UNITED STATES SECURITIES AND EXCHANGE COMMISSION
(Mark One)
For the quarterly period ended September 30, 2002.
OR
For the transition period from . . . . . . to . . . . . .
Commission file number 1-8957
ALASKA AIR GROUP, INC.
19300 Pacific Highway South, Seattle, Washington 98188(Address of principal executive offices)
Registrant’s telephone number, including area code: (206) 431-7040
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
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 26,549,161 common shares, par value $1.00, outstanding at October 31, 2002.
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TABLE OF CONTENTS
PART I. FINANCIAL INFORMATIONITEM 1. Financial StatementsCONSOLIDATED BALANCE SHEETS (unaudited)Alaska Air Group, Inc.
ASSETS
See accompanying notes to consolidated financial statements.
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CONSOLIDATED BALANCE SHEETS (unaudited)Alaska Air Group, Inc.
LIABILITIES AND SHAREHOLDERS’ EQUITY
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CONSOLIDATED STATEMENTS OF INCOME (unaudited)Alaska Air Group, Inc.
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CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (unaudited)Alaska Air Group, Inc.
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CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)Alaska Air Group, Inc.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)Alaska Air Group, Inc.
Note 1. Basis of Presentation and Significant Accounting Policies
The accompanying unaudited consolidated financial statements of Alaska Air Group, Inc. (the Company) include the accounts of its principal subsidiaries, Alaska Airlines, Inc. (Alaska) and Horizon Air Industries, Inc. (Horizon). These interim 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, 2001, subject to the restatement described in Note 2 below In the opinion of management, all adjustments (consisting only of normal recurring accruals) have been made which are necessary to present fairly the financial position of the Company as of September 30, 2002, as well as the results of its operations for the three and nine months ended September 30, 2002 and 2001. Except for the restatement of the prior year’s financial statements as described below, the adjustments made were of a normal recurring nature. Certain reclassifications have been made in the prior year’s restated financial statements to conform to the 2002 presentation.
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management 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 include assumptions used to record liabilities, expenses and revenue associated with the Company’s Mileage Plan, estimated useful lives of property and equipment and the amounts of certain accrued liabilities. Actual results may differ from these estimates.
As further discussed in Note 2, in June 2002, the Company restated its consolidated financial statements for the year ended December 31, 2001 and its unaudited consolidated financial statements for the quarterly period ended March 31, 2002 and for all quarterly periods during the year ended December 31, 2001. The Company expects to file an amendment to its Annual Report on Form 10-K for the year ended December 31, 2001, which will include its restated financial statements.
Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets”. Under this Statement the Company’s goodwill will no longer be amortized, but instead will be tested for impairment on a minimum of an annual basis. The impact of discontinuing amortization of existing goodwill has resulted in an increase of net income of $1.5 million for the nine months ended September 30, 2002. During the second quarter of 2002, the Company completed the first step of its impairment test related to its $51.4 million of goodwill. The test was performed using Alaska and Horizon as separate reporting units. Results of the test indicate that there may be an impairment in each reporting unit as it was determined that the net book value of each reporting unit exceeded its fair value. As a result, the Company is in the process of completing the second step of the impairment test to determine the amount of impairment, if any. The Company is unable to estimate the amount of the possible impairment, but is expected to complete the second step of the impairment test during the fourth quarter of 2002.
In August 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations”, which requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The statement also requires that the associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of this
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statement is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. This Statement supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” and APB Opinion No. 30, “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”. Adoption of this Statement, in the fiscal year beginning January 1, 2002, did not have a material impact on the Company’s financial position, results of operations or cash flows.
In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“Statement 145”). This Statement requires that only certain debt extinguishment transactions be classified as an extraordinary item. Additionally, under this Statement, capital leases that are modified so that the resulting agreement is an operating lease shall be accounted for under the sale-leaseback provisions of SFAS No. 98. Statement 145 also includes minor modifications to existing GAAP literature. Statement 145 is generally effective for financial statements issued for fiscal years beginning after May 15, 2002. The adoption of this statement is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)”. The Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The Statement is effective for the Company for transactions on or after January 1, 2003 and is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
Note 2. Restatement of Financial Statements
In June 2002, the Company changed its accounting policies relating to the accrual for certain lease return costs and the capitalization of software development costs, and restated its previously issued consolidated financial statements for the year ended December 31, 2001, including the interim periods within that year. The effect of these changes is as shown below and results in an increase in shareholders’ equity of $28.9 million as of December 31, 2001. In addition, the Company changed its accounting for aircraft purchase commitments assumed by a third party, and made a reclassification of deferred income taxes, neither of which impact previously reported equity or earnings. These changes are more fully described below. Because the former methods are not considered to be in compliance with generally accepted accounting principles in the United States of America, the financial statements have been restated to give retroactive effect to these changes.
Leased Aircraft Return Costs
The Company leases many of its aircraft under relatively long-term operating lease agreements. These aircraft are subject to periodic airframe and engine overhauls based on the Company’s maintenance program. The Company’s previous policy was to capitalize these overhauls and amortize the costs over the estimated lives of the overhauls. Separately, many of the Company’s lease agreements contain provisions which require that at the end of the lease, either certain minimum times remain until the next overhaul or the Company make a cash payment to the lessor. At the inception of the lease, the Company does not know the balance between actual time remaining to the next overhaul and cash
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payments that will be used to satisfy its return commitments. Under the previous method, the Company accrued the costs of returning leased aircraft, including any cash payments due to lessors and any unamortized overhauls, on a straight-line basis over the lives of the leases. Airframe and engine overhauls are now capitalized and amortized over the remaining lease term, if shorter than the life of the overhaul. Additionally, under our new method, since the amount of cash payments by themselves cannot be reasonably predicted at the inception of the lease, the Company will accrue cash payments expected to be made to lessors over the last few years of the lease when probable and estimable, versus over the entire lease term.
Internally Developed Software
The Company also revised its accounting practices for certain costs of internally developed software. These costs were previously charged to expense as they were incurred, and they are now capitalized and amortized over the estimated lives of the software.
Aircraft Purchase Commitments
The Company has a purchase commitment that may trigger a liability under certain events of default. The Company previously recognized a portion of this commitment which was funded by a third party as a liability, and related aircraft purchase deposits, on its balance sheet. Since the executory contract for the purchase commitment is not an obligation of the Company until the aircraft is delivered, this commitment is disclosed as a purchase commitment and not included in long-term debt or deposits for future flight equipment.
The effect of the restatement for the three and nine months ended September 30, 2001 is as follows:
The effect of the restatement on selected balance sheet items is as follows as of December 31, 2001:
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Note 3. Frequent Flyer Program
Alaska’s Mileage Plan liabilities are included under the following balance sheet captions:
Note 4. Other Assets
At December 31, 2001 and September 30, 2002, other assets included prepaid pension cost of $98.4 million and $90.2 million, respectively.
Note 5. Earnings per Share
Earnings per share (EPS) calculations were as follows (in millions except per share amounts). Stock options excluded from the calculation of diluted EPS, because they are antidilutive, represented 2.0 million and 3.1 million shares, respectively, for the three months ended September 30, 2001 and 2002, and 2.3 million and 2.4 million shares, respectively, for the nine months ended September 30, 2001 and 2002.
Note 6. Operating Segment Information
Operating segment information for Alaska and Horizon was as follows (in millions):
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Note 6 (continued)
Note 7. U.S. Government Compensation
In September 2001, the U.S. Government passed the Air Transportation Safety and System Stabilization Act to compensate the airlines for direct and incremental losses as a result of the September 11th terrorist attacks. In the second quarter of 2002, Alaska and Horizon each submitted final applications to the Department of Transportation (DOT) based on each company’s losses. During the third quarter of 2002, the DOT completed its review procedures and remitted final compensation payments to Alaska and Horizon of $0.3 million and $0.2 million, respectively. These amounts are reflected in the consolidated statement of income during the three months ended September 30, 2002.
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ALASKA AIRLINES FINANCIAL AND STATISTICAL DATA (unaudited)
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HORIZON AIR FINANCIAL AND STATISTICAL DATA (unaudited)
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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Information
As discussed in Note 2 to the consolidated financial statements, in June 2002 the Company restated its financial statements for the year ended December 31, 2001 and the interim periods within that year. The accompanying management’s discussion and analysis gives effect to the restatement.
Results of Operations
Alaska Airlines
Freight and mail revenues decreased 5.3% during the three months ended September 30, 2002 when compared to comparable periods in 2001. This decrease is primarily a result of increases in freight revenues offset by decreases in mail revenues.
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Other-net revenues increased 14.5%, due largely to increased revenue related to the sale of miles in Alaska’s frequent flyer program, new security fee reimbursement revenue and higher essential air service subsidy rates.
Total operating expenses increased 5.7% during the three months ended September 30, 2002 when compared to the same period in 2001, while our cost per ASM decreased by 4.9%. Our cost per ASM excluding fuel decreased by 3.7%. Explanations of significant period over period changes in the components of operating expenses are as follows:
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Horizon Air
Freight and mail revenues decreased 26.3% primarily due to lower freight volumes attributable to increased security restrictions and a slower economy. Other-net revenues decreased 27.8%, primarily due to lower levels of manufacturer support received as compensation for delays in delivery of new aircraft.
Operating expenses decreased by $1.7 million, or 1.5%, during the three months ended September 30, 2002 compared to the same period in 2001. This decrease is due principally to decreases in maintenance expense and fuel expense benefits due to the transition to our new fleet. The decreases in operating expenses were largely offset by increases in aircraft rent and other expenses. Our cost per ASM decreased by 16.9%, while our cost per ASM excluding fuel decreased by 15.5%. Explanations of significant year-over-year changes in the components of operating expenses are as follows:
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Consolidated Nonoperating Income (Expense)
Nine Months 2002 Compared with Nine Months 2001
Freight and mail revenue decreased 8.1% due to lower freight volumes attributable to increased security restrictions and a slower economy.
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Other-net revenues increased 24.6% primarily due to increased revenue related to the sale of miles in Alaska’s frequent flyer program, new security fee reimbursement revenue and higher essential air service subsidy rates.
Total operating expenses increased 2.9% during the nine months ended September 30, 2002 when compared to the same period in 2001. Cost per ASM decreased 2.8% and cost per ASM excluding fuel increased slightly by 0.2 percentage points. Explanations of significant year-over-year changes in the components of operating expenses are as follows:
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Other-net revenues increased 5.1% primarily due to higher levels of manufacturer support received as compensation for delays in delivery of new aircraft during the first quarter of 2002.
Operating expenses decreased by $23.5 million, or 6.8%, during the nine months ended September 30, 2002 compared to the same period in 2001. This decrease is due principally to decreases in maintenance expense and fuel expense due to the transition to our new fleet. These decreases in operating expenses were largely offset by increases in aircraft rent and other expenses. Our cost per ASM decreased by 13.2%, while our cost per ASM excluding fuel decreased by 10.1%. Explanations of significant year-over-year changes in the components of operating expenses are as follows:
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Consolidated Income Tax Benefit (Expense)
Critical Accounting Policies
Liquidity and Capital Resources
The Company’s cash and marketable securities portfolio increased $1.9 million during the first nine months of 2002. Operating activities provided $117.0 million of cash during this period. Additional cash was provided by the issuance of $25.5 million of new debt. Cash outflows included $107 million of capital expenditures, including the purchase of spare parts, airframe and engine
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overhauls and $36.8 million for purchases of new aircraft. In addition, the Company made $26.8 million of debt repayments.
Shareholders’ equity decreased $12.8 million due principally to the net loss of $28.0 million, partially offset by an increase in accumulated other comprehensive income of $14.7 million
Financing Activities - During the first nine months of 2002, Horizon added three Dash 8-400 and six CRJ 700 aircraft to its operating fleet. The aircraft were financed with a combination of U.S. leveraged leases and single investor leases with terms of approximately 16.5 years. Future minimum lease payments under these nine leases total $221.2 million. Because these aircraft were financed at delivery, they are not included in the capital expenditures amount stated above.
Aircraft Purchase Commitments - At September 30, 2002, the Company had firm orders for 29 aircraft requiring aggregate remaining payments of approximately $587 million, as set forth below. In addition, Alaska has options to acquire 24 more B737s, and Horizon has options to acquire 15 Dash 8-400s and 25 CRJ 700s. Alaska expects to finance five of the B737-700 deliveries in 2003 with operating leases and the remainder of the new planes with long-term debt or internally generated cash. Horizon expects to finance its new aircraft with operating leases.
The Company has a purchase commitment that may trigger a liability under certain events of default. The Company previously recognized a portion of this commitment, which was funded by a third party as a liability, and related aircraft purchase deposits on its balance sheet. Since the executory contract for the purchase commitment is not an obligation of the Company until the aircraft is delivered, this commitment is now disclosed as a purchase commitment and not included in long-term debt or deposits for future flight equipment. See Note 2 to the financial statements.
New Accounting Standards – Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets”. Under this Statement the Company’s goodwill will no longer be amortized, but instead will be tested for impairment on a minimum of an annual basis. The impact of discontinuing amortization of existing goodwill has resulted in an increase of net income of $1.5 million for the nine months ended September 30, 2002. During the second quarter of 2002, the Company completed the first step of its impairment test related to its $51.4 million of goodwill. The test was performed using Alaska and Horizon as separate reporting units. Results of the test indicate that there may be an impairment in each reporting unit as it was determined that the net book value of each reporting unit exceeded its fair value. As a result, the Company is in the process of completing the second step of the
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impairment test to determine the amount of impairment, if any. The Company is unable to estimate the amount of the possible impairment, but is expected to complete the second step of the impairment test during the fourth quarter of 2002.
In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, “Accounting for Asset Retirement Obligations”, which requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The statement also requires that the associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of this statement is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“Statement 145”). This Statement requires that only certain debt extinguishment transactions be classified as an extraordinary item. Additionally, under this Statement, capital leases that are modified so that the resulting agreement is an operating lease, shall be accounted for under the sale-leaseback provisions of SFAS No. 98. Statement 145 also includes minor modifications to existing U.S. Generally Accepted Accounting Principles literature. Statement 145 is generally effective for financial statements issued for fiscal years beginning after May 15, 2002. The adoption of this statement is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)”. The Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The Statement is effective for the Company on January 1, 2003 and is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
ITEM 3. Quantitative and Qualitative Disclosure about Market Risk
During the three and nine months ended September 30, 2002, the Company recognized approximately $5.8 million and $6.8 million in realized hedging gains which are reflected in aircraft
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fuel in the consolidated statements of income. During the three and nine months ended September 30, 2002, the Company recorded $3.1 million expense and $5.5 million income, respectively, related to the ineffectiveness of the Company’s hedges. These amounts are recorded as non-operating income (expense) in other-net in the consolidated statements of income.
As of September 30, 2002, the Company had unrealized gains, net of tax of $12.7 million. These amounts are reflected in accumulated other comprehensive income (loss) in the consolidated balance sheets as of September 30, 2002.
ITEM 4. Controls and Procedures
In the 90-day period before the filing of this report, the chief executive officer and chief financial officer of the Company (collectively, the certifying officers) have evaluated the effectiveness of the Company’s disclosure controls and procedures. These disclosure controls and procedures are designed to ensure that the information required to be disclosed by the Company in its periodic reports filed with the Securities and Exchange Commission (the Commission) is recorded, processed, summarized and reported, within the time periods specified by the Commission’s rules and forms, and that the information is communicated to the certifying officers on a timely basis.
The certifying officers concluded, based on their evaluation, that the Company’s disclosure controls and procedures are effective for the Company, taking into consideration the size and nature of the Company’s business and operations.
No significant changes in the Company’s internal controls or in other factors were detected that could significantly affect the Company’s internal controls subsequent to the date when the internal controls were evaluated.
PART II. OTHER INFORMATION
Management believes the ultimate disposition of this matter 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; it is subject to various contingencies, including the potential costs and risks associated with litigation and the actions of judges and juries.
The Company is also a party to other ordinary routine litigation incidental to its business and with respect to which no material liability is expected.
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ITEM 5. Other Information
Alaska has a labor contract with the Transit Workers Union (TWU), which covers 29 dispatchers. The contract was amendable on August 9, 2002. During the third quarter 2002, the Company and TWU agreed to a five-year contract term on all issues except hourly wage rate and certain wage-related issues. By agreement of both parties, those issues were submitted to interest arbitration to determine wages for a three-year period. The Company hopes to have resolution to these issues in the fourth quarter of 2002.
Horizon is continuing negotiations with the Association of Flight Attendants regarding the flight attendant employee group, whose contract is amendable January 28, 2003. During the third quarter of 2002, negotiations started with AMFA (that recently replaced the Transport Workers Union) regarding the mechanics and related classifications employee group, whose contract is amendable December 15, 2002.
ITEM 6. Exhibits and Reports on Form 8-K
Exhibits
Reports on Form 8-K
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Signatures
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CERTIFICATIONS
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I, Bradley D. Tilden, certify that:
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