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ALASKA AIR GROUP, INC. filed this Form 10-K on 02/13/2014
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ALK 10-K 12/31/13
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-K
 
T
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
 
OR

£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from                      to                     
 
Commission File Number 1-8957
ALASKA AIR GROUP, INC.
Delaware
 
91-1292054
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
 
19300 International Boulevard, Seattle, Washington 98188

Telephone: (206) 392-5040
 
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $1.00 Par Value
New York Stock Exchange
 Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  T   No  £ 
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes £      No   T
 
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  T  No  £ 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes T No £

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  T
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act: 
Large accelerated filer   T  Accelerated filer  £     Non-accelerated filer   £  Smaller reporting company   £
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes £ No T
 
As of January 31, 2014, shares of common stock outstanding totaled 68,687,253. The aggregate market value of the shares of common stock of Alaska Air Group, Inc. held by nonaffiliates on June 30, 2013, was approximately $3.6 billion (based on the closing price of $51.70 per share on the New York Stock Exchange on that date). 

DOCUMENTS INCORPORATED BY REFERENCE
Portions of Definitive Proxy Statement relating to 2014 Annual Meeting of Shareholders are incorporated by reference in Part III.



ALASKA AIR GROUP, INC.
ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2013
 
TABLE OF CONTENTS
 
 
 
 
 
 

 
As used in this Form 10-K, the terms “Air Group,” the "Company," “our,” “we” and "us," refer to Alaska Air Group, Inc. and its subsidiaries, unless the context indicates otherwise. Alaska Airlines, Inc. and Horizon Air Industries, Inc. are referred to as “Alaska” and “Horizon,” respectively, and together as our “airlines.”
 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
In addition to historical information, this Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. You can generally identify forward-looking statements as statements containing the words “believe,” “expect,” “will,” “anticipate,” “intend,” “estimate,” “project,” “assume” or other similar expressions, although not all forward-looking statements contain these identifying words. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from historical experience or the Company’s present expectations.
 
You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control.

Our forward-looking statements are based on the information currently available to us and speak only as of the date on which this report was filed with the SEC. We expressly disclaim any obligation to issue any updates or revisions to our forward-looking statements, even if subsequent events cause our expectations to change regarding the matters discussed in those statements. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such differences might be significant and materially adverse to our shareholders. For a discussion of these and other risk factors in this Form 10-K, see “Item 1A: Risk Factors.” Please consider our forward-looking statements in light of those risks as you read this report.


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PART I
 
ITEM 1.  OUR BUSINESS

Alaska Air Group operates Alaska Airlines and Horizon Air, which together with its partner regional airlines, serve nearly 100 cities through an expansive network in Alaska, the Lower 48, Hawaii, Canada and Mexico. During 2013, we carried 27 million passengers while earning record full-year adjusted earnings of $383 million.

Our objective is to be one of the most respected U.S. airlines by our customers, employees, and shareholders. We believe our success depends on our ability to provide safe air transportation, develop relationships with customers by providing exceptional customer service and low fares, and maintain a competitive cost structure to compete effectively. Over the past decade, we have worked to transform our company to achieve these objectives. In 2013, Alaska Airlines ranked “Highest in Customer Satisfaction among Traditional Network Carriers” by J.D. Power and Associates for the sixth year in a row. We have been the leader in the industry for on-time performance among major airlines for the past four years. In 2013, we reported our tenth consecutive annual profit on an adjusted basis, and achieved an after-tax return on invested capital of 13.6%, surpassing our 10% goal for the fourth year in a row. Strong earnings improved our cash flow and strengthened our balance sheet resulting in (i) lower debt-to-capital ratio of 35%, (ii) cash and marketable securities balance of $1.3 billion, and (iii) fully-funded defined-benefit pension plans. This minimizes our financial risk and led Standard and Poor's to upgrade our credit rating to "BB+" in 2013. In addition, over the past decade, we have diversified our network to better respond to the seasonality in our business and provide more destinations for our customers. Since 2007, we have added 102 new routes to our network. As we look to the future, we will build on the success of the past few years by executing our strategic plan — the Five Focus Areas:

Safety and Compliance
We have an unwavering commitment to run a safe and compliant operation, and we will not compromise this commitment in the pursuit of other initiatives. Alaska and Horizon, in coordination with the FAA, began implementing a Safety Management System (SMS) to better identify and manage risk. Both airlines achieved Level 2 certification in 2013, and are currently moving forward to Level 3 certification. Our goal is to reach Level 4 certification for a fully-implemented and FAA-approved SMS by 2015. During the current year, 100% of our Alaska aircraft technicians completed the requirements for the FAA's "Diamond Certificate of Excellence" award for the 12th consecutive year and our Horizon aircraft technicians completed the requirements for the 12th time in the last 14 years.
  
People Focus
While aircraft and technology enable us to provide air transportation, we recognize this is fundamentally a people business and our success depends on our employees. Strengthening our "small company feel" will allow our employees to execute as a unified team on the frontlines and behind the scenes. Air Group employees have attended our Flight Path program, a one-day workshop to share the future vision for our company. In addition, all employees participate in the Performance-Based Pay (PBP) and Operational Performance Rewards (OPR) programs, which encourage employees to work together to achieve metrics related to safety, profitability, on-time performance, low costs and customer satisfaction. Over the last five years, our incentive programs have paid out over $430 million. This is consistent with one of our guiding principles that we want to pay our people well with a goal of reaching the industry’s best productivity over time. To that end, we signed three long-term agreements with various labor groups during the year and reached tentative five-year agreements with the Alaska flight attendants in December 2013 and with the clerical, office, and passenger service employees in February 2014. Additionally, we have voluntarily contributed $620 million to our pensions over the past five years, making us the only airline that has fully-funded defined-benefit pension plans.

Hassle-Free Customer Experience
We want to be the easiest airline to fly, which we will do by improving each step of the customer's journey from booking a ticket to our in-flight experience. During 2013, we upgraded our Android and iPhone applications to allow our customers to book tickets, shop for partner awards, sign up for the Mileage Plan, pay for bags, track flight details, check-in, get push notifications, utilize iPhone Passbook and Google Wallet, and view upgrade status and standby lists. We surpassed 1 million customer downloads of our apps during the year. We also increased the number of self-bag tagging locations to eight in 2013 (SEA, PDX, ANC, SAN, SAT, SLC, MCI, and MSP), which allows customers to print and attach their own luggage tags from a self-service kiosk in the airport lobby. We tested at home web bag-tagging for those traveling direct to our Hawaii destinations and are working closely with the TSA to offer this option more broadly in 2014. The Transportation Security Administration (TSA) Pre-Check Program is available in 27 of our locations, which allows eligible customers to opt-in for reduced screening

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requirements, and the Pre-Check notification is now visible on our boarding passes. As passengers take more control of their travel experience, we are able to reduce the time it takes a customer to move from the airport curb to the aircraft.

At Seattle-Tacoma International Airport (Sea-Tac), we started transforming the airport's North Satellite terminal into an upgraded, modernized facility that will become our airlines' primary terminal and will enhance the customer experience and support growth. The project will include design upgrades, enhanced traveler amenities, additional gates, and a new roof-top Boardroom. Together with the Sea-Tac Airport, we will break ground in 2014 on a project to install sloped walkways from the C-Concourse to ground-level boarding areas along with new covered walkways to the aircraft. In several years, Alaska will be the sole airline tenant of the North Satellite and Horizon will operate entirely from the C Concourse.

We continued to improve our in-flight experience with our cabin upgrade project, featuring the innovative and comfortable Recaro seats with both 110-volt and USB power outlets for every passenger, and an enhanced inflight entertainment system that allows customers to stream movies and television shows to any Wi-Fi enabled device. The first aircraft complete with seats with power debuted in December and we expect to finish the project for the majority of our 737's by the end of 2014. Also in 2013, we purchased nine new 737-900ER's with the Boeing Sky Interior, which includes variable ambient cabin lighting, larger window recesses, and overhead bins which provide more headroom all designed to offer a greater sense of space. In 2014, we expect to purchase ten new 737-900ER's with the Boeing Sky Interior.

Energetic and Compelling Brand
We are fortunate to have high brand awareness and customer loyalty in the Pacific Northwest and Alaska, our core markets. To maintain market share in core markets, while also growing in newer markets like California, Hawaii and cities in the mid-continental and eastern U.S., we believe we must better understand what is important to our customers, and position our brand appropriately to help differentiate us from the competition. In 2013, we aggressively optimized our marketing initiatives to help us to continue to raise awareness and consideration in new markets and increase advocacy in established ones. In pursuit of building an energetic and compelling brand, in 2014, we will be making a significant investment in our brand refresh initiative.

We continue to leverage our brand and technology to develop a direct relationship with more of our customers. In 2013, approximately 55% of our ticket sales were made through alaskaair.com, up a point from 2012. In addition to more traditional online advertising efforts, we continue to invest in our social media communities, such as Facebook and Twitter. We saw healthy increases in both of our primary social communities with Facebook growing by 45.9% and Twitter by 43.2%.
In 2013, we expanded our customer support team so that we can continue to provide customers with exceptional customer service throughout their journey.

Also in support of our brand, we position ourselves as the industry leader in community and environmental stewardship. In 2013, we were named the most fuel-efficient airline in the U.S. by the International Council on Clean Transportation, collected and recycled over 77% of waste collected during flights, and donated $7.6 million to more than 1,300 charitable organizations including support for the grand opening of Aviation High School in Seattle and other educational efforts. Our employees also volunteered more than 10,500 hours of community service.

Low Fares, Low Costs and Network Growth
In order to provide low fares to our customers while returning value to our shareholders, we believe we must maintain a competitive cost structure. In 2013, we lowered our unit costs, excluding fuel, by 0.1% on a consolidated basis, representing the 11th such annual reduction out of the past 12 years. We achieved this through a continued focus on productivity. In 2013, we increased employee productivity by 4.0% and will continue to focus on that metric as we leverage growth. We also continue to manage fuel costs by flying larger, more fuel-efficient aircraft, which have increased our fuel efficiency as measured by available seat miles flown per gallon by 3.7% over the last five years. Looking forward, we have committed to purchasing 32 737-900ER and 37 737-MAX aircraft, with deliveries in 2014 to 2022, to position us for growth and ensure we will continue to operate the quietest and most fuel-efficient aircraft available for the foreseeable future.

In 2013, we added 17 new markets to our network and exited two as we continued to better match supply with demand. We diversified our network further to offer more utility to our customers by expanding services out of Anchorage, Portland, San Diego, and Seattle, and began service to Salt Lake City, Omaha, Steamboat Springs, and Colorado Springs. We will also add new routes out of Salt Lake City to Boise, Los Angeles, Las Vegas, Portland, San Diego, San Jose, and San Francisco in 2014.


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AIR GROUP

Alaska Air Group is a Delaware corporation incorporated in 1985 and the holding company of Alaska Airlines and Horizon Air. Although Alaska and Horizon both operate as airlines, their business plans, competition, and economic risks differ substantially. Alaska Airlines is an Alaska corporation that was organized in 1932 and incorporated in 1937. Horizon Air Industries is a Washington corporation that first began service and was incorporated in 1981. Horizon was acquired by Air Group in 1986. Alaska operates a fleet of passenger jets (mainline) and contracts with Horizon, SkyWest Airlines, Inc. (SkyWest) and Peninsula Airways, Inc. (PenAir) for regional capacity under which Alaska receives all passenger revenue from those flights. Horizon operates a fleet of turboprop aircraft and sells all of its capacity to Alaska pursuant to a capacity purchase arrangement.

We attempt to deploy aircraft into the network in ways that best optimize our revenues and profitability, and reduce our seasonality.

The percentage of our capacity by market is as follows:
 
2013
 
2012
 
2011
 
2010
 
2009
West Coast
34
%
 
35
%
 
37
%
 
41
%
 
45
%
Alaska
16
%
 
17
%
 
18
%
 
19
%
 
20
%
Transcon/midcon
22
%
 
19
%
 
19
%
 
19
%
 
17
%
Hawaii
19
%
 
20
%
 
16
%
 
11
%
 
7
%
Mexico
7
%
 
7
%
 
9
%
 
8
%
 
8
%
Canada
2
%
 
2
%
 
1
%
 
2
%
 
3
%
Total
100
%
 
100
%
 
100
%
 
100
%
 
100
%

MAINLINE

We offer extensive north/south service within the western U.S., Canada and Mexico, and passenger and dedicated cargo services to and within the state of Alaska. We also provide long-haul east/west service to Hawaii and 20 cities in the mid-continental and eastern U.S., primarily from Seattle, where we have our largest concentration of departures; although we do offer long-haul departures from other cities as well.
 
In 2013, we carried 19.7 million revenue passengers in our mainline operations, and we carry more passengers between Alaska and the U.S. mainland than any other airline. Based on the number of passengers carried in 2013, Alaska’s leading airports are Seattle, Los Angeles, Anchorage, Portland, and San Diego. Based on 2013 revenues, the leading nonstop routes are Seattle-Anchorage, Seattle-Los Angeles, Seattle-San Diego, Seattle-Las Vegas, and Seattle-San Francisco. At December 31, 2013, Alaska’s operating fleet consisted of 131 Boeing 737 jet aircraft, compared to 124 B737 aircraft as of December 31, 2012.

The percentage of mainline passenger capacity by market and average stage length is presented below:
 
2013
 
2012
 
2011
 
2010
 
2009
West Coast
28
%
 
29
%
 
31
%
 
33
%
 
37
%
Within Alaska and between Alaska and the U.S. mainland
18
%
 
18
%
 
20
%
 
21
%
 
23
%
Transcon/midcon
25
%
 
22
%
 
21
%
 
24
%
 
23
%
Hawaii
21
%
 
22
%
 
18
%
 
13
%
 
8
%
Mexico
7
%
 
8
%
 
8
%
 
7
%
 
7
%
Canada
1
%
 
1
%
 
2
%
 
2
%
 
2
%
Total
100
%
 
100
%
 
100
%
 
100
%
 
100
%
 
 
 
 
 
 
 
 
 
 
Average Stage Length
1,177

 
1,161

 
1,114

 
1,085

 
1,034




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REGIONAL
 
Our regional operations consist of flights operated by Horizon, SkyWest and PenAir. In 2013, our regional operations carried approximately 7.7 million revenue passengers, primarily in the states of Washington, Oregon, Idaho and California. Horizon is the largest regional airline in the Pacific Northwest and represents over 90% of Air Group's regional revenue passengers.

Based on 2013 passenger enplanements on regional aircraft, our leading airports are Seattle and Portland. Based on revenues in 2013, our leading nonstop routes are Seattle-Portland, Seattle-Spokane, and Seattle-Boise. At December 31, 2013, Horizon’s operating fleet consisted of 51 Bombardier Q400 turboprop aircraft, compared to 48 Q400's at December 31, 2012. Horizon flights are listed under Alaska's designator code in airline reservation systems, and in all customer-facing locations.

The percentage of regional passenger capacity by market and average stage length is presented below:
 
2013
 
2012
 
2011
 
2010
 
2009
West Coast
66
%
 
68
%
 
68
%
 
71
%
 
71
%
Pacific Northwest
21
%
 
20
%
 
19
%
 
17
%
 
18
%
Canada
9
%
 
9
%
 
9
%
 
9
%
 
8
%
Within Alaska
2
%
 
2
%
 
2
%
 
2
%
 
2
%
Mexico
1
%
 
1
%
 
2
%
 
1
%
 
1
%
Midcon
1
%
 
%
 
%
 
%
 
%
Total
100
%
 
100
%
 
100
%
 
100
%
 
100
%
 
 
 
 
 
 
 
 
 
 
Average Stage Length
290

 
294

 
309

 
333

 
327


INDUSTRY CONDITIONS, COMPETITION, AND ALLIANCES
 
GENERAL

The airline industry is highly competitive, subject to various uncertainties, and has historically been characterized by low profit margins. Uncertainties include general economic conditions, volatile fuel prices, industry instability, new competition, a largely unionized work force, the need to finance large capital expenditures and the related availability of capital, government regulation, and potential aircraft incidents. Airlines have high fixed costs, primarily for wages, aircraft fuel, aircraft ownership, and facilities rents. Because expenses of a flight do not vary significantly based on the number of passengers carried, a relatively small change in the number of passengers or in pricing has a disproportionate effect on an airline’s operating and financial results. In other words, a minor shortfall in expected revenue levels could cause a disproportionately negative impact on our operating and financial results. Passenger demand and ticket prices are, to a large measure, influenced by the general state of the economy, current global economic and political events, and total available airline seat capacity.

In 2013, the airline industry is expected to report record revenues and profits with passengers topping 3 billion for the first time in history. As the industry recovers from the deficits accumulated in the past decade, airlines are now moving toward making significant investments in the customer experience to attract demand, and thus, the level of competition is expected to increase in the future years.

FUEL

Our business and financial results are highly affected by the price and, potentially, the availability of aircraft fuel. The cost of aircraft fuel is volatile and outside of our control, and it can have a significant and immediate impact on our operating results. Over the past five years, aircraft fuel expense ranged from 21% to 35% of operating expenses. Fuel prices are impacted by changes in both the price of crude oil and refining margins, and can vary by region in the U.S.
  
The price of crude oil has ranged from a low of $62 per barrel in 2009 to a high of $112 in 2011, and averaged $98 per barrel in 2013. For us, a $1 per barrel increase in the price of oil equates to approximately $11 million of additional fuel cost annually.  Said another way, a one-cent change in our fuel price per gallon will impact our expected annual fuel cost by approximately $4.5 million per year.


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Refining margins, which represent the price of refining crude oil into aircraft fuel, are a smaller portion of the overall price of jet fuel, but also contributed to the price volatility in recent years. Refining margin prices have fluctuated between $2 per barrel and $50 per barrel in the last five years.

Generally, West Coast aircraft fuel prices are somewhat higher and more volatile than prices in the Gulf Coast or on the East Coast, putting our mainline operation at a competitive disadvantage. Our average raw fuel cost per gallon decreased 4% in 2013, increased 2% in 2012, and increased 36% in 2011.

The percentage of our aircraft fuel expense by crude and refining margins, as well as the percentage of our aircraft fuel expense of operating expenses are as follows:
 
2013
 
2012
 
2011
 
2010
 
2009
Crude oil
71
%
 
65
%
 
70
%
 
79
%
 
82
%
Refining margins
19
%
 
25
%
 
24
%
 
14
%
 
13
%
Other(a)
10
%
 
10
%
 
6
%
 
7
%
 
5
%
Total
100
%
 
100
%
 
100
%
 
100
%
 
100
%
 
 
 
 
 
 
 
 
 
 
Aircraft fuel expense
34
%
 
35
%
 
34
%
 
27
%
 
21
%
(a) 
Other includes gains and losses on settled fuel hedges, unrealized mark-to-market fuel hedge gains or losses, taxes and other into-plane costs.

We use crude oil call options and jet fuel refining margin swap contracts as hedges to decrease our exposure to the volatility of jet fuel prices. Both call options and swaps effectively cap our pricing for the crude oil and refining margin components, limiting our exposure to increasing fuel prices for about half of our planned fuel consumption. With the call option contracts, we still benefit from the decline in crude oil prices, as there is no future cash exposure above the premiums we pay to enter into the contracts. The swap contracts do not require an upfront premium, but do expose us to future cash outlays in the event actual prices are below the swap price during the hedge period. During the second quarter of 2013, we changed the tenor of our hedging program. Since then, we have been hedging approximately 18 months in advance of consumption compared to 36 months historically. Additionally, we will reach our target of having 50% of consumption hedged 6 months in advance compared to 12 months historically.

We believe that operating fuel-efficient aircraft is the best hedge against high fuel prices. Alaska operates an all-Boeing 737 fleet and Horizon operates an all-Bombardier Q400 turboprop fleet. Air Group's fuel-efficiency rate expressed in available seat miles flown per gallon (ASMs/g) improved from 72.6 ASMs/g in 2009 to 75.3 ASMs/g in 2013. These improvements have not only reduced our fuel consumption rate, but also the amount of greenhouse gases and other pollutants that our operations emit.

COMPETITION

Competition in the airline industry is intense and unpredictable. Our competitors consist primarily of other airlines and, to a lesser extent, other forms of transportation. Competition can be direct, in the form of another carrier flying the exact non-stop route, or indirect, where a carrier serves the same two cities non-stop from an alternative airport in that city or via an itinerary requiring a connection at another airport. Our five principal competitors, in order of competitive overlap, are Delta, United, Southwest, American, and Hawaiian. Based on schedules filed with the U.S. Department of Transportation, we expect the amount of competitive overlap from these carriers to increase 9% in 2014. We also compete with several other domestic and international carriers, but to a lesser extent than our principal competitors.

We believe that the following principal competitive factors are important to our customers:
 
Safety record
 
Customer service and reputation

We compete with other airlines in areas of customer service such as on-time performance, passenger amenities - including first class seating, quality of buy-on-board products, aircraft type, and comfort. In 2013, Alaska Airlines ranked “Highest in Customer Satisfaction among Traditional Network Carriers” by J.D. Power and Associates for the sixth year in a row. All of our 2013 mainline aircraft deliveries included the Boeing Sky Interior and the innovative and comfortable Recaro seats. In 2014, we will continue to improve our in-flight experience with our cabin upgrade project featuring the Recaro seats with power outlets for every passenger flying our B737-800, -900, and -900ER

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aircraft. Additionally, FlightStats.com has named Alaska Airlines the No. 1 on-time major carrier in North America for each of the past three years, 2010-2012, and as of November 2013, we were the No. 1 on-time major carrier in North America for the past 12 months.

Fares and ancillary services

The pricing of fares is a significant competitive factor in the airline industry, and the increased availability of fare information on the Internet allows travelers to easily compare fares and identify competitor promotions and discounts. Pricing is driven by a variety of factors, including but not limited to, market-specific capacity, market share per route/geographic area, cost structure, fare vs. ancillary revenue strategies, and demand.

For example, airlines often discount fares to drive traffic in new markets or to stimulate traffic when necessary to improve load factors. In addition, legacy carriers have been able to reduce their operating costs through bankruptcies and mergers, while low-cost carriers have continued to grow their fleets and expand their networks, potentially enabling them to better control costs per available seat mile (the average cost to fly an aircraft seat (empty or full) one mile), which in turn may enable them to lower their fares. These factors can reduce our pricing power and that of the airline industry as a whole.

The domestic airline capacity is dominated by four large carriers, representing approximately 85% of total seats. Accordingly, if these carriers discount their fares or enter into our core markets, we must match those fares in order to maintain our load factors, often resulting in year-over-year decreases in our yields. We will defend our core markets vigorously, and if necessary redeploy capacity to better match supply with demand. We believe the restructuring we've made over the past decade has decreased our costs to the point we can offer low fares while still earning a pre-tax margin greater than 10%.

Routes served, flight schedules, codesharing and interline relationships, and frequent flyer programs

We also compete with other airlines based on markets served, the frequency of service to those markets, and frequent flyer opportunities. Some airlines have more extensive route structures than we do, and they offer significantly more international routes. In order to expand opportunities for our customers, we enter into codesharing and interline relationships with other airlines that provide reciprocal frequent flyer mileage credit and redemption privileges. These relationships allow us to offer our customers access to more destinations than we can on our own, gain exposure in markets we don't serve, and allow our customers more opportunities to earn and redeem frequent flyer miles. In December 2013, we announced that our Mileage Plan members will be able to earn elite qualifying miles on all of our international parters, providing them with even more utility from their membership. The Mileage Plan elite-level programs include bonus flight miles, complimentary upgrades, priority check-in and boarding, preferred seats, discounted airport lounge membership, fee waivers and access to exclusive events.

In addition to domestic or foreign airlines that we compete with on most of our routes, we also compete with ground transportation in our short-haul markets in the regional operations.  Both carriers, to some extent, also compete with technology such as video conferencing and internet-based meeting tools that have changed the need for, or frequency of face-to-face business meetings.

AGREEMENTS WITH OTHER AIRLINES

Our agreements fall into three different categories: Frequent Flyer, Codeshare, and Interline agreements. Frequent Flyer Agreements offer reciprocal frequent flyer mileage credit and redemption privileges for our customers. Alaska offers one of the most comprehensive frequent flyer programs for our Mileage Plan members through our frequent flyer partnerships with a number of domestic and international carriers.

Codeshare agreements allow one or more marketing carriers to sell seats on a single operating carrier that services passengers under multiple flight numbers. The sale of codeshare seats can vary depending on the sale arrangement. For example, in a free-sale arrangement, the marketing carrier sells the operating carrier's inventory without any restriction; whereas in a block space arrangement, fixed amount of seats are sold to the marketing carrier by the operating carrier. The interchangeability of the flight code between carriers provides a greater selection of flights for customers, along with increased flexibility for mileage accrual and redemption.

Interline agreements allow airlines to jointly offer a competitive, single-fare itinerary to customers traveling via multiple carriers to a final destination. An interline itinerary offered by one airline may not necessarily be offered by the other, and the

9


fare collected from passengers are prorated and distributed to interline partners according to preexisting agreements between the carriers. Frequent Flyer, Codeshare, and Interline agreements help increase our traffic and revenue by providing more route choices to customers.

We have marketing alliances with a number of airlines that provide frequent flyer and codesharing opportunities. Alliances are an important part of our strategy and enhance our revenues by:
 
offering our customers more travel destinations and better mileage credit/redemption opportunities, including elite qualifying miles on all of our major U.S. and international airline partners;

giving our Mileage Plan program a competitive advantage because of our partnership with carriers from two of the three major global alliances (Oneworld and Skyteam);
 
giving us access to more connecting traffic from other airlines; and
 
providing members of our alliance partners’ frequent flyer programs an opportunity to travel on Alaska and its regional affiliates while earning mileage credit in our partners’ programs.
 
Most of our codeshare relationships are free-sale codeshares, where the marketing carrier sells seats on the operating carrier’s flights from the operating carrier’s inventory, but takes no inventory risk. Our marketing agreements have various termination dates, and at any time, one or more may be in the process of renegotiation.

The comprehensive summary of alliances with other airlines are as follows:
 
Frequent
Flyer
Agreement
 
Codeshare —
Alaska Flight # on
Flights Operated by
Other Airline
 
Codeshare —
Other Airline Flight #
on Flights Operated by
Alaska / Horizon / SkyWest
Major U.S. or International Airlines
 
 
 
 
 
Aeromexico(a)
Yes
 
No
 
Yes
American Airlines/American Eagle
Yes
 
Yes
 
Yes
Air France
Yes
 
No
 
Yes
British Airways
Yes
 
No
 
No
Cathay Pacific Airways
Yes
 
No
 
Yes
Delta Air Lines(b)
Yes
 
Yes
 
Yes
Emirates
Yes
 
No
 
Yes
KLM
Yes
 
No
 
Yes
Korean Air
Yes
 
No
 
Yes
LAN S.A.
Yes
 
No
 
Yes
Fiji Airways(c)
Yes
 
No
 
Yes
Qantas
Yes
 
No
 
Yes
Regional Airlines
 
 
 
 
 
SkyWest(c)
Yes
 
Yes
 
No
Era Alaska
Yes
 
Yes
 
No
PenAir(c)
Yes
 
Yes
 
No
(a) 
Alaska and Aeromexico launched a new codeshare partnership in December 2012, and began reciprocal frequent flyer partnership in July 2013.
(b) 
Alaska has codeshare agreements with the Delta Connection carriers SkyWest, ExpressJet, Pinnacle, and Compass as part of its agreement with Delta.  
(c) 
These airlines do not have their own frequent flyer program. However, Alaska’s Mileage Plan members can earn and redeem miles on these airlines’ route systems.


10


The following is the financial impact of our marketing alliances:
 
2013
 
2012
 
2011
 
2010
 
2009
Air Group Marketed Revenues
90.0%
 
90.2%
 
89.3%
 
89.9%
 
89.3%
 
 
 
 
 
 
 
 
 
 
Codeshare Agreements:
 
 
 
 
 
 
 
 
 
Delta Air Lines
3.8%
 
3.4%
 
3.6%
 
3.7%
 
1.9%
American Airlines
2.6%
 
2.7%
 
3.4%
 
3.1%
 
3.4%
Others
0.9%
 
0.8%
 
0.8%
 
0.8%
 
2.3%
 
 
 
 
 
 
 
 
 
 
Interline Agreements:
 
 
 
 
 
 
 
 
 
Domestic Interline
1.9%
 
2.1%
 
2.2%
 
1.9%
 
2.5%
International Interline
0.8%
 
0.8%
 
0.7%
 
0.6%
 
0.6%
Total Operating Revenue
100.0%
 
100.0%
 
100.0%
 
100.0%
 
100.0%

TICKET DISTRIBUTION
 
Airline tickets are distributed through three primary channels:
 
Alaskaair.com: It is less expensive for us to sell through this direct channel and, as a result, we continue to take steps to drive more business to our website. In addition, we believe this channel is preferable from a branding and customer-relationship standpoint in that we can establish ongoing communication with the customer and tailor offers accordingly.
 
Traditional and online travel agencies: Both traditional and online travel agencies typically use Global Distribution Systems (GDS), such as Sabre, to obtain their fare and inventory data from airlines. Bookings made through these agencies result in a fee that is charged to the airline. Many of our large corporate customers require us to use these agencies. Some of our competitors do not use this distribution channel and, as a result, have lower ticket distribution costs.
 
Reservation call centers: These call centers are located in Phoenix, AZ, Kent, WA, and Boise, ID. We generally charge a $15 fee for booking reservations through these call centers.

Our sales by channel are as follows: 
 
2013
 
2012
 
2011
 
2010
 
2009
Alaskaair.com
55
%
 
54
%
 
51
%
 
48
%
 
45
%
Traditional agencies
27
%
 
27
%
 
28
%
 
28
%
 
32
%
Online travel agencies
13
%
 
13
%
 
13
%
 
15
%
 
11
%
Reservation call centers
5
%
 
6
%
 
8
%
 
9
%
 
12
%
Total
100
%
 
100
%
 
100
%
 
100
%
 
100
%

SEASONALITY AND OTHER FACTORS

Our results of operations for any interim period are not necessarily indicative of those for the entire year because our business is subject to seasonal fluctuations. Our profitability is generally lowest during the first and fourth quarters due principally to lower traffic. Profitability typically increases in the second quarter and then reaches its highest level during the third quarter as a result of vacation travel, including increased activity in the state of Alaska. However, we have taken steps over the past few years to better manage the seasonality of our operations by adding flights to leisure destinations, like Hawaii, and expanding to cities in the mid-continental and eastern U.S.

In addition to passenger loads, factors that could cause our quarterly operating results to vary include:  

general economic conditions and resulting changes in passenger demand,

•      changes in fuel costs,
 
pricing initiatives by us or our competitors,

11


 
the timing and amount of maintenance expenditures (both planned and unplanned), and
 
increases or decreases in passenger and volume-driven variable costs.
 
Many of the markets we serve experience inclement weather conditions in the winter, causing increased costs associated with deicing aircraft, canceling flights, and reaccommodating displaced passengers. Due to our geographic area of operations, we can be more susceptible to adverse weather conditions, particularly in the state of Alaska and the Pacific Northwest, than some of our competitors, who may be better able to spread weather-related risks over larger route systems.

No material part of our business or that of our subsidiaries is dependent upon a single customer, or upon a few high-volume customers.

EMPLOYEES

Our business is labor intensive. As of December 31, 2013, we employed 13,177 (10,201 at Alaska and 2,976 at Horizon) active full-time and part-time employees. Wages and benefits, including variable incentive pay, represented approximately 42% of our total non-fuel operating expenses in both 2013 and 2012.

Most major airlines, including ours, have employee groups that are covered by collective bargaining agreements. Airlines with unionized work forces have higher labor costs than carriers without unionized work forces, and they may not have the ability to adjust labor costs downward quickly enough to respond to new competition. At December 31, 2013, labor unions represented 83% of Alaska’s and 49% of Horizon’s employees. Our relations with our U.S. labor organizations are governed by the Railway Labor Act (RLA). Under this act, collective bargaining agreements do not expire but instead become amendable as of a stated date. If either party wishes to modify the terms of any such agreement, it must notify the other party in the manner prescribed by the RLA and/or described in the agreement. After receipt of such notice, the parties must meet for direct negotiations, and if no agreement is reached, either party may request the National Mediation Board (NMB) to initiate a process including mediation, arbitration, and a potential “cooling off” period that must be followed before either party may engage in self-help.

Alaska’s union contracts at December 31, 2013 were as follows:
Union
 
Employee Group
 
Number of Employees
 
Contract Status
Air Line Pilots Association International (ALPA)
 
Pilots
 
1,440

 
Amendable 03/31/2018
Association of Flight Attendants (AFA)
 
Flight attendants
 
3,132

 
Tentative agreement reached.
International Association of Machinists and Aerospace Workers (IAM)
 
Ramp service and stock clerks
 
598

 
Amendable 7/19/2018
IAM
 
Clerical, office and passenger service
 
2,508

 
Tentative agreement reached.
Aircraft Mechanics Fraternal Association (AMFA)
 
Mechanics, inspectors and cleaners
 
632

 
Amendable 10/17/2016
Mexico Workers Association of Air Transport
 
Mexico airport personnel
 
99

 
Amendable 9/29/2014
Transport Workers Union of America (TWU)
 
Dispatchers
 
41

 
Amendable 3/24/2015

12


Horizon’s union contracts at December 31, 2013 were as follows:
Union
 
Employee Group
 
Number of Employees
 
Contract Status
International Brotherhood of Teamsters (IBT)
 
Pilots
 
551

 
Amendable 12/14/2018
AFA
 
Flight attendants
 
545

 
Amendable 07/18/18
IBT
 
Mechanics and related classifications
 
274

 
Amendable 12/16/2014
TWU
 
Dispatchers
 
16

 
Amendable 8/26/2014
National Automobile, Aerospace, Transportation and General Workers
 
Station personnel in 
Vancouver and Victoria, BC, Canada
 
49

 
Amendable 2/14/2016
IAM
 
Maintenance Stores
 
33

 
In Negotiations

EXECUTIVE OFFICERS
 
The executive officers of Alaska Air Group, Inc. and executive officers of Alaska and Horizon who have significant decision-making responsibilities, their positions and their respective ages are as follows: 
Name
 
Position
 
Age
 
Air Group
or Subsidiary
Officer Since
Bradley Tilden
 
Chairman, President and Chief Executive Officer of Alaska Air Group, Inc. and Alaska Airlines, Inc. and Chief Executive Officer of Horizon Air Industries, Inc.
 
53
 
1994
 
 
 
 
 
 
 
Glenn Johnson
 
Executive Vice President of Alaska Air Group, Inc. and President of Horizon Air Industries, Inc.
 
55
 
1991
 
 
 
 
 
 
 
Keith Loveless
 
Executive Vice President, General Counsel and Corporate Secretary of Alaska Air Group, Inc. and Alaska Airlines, Inc.
 
57
 
1996
 
 
 
 
 
 
 
Benito Minicucci
 
Executive Vice President/Operations and Chief Operating Officer of Alaska Airlines, Inc.
 
47
 
2004
 
 
 
 
 
 
 
Brandon Pedersen
 
Vice President/Finance and Chief Financial Officer of Alaska Air Group, Inc. and Alaska Airlines, Inc.
 
47
 
2003
 
Mr. Tilden joined Alaska Airlines in 1991, became Controller of Alaska Air Group, Inc. and Alaska Airlines in 1994, Chief Financial Officer in February 2000, Executive Vice President/Finance and Chief Financial Officer in January 2002, Executive Vice President/Finance and Planning in 2007, and President of Alaska Airlines in December 2008. He is a member of Air Group’s Management Executive Committee and was elected to the Air Group Board in 2010. He was elected Chief Executive Officer of Alaska Air Group, Inc., Alaska Airlines and Horizon Air Industries in May 2012, and was elected Chairman of the Board in November 2013.
 
Mr. Johnson joined Alaska Airlines in 1982, became Vice President/Controller and Treasurer of Horizon Air Industries in 1991 and Vice President/Customer Services in 2002. He returned to Alaska Airlines in 2003 where he has served in several roles, including Vice President/Finance and Controller and Vice President/Finance and Treasurer. He served as Senior Vice President/Customer Service – Airports from January 2006 through April 2007 and in April 2007, he was elected Executive Vice President/Airports and Maintenance and Engineering. He was elected Executive Vice President/Finance and Chief Financial Officer of Alaska Air Group and Alaska Airlines in December 2008. He was elected President of Horizon Air Industries in June 2010. He was elected Executive Vice President Alaska Air Group in November 2012. He is a member of Air Group’s Management Executive Committee.
 
Mr. Loveless became Corporate Secretary and Assistant General Counsel of Alaska Air Group and Alaska Airlines in 1996. In 1999, he was named Vice President/Legal and Corporate Affairs, General Counsel and Corporate Secretary of Alaska Air

13


Group and Alaska Airlines. He was elected Executive Vice President Alaska Air Group in November 2012. He is a member of Air Group’s Management Executive Committee.

Mr. Minicucci joined Alaska Airlines in 2004 as Staff Vice President of Maintenance and Engineering and was promoted to Vice President of Seattle Operations in June 2008. He was elected Executive Vice President/Operations and Chief Operating Officer of Alaska Airlines in December 2008. He is a member of Air Group’s Management Executive Committee.

Mr. Pedersen joined Alaska Airlines in 2003 as Staff Vice President/Finance and Controller of Alaska Air Group and Alaska Airlines and was elected Vice President/Finance and Controller for both entities in 2006. He was elected Vice President/Finance and Chief Financial Officer of Alaska Air Group and Alaska Airlines in June 2010. He is a member of Air Group's Management Executive Committee.

REGULATION
 
GENERAL
 
The airline industry is highly regulated. The Department of Transportation (DOT), the Federal Aviation Administration (FAA) and the Transportation Security Administration (TSA) exercise significant regulatory authority over air carriers.
 
DOT: In order to provide passenger and cargo air transportation in the U.S., a domestic airline is required to hold a certificate of public convenience and necessity issued by the DOT. Subject to certain individual airport capacity, noise and other restrictions, this certificate permits an air carrier to operate between any two points in the U.S. Certificates do not expire, but may be revoked for failure to comply with federal aviation statutes, regulations, orders or the terms of the certificates. While airlines are permitted to establish their own fares without governmental regulation, the DOT has jurisdiction over the approval of international codeshare agreements, marketing alliance agreements between major domestic carriers, international and some domestic route authorities, Essential Air Service market subsidies, carrier liability for personal or property damage, and certain airport rates and charges disputes. International treaties may also contain restrictions or requirements for flying outside of the U.S. and impose different carrier liability limits than those applicable to domestic flights. The DOT has recently been active in implementing a variety of “passenger protection” regulations, covering subjects such as advertising, passenger communications, denied boarding compensation and tarmac delay response.

FAA: The FAA, through Federal Aviation Regulations (FARs), generally regulates all aspects of airline operations, including establishing personnel, maintenance and flight operation standards. Domestic airlines are required to hold a valid air carrier operating certificate issued by the FAA. Pursuant to these regulations we have established, and the FAA has approved, our operations specifications and a maintenance program for each type of aircraft we operate. The maintenance program provides for the ongoing maintenance of such aircraft, ranging from frequent routine inspections to major overhauls. From time to time the FAA issues airworthiness directives (ADs) that must be incorporated into our aircraft maintenance program and operations. All airlines are subject to enforcement actions that are brought by the FAA from time to time for alleged violations of FARs or ADs. At this time, we are not aware of any enforcement proceedings that could either materially affect our financial position or impact our authority to operate.

TSA: Airlines serving the U.S. must operate a TSA-approved Aircraft Operator Standard Security Program (AOSSP), and comply with TSA Security Directives (SDs) and regulations. Airlines are subject to enforcement actions that are brought by the TSA from time to time for alleged violations of the AOSSP, SDs or security regulations. We are not aware of any enforcement proceedings that could either materially affect our financial position or impact our authority to operate. Under TSA authority, we are also required to collect a September 11 Security Fee of $2.50 per enplanement from passengers and remit that sum to the government to fund aviation security measures. Carriers also pay the TSA a security infrastructure fee to cover passenger and property screening costs. These security infrastructure fees amounted to $13 million each year in 2013, 2012 and 2011. Starting July 1, 2014, the TSA security fee will increase to $5.60 per one-way trip. In addition, starting October 1, 2014, the security infrastructure fees will no longer be in effect.

The Department of Justice and DOT have jurisdiction over airline antitrust matters. The U.S. Postal Service has jurisdiction over certain aspects of the transportation of mail and related services. Labor relations in the air transportation industry are regulated under the Railway Labor Act. To the extent we continue to fly to foreign countries and pursue alliances with international carriers, we may be subject to certain regulations of foreign agencies and international treaties.


14


ENVIRONMENTAL AND OCCUPATIONAL SAFETY MATTERS
 
We are subject to various laws and government regulations concerning environmental matters and employee safety and health in the U.S. and other countries. U.S. federal laws that have a particular effect on us include the Airport Noise and Capacity Act of 1990, the Clean Air Act, the Resource Conservation and Recovery Act, the Clean Water Act, the Safe Drinking Water Act, and the Comprehensive Environmental Response, Compensation and Liability Act, Superfund Amendments and Reauthorization Act, and the Oil Pollution Control Act. We are also subject to the oversight of the Occupational Safety and Health Administration (OSHA) concerning employee safety and health matters. The U.S. Environmental Protection Agency, OSHA, and other federal agencies have been authorized to create and enforce regulations that have an impact on our operations. In addition to these federal activities, various states have been delegated certain authorities under these federal statutes. Many state and local governments have adopted environmental and employee safety and health laws and regulations. We maintain our safety, health and environmental programs in order to meet or exceed these requirements.

We expect there will be legislation in the future to reduce carbon and other greenhouse gas emissions. Alaska and Horizon have transitioned to more fuel-efficient aircraft fleets.

The Airport Noise and Capacity Act recognizes the rights of airport operators with noise problems to implement local noise abatement programs so long as they do not interfere unreasonably with interstate or foreign commerce or the national air transportation system. Authorities in several cities have established aircraft noise reduction programs, including the imposition of nighttime curfews. We believe we have sufficient scheduling flexibility to accommodate local noise restrictions.
 
Although we do not currently anticipate that these regulatory matters, individually or collectively, will have a material effect on our financial condition, results of operations or cash flows, new regulations or compliance issues that we do not currently anticipate could have the potential to harm our financial condition, results of operations or cash flows in future periods.

INSURANCE

We carry Airline Hull, Spares and Comprehensive Legal Liability Insurance in amounts and of the type generally consistent with industry practice to cover damage to aircraft, spare parts and spare engines, as well as bodily injury and property damage to passengers and third parties. Since the September 11, 2001 attacks, this insurance program excludes coverage for War and Allied Perils, including hijacking, terrorism, malicious acts, strikes, riots, civil commotion and other identified perils. So, like other airlines, the company has purchased war risk coverage for such events through the U.S. government.

We believe that our emphasis on safety and our state-of-the-art flight deck safety technology help to control the cost of aviation insurance.

WHERE YOU CAN FIND MORE INFORMATION
 
Our filings with the Securities and Exchange Commission, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available on our website at www.alaskaair.com, free of charge, as soon as reasonably practicable after the electronic filing of these reports with the Securities and Exchange Commission. The information contained on our website is not a part of this annual report on Form 10-K.
 
ITEM 1A. RISK FACTORS
 
If any of the following occurs, our business, financial condition and results of operations could suffer. In such case, the trading price of our common stock could also decline. We operate in a continually changing business environment.  In this environment, new risks may emerge and already identified risks may vary significantly in terms of impact and likelihood of occurrence. Management cannot predict such developments, nor can it assess the impact, if any, on our business of such new risk factors or of events described in any forward-looking statements.

We have adopted an enterprise wide Risk Analysis and Oversight Program designed to identify the various risks faced by the organization, assign responsibility for managing those risks to individual executives as well as align these risks with Board oversight. These enterprise-level identified risks have been aligned to the risk factors discussed below.


15


SAFETY, COMPLIANCE AND OPERATIONAL EXCELLENCE

Our reputation and financial results could be harmed in the event of an airline accident or incident.
 
An accident or incident involving one of our aircraft or an aircraft operated by one of our codeshare partners or CPA carriers could involve a significant loss of life and result in a loss of confidence in our airlines by the flying public and/or aviation authorities. We could experience significant claims from injured passengers, by-standers and surviving relatives, as well as costs for the repair or replacement of a damaged aircraft and its consequential temporary or permanent loss from service. We maintain liability insurance in amounts and of the type generally consistent with industry practice, as do our codeshare partners and CPA carriers. However, the amount of such coverage may not be adequate to fully cover all claims and we may be forced to bear substantial economic losses from an accident. Substantial claims resulting from an accident in excess of our related insurance coverage would harm our business and financial results. Moreover, any aircraft accident or incident, even if fully insured and even if it does not involve one of our aircraft, could cause a public perception that our airlines or the equipment they fly are less safe or reliable than other transportation alternatives, which would harm our business.

Changes in government regulation imposing additional requirements and restrictions on our operations or on the airports at which we operate could increase our operating costs and result in service delays and disruptions.
 
Airlines are subject to extensive regulatory and legal requirements, both domestically and internationally, that involve significant compliance costs. In the last several years, Congress has passed laws, and the U.S. DOT, the TSA and the FAA have issued regulations that have required significant expenditures relating to the maintenance and operation of airlines and establishment of consumer protections.

Similarly, there are a number of legislative and regulatory initiatives and reforms at the federal, state, and local level, including increasingly stringent laws protecting the environment, minimum wage requirements, and health care mandates that could affect our relationship with our workforce and cause our expenses to increase without an ability to pass through these costs.
 
Almost all commercial service airports are owned and/or operated by units of local or state governments. Airlines are largely dependent on these governmental entities to provide adequate airport facilities and capacity at an affordable cost. Many airports have increased their rates and charges to air carriers related to higher security costs, increased costs related to updated infrastructures, and other costs. Additional laws, regulations, taxes, and airport rates and charges have been proposed from time to time that could significantly increase the cost of airline operations or reduce the demand for air travel. Although lawmakers may impose these additional fees and view them as “pass-through” costs, we believe that a higher total ticket price will influence consumer purchase and travel decisions and may result in an overall decline in passenger traffic, which would harm our business.

The airline industry continues to face potential security concerns and related costs.

The terrorist attacks of September 11, 2001 and their aftermath negatively affected the airline industry, including our company. Additional terrorist attacks, the fear of such attacks or other hostilities involving the U.S. could have a further significant negative effect on the airline industry, including us, and could:
 
significantly reduce passenger traffic and yields as a result of a potentially dramatic drop in demand for air travel;
 
significantly increase security and insurance costs;
 
make war risk or other insurance unavailable or extremely expensive;
 
increase fuel costs and the volatility of fuel prices;
 
increase costs from airport shutdowns, flight cancellations and delays resulting from security breaches and perceived safety threats; and
 
result in a grounding of commercial air traffic by the FAA.
 
The occurrence of any of these events would harm our business, financial condition and results of operations.
 

16


We rely on third-party vendors for certain critical activities.
 
We have historically relied on outside vendors for a variety of services and functions critical to our business, including airframe and engine maintenance, ground handling, fueling, computer reservation system hosting, telecommunication systems, and information technology infrastructure and services. As part of our cost-reduction efforts, our reliance on outside vendors has increased and may continue to do so in the future, especially since we rely on timely and effective third-party performance in conjunction with many of our technology-related initiatives. In addition, in recent years, Alaska and Horizon have subcontracted their heavy aircraft maintenance, fleet service, facilities maintenance, and ground handling services at certain airports, including Seattle-Tacoma International Airport, to outside vendors.
 
Even though we strive to formalize agreements with these vendors that define expected service levels, our use of outside vendors increases our exposure to several risks. In the event that one or more vendors go into bankruptcy, ceases operation or fails to perform as promised, replacement services may not be readily available at competitive rates, or at all. If one of our vendors fails to perform adequately, we may experience increased costs, delays, maintenance issues, safety issues or negative public perception of our airline. Vendor bankruptcies, unionization, regulatory compliance issues or significant changes in the competitive marketplace among suppliers could adversely affect vendor services or force us to renegotiate existing agreements on less favorable terms. These events could result in disruptions in our operations or increases in our cost structure.

Our operations are often affected by factors beyond our control, including delays, cancellations, and other conditions, which could harm our business, financial condition and results of operations.

Like other airlines, our operations often are affected by delays, cancellations and other conditions caused by factors largely beyond our control.

Other conditions that might impact our operations include:
 
lack of a national airline policy;

lack of operational approval (e.g. new routes, aircraft deliveries, etc.) due to government shutdown;

air traffic congestion at airports or other air traffic control problems;
 
adverse weather conditions;
 
increased security measures or breaches in security;
 
international or domestic conflicts or terrorist activity; and

other changes in business conditions.

Due to our concentration of flights in the Pacific Northwest and Alaska, we believe a large portion of our operation is more susceptible to adverse weather conditions. A general reduction in airline passenger traffic as a result of any of the above-mentioned factors could harm our business, financial condition and results of operations.

STRATEGY

The airline industry is highly competitive and susceptible to price discounting and changes in capacity, which could have a material adverse effect on the Company. If we cannot successfully compete in the marketplace, our business, financial condition and operating results will be materially adversely affected.

The U.S. airline industry is characterized by substantial price competition. In recent years, the market share held by low-cost carriers has increased significantly and is expected to continue to increase. Airlines also compete for market share by increasing or decreasing their capacity, including route systems and the number of markets served. Several of our competitors have increased their capacity in markets we serve, particularly on the West Coast, therefore increasing competition for those destinations. This increased competition in both domestic and international markets may have a material adverse effect on the Company’s results of operations, financial condition or liquidity.

We continue to strive toward aggressive cost-reduction goals that are an important part of our business strategy of offering the best value to passengers through competitive fares while achieving acceptable profit margins and return on capital. If we are

17


unable to reduce our costs over the long-term and achieve sustained targeted return on invested capital, we will likely not be able to grow our business in the future or weather industry downturns and therefore our financial results may suffer.

The airline industry may undergo further restructuring, consolidation, or the creation or modification of alliances or joint ventures, any of which could have a material adverse effect on our business, financial condition and results of operations.

We continue to face strong competition from other carriers due to restructuring, consolidation, and the creation and modification of alliances and joint ventures. Since deregulation, both the U.S. and international airline industries have experienced consolidation through a number of mergers and acquisitions. Carriers may improve their competitive positions through airline alliances, slot swaps/acquisitions, and/or joint ventures. Certain airline joint ventures further competition by allowing airlines to coordinate routes, pool revenues and costs, and enjoy other mutual benefits, achieving many of the benefits of consolidation.

We depend on a few key markets to be successful.
 
Our strategy is to focus on serving a few key markets, including Seattle, Los Angeles, Anchorage, Portland, Hawaii and San Diego. A significant portion of our flights occur to and from our Seattle hub. In 2013, passengers to and from Seattle accounted for 61% of our total passengers.

We believe that concentrating our service offerings in this way allows us to maximize our investment in personnel, aircraft, and ground facilities, as well as to gain greater advantage from sales and marketing efforts in those regions. As a result, we remain highly dependent on our key markets. Our business could be harmed by any circumstances causing a reduction in demand for air transportation in our key markets. An increase in competition in our key markets could also cause us to reduce fares or take other competitive measures that could harm our business, financial condition and results of operations.

Economic uncertainty or another recession would likely impact demand for our product and could harm our financial condition and results of operations.
 
The airline industry, which is subject to relatively high fixed costs and highly variable and unpredictable demand, is particularly sensitive to changes in economic conditions. We are also highly dependent on U.S. consumer confidence and the health of the U.S. economy. Unfavorable U.S. economic conditions have historically driven changes in travel patterns and have resulted in reduced spending for both leisure and business travel. For some consumers, leisure travel is a discretionary expense, and shorthaul travelers, in particular, have the option to replace air travel with surface travel. Businesses are able to forego air travel by using communication alternatives such as videoconferencing and the Internet or may be more likely to purchase less expensive tickets to reduce costs, which can result in a decrease in average revenue per seat. Unfavorable economic conditions also hamper the ability of airlines to raise fares to counteract increased fuel, labor, and other costs. Unfavorable or even uncertain economic conditions could negatively affect our financial condition and results of operations.

We are dependent on a limited number of suppliers for aircraft and parts.
 
Alaska is dependent on Boeing as its sole supplier for aircraft and many aircraft parts. Horizon is similarly dependent on Bombardier. Additionally, each carrier is dependent on sole suppliers for aircraft engines. As a result, we are more vulnerable to any problems associated with the supply of those aircraft and parts, including design defects, mechanical problems, contractual performance by the manufacturers, or adverse perception by the public that would result in customer avoidance or in actions by the FAA resulting in an inability to operate our aircraft.

We rely on partner airlines for codeshare and frequent flyer marketing arrangements.
 
Alaska and Horizon are parties to marketing agreements with a number of domestic and international air carriers, or “partners," including, but not limited to, American Airlines and Delta Air Lines. These agreements provide that certain flight segments operated by us are held out as partner “codeshare” flights and that certain partner flights are held out for sale as Alaska codeshare flights. In addition, the agreements generally provide that members of Alaska’s Mileage Plan program can earn miles on or redeem miles for partner flights and vice versa. We receive revenue from flights sold under codeshare and from interline arrangements. In addition, we believe that the frequent flyer arrangements are an important part of our Mileage Plan program. The loss of a significant partner through bankruptcy, consolidation, or otherwise, could have a negative effect on our revenues or the attractiveness of our Mileage Plan, which we believe is a source of competitive advantage.


18


There is ongoing speculation that further airline consolidations or reorganizations could occur in the future. We routinely engage in analysis and discussions regarding our own strategic position, including alliances, codeshare arrangements, interline arrangements, frequent flyer program enhancements, and may have future discussions with other airlines regarding similar activities. If other airlines participate in consolidations or reorganizations, those airlines may significantly improve their cost structures or revenue generation capabilities, thereby potentially making them stronger competitors of ours and potentially impairing our ability to realize expected benefits from our own strategic relationships.

INFORMATION TECHNOLOGY

We rely heavily on automated systems to operate our business, and a failure to invest in new technology, or a disruption of our current systems or their operators could harm our business.
 
We depend on automated systems to operate our business, including our airline reservation system, our telecommunication systems, our website, our maintenance systems, our check-in kiosks, and other systems. Substantially all of our tickets are issued to passengers as electronic tickets and the majority of our customers check in using our website or our airport kiosks. We depend on our reservation system to be able to issue, track and accept these electronic tickets. In order for our operations to work efficiently, we must continue to invest in new technology to ensure that our website, reservation system, and check-in systems are able to accommodate a high volume of traffic, maintain secure information, and deliver important flight information. Substantial or repeated website, reservations system or telecommunication systems failures or service disruptions could reduce the attractiveness of our services and cause our customers to do business with another airline. In addition, we rely on other automated systems for crew scheduling, flight dispatch, and other operational needs. Disruptions, untimely recovery, or a breach of these systems could result in the loss of important data, an increase of our expenses, an impact on our operational performance, or a possible temporary cessation of our operations.

If we do not maintain the privacy and security of our information, we could damage our reputation and incur substantial legal and regulatory costs.

We accept, store, and transmit information about our customers, our employees, our business partners and our business.  In addition, we frequently rely on third-party hosting sites and data processors, including cloud providers. Our sensitive information relies on secure transmission over public and private networks.  A compromise of our systems, the security of our infrastructure, or those of other business partners that result in our information being accessed or stolen by unauthorized persons could adversely affect our operations and our reputation.

FINANCIAL CONDITION AND FINANCIAL MARKETS

Our business, financial condition, and results of operations are substantially exposed to the volatility of jet fuel prices. Increases in jet fuel costs would harm our business.
 
Fuel costs constitute a significant portion of our total operating expenses, accounting for 34%, 35% and 34% of total operating expenses for the years ended 2013, 2012 and 2011, respectively. Future increases in the price of jet fuel may harm our business, financial condition and results of operations, unless we are able to increase fares and fees, or add additional ancillary fees to attempt to recover increasing fuel costs.

Certain of the Company’s financing agreements have covenants that impose operating and financial restrictions on the Company and its subsidiaries.

Certain of our credit facilities and indentures governing our secured borrowings impose certain operating and financial covenants on us. Such covenants require us to maintain, depending on the particular agreement, minimum fixed charge coverage ratios, minimum liquidity and/or minimum collateral coverage ratios, and other negative covenants customary for such financings. A decline in the value of collateral could result in a situation where we may not be able to maintain the required collateral coverage ratio.

Our ability to comply with these covenants may be affected by events beyond our control, including the overall industry revenue environment and the level of fuel costs, and we may be required to seek waivers or amendments of covenants, repay all or a portion of the debt or find alternative sources of financing.


19


Our maintenance costs will increase as our fleet ages, and we will periodically incur substantial maintenance costs due to the maintenance schedules of our aircraft fleet.

As of December 31, 2013, the average age of our NextGen aircraft (B737-800, -900, -900ERs) was approximately 5.8 years, and the average age of our Q400 aircraft was approximately 7.1 years. Our relatively new aircraft require less maintenance now than they will in the future. Our fleet will require more maintenance as it ages. Additionally, during the current year we modified one of our power-by-the-hour agreements and terminated another agreement, meaning that we could be more susceptible to variances in our maintenance expense due to more expensive scheduled maintenance, foreign object damage, unplanned engine removal or other unplanned maintenance event. Any significant increase in maintenance expenses could have a material adverse effect on our results of operations.

BRAND AND REPUTATION

As we evolve our brand to appeal to a changing demographic and grow into new markets, we will engage in strategic initiatives that may not be favorably received by all customers .
 
We continue to focus on strategic initiatives designed to increase our brand appeal to a diverse and evolving demographic of airline travelers. These efforts could include significant improvements to our in-airport and on-board environments, increasing our direct customer relationships through improvements to our purchasing portals (digital and mobile), and optimization of our customer loyalty programs.

In pursuit of these efforts we may negatively affect our reputation with some of our existing customer base.
 
LABOR RELATIONS AND LABOR STRATEGY

A significant increase in labor costs, unsuccessful attempts to strengthen our relationships with union employees, or loss of
key personnel could adversely affect our business and results of operations.
  
Labor costs are a significant component of our total expenses, accounting for approximately 42%, 42% and 41% of our non-fuel operating expenses in 2013, 2012 and 2011, respectively. Each of our represented employee groups has a separate collective bargaining agreement, and could make demands that would increase our operating expenses and adversely affect our financial performance if we agree to them. The same result could apply if we experience a significant increase in vendor labor costs that ultimately flow-through to us.

As of December 31, 2013, labor unions represented approximately 83% of Alaska’s and 49% of Horizon’s employees. Although we have been successful in maturing communications, negotiating approaches, and other strategies to enhance workforce engagement in the Company's long-term vision, future uncertainty around open contracts could be a distraction, affecting employee focus in our business and diverting management’s attention from other projects and issues.

We compete against the major U.S. airlines and other businesses for labor in many highly skilled positions. If we are unable to hire, train and retain qualified employees at a reasonable cost, sustain employee engagement in the Company's strategic vision, or if we are unsuccessful at implementing succession plans for our key staff, we may be unable to grow or sustain our business. In such case, our operating results and business prospects could be harmed.

ITEM 1B.     UNRESOLVED STAFF COMMENTS
 
None


20


ITEM 2.      PROPERTIES
 
AIRCRAFT
 
The following table describes the aircraft we operate and their average age at December 31, 2013:
Aircraft Type
Seats
 
Owned
 
Leased
 
Total
 
Average
Age in
Years
B737 Freighters & Combis
0/72
 
6

 

 
6

 
20.2

B737-400/700
144/124
 
17

 
22

 
39

 
16.1

B737-800/900/900ER
157/172/181*
 
76

 
10

 
86

 
5.8

B737 Passenger Aircraft
 
 
93

 
32

 
125

 
9.0

Total Mainline Fleet
 
 
99

 
32

 
131

 
9.5

Q400
76
 
36

 
15

 
51

 
7.1

Total
 
 
135

 
47

 
182

 
8.8

* The number of seats for -800's and -900's indicate seats prior to the cabin upgrade project. For the -800's and -900's that have completed the cabin upgrade project with the Recaro seats, the number of seats will increase to 163 and 181, respectively.

“Management’s Discussion and Analysis of Financial Condition and Results of Operations" discusses future orders and options for additional aircraft.
 
Thirteen of our owned aircraft secure long-term debt arrangements or collateralize our revolving credit facility.  See further discussion in “Liquidity and Capital Resources."

Alaska’s leased B737 aircraft have lease expiration dates between 2014 and 2021. Horizon’s leased Q400 aircraft have expiration dates in 2018. Horizon also has 2 owned and 14 leased CRJ-700 aircraft, of which 13 are subleased to third-party carriers. The head leases on the 14 leased CRJ-700 aircraft have expiration dates between 2018 and 2020.  Alaska and Horizon have the option to extend most of the leases for additional periods, or the right to purchase the aircraft at the end of the lease term, usually at the then-fair-market value of the aircraft.

GROUND FACILITIES AND SERVICES
 
Alaska and Horizon lease ticket counters, gates, cargo and baggage space, ground equipment, office space, and other support areas at the majority of the airports they serve. Alaska also owns terminal buildings in various cities in the state of Alaska.
 
Alaska owns several buildings located at or near Seattle-Tacoma International Airport (Sea-Tac) near Seattle, WA. These include a multi-bay hangar and shops complex (used primarily for line maintenance), a flight operations and training center, an air cargo facility, an information technology office and datacenter, and various other commercial office buildings, including its Seattle corporate headquarters complex. Alaska also leases a stores warehouse and additional office space in Kent, WA for its call center functions. Alaska’s major facilities outside of Seattle include a regional headquarters building, an air cargo facility and a hangar/office facility in Anchorage, AK, as well as leased call center facilities in Phoenix, AZ and Boise, ID. Alaska uses its own employees for ground handling services at most of its airports in the state of Alaska. At other airports throughout its system, those services are contracted to various third-party vendors.
 
Horizon owns its Seattle corporate headquarters building. It leases operations, training, and aircraft maintenance facilities in Portland and Spokane, as well as line maintenance stations in Boise, Bellingham, Eugene, San Jose, Medford, Redmond, Seattle, and Spokane.

ITEM 3.         LEGAL PROCEEDINGS
 
We are a party to routine litigation matters incidental to our business. Management believes the ultimate disposition of these matters is not likely to materially affect our financial position or results of operations. This forward-looking statement is based on management’s current understanding of the relevant law and facts, and it is subject to various contingencies, including the potential costs and risks associated with litigation and the actions of judges and juries.


21


ITEM 4.       MINE SAFETY DISCLOSURES
 
Not applicable.


22


PART II
ITEM 5.    MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
 
As of December 31, 2013, there were 68,766,691 shares of common stock of Alaska Air Group, Inc. issued and 68,745,953 shares outstanding and 2,801 shareholders of record. In 2013, we initiated our first quarterly dividend since 1992, and paid $0.20 per share in August and December. Our common stock is listed on the New York Stock Exchange (symbol: ALK). The following table shows the trading range of Alaska Air Group, Inc. common stock on the New York Stock Exchange: 
 
2013
 
2012
 
High
 
Low
 
High
 
Low
First Quarter
$
63.96

 
$
43.94

 
$
39.77

 
$
33.69

Second Quarter
67.47

 
50.42

 
36.62

 
31.29

Third Quarter
64.21

 
51.65

 
38.46

 
32.69

Fourth Quarter
78.19

 
61.17

 
45.15

 
34.57


SALES OF NON-REGISTERED SECURITIES
 
None

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
 
 
Total Number of
Shares Purchased
 
Average Price
Paid per Share
 
Total Number of Shares (or units) Purchased as Part of Publicly Announced Plans or Programs
 
Maximum remaining
dollar value of shares
that can be purchased
under the plan (in millions)
October 1, 2013 – October 31, 2013
170,569

 
$
65.71

 
170,569

 
 
November 1, 2013 – November 30, 2013
161,876

 
74.94

 
161,876

 
 
December 1, 2013 – December 31, 2013
704,858

 
73.08

 
704,858

 
 
Total
1,037,303

 
$
71.24

 
1,037,303

 
$
83


Purchased pursuant to a $250 million repurchase plan authorized by the Board of Directors in September 2012. The plan has no expiration date, but is expected to be completed by December 2014.


23


PERFORMANCE GRAPH
 
The following graph compares our cumulative total stockholder return since December 31, 2008 with the S&P 500 Index and the Dow Jones U.S. Airlines Index. The graph assumes that the value of the investment in our common stock and each index (including reinvestment of dividends) was $100 on December 31, 2008.



24


ITEM 6. SELECTED FINANCIAL AND OPERATING DATA
 
 
 
 
 
 
 
 
 
 
 
2013
 
2012
 
2011
 
2010
 
2009
CONSOLIDATED OPERATING RESULTS (audited)
 
 
 
 
 
 
 
 
 
Year Ended December 31 (in millions, except per-share amounts):
 
 
 
 
 
 
 
 
 
Operating Revenues(a)
5,156

 
4,657

 
4,318

 
3,832

 
3,400

Operating Expenses
4,318

 
4,125

 
3,869

 
3,361

 
3,133

Operating Income
838

 
532

 
449

 
471

 
267

Nonoperating expense, net of interest capitalized(b)
(22
)
 
(18
)
 
(55
)
 
(65
)
 
(64
)
Income before income tax
816

 
514

 
394

 
406

 
203

Net Income
508

 
316

 
245

 
251

 
122

Average basic shares outstanding
69.955

 
70.708

 
71.755

 
71.644

 
71.630

Average diluted shares outstanding
70.939

 
71.784

 
73.421

 
73.571

 
72.308

Basic earnings per share
7.26

 
4.47

 
3.41

 
3.50

 
1.70

Diluted earnings per share
7.16

 
4.40

 
3.33

 
3.41

 
1.69

Cash dividend declared per share
$
0.40

 

 

 

 

CONSOLIDATED FINANCIAL POSITION (audited)
 

 
 

 
 

 
 

 
 

At End of Period (in millions):
 

 
 

 
 

 
 

 
 

Total assets
5,838

 
5,505

 
5,167

 
5,017

 
4,996

Long-term debt, including current portion
871

 
1,032

 
1,307

 
1,534

 
1,855

Shareholders' equity
2,029

 
1,421

 
1,174

 
1,106

 
872

OPERATING STATISTICS (unaudited)
 

 
 

 
 

 
 

 
 

Consolidated:(c)
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
27,414

 
25,896

 
24,790

 
23,334

 
22,320

Revenue passenger miles (RPM) (000,000) "traffic"
28,833

 
27,007

 
25,032

 
22,841

 
20,811

Available seat miles (ASM) (000,000) "capacity"
33,672

 
31,428

 
29,627

 
27,736

 
26,501

Load factor
85.6
%
 
85.9
%
 
84.5
%
 
82.4
%
 
78.5
%
Yield

14.80
¢
 

14.92
¢
 

14.81
¢
 

14.30
¢
 

14.16
¢
Passenger revenues per ASM (PRASM)

12.67
¢
 

12.82
¢
 

12.51
¢
 

11.78
¢
 

11.12
¢
Operating revenues per ASM (RASM)(d)

14.74
¢
 

14.82
¢
 

14.57
¢
 

13.82
¢
 

12.83
¢
Operating expenses per ASM, excluding fuel and noted items (CASMex)(d)

8.47
¢
 

8.48
¢
 

8.55
¢
 

8.82
¢
 

9.20
¢
Mainline:
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
19,737

 
18,526

 
17,810

 
16,514

 
15,561

RPMs (000,000) "traffic"
26,172

 
24,417

 
22,586

 
20,350

 
18,362

ASMs (000,000) "capacity"
30,411

 
28,180

 
26,517

 
24,434

 
23,144

Load factor
86.1
%
 
86.6
%
 
85.2
%
 
83.3
%
 
79.3
%
Yield

13.33
¢
 

13.45
¢
 

13.26
¢
 

12.75
¢
 

12.60
¢
PRASM

11.48
¢
 

11.65
¢
 

11.29
¢
 

10.62
¢
 

10.00
¢
CASMex(d)

7.54
¢
 

7.56
¢
 

7.60
¢
 

7.85
¢
 

8.26
¢
Regional:
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
7,677

 
7,371

 
6,980

 
6,820

 
6,759

RPMs (000,000) "traffic"
2,661

 
2,590

 
2,446

 
2,491

 
2,449

ASMs (000,000) "capacity"
3,261

 
3,247

 
3,110

 
3,302

 
3,357

Load factor
81.6
%
 
79.8
%
 
78.6
%
 
75.4
%
 
73.0
%
Yield

29.20
¢
 

28.81
¢
 

29.13
¢
 

26.95
¢
 

25.88
¢
PRASM

23.83
¢
 

22.98
¢
 

22.94
¢
 

20.33
¢
 

18.88
¢
(a) 
In the third quarter the Company adopted Accounting Standards Update 2009-13, "Multiple-Deliverable Revenue Arrangements - a consensus of the FASB Emerging Issues Task Force" (ASU 2009-13). Refer to Note 2 of the consolidated financial statements for further details.
(b) 
Includes capitalized interest of $21 million, $18 million, $12 million, $6 million, and $8 million for 2013, 2012, 2011, 2010, and 2009, respectively.
(c) 
Includes flights operated by SkyWest beginning in May 2011 and flights operated by PenAir under Capacity Purchase Agreements (CPA).
(d) 
See reconciliation of RASM and CASMex to the most directly related GAAP measure in the "Results of Operations" section.

25


ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
OVERVIEW
 
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand the Company, our operations and our present business environment. MD&A is provided as a supplement to – and should be read in conjunction with – our consolidated financial statements and the accompanying notes. All statements in the following discussion that are not statements of historical information or descriptions of current accounting policy are forward-looking statements. Please consider our forward-looking statements in light of the risks referred to in this report’s introductory cautionary note and the risks mentioned in Part I, “Item 1A. Risk Factors.” This overview summarizes the MD&A, which includes the following sections:
 
Year in Review—highlights from 2013 outlining some of the major events that happened during the year and how they affected our financial performance.
 
Results of Operations—an in-depth analysis of our revenues by segment and our expenses from a consolidated perspective for the three years presented in our consolidated financial statements. To the extent material to the understanding of segment profitability, we more fully describe the segment expenses per financial statement line item. We believe this analysis will help the reader better understand our consolidated statements of operations. Financial and statistical data is also included here. This section also includes forward-looking statements regarding our view of 2014
  
Liquidity and Capital Resources—an analysis of cash flows, sources and uses of cash, contractual obligations, commitments and off-balance sheet arrangements, and an overview of financial position.

Critical Accounting Estimates—a discussion of our accounting estimates that involve significant judgment and uncertainties.

YEAR IN REVIEW

Our 2013 consolidated pretax income was $816 million compared to $514 million in 2012. The $302 million improvement was primarily due to the $499 million increase in revenues, partially offset by the $8 million increase in aircraft fuel expense and $185 million increase in other operating expenses. Our improvement in revenues of $499 million was partially due to a one-time, non-cash Special mileage plan revenue item of $192 million related to the accounting for our recently modified affinity card agreement, where the accounting rules required us to revalue the deferred revenue associated with miles previously sold to our bank partner with a corresponding benefit to revenue. Additionally, passenger revenue increased $237 million due to a 6.8% increase in traffic, offset by 0.8% lower ticket yields. The increase in fuel cost was driven by the 5.9% increase in consumption offset by a 3.6% decrease in raw cost per gallon. The increase in other operating expenses was primarily due to increases in wages and incentive pay, aircraft maintenance, contracted services, and other operating expenses as we grew into new markets and increased spending in IT and other areas.

See “Results of Operations” below for further discussion of changes in revenues and operating expenses and our reconciliation of Non-GAAP measures to the most directly comparable GAAP measure.

Accomplishments and Highlights
 
Financial highlights from 2013 include:
Reported record adjusted earnings for 2013, marking our tenth consecutive year in which we reported an adjusted profit.
Air Group employees earned $105 million in incentive pay, or more than one-month's pay for most employees. Over the last four years, employees have earned more than $357 million in incentive pay, averaging 8.8% of annual pay for most employees.
Achieved return on invested capital of 13.6% in 2013, compared to 13% in 2012.
Lowered adjusted debt-to-total capitalization ratio to 35.0% as of December 31, 2013.
Fully funded the Company's defined-benefit pension plans in 2013.

26


Held $1.3 billion in unrestricted cash and marketable securities as of December 31, 2013.
Repurchased 2,492,093 shares of common stock for approximately $159 million in 2013. Since 2007, Air Group has used $478 million to repurchase 21 million shares.
Modified affinity card agreement with Bank of America and extended through 2017, estimated to generate $55 million in additional cash flows on an annual basis.
Received credit rating upgrade from Standard and Poor's to "BB+" with a stable outlook.

Other highlights and achievements from 2013 include:
Ranked "Highest in Customer Satisfaction Among Traditional Network Carriers" by J.D. Power and Associates for the sixth year in a row.
Ranked as the best major airline in the U.S. by The Wall Street Journal's "Middle Seat" scorecard.
Named Airline Industry Leader in the 2013 Temkin Customer Service Rankings.
Held the top spot in U.S. Department of Transportation on-time performance among major U.S. airlines for the twelve months ended November 2013.
Alaska Airlines received the FAA's "Diamond Certificate of Excellence" award for the 12th consecutive year; and Horizon Air received the certificate for the 12th time in the last 14 years.
Improved employee productivity in 2013 by 4% compared to 2012.
Signed five-year collective bargaining agreements with Alaska pilots and Horizon flight attendants.
Named most fuel-efficient airline in the U.S. in a report released by the International Council on Clean Transportation.
Donated $7.6 million to more than 1,300 charitable organizations, including support for the grand opening of Aviation High School in Seattle and other educational efforts. Our employees also volunteered more than 10,500 hours of community service.
Signed an exclusive multi-year partnership with Seattle Seahawks quarterback, Russell Wilson, and named him our "Chief Football Officer."

New Markets
In 2013, we added non-stop routes to our network as follows:
New Non-Stop Routes
Frequency
Start Date
San Diego to Boston
Daily
3/29/2013
Seattle to Salt Lake City
2x Daily
4/4/2013
San Diego to Lihue
Daily (Seasonal), 4x Weekly
6/7/2013
Portland to Fairbanks
Daily (Seasonal)
6/9/2013
Portland to Atlanta
Daily
8/26/2013
Portland to Dallas
Daily
9/16/2013
Seattle to Colorado Springs
Daily
11/1/2013
Portland to Tucson
Daily
11/1/2013
Portland to Boise
Daily
11/1/2013
San Diego to Boise
Daily
11/1/2013
Seattle to Omaha
Daily
11/7/2013
Portland to Reno
Daily
11/8/2013
Seattle to Steamboat Springs
2x Weekly (Seasonal)
12/18/2013
Anchorage to Phoenix
3x Weekly (Seasonal)
12/18/2013
Anchorage to Las Vegas
3x Weekly
12/19/2013
San Diego to Mammoth Lakes
Daily (Seasonal)
12/19/2013

27



We will also add new cities and non-stop routes in 2014 as follows:
New Non-Stop Routes
Frequency
Start Date
Portland to Salt Lake City
2x Daily
6/9/2014
Portland to Kalispell
Daily (Seasonal)
6/9/2014
San Diego to Salt Lake City
2x Daily
6/10/2014
Los Angeles to Salt Lake City
Daily
6/11/2014
San Jose to Salt Lake City
Daily
6/12/2014
Seattle to New Orleans
Daily
6/12/2014
Boise to Salt Lake City
Daily
6/16/2014
Las Vegas to Salt Lake City
2x Daily
6/16/2014
San Francisco to Salt Lake City
Daily
6/18/2014
Seattle to Detroit
Daily
6/20/2014
Seattle to Tampa
Daily
9/4/2014

Update on Labor Negotiations

In July 2013, Alaska Airlines' pilots and Horizon's flight attendants approved new, five-year contracts.

In December 2013, we reached a tentative five-year agreement with Alaska's flight attendants, represented by the Association of Flight Attendants (AFA), which if approved, will provide the Company and our employees the certainty that comes with a long-term deal. The results of voting are due February 14, 2014.

In February 2014, we reached a tentative five-year agreement with the International Association of Machinists and Aerospace Workers (IAM) on terms of a new contract for Alaska's clerical, operations, and passenger services employees, whose contract became amendable January 1, 2014. Horizon's maintenance store employees, represented by the IAM, continue to work towards their first contract.

Capital Allocation

In 2013, we repurchased 2,492,093 shares of our common stock for $159 million under the share repurchase program authorized by our Board of Directors. Since 2007, we have repurchased 21 million shares of common stock under such programs for $478 million for an average price of approximately $23 per share. Additionally, starting in the third quarter and for the first time since 1992, we paid quarterly dividends to our shareholders, totaling $28 million in 2013.

Outlook
 
Our primary focus every year is to run safe, compliant and reliable operations at our airlines.  In addition to our primary objective, we will remain focused on providing a hassle-free experience for our customers, and building a compelling brand to support network growth. Specifically, we will continue to improve our in-flight experience with our cabin upgrade project featuring the Recaro seats with power outlets for every passenger flying our B737-800, -900, and -900ER aircraft.

Our biggest concern going forward is increased competition in our markets, from both traditional and low-cost competitors. Specifically, Delta Air Lines is significantly increasing its international and domestic departures in Seattle. We plan to vigorously defend our markets through Mileage Plan promotions, schedule changes, community events, and similar responses. We also continue to focus on lowering unit costs in the long-term so that we can compete more effectively, and increasing fuel efficiency by replacing older 737-400 and 737-700 aircraft with larger 737-900ER aircraft.


28


In January 2014, our load factors were down 0.3 pts compared to January 2013. Our advance bookings suggest our load factors will be down 1 pt in February and 3 pts in March compared to the same periods in 2013. Our current expectations for capacity and operating costs per ASM are summarized below:
 
Forecast
Q1 2014
 
Change
Y-O-Y
 
Forecast
Full Year 2014
 
Change
Y-O-Y
Consolidated:
 
 
 
 
 
 
 
Capacity (ASMs in millions)
8,325 - 8,375
 
~ 4.5%
 
35,250 - 35,750
 
~ 5.5%
Cost per ASM excluding fuel and special items (cents)
9.00¢ - 9.05¢
 
~ 4.5%
 
8.52¢ - 8.57¢
 
~ 1.0%
 
 
 
 
 
 
 
 
Mainline:
 
 
 
 
 
 
 
Capacity (ASMs in millions)
7,475 - 7,525
 
~ 4.0%
 
31,750 - 32,250
 
~ 5.0%
Cost per ASM excluding fuel and special items (cents)
8.00¢ - 8.05¢
 
~ 6.0%
 
7.62¢ - 7.67¢
 
~ 1.5%

RESULTS OF OPERATIONS
 
2013 COMPARED WITH 2012

Our consolidated net income for 2013 was $508 million, or $7.16 per diluted share, compared to net income of $316 million, or $4.40 per diluted share, in 2012. Significant items impacting the comparability between the periods are as follows:

Both periods include adjustments to reflect the timing of net unrealized mark-to-market gains or losses related to our fuel hedge positions. For 2013, we recognized net mark-to-market gains of $8 million ($5 million after tax, or $0.06 per diluted share) compared to losses of $38 million ($23 million after tax, or $0.33 per share) in 2012.

In 2013, we recognized a one-time, non-cash Special mileage plan revenue item of $192 million ($120 million after tax, or $1.70 per diluted share) that resulted from the application of new accounting rules associated with the modified Bank of America Affinity Card Agreement, and the effect of an increase in the estimate of the number of frequent flier miles expected to expire unused.

ADJUSTED (NON-GAAP) RESULTS AND PER-SHARE AMOUNTS

We believe disclosure of earnings excluding the impact of mark-to-market gains or losses or other individual revenues or expenses is useful information to investors because:

We believe it is the basis by which we are evaluated by industry analysts;

By eliminating fuel expense and certain special items from our unit metrics, we believe that we have better visibility into the results of our non-fuel continuing operations. Our industry is highly competitive and is characterized by high fixed costs, so even a small reduction in non-fuel operating costs can result in a significant improvement in operating results. In addition, we believe that all domestic carriers are similarly impacted by changes in jet fuel costs over the long run, so it is important for management (and thus investors) to understand the impact of (and trends in) company-specific cost drivers such as labor rates and productivity, airport costs, maintenance costs, etc., which are more controllable by management;

Operating revenue per ASM (RASM) excludes a favorable, one-time, non-cash Special mileage plan revenue item of $192 million primarily related to our modified affinity card agreement with Bank of America, executed in July 2013. In accordance with accounting standards, we recorded this item in the the third quarter, and it reflects a non-cash adjustment of the value of miles outstanding in the program. We believe it is appropriate to exclude this special revenue item from recurring revenues from operations;

CASM excluding fuel and certain special items is one of the most important measures used by management and by the
Air Group Board of Directors in assessing quarterly and annual cost performance;

Our results excluding fuel expense and certain special items serve as the basis for our various employee incentive plans, thus the information allows investors to better understand the changes in variable incentive pay expense in our consolidated statements of operations; and

29



It is useful to monitor performance without these items as it improves a reader’s ability to compare our results to those of other airlines.

Although we are presenting these non-GAAP amounts for the reasons above, investors and other readers should not necessarily conclude that these amounts are non-recurring, infrequent, or unusual in nature.

Excluding the impact of mark-to-market fuel hedge adjustments, and the one-time Special mileage plan revenue item, our adjusted consolidated net income for 2013 was $383 million, or $5.40 per diluted share, compared to an adjusted consolidated net income of $339 million, or $4.73 per share, in 2012.
 
Years Ended December 31,
 
2013
 
2012
(in millions, except per-share amounts)
Dollars
 
Diluted EPS
 
Dollars
 
Diluted EPS
Net income and diluted EPS as reported
$
508

 
$
7.16

 
$
316

 
$
4.40

Mark-to-market fuel hedge adjustments, net of tax
(5
)
 
(0.06
)
 
23

 
0.33

Special mileage plan revenue
$
(120
)
 
$
(1.70
)
 
$

 
$

Non-GAAP adjusted income and per-share amounts
$
383

 
$
5.40

 
$
339

 
$
4.73


Revenues adjusted for the one-time Special mileage plan item is as follows:
 
Twelve Months Ended December 31,
 
2013
 
2012
 
% Change
Total operating revenues
$
5,156

 
$
4,657

 
10.7

Less: Special mileage plan revenue
192

 

 
NM

Adjusted Revenue
$
4,964

 
$
4,657

 
6.6

Consolidated ASMs
33,672

 
31,428

 
7.1

RASM

14.74
¢
 

14.82
¢
 
(0.5
)
NM - Not meaningful

Our operating costs per ASM (CASM) are summarized below:
 
Year Ended December 31,
 
2013
 
2012
 
% Change
Consolidated:
 
 
 
 
 
Total operating expenses per ASM (CASM)

12.82
¢
 

13.12
¢
 
(2.3
)
Less the following components:
 
 
 

 
 

Aircraft fuel, including hedging gains and losses
4.35

 
4.64

 
(6.3
)
CASM, excluding fuel and fleet transition costs

8.47
¢
 

8.48
¢
 
(0.1
)
 
 
 
 
 
 
Mainline:
 
 
 
 
 
Total mainline operating expenses per ASM (CASM)

11.77
¢
 

12.09
¢
 
(2.6
)
Less the following components:
 
 
 

 
 

Aircraft fuel, including hedging gains and losses
4.23

 
4.53

 
(6.6
)
CASM, excluding fuel

7.54
¢
 

7.56
¢
 
(0.3
)




30


OPERATING STATISTICS SUMMARY (unaudited)
Alaska Air Group, Inc.

Below are operating statistics we use to measure performance. We often refer to unit revenues and adjusted unit costs, which is a non-GAAP measure.
 
Twelve Months Ended December 31,
 
2013
 
2012
 
Change
 
2011
 
Change
Consolidated Operating Statistics:(a)
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
27,414

 
25,896

 
5.9
 %
 
24,790

 
4.5
 %
RPMs (000,000) "traffic"
28,833

 
27,007

 
6.8
 %
 
25,032

 
7.9
 %
ASMs (000,000) "capacity"
33,672

 
31,428

 
7.1
 %
 
29,627

 
6.1
 %
Load factor
85.6
%
 
85.9
%
 
(0.3
) pts
 
84.5
%
 
1.4
 pts
Yield

14.80
¢
 

14.92
¢
 
(0.8
)%
 

14.81
¢
 
0.7
 %
PRASM

12.67
¢
 

12.82
¢
 
(1.2
)%
 

12.51
¢
 
2.5
 %
RASM(b)

14.74
¢
 

14.82
¢
 
(0.5
)%
 

14.57
¢
 
1.7
 %
CASM excluding fuel and fleet transition costs(b)

8.47
¢
 

8.48
¢
 
(0.1
)%
 

8.55
¢
 
(0.8
)%
Economic fuel cost per gallon(b)
$
3.30

 
$
3.37

 
(2.1
)%
 
$
3.18

 
6.0
 %
Fuel gallons (000,000)
447

 
422

 
5.9
 %
 
398

 
6.0
 %
Average number of full-time equivalent employees
12,163

 
11,955

 
1.7
 %
 
11,840

 
1.0
 %
 
 
 
 
 
 
 
 
 
 
Mainline Operating Statistics:
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
19,737

 
18,526

 
6.5
 %
 
17,810

 
4.0
 %
RPMs (000,000) "traffic"
26,172

 
24,417

 
7.2
 %
 
22,586

 
8.1
 %
ASMs (000,000) "capacity"
30,411

 
28,180

 
7.9
 %
 
26,517

 
6.3
 %
Load factor
86.1
%
 
86.6
%
 
(0.5
) pts
 
85.2
%
 
1.4
 pts
Yield

13.33
¢
 

13.45
¢
 
(0.9
)%
 

13.26
¢
 
1.4
 %
PRASM

11.48
¢
 

11.65
¢
 
(1.5
)%
 

11.29
¢
 
3.2
 %
CASM excluding fuel(b)

7.54
¢
 

7.56
¢
 
(0.3
)%
 

7.60
¢
 
(0.5
)%
Economic fuel cost per gallon(b)
$
3.30

 
$
3.36

 
(1.8
)%
 
$
3.18

 
5.7
 %
Fuel gallons (000,000)
393

 
368

 
6.8
 %
 
346

 
6.4
 %
Average number of full-time equivalent employees
9,493

 
9,178

 
3.4
 %
 
8,916

 
2.9
 %
Aircraft utilization
10.6

 
10.7

 
(0.9
)%
 
10.5

 
1.9
 %
Average aircraft stage length
1,177

 
1,161

 
1.4
 %
 
1,114

 
4.2
 %
Mainline operating fleet at period-end
131
 a/c
 
124
 a/c
 
7
 a/c
 
117

 
7
 a/c
 
 
 
 
 
 
 
 
 
 
Regional Operating Statistics:(c)
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
7,677

 
7,371

 
4.2
 %
 
6,980

 
5.6
 %
RPMs (000,000) "traffic"
2,661

 
2,590

 
2.7
 %
 
2,446

 
5.9
 %
ASMs (000,000) "capacity"
3,261

 
3,247

 
0.4
 %
 
3,110

 
4.4
 %
Load factor
81.6
%
 
79.8
%
 
1.8
 pts
 
78.6
%
 
1.2
 pts
Yield

29.20
¢
 

28.81
¢
 
1.4
 %
 

29.13
¢
 
(1.1
)%
PRASM

23.83
¢
 

22.98
¢
 
3.7
 %
 

22.94
¢
 
0.2
 %
(a) 
Except for FTEs, data includes information related to regional CPA flying with Horizon, SkyWest and PenAir.
(b) 
See reconciliation of this measure to the most directly related GAAP measure in the "Results of Operations" section.
(c) 
Data presented includes information related to regional CPAs.


31


OPERATING REVENUES

Total operating revenues increased $499 million, or 11%, during 2013 compared to the same period in 2012. The changes are summarized in the following table:
 
Year Ended December 31,
(in millions)
2013
 
2012
 
% Change
Passenger
 
 
 
 
 
Mainline
$
3,490

 
$
3,284

 
6
Regional
777

 
746

 
4
Total passenger revenue
$
4,267

 
$
4,030

 
6
Freight and mail
113

 
111

 
2
Other - net
584

 
516

 
13
Special mileage plan revenue
192

 

 
Total operating revenues
$
5,156

 
$
4,657

 
11

Passenger Revenue – Mainline

Mainline passenger revenue for 2013 increased by 6% on a 7.9% increase in capacity and a 1.5% decrease in PRASM compared to 2012. The increase in capacity was driven by new routes added in 2013 and larger aircraft. The decrease in PRASM was driven by a 0.9% decrease in ticket yield and a 0.5 point decrease in load factor compared to the prior year. Increased competition in the state of Alaska and along the west coast put downward pressures on yield and load factor.

Due to increased competitive capacity in our markets we expect pressure on unit revenues, while we expect total passenger revenue to increase.

Passenger Revenue – Regional

Regional passenger revenue increased by $31 million, or 4%, compared to 2012 on a 0.4% increase in capacity and 3.7% increase in PRASM compared to 2012. The increase in PRASM was due to a 1.4% increase in ticket yield coupled with a 1.8 point increase in load factor compared to the prior year. The increase in regional revenues is due to better matching the right aircraft with the right market to avoid over-supply of capacity and maintaining yields and load factors.

Freight and Mail

Freight and mail revenue increased $2 million, or 2%, primarily due to increased freight volumes.

Other – Net

Other—net revenue increased $68 million, or 13%, from 2012. This is primarily due to an increase in our Mileage Plan revenues of $47 million or 22%, as a result of a higher rate per mile sold to Bank of America Corporation (BAC) under our new affinity card program and growth in the Mileage Plan program. Additionally, bag fees increased by 7.8%, and change fees increased by 7.3%, due to increases in the number of passengers. We expect increases in other revenue will outpace increases in passenger revenue on a percentage basis in 2014 as we continue to see the benefit from the new affinity card agreement and the increase in bag and change fees implemented in late 2013.

Special Mileage Plan Revenue

In the third quarter, we modified and extended our co-branded credit card agreement with BAC. In connection with this agreement and as a result of applying related accounting standards, we recorded a one-time, non-cash Special mileage plan revenue item of $192 million primarily related to our revaluation of the deferred revenue liability related to miles previously sold to BAC.


32


OPERATING EXPENSES

Total operating expenses increased $193 million, or 5%, compared to 2012, primarily driven by wages and variable incentive pay. Fuel expense remained flat due to decrease in fuel cost per gallon offset by an increase in fuel consumption. We believe it is useful to summarize operating expenses as follows, which is consistent with the way expenses are reported internally and evaluated by management:
 
Year Ended December 31,
(in millions)
2013
 
2012
 
% Change
Fuel expense
$
1,467

 
$
1,459

 
1
Non-fuel expenses
2,851

 
2,666

 
7
Total Operating Expenses
$
4,318

 
$
4,125

 
5

Significant operating expense variances from 2012 are more fully described below.

Wages and Benefits

Wages and benefits increased during 2013 by $48 million, or 5%, compared to 2012. The primary components of wages and benefits are shown in the following table:
 
Year Ended December 31,
(in millions)
2013
 
2012
 
% Change
Wages
$
791

 
$
745

 
6

Pension - Defined benefit plans
50

 
57

 
(12
)
Defined contribution plans
44

 
43

 
2

Medical and other benefits
142

 
135

 
5

Payroll taxes
59

 
58

 
2

Total wages and benefits
$
1,086

 
$
1,038

 
5


Wages increased 6%, primarily due to a newly ratified contract with Alaska's pilots that was effective April 1, 2013. Additionally, we hired 2% more FTEs to support increased flying and other strategic initiatives, such as IT and hassle-free projects.

Pension expense decreased 12%, compared to the same period in the prior year. The decline is due to having a lower accumulated loss to amortize as a result of higher plan assets and improved funded status compared to the prior year.

Medical benefits increased 5% from the prior year primarily due to an increase in employee health-care claims and an increase in the cost of health care services.

We expect wages and benefits to be higher in 2014 compared to 2013 on a 3% to 4% increase in FTEs, partially offset by reduced pension expense of approximately $40 million, as a result of having higher plan assets and a higher discount rate related to our benefit obligation.

Variable Incentive Pay

Variable incentive pay expense increased from $88 million in 2012 to $105 million in 2013. The increase is due to actual results exceeding our targets for financial and operational performance more so than in the prior year.

We expect variable incentive pay in 2014 to be similar to amounts recorded over the past three years.


33


Aircraft Fuel

Aircraft fuel expense includes both raw fuel expense (as defined below) plus the effect of mark-to-market adjustments to our fuel hedge portfolio included in our consolidated statement of operations as the value of that portfolio increases and decreases. Our aircraft fuel expense is very volatile, even between quarters, because it includes these gains or losses in the value of the underlying instrument as crude oil prices and refining margins increase or decrease. Raw fuel expense is defined as the price that we generally pay at the airport, or the “into-plane” price, including taxes and fees. Raw fuel prices are impacted by world oil prices and refining costs, which can vary by region in the U.S.  Raw fuel expense approximates cash paid to suppliers and does not reflect the effect of our fuel hedges.

Aircraft fuel expense increased $8 million, or 1% compared to 2012