Certain Airbus leases include contractually required maintenance deposit payments to the lessor, which collateralize the lessor for future maintenance events should the Company not perform required maintenance. Most of the lease agreements provide that maintenance deposits are reimbursable upon completion of the major maintenance event in an amount equal to the lesser of (i) the amount qualified for reimbursement from maintenance deposits held by the lessor associated with the specific major maintenance event or (ii) the qualifying costs related to the specific major maintenance event.
Aircraft Maintenance and Parts Management
Through its acquisition of Virgin America, the Company has a separate maintenance-cost-per-hour contract for management and repair of certain rotable parts to support Airbus airframe and engine maintenance and repair. On October 1, 2017, Alaska entered into a similar contract for maintenance on its B737-800 aircraft engines. These agreements require monthly payments based upon utilization, such as flight hours, cycles and age of the aircraft, and, in turn, the agreement transfers certain risks to the third-party service provider. There are minimum payments under both agreements, which are reflected in the table above. Accordingly, payments could differ materially based on actual aircraft utilization.
Contingencies
The Company is a party to routine litigation matters incidental to its business and with respect to which no material liability is expected. Liabilities for litigation related contingencies are recorded when a loss is determined to be probable and estimable.
In 2015, three flight attendants filed a class action lawsuit seeking to represent all Virgin America flight attendants for damages based on alleged violations of California and City of San Francisco wage and hour laws. Plaintiffs received class certification in November 2016. Virgin America filed a motion for summary judgment seeking to dismiss all claims on various federal preemption grounds. In January 2017, the Court denied in part and granted in part Virgin America’s motion. In January 2018, Virgin America filed a motion to decertify the class and Plaintiffs filed a motion for summary judgment seeking the court to rule in their favor on all remaining claims. The Company believes the claims in this case are without factual and legal merit and intends to defend this lawsuit.
Management believes the ultimate disposition of these matters is not likely to materially affect the Company's financial position or results of operations. This forward-looking statement is based on management's current understanding of the relevant law and facts, and it is subject to various contingencies, including the potential costs and risks associated with litigation and the actions of arbitrators, judges and juries.
NOTE 9. SHAREHOLDERS' EQUITY
Common Stock Changes
During the second quarter of 2017, shareholders voted to increase the number of authorized shares of common stock from
200 million
to
400 million
.
Dividends
During
2017
, the Board of Directors declared dividends of
$1.20
per share. The Company paid dividends of
$148 million
,
$136 million
and
$102 million
to shareholders of record during
2017
,
2016
and
2015
.
Subsequent to year-end, the Board of Directors declared a quarterly cash dividend of
$0.32
per share to be paid in March 2018 to shareholders of record as of February 20, 2018. This is a
7%
increase from the most recent quarterly dividend of
$0.30
per share.
Common Stock Repurchase
In
May 2014
, the Board of Directors authorized a
$650 million
share repurchase program, which was completed in
October 2015
. In
August 2015
, the Board of Directors authorized a
$1 billion
share repurchase program. As of
December 31, 2017
, the Company has repurchased
5.1 million
shares for
$388 million
under this program.
At
December 31, 2017
, the Company held
6,842,860
shares in treasury. Management does not anticipate retiring common shares held in treasury for the foreseeable future.
Share repurchase activity (in millions, except shares):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
|
Shares
|
|
Amount
|
|
Shares
|
|
Amount
|
|
Shares
|
|
Amount
|
2015 Repurchase Program – $1 billion
|
981,277
|
|
|
$
|
75
|
|
|
2,594,809
|
|
|
$
|
193
|
|
|
1,517,277
|
|
|
$
|
120
|
|
2014 Repurchase Program – $650 million
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
5,691,051
|
|
|
385
|
|
Total
|
981,277
|
|
|
$
|
75
|
|
|
2,594,809
|
|
|
$
|
193
|
|
|
7,208,328
|
|
|
$
|
505
|
|
Accumulated Other Comprehensive Loss (AOCL)
AOCL consisted of the following (in millions, net of tax):
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
Related to marketable securities
|
$
|
(5
|
)
|
|
$
|
(3
|
)
|
Related to employee benefit plans
|
(376
|
)
|
|
(299
|
)
|
Related to interest rate derivatives
|
1
|
|
|
(3
|
)
|
|
$
|
(380
|
)
|
|
$
|
(305
|
)
|
In relation to the Tax Cuts and Jobs Act, amounts recognized in other comprehensive income subsequent to the December 22, 2017 enactment date, are taxed at the revised federal income tax rates. The Company's actuarial adjustments for employee benefit plans occur annually at December 31, and therefore are tax effected at the new lower rates. Accordingly, the effective tax rate for employee benefit plan amounts recognized in other comprehensive income at December 31, 2017 is lower than it historically has been.
NOTE 10. SPECIAL ITEMS
In 2017, the Company recognized special items of
$118 million
for merger-related costs associated with its acquisition of Virgin America. Costs classified as merger-related are directly attributable to merger activities. The Company also recognized a special tax benefit of
$280 million
due to the remeasurement of net deferred tax liabilities as a result of the Tax Cuts and Jobs Act signed into law on December 22, 2017, partially offset by certain state tax law enactments.
In 2016, the Company recognized
$117 million
in merger-related costs.
$39 million
of these costs were not deductible under the U.S. federal tax law, as discussed in
Note 6
. The Company recognized a special tax expense of
$17 million
representing the impact of adjustments to the Company's position on income sourcing in various states.
In 2015, the Company recognized special items of
$32 million
in aggregate. The special items included expense of
$14 million
for a lump sum settlements offered to terminated and vested participants in the qualified defined benefit pension plans and a litigation-related matter. See
Note 7
for more information regarding the pension settlement charge. The Company also recognized a special tax benefit of
$26 million
representing the discrete impacts of adjustments to the Company's position on income sourcing in various states.
The following breaks down merger-related costs incurred in 2017 and 2016 (in millions):
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
Consulting and professional services
|
$
|
52
|
|
|
$
|
32
|
|
Severance and retention benefits
|
40
|
|
|
22
|
|
Banking fees
|
—
|
|
|
36
|
|
Legal and accounting fees
|
3
|
|
|
22
|
|
Other merger-related costs
(a)
|
23
|
|
|
5
|
|
Total Merger-related Costs
|
$
|
118
|
|
|
$
|
117
|
|
|
|
(a)
|
Other merger-related costs consist primarily of costs for marketing and advertising, IT, training and skill development, employee appreciation and company sponsored events, moving expenses, supplies, and other immaterial expenses.
|