ALASKA AIR GROUP, INC. OVERVIEW
The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand our 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 2020 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 most recent two 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. Financial and statistical data is also included here. This section also includes forward-looking statements regarding our view of 2021. •Liquidity and Capital Resources-an overview of our financial position, analysis of cash flows, sources and uses of cash, contractual obligations and commitments and off-balance sheet arrangements.
•Critical Accounting Estimates-a discussion of our accounting estimates that involve significant judgment and uncertainties.
This section of the Form 10-K covers discussion of 2020 and 2019 results, and comparisons between those years. Discussion of 2018 results and comparisons between 2019 and 2018 have been removed from this Form 10-K, and can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 .
YEAR IN REVIEW
COVID-19 impact and response
The public health and economic crises resulting from the outbreak of COVID-19 has had and continues to have an unprecedented impact on our business. The adverse impacts from the crises have been material to our business, operating results, and financial condition. The cancellation of large public events, suspension of business travel, closure of popular tourist destinations and implementation of stay-at-home orders throughout the country that began inMarch 2020 drove demand for air travel to historic lows. Passenger enplanements were lowest inApril 2020 , and experienced a slow and volatile recovery pattern through the end of the year. In response to the crises at hand, we took immediate action to reinforce the health and safety standards for our guests. Through our Next-Level Care initiative, we emphasized nearly 100 measures aimed at creating layers of safety aimed and a safe and healthy environment at all stages of travel. We also moved quickly to reduce flying and associated costs. Compared to the same quarters in the prior year, our flown capacity was down 75% in Q2, down 55% in Q3 and down 42% in Q4, resulting in full year capacity that was 44% below 2019 levels. By reducing flying, we were able to reduce variable costs, which we supplemented with efforts to minimize discretionary and non-essential spend. Our efforts included officer pay reductions, including 100% pay reductions for both the CEO and Alaska President, suspending or cancellation of pay increases for all employees, reducing management hours and offering voluntary leave programs. We also solicited early-outs and provided incentive leaves for certain workgroups, which reduced our need to furlough employees. In October, we did furlough approximately 400 flight attendants, the majority of whom have returned to work, and reduced management positions by approximately 300. As a result, our non-fuel operating expenses, excluding the Payroll Support Program grant wage offset and special items, declined 22% for the year. 32 --------------------------------------------------------------------------------
To further curb cash outflows, we suspended our cash dividend and share
repurchase program, and cut capital expenditures to
In addition to these efforts, we also sought to fortify our liquidity position. We accessed over$5 billion in new capital, including approximately$1.2 billion raised in the capital markets through the issuance of EETCs, approximately$600 million in bank financing, approximately$280 million from the sale of 10 Airbus aircraft, approximately$1.1 billion received under the CARES Act Payroll Support Program and approximately$1.9 billion made available under the CARES Act Loan Program. Remarkably, we ended the year with adjusted net debt of$1.7 billion , essentially flat to 2019 levels despite a decline in total operating revenues of$5.2 billion in 2020. We were able to keep this metric flat to prior year as a result of our immediate actions taken to reduce cash spend, through the reduction of operating expenses and discretionary spend. These actions, coupled with$753 million in Payroll Support Program grants enabled us to preserve our balance sheet strength, which was a significant achievement in such a challenging year. This strength positions us well to seize opportunities in the recovery expected ahead. 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.
Recovery and 2021 Outlook
The timing and rate of recovery remains difficult to predict. The slow and, at times, volatile return of demand that we experienced in 2020 is likely to continue into 2021. We are cautiously optimistic that there will be a step change in demand once the vaccine has been broadly distributed, and state and local authorities begin to relax restrictions. Leisure travel has led in the recovery thus far, and we believe it will continue to do so. Business travel has remained more severely depressed, and we believe it will be slower to recover in 2021. This is in part due to the expectation that businesses will be addressing duty of care concerns, plans for reopening corporate offices, and potential resizing corporate travel budgets. Our focus is on preparing our company and operation to rebuild capacity to levels that meet demand as it returns. We believe low-costs are critical to our success, and returning to pre-pandemic CASMex levels is a priority, even if we remain a smaller business for some time. In the first quarter of 2021, we expect to incur unit costs that are approximately 20% over 2019 levels, and expect sequential improvement in the quarters beyond with a goal of reaching 2019 unit costs as we move into 2022. Although there is still significant work to be done to achieve these goals, we believe that our employees are up to the challenge. Our outlook, and the guidance provided, will be directly impacted by health trends, the vaccine roll-out, and regulations and restrictions imposed by state, local and federal authorities. Our plans for 2021 will be responsive to emerging information from all of these areas, and the guidance we have provided above is subject to greater uncertainty than we have historically experienced. The work we have done in 2020 to keep our balance sheet strong provides a strong foundation for taking advantage of the recovery ahead, whatever course it may take. Our people are focused on keeping our costs low, running a great operation, and welcoming guests back to travel with Next-Level Care to ensure they are safe and comfortable when they fly. These competitive advantages we have cultivated over many years will continue to serve us well in 2021 and beyond, and we are confident that we are prepared to meet the challenges ahead and that we will emerge from the pandemic a stronger and more resilient airline.
RESULTS OF OPERATIONS
ADJUSTED (NON-GAAP) RESULTS AND PER-SHARE AMOUNTS
We believe disclosure of earnings excluding the impact of merger-related costs,
mark-to-market gains or losses or other individual special revenues or expenses
is useful information to investors because:
•By excluding fuel expense and certain special items (including the payroll
support program wage offset, impairment and restructuring charges and
merger-related costs) from our unit metrics, we believe that we have better
visibility into the results of operations as we focus on cost-reduction
initiatives emerging from the COVID-19 pandemic. 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
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--------------------------------------------------------------------------------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.
•Cost per ASM (CASM) excluding fuel and certain special items, such as the payroll support program wage offset, impairment and restructuring charges and merger-related costs, 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.
•Adjusted income before income tax and CASM excluding fuel (and other items as
specified in our plan documents) are important metrics for the employee
incentive plan, which covers the majority of
•CASM excluding fuel and certain special items is a measure commonly used by industry analysts and we believe it is an important metric by which they compare our airlines to others in the industry. The measure is also the subject of frequent questions from investors. •Disclosure of the individual impact of certain noted items provides investors the ability to measure and monitor performance both with and without these special items. We believe that disclosing the impact of certain items, such as merger-related costs and mark-to-market hedging adjustments, is important because it provides information on significant items that are not necessarily indicative of future performance. Industry analysts and investors consistently measure our performance without these items for better comparability between periods and among other airlines. •Although we disclose our passenger unit revenues, we do not (nor are we able to) evaluate unit revenues excluding the impact that changes in fuel costs have had on ticket prices. Fuel expense represents a large percentage of our total operating expenses. Fluctuations in fuel prices often drive changes in unit revenues in the mid-to-long term. Although we believe it is useful to evaluate non-fuel unit costs for the reasons noted above, we would caution readers of these financial statements not to place undue reliance on unit costs excluding fuel as a measure or predictor of future profitability because of the significant impact of fuel costs on our business.
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.
2020 COMPARED WITH 2019
Our consolidated net loss for 2020 was
Excluding the impact of the payroll support program grant wage offset, special items and mark-to-market fuel hedge adjustments, our adjusted consolidated net loss for 2020 was$1.3 billion , or$10.17 per diluted share, compared to an adjusted consolidated net income of$798 million , or$6.42 per share, in 2019. The following table reconciles our adjusted net income and earnings per diluted share (EPS) during the full year 2020 and 2019 to amounts as reported in accordance with GAAP.
Twelve Months Ended
2020 2019
(in millions, except per-share amounts) Dollars Diluted EPS Dollars Diluted EPS
Reported GAAP net income (loss) and diluted EPS $ (1,324)
(782) (6.33) - -
Mark-to-market fuel hedge adjustments (8) (0.06) (6) (0.05)
Special items - impairment charges and other 627 5.08 - -
Special items - restructuring charges 220 1.78 - -
Special items - merger-related costs 6 0.05 44 0.35
Special items - net non-operating 26 0.21 - -
Income tax effect on special items and fuel hedge
adjustments (21) (0.18) (9) (0.07)
Non-GAAP adjusted net income (loss) and diluted EPS $ (1,256) $ (10.17) $ 798 $ 6.42
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CASMex is reconciled to CASM below:
Twelve Months Ended
2020 2019 % Change
Consolidated:
Total CASM 14.39 ¢ 11.58 ¢ 24%
Less the following components:
Payroll support program grant wage offset (2.11) - NM
Aircraft fuel, including hedging gains and losses 1.95 2.82 (31)%
Special items - impairment charges and other 1.69 - NM
Special items - restructuring charges 0.59 - NM
Special items - merger-related costs 0.02 0.06 (67)%
CASM, excluding fuel and special items 12.25 ¢ 8.70 ¢ 41%
Mainline:
Total CASM 13.66 ¢ 10.73 ¢ 27%
Less the following components:
Payroll support program grant wage offset (2.17) - NM
Aircraft fuel, including hedging gains and losses 1.79 2.65 (32)%
Special items - impairment charges and other 1.80 - NM
Special items - restructuring charges 0.65 - NM
Special items - merger-related costs 0.02 0.08 (75)%
CASM, excluding fuel and special items 11.57 ¢ 8.00 ¢ 45%
35-------------------------------------------------------------------------------- OPERATING STATISTICS SUMMARY (unaudited)Alaska Air Group, Inc.
Below are operating statistics we use to measure performance.
Twelve Months Ended
2020 2019 Change 2018 Change
Consolidated Operating
Statistics:(a)
Revenue passengers (000) 17,927 46,733 (61.6)% 45,802 2.0%
RPMs (000,000) "traffic" 20,493 56,040 (63.4)% 54,673 2.5%
ASMs (000,000) "capacity" 37,114 66,654 (44.3)% 65,335 2.0%
Load factor 55.2% 84.1% (28.9) pts 83.7% 0.4 pts
Yield 14.73¢ 14.45¢ 1.9% 13.96¢ 3.5%
RASM 9.61¢ 13.17¢ (27.0)% 12.65¢ 4.2%
CASM excluding fuel and special
items(b) 12.25¢ 8.70¢ 40.8% 8.50¢ 2.3%
Economic fuel cost per gallon(b) $1.58 $2.19 (27.9)% $2.28 (3.9)%
Fuel gallons (000,000) 461 862 (46.5)% 839 2.7%
ASM's per gallon 80.5 77.3 4.1% 77.9 (0.8)%
Average number of full-time
equivalent employees (FTEs) 17,596 22,126 (20.5)% 21,641 2.2%
Employee productivity
(PAX/FTEs/months) 84.9 176.0 (51.8)% 176.4 (0.2)%
Mainline Operating Statistics:
Revenue passengers (000) 12,280 35,530 (65.4)% 35,603 (0.2)%
RPMs (000,000) "traffic" 17,438 50,413 (65.4)% 49,781 1.3%
ASMs (000,000) "capacity" 31,387 59,711 (47.4)% 59,187 0.9%
Load factor 55.6% 84.4% (28.8) pts 84.1% 0.3 pts
Yield 13.48¢ 13.39¢ 0.7% 13.01¢ 2.9%
RASM 9.01¢ 12.36¢ (27.1)% 11.93¢ 3.6%
CASM excluding fuel and special
items(b) 11.57¢ 8.00¢ 44.6% 7.73¢ 3.5%
Economic fuel cost per gallon(b) $1.59 $2.17 (26.7)% $2.27 (4.4)%
Fuel gallons (000,000) 358 731 (51.0)% 727 0.6%
ASM's per gallon 87.7 81.7 7.3% 81.4 0.4%
Average number of FTEs 13,214 16,642 (20.6)% 16,353 1.8%
Aircraft utilization 8.3 10.9 (23.9)% 11.2 (2.7)%
Average aircraft stage length 1,272 1,299 (2.1)% 1,298 0.1%
Mainline operating fleet at
period-end(d) 197 a/c 237 a/c (40) a/c 233 a/c 4 a/c
Regional Operating Statistics:(c)
Revenue passengers (000) 5,647 11,203 (49.6)% 10,199 9.8%
RPMs (000,000) "traffic" 3,055 5,627 (45.7)% 4,892 15.0%
ASMs (000,000) "capacity" 5,727 6,943 (17.5)% 6,148 12.9%
Load factor 53.3% 81.0% (27.7) pts 79.6% 1.4 pts
Yield 21.90¢ 23.90¢ (8.4)% 23.66¢ 1.0%
(a)Except for FTEs, data includes information related to third-party regional
capacity purchase flying arrangements.
(b)See reconciliation of this non-GAAP measure to the most directly related GAAP
measure in the accompanying pages.
(c)Data presented includes information related to flights operated by Horizon
and third-party carriers.
(d)Excludes 40 Airbus aircraft permanently parked during 2020.
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--------------------------------------------------------------------------------OPERATING REVENUES
Total operating revenues decreased
Twelve Months Ended December 31,
(in millions) 2020 2019 % Change
Passenger revenue $ 3,019 $ 8,095 (63) %
Mileage Plan other revenue 374 465 (20) %
Cargo and other 173 221 (22) %
Total operating revenues $ 3,566 $ 8,781 (59) %
Passenger Revenue
On a consolidated basis, passenger revenue for 2020 decreased by $5.1 billion ,
or 63%, on a 44% decrease in capacity, and a 29 point decrease in load factor.
Decreased revenue year-over-year is primarily due to the significant loss of
demand due to the COVID-19 pandemic. Beginning in March 2020 , load factors were
severely depressed, and in response we reduced our capacity, which remained well
below 2019 levels through the end of 2020. Although we saw modest recovery
during summer months and over the holiday periods, primarily led by leisure
travelers, resurgence of cases throughout the United States coupled with
restrictions imposed by state and local governments stalled further
improvements.
Mileage Plan other revenue
On a consolidated basis, Mileage Plan other revenue decreased$91 million , or 20%, as compared to 2019, largely due to a reduction in purchased miles and decreased commissions received from our affinity card partner, and an overall reduction in consumer spending.
Cargo and Other Revenue
On a consolidated basis, Cargo and other revenue decreased$48 million , or 22%, from 2019. The decrease is primarily driven by reduced belly cargo activity as a result of schedule reductions for passenger aircraft, as well as capacity limitations on our freighters that resulted from an issue with the barrier walls in the aircraft that was identified in 2020. The barrier walls will eventually be replaced, but the freighters can be operated at reduced capacity until the replacement occurs. These reductions were offset by new cargo routes announced inAlaska , as well as an increase in online shopping activity, leading to increased overall cargo volumes. We expect that our cargo revenues will increase in 2021 as compared to 2020, as all three freighters return to full capacity and as cargo capacity on passenger aircraft increases. OPERATING EXPENSES
Total operating expenses decreased
Twelve Months Ended December 31,
(in millions) 2020 2019 % Change
Fuel expense $ 723 $ 1,878 (62) %
Non-fuel expenses 4,547 5,796 (22) %
Payroll support program grant wage offset (782) - NM
Special items - merger-related costs 6 44 (86) %
Special items - impairment charges and other 627 - NM
Special items - restructuring charges 220 - NM
Total Operating Expenses $ 5,341 $ 7,718 (31) %
Significant operating expense variances from 2019 are more fully described below.
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--------------------------------------------------------------------------------Aircraft Fuel
Aircraft fuel expense includes both raw fuel expense (as defined below) and 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. Aircraft fuel expense can be 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 theU.S. Raw fuel expense approximates cash paid to suppliers and does not reflect the effect of our fuel hedges.
Aircraft fuel expense decreased
Twelve
Months Ended
2020 2019
(in millions, except for per gallon
amounts) Dollars Cost/Gal Dollars Cost/Gal
Raw or "into-plane" fuel cost $ 713 $ 1.54 $ 1,868 $ 2.17
(Gain)/loss on settled hedges 18 0.04 16 0.02
Consolidated economic fuel expense
$ 1,884 $ 2.19 Mark-to-market fuel hedge adjustments (8) (0.01) (6) (0.01) GAAP fuel expense$ 723 $ 1.57 $ 1,878 $ 2.18 Fuel gallons 461 862 Raw fuel expense per gallon decreased 29% due to lowerWest Coast jet fuel prices.West Coast jet fuel prices are impacted by both the price of crude oil, as well as the refining costs associated with the conversion of crude oil to jet fuel. The decrease in raw fuel price per gallon during 2020 was driven by a 26% decrease in crude oil prices and a 57% decrease in refining margins, as compared to the prior year. Fuel gallons consumed decreased by 401 million, or 47%, consistent with the decrease in capacity of 44%, and a 42% decrease in block hours. We also evaluate economic fuel expense, which we define as raw fuel expense adjusted for the cash we receive from hedge counterparties for hedges that settle during the period, and for the premium expense that we paid for those contracts. A key difference between aircraft fuel expense and economic fuel expense is the timing of gain or loss recognition on our hedge portfolio. When we refer to economic fuel expense, we include gains and losses only when they are realized for those contracts that were settled during the period based on their original contract terms. We believe this is the best measure of the effect that fuel prices have on our business because it most closely approximates the net cash outflow associated with purchasing fuel for our operations. Accordingly, many industry analysts evaluate our results using this measure, and it is the basis for most internal management reporting and incentive pay plans. Losses recognized for hedges that settled during the year were$18 million in 2020, compared to losses of$16 million in 2019. These amounts represent cash paid for premium expense, offset by any cash received from those hedges at settlement. As of the date of this filing, we expect our economic fuel price per gallon to decrease approximately 10% in the first quarter of 2021, as compared to the first quarter of 2020 for similar reasons as noted above. As both oil prices and refining margins are volatile, we are unable to forecast the full-year cost with any certainty. Wages and Benefits Wages and benefits decreased during 2020 by$317 million , or 13%, compared to 2019, excluding the impact of the Payroll support program grant wage offset. The primary components of wages and benefits are shown in the following table: 38 --------------------------------------------------------------------------------
Twelve Months Ended December 31,
(in millions) 2020 2019 % Change
Wages $ 1,490 $ 1,760 (15) %
Pension - Defined benefit plans 46 42 10 %
Defined contribution plans 126 132 (5) %
Medical and other benefits 288 311 (7) %
Payroll taxes 103 125 (18) %
Total wages and benefits $ 2,053 $ 2,370 (13) %
Wages and payroll taxes decreased by a combined $292 million on a 21% decrease
in FTEs. Decreased wages are primarily due to voluntary leaves of absence taken
by thousands of our employees throughout 2020, voluntary early-outs accepted by
600 employees, and a reduction in executive pay and hours for management
employees.
Medical and other benefits expense decreased $23 million , or 7%, partially due
to an overall reduction in FTEs, coupled with reduced usage of medical benefits
as compared to the prior year. Decreases were offset by increased medical rates
in 2020.
We expect wages and benefits expense to be higher in 2021 compared to 2020 given
our expected growth in overall FTEs needed to support our expected capacity
growth. Our guidance does not include the impacts of any future agreements we
may reach in 2021, most notably with our mainline pilots whose contract became
amendable in April 2020 .
Variable Incentive Pay
Variable incentive pay expense decreased to $130 million in 2020 from $163
million in 2019 on a decreased overall wage base coupled with reduced
achievement of stated goals as compared to the prior year. The decrease was
offset by achievement on a supplemental incentive pay plan approved in 2020, and
increased achievement from our quarterly operational bonus program as compared
to 2019.
Aircraft Maintenance
Aircraft maintenance costs decreased by $116 million compared to 2019, primarily
due to a significant reduction in engine events and heavy checks, as well as
reduced power-by-the-hour expense on reduced utilization of covered aircraft.
Lower maintenance costs and activity is offset by penalties recorded for failure
to meet certain contractual minimum obligations.
We expect aircraft maintenance expense to increase in 2021 as we return temporarily grounded aircraft to flying, which will result in increased heavy maintenance events and additional power-by-the-hour expense on covered aircraft.
Aircraft Rent
Aircraft rent expense decreased
We expect aircraft rent to be lower in 2021 given the permanent parking and impairment of 40 leased Airbus aircraft in 2020.
Landing Fees and Other Rentals
Landing fees and other rental expenses decreased
We expect landing fees and other rental expense to increase in 2021 as we bring
capacity back to our network. We also expect rate increases at many airports we
serve, specifically our hubs, as significant capital programs are underway and
will be included in our lease rates.
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--------------------------------------------------------------------------------Selling Expenses
Selling expenses decreased by$212 million , or 68%, compared to 2019 primarily driven by a significant reduction in distribution costs and credit card commissions due to lower sales. Reduced marketing spend and sponsorship costs due to the renegotiation of certain agreements with partners also contributed to the year-over-year decline.
We expect selling expense to increase in 2021, due primarily to higher sales as demand for air travel returns.
Depreciation and Amortization
Depreciation and amortization expenses decreased slightly as compared to 2019 due to the impairment in the first quarter of 2020 of our owned Q400 fleet, as well as the write-off of certain leasehold improvements.
We expect depreciation and amortization expense to increase in 2021, primarily due to depreciation taken on the 737 MAX aircraft scheduled for delivery in 2021.
Third-party Regional Carrier Expense
Third-party regional carrier expense, which represents payments made to SkyWest and PenAir under our CPA agreements, decreased$38 million , or 23%, in 2020 compared to 2019. The decrease is primarily due to a 23% decrease in capacity flown by SkyWest as compared to the prior year and reduced contractual rates incurred for a portion of 2020.
We expect third-party regional carrier expense to be higher in 2021 as regional capacity has largely rebounded to where it was prior to the pandemic.
Special Items - Impairment charges and other
We recorded impairment and other charges of$627 million in 2020. The charges were largely driven by our decision to permanently remove certain leased Airbus aircraft from operating service. For these aircraft, any remaining operating lease assets and related leasehold improvements, spare inventory and parts were expensed. Additionally, for these aircraft we recorded an accrual for total estimated lease return costs. Charges also include the write-down of the ten owned Airbus A320 aircraft and our Q400 fleet to their respective fair value, an accrued loss on a class action lawsuit judgment received subsequent toDecember 31, 2020 , and the full write-off of gate assets atDallas-Love Field , plus certain other immaterial items.
Special Items - Restructuring charges
We recorded restructuring charges of$220 million in 2020 relating to the reduction of our workforce through voluntary early retirement and temporary leaves, incentive leave programs, involuntary furloughs and reductions in force. Charges are primarily comprised of wages for those pilots and mechanics on incentive leave programs, ongoing medical benefit coverage, and lump-sum termination payments. The total charge for the program was revised in the fourth quarter to capture pilot recalls anticipated in 2021 as a result of increased capacity expectations in our network and a change in the mix of aircraft type. Additional changes to this charge could be necessary in the future if the pilot recall schedule changes again.
Special Items - Merger-Related Costs
We recorded$6 million of merger-related costs in 2020 associated with our ongoing integration of formerVirgin America operations compared to$44 million in 2019. Costs incurred in 2020 are primarily comprised of certain technology integration costs. We do not expect to incur integration related charges in 2021.
Consolidated Non-operating Income (Expense)
During 2020, we recorded net non-operating expense, excluding special items, of$39 million , compared to$47 million in 2019. The decrease is primarily due to an increase in income generated by additional cash and marketable securities on hand and reduced expense from our defined-benefit pension plan. Improved non-operating expense was offset by increased interest expense on an increased outstanding debt balance. We recorded special items in non-operating expense of$26 million in 2020 for pre-payment penalties and swap-break charges related to the early repayment of debt that was previously collateralized by the A320 aircraft which we sold in 2020. 40 --------------------------------------------------------------------------------
ADDITIONAL SEGMENT INFORMATION
Refer to Note 14 of the consolidated financial statements for a detailed description of each segment. Below is a summary of each segment's profitability.
Mainline
Mainline pretax loss was$1.4 billion in 2020 compared to pretax income of$993 million in 2019. The$2.4 billion shift to pretax loss was driven by a$4.6 billion decrease in Mainline operating revenue, offset by a$1.1 billion decrease in Mainline non-fuel operating expense and a$1 billion decrease in Mainline fuel expense. As compared to the prior year, lower Mainline revenues are primarily attributable to a 65% decrease in traffic on a 47% reduction in capacity, driven by the significant reduction in demand as a result of the COVID-19 pandemic. Non-fuel operating expenses declined significantly on cost savings driven by reduced variable costs on lower capacity, as well as decreased wages and benefits expense from voluntary leaves of absence and a reduction in hours for management employees. Lower raw fuel prices, coupled with decreased consumption from the reduction in flying, drove the decrease in Mainline fuel expense. Regional Our Regional operations generated a pretax loss of$421 million in 2020 compared to a pretax profit of$2 million in 2019. The shift to pretax loss was primarily attributable to a$660 million decrease in operating revenues, partially offset by a$104 million decrease in non-fuel operating expense and a$133 million decrease in fuel costs. Decreased regional revenues is primarily the result of a 50% decrease in revenue passengers on an 18% decrease in capacity flown, stemming from the impacts of the COVID-19 pandemic.
Horizon
Horizon achieved a pretax profit of$41 million in 2020 compared to$38 million in 2019, primarily as a result of significant cost reduction efforts implemented in response to the COVID-19 pandemic. As Horizon records revenue based on total capacity sold toAlaska under the terms of the CPA, revenue was impacted to a lesser degree by the overall reduction in demand spurred by the pandemic.
LIQUIDITY AND CAPITAL RESOURCES
As a result of the COVID-19 pandemic, we have taken, and will continue to take, action to reduce costs, increase liquidity and preserve the relative strength of our balance sheet. From the onset of the pandemic, we have taken the following key actions to enhance and preserve our liquidity: •Obtained approximately$1.6 billion in Payroll Support Program funding to use towards payments of wages and benefits, including the extension finalized inJanuary 2021 ; •Executed an agreement with theU.S. Department of the Treasury to obtain up to$1.9 billion through the CARES Act loan program. The collateral pool for the agreement includes certain Mileage PlanTM assets and cash flow streams, 34 aircraft and 15 spare engines;
•Obtained
•Reached an agreement in principle to restructure our aircraft purchase agreement with Boeing, allowing for greater flexibility and lower cash outflows in 2021;
•Drew
•Suspended our share repurchase program and quarterly dividend indefinitely.
41
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Although we have no plans to access equity markets, we believe our equity would
be of high interest to investors. The liquidity raised from these financings,
coupled with the availability of additional liquidity and our meaningful cost
reductions have provided the Company with confidence in our ability to withstand
the depressed demand and prepare for recovery. Because of our successful efforts
to reduce spending and preserve cash, our adjusted net debt is nearly flat as
compared to December 31, 2019 .
As the business recovers and eventually returns to profitability, reducing
outstanding debt and strengthening our balance sheet will be a high priority.
Based on our expectations about the recovery ahead, we expect to incur cash flow
from operations of $100 million to zero in the first quarter including funds
received as part of the CARES Act Payroll Support Program. For the first half of
the year we expect cash flows from operations to be positive.
We believe that our current cash and marketable securities balance, combined
with available sources of liquidity, will be sufficient to fund our operations
and meet our debt payment obligations, and to remain in compliance with the
financial debt covenants in existing financing arrangements for the foreseeable
future.
In our cash and marketable securities portfolio, we invest only in securities
that meet our primary investment strategy of maintaining and securing investment
principal. The portfolio is managed by reputable firms that adhere to our
investment policy that sets forth investment objectives, approved and prohibited
investments, and duration and credit quality guidelines. Our policy, and the
portfolio managers, are continually reviewed to ensure that the investments are
aligned with our strategy.
The table below presents the major indicators of financial condition and liquidity: (in millions)
December 31, 2020 December 31, 2019 Change
Cash and marketable securities $3,346 $1,521 $1,825
Cash, marketable securities, and unused lines of
credit as a percentage of trailing twelve months
revenue 94% 22% 72 pts
Long-term debt, net of current portion $2,357 $1,264 $1,093
Shareholders' equity $2,988 $4,331 $(1,343) Debt-to-capitalization, adjusted for operating leases
December 31, December 31,
(in millions) 2020 2019 Change
Long-term debt, net of current portion $ 2,357 $ 1,264 86%
Capitalized operating leases 1,558 1,708 (9)%
COVID-19 related borrowings(a) 734 - NM
Adjusted debt $ 4,649 $ 2,972
Shareholders' equity 2,988 4,331 (31)%
Total invested capital 7,637 7,303 5%
Debt-to-capitalization, including operating leases 61% 41%
(a) To best reflect our leverage at
42
--------------------------------------------------------------------------------Adjusted net debt to earnings before interest, taxes, depreciation, amortization, special items and rent (in millions)
December 31, 2020 December 31, 2019
Current portion of long-term debt $ 1,138 $ 235
Current portion of operating lease
liabilities 290 269
Long-term debt 2,357 1,264
Long-term operating lease liabilities, net
of current portion 1,268 1,439
Total adjusted debt 5,053 3,207
Less: Cash and marketable securities (3,346) (1,521)
Adjusted net debt $ 1,707 $ 1,686
(in millions) Year-ended December 31, 2020 Year-ended December 31, 2019
GAAP Operating Income (Loss) $ (1,775) $ 1,063
Adjusted for:
Payroll support program grant wage offset
and special items 71 44
Mark-to-market fuel hedge adjustments (8) (6)
Depreciation and amortization 420 423
Aircraft rent 299 331
EBITDAR $ (993) $ 1,855
Adjusted net debt to EBITDAR (1.7x) 0.9x
The following discussion summarizes the primary drivers of the increase in our cash and marketable securities balance and our expectation of future cash requirements.
ANALYSIS OF OUR CASH FLOWS
Cash Used in Operating Activities
Net cash used in operating activities was$234 million in 2020 compared to net cash provided of$1.7 billion in 2019. Cash provided by ticket sales is the primary source of our operating cash flow. Our primary use of operating cash flow is operating expenses. Changes in demand that resulted from the pandemic and the changes we made to our operations in response had a dramatic impact on our operating cash flows in 2020 . In 2020, revenues declined$5.2 billion versus prior year. Through reduced flying levels and removal of fixed costs, we reduced operating expenses by$2.4 billion versus prior year, which reflects the benefit of the$753 million cash grant we received under the Payroll Support Program. 2020 operating expenses included$627 million in special items that were largely non-cash during the period. This included impairment of property, plant and equipment, for which the cash outflow occurred in the past, and accruals that are associated with future cash out flows, such as the expected costs of lease returns and the impairment of leased aircraft. In 2020, Air Traffic Liability (ATL) increased$173 million , which included approximately$1.3 billion in new ticket purchases, offset by approximately$500 million in tickets that existed in ATL at the end of 2019 which flew and were recognized in revenue in 2020, and approximately$600 million in cash refunds issued to guests. Although Air Traffic Liability was a source of working capital in 2020, as ofDecember 31, 2020 it includes$569 million in eWallet credits that were issued to guests as a result of trip cancellations. These credits are expected to be redeemed by guests for travel in future periods and will represent a working capital headwind. 43 -------------------------------------------------------------------------------- Also in 2020, we recognized a$516 million tax benefit associated with the net operating losses that were incurred during the period, which will be carried back to prior tax years or used in future tax years. These benefits are expected to result in operating cash inflows in future periods, but none were received in 2020.
Cash Used in Investing Activities
Cash used in investing activities was$593 million during 2020, compared to$791 million in 2019. Our capital expenditures were$206 million , or$490 million lower than in 2019, primarily driven by the elimination or postponement of capital expenditures and temporary cessation of predelivery deposits as a result of the COVID-19 pandemic. Our net purchases of marketable securities were$644 million in 2020, compared to net purchases of$136 million in 2019. Increased net purchases are primarily driven by additional cash on hand from borrowings and the PSP, which allowed the Company to invest additional funds.
Cash Provided by Financing Activities
Cash provided by financing activities was$2.0 billion during 2020, compared to cash used in financing activities of$813 million in 2019. During the year, we received funds from new secured debt financing of$2.6 billion , including$1.2 billion from the issuance of the EETCs,$290 million from the loan portion of the proceeds from the PSP, and$135 million drawn on the CARES Act secured term loan. These proceeds were partially offset by debt payments of$565 million , dividend payments of$45 million , and$31 million in common stock repurchases.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Aircraft Purchase Commitments
As ofDecember 31, 2020 ,Alaska had commitments to purchase 32 Boeing 737-9 MAX aircraft with deliveries in 2021 through 2023, and cancelable purchase commitments for 30 Airbus A320neo aircraft with deliveries from 2024 through 2026. At this time, we do not expect to take delivery of these 30 Airbus aircraft. Horizon also has commitments to purchase three E175 aircraft with deliveries in 2023.Alaska has options to acquire up to 37 additional 737 MAX aircraft and Horizon has options to acquire 30 E175 aircraft with deliveries from 2022 to 2024. In addition to the 32 E175 aircraft currently operated by SkyWest in our regional fleet, we have options in future periods to add regional capacity by having SkyWest operate up to eight more E175 aircraft. InDecember 2020 ,Alaska announced an agreement in principle with Boeing to restructure the existing aircraft purchase agreement. Upon execution of the agreement, Alaska will have commitments to purchase an additional 23 737-9 MAX aircraft with deliveries between 2023 and 2024. The agreement in principle also provides for an incremental 15 options to purchase aircraft. These options, as well as the 37 available under the existing contractual agreement, are expected to be available for delivery between 2023 and 2026. 44 -------------------------------------------------------------------------------- To best reflect our expectations of future fleet activity, we have included the firm deliveries from the Boeing agreement in principle in the table below, which summarizes our expected fleet count by year, as ofFebruary 26, 2021 : Actual Fleet Count Anticipated Fleet Activity(a) Aircraft Dec 31, 2019 Dec 31, 2020 2021 Changes Dec 31, 2021 2022 Changes Dec 31, 2022 2023 changes Dec 31, 2023 B737 Freighters 3 3 - 3 - 3 - 3 B737-700 11 11 - 11 - 11 - 11 B737-800 61 61 - 61 - 61 - 61 B737-900 12 12 - 12 - 12 - 12 B737-900ER 79 79 - 79 - 79 - 79 B737-9 MAX - - 13 13 30 43 13 56 A319/A320(b) 61 21 - 21 (8) 13 (13) - A321 NEO 10 10 - 10 - 10 - 10 Total Mainline Fleet 237 197 13 210 22 232 - 232 Q400 operated by Horizon(c) 33 32 - 32 (1) 31 (6) 25 E175 operated by Horizon(c) 30 30 30 - 30 3 33 E175 operated by third party(c) 32 32 - 32 - 32 - 32 Total Regional Fleet 95 94 - 94 (1) 93 (3) 90 Total 332 291 13 304 21 325 (3) 322 (a)Anticipated fleet activity reflects intended early retirement and extensions or replacement of certain leases, not all of which have been contracted yet. (b)AtDecember 31, 2019 ,Alaska had 10 operating A319 aircraft, all of which were removed from operating service in 2020. (c)Aircraft are either owned or leased by Horizon or operated under capacity purchase agreement with a third party.
Firm orders and option exercises beyond 2021 are expected to be financed primarily through long-term debt and operating cash flows.
Future Fuel Hedge Positions
All of our future oil positions are call options, which are designed to
effectively cap the cost of the crude oil component of our jet fuel purchases.
With call options, we are hedged against volatile crude oil price increases;
and, during a period of decline in crude oil prices, we only forfeit cash
previously paid for hedge premiums. Our crude oil positions are as follows:
Approximate Gallons Weighted-Average Crude Oil Average Premium
Hedged (in millions) Price per Barrel Cost per Barrel
First Quarter 2021 60 $62 $2
Second Quarter 2021 80 $59 $2
Third Quarter 2021 70 $56 $2
Fourth Quarter 2021 50 $51 $3
Full Year 2021 260 $58 $2
First Quarter 2022 25 $53 $3
Second Quarter 2022 15 $54 $3
Full Year 2022 40 $53 $3
45--------------------------------------------------------------------------------
Contractual Obligations
The following table provides a summary of our obligations as ofDecember 31, 2020 . For agreements with variable terms, amounts included reflect our minimum obligations. (in millions) 2021 2022 2023 2024 2025 Beyond Total Current and long-term debt obligations$ 1,145 $ 371 $
334
328 279 219 167 160 518 1,671
Facility lease commitments 10 9 9 8 6 87 129
Aircraft-related commitments(b) 185 1,325 672 194 16 13 2,405
Interest obligations(c) 111 81 68 58 50 103 471
Other obligations(d) 181 185 190 197 198 711 1,662
Total $ 1,960 $ 2,250 $ 1,492 $ 864 $ 826 $ 2,474 $ 9,866
(a)Future minimum lease payments for aircraft includes commitments for aircraft
which have been removed from operating service, as we have remaining obligations
under existing terms.
(b)Includes non-cancelable contractual commitments for aircraft and engines,
buyer furnished equipment, and contractual aircraft maintenance obligations.
(c)For variable-rate debt, future obligations are shown above using interest
rates forecast as of December 31, 2020 .
(d)Primarily comprised of non-aircraft lease costs associated with capacity
purchase agreements.
The table above includes changes to our existing purchase agreement with Boeing
as outlined in the agreement in principle reached with Boeing in 2020. As of
December 31, 2020 , Alaska has approximately $550 million in pre-delivery
deposits on hand with Boeing. The revised delivery timeline for our existing
firm orders, in connection with the pre-delivery payment schedule we have agreed
upon with Boeing, will reduce our 2021 capital commitments significantly from
those outlined above. Additionally, in the event that the demand environment
does not support the need for deliveries as scheduled, we can utilize slide
rights under the agreement to defer as much as $300 million of these capital
commitments from 2022 into later years.
InMay 2019 , we executed an amended lease agreement withLos Angeles World Airports , which includes an agreement to renovate and upgrade the fuel system, jet bridges and concourse facilities at Terminal 6 of LAX. Project terms and pre-construction readiness was approved and finalized in 2020. We expect construction will be completed by early 2024. Under the terms of the agreement, we expect to have total reimbursable cash outlays for the project of approximately$230 million . To date, we have made total cash outlays of$24 million and have received reimbursement for$8.7 million of that total.
Defined Benefit Pensions
The table above excludes contributions to our various pension plans, for which there are no minimum required contributions given the funded status of the plans. The unfunded liability for our qualified defined-benefit pension plans was$446 million atDecember 31, 2020 , compared to a$363 million unfunded position atDecember 31, 2019 . This results in an 85% funded status on a projected benefit obligation basis compared to 86% funded as ofDecember 31, 2019 . There were no contributions to the plans in 2020.
Credit Card Agreements
We have agreements with a number of credit card companies to process the sale of tickets and other services. Under these agreements, there are material adverse change clauses that, if triggered, could result in the credit card companies holding back a reserve from our credit card receivables. Under one such agreement, we could be required to maintain a reserve if our credit rating is downgraded to or below a rating specified by the agreement or our cash and marketable securities balance fell below$500 million . Under another such agreement, we could be required to maintain a reserve if our cash and marketable securities balance fell below$500 million . We are not currently required to maintain any reserve under these agreements, but if we were, our financial position and liquidity could be materially harmed. 46 --------------------------------------------------------------------------------
Deferred Income Taxes
For federal income tax purposes, the majority of our assets are fully depreciated over a seven-year life using an accelerated depreciation method or bonus depreciation, if available. For financial reporting purposes, the majority of our assets are depreciated over 15 to 25 years to an estimated salvage value using the straight-line basis. This difference has created a significant deferred tax liability. At some point in the future the depreciation basis will reverse, potentially resulting in an increase in income taxes paid. While it is possible that we could have material cash obligations for this deferred liability at some point in the future, we cannot estimate the timing of long-term cash flows with reasonable accuracy. Taxable income and cash taxes payable in the short-term are impacted by many items, including the amount of book income generated (which can be volatile depending on revenue and fuel prices), usage of net operating losses, whether bonus depreciation provisions are available, any future tax reform efforts at the federal level, as well as other legislative changes that are beyond our control.
In 2020, we received a net refund of tax payments of
47
--------------------------------------------------------------------------------CRITICAL ACCOUNTING ESTIMATES
The discussion and analysis of our financial position and results of operations in this MD&A are based upon our consolidated financial statements. The preparation of these financial statements requires us to make estimates and judgments that affect our financial position and results of operations. See Note 1 to the consolidated financial statements for a description of our significant accounting policies. Critical accounting estimates are defined as those that reflect significant management judgment and uncertainties and that potentially may lead to materially different results under varying assumptions and conditions. Management has identified the following critical accounting estimates and has discussed the development, selection and disclosure of these policies with our audit committee. FREQUENT FLYER PROGRAMSAlaska's Mileage Plan™ loyalty program awards mileage credits to members who fly on our airlines and our airline partners, referred to as flown miles. We also sell services, including miles for transportation, Companion Fare™ certificates, bag fee waivers, and access to our brand and customer lists to major banks that offerAlaska co-brand credit cards. To a lesser extent, miles for transportation are also sold to other non-airline partners, such as hotels, and car rental agencies. The outstanding miles may be redeemed for travel on our airlines or eligible airline partners, and for non-airline products such as hotels. As long as the Mileage Plan™ is in existence, we have an obligation to provide future travel. Mileage credits and the various other services we sell under our loyalty program represent performance obligations that are part of a multiple deliverable revenue arrangement. Accounting guidance requires that we use a relative standalone selling price model to allocate consideration received to the material performance obligations in these contracts. Our relative standalone selling price models are refreshed when contracts originate or are materially modified. We also update our model annually based on observed volumes. AtDecember 31, 2020 , we had approximately 295 billion miles outstanding, resulting in an aggregate deferred revenue balance of$2.3 billion . The deferred revenue resulting from our relative selling price allocations requires significant management judgment. There are uncertainties inherent in these estimates. Therefore, different assumptions could affect the amount and/or timing of revenue recognition or expenses. The most significant assumptions are described below. 1.The rate at which we defer sales proceeds related to services sold: We estimate the standalone selling price for each performance obligation, including mileage credits, by considering multiple inputs and methods, including but not limited to, the estimated selling price of comparable travel, discounted cash flows, brand value, published selling prices, number of miles awarded, and the number of miles redeemed. We estimate the selling prices and volumes over the terms of the agreements in order to determine the allocation of proceeds to each of the multiple deliverables.
2.The number of miles that will not be redeemed for travel (breakage):
We estimate how many miles will be used per award. For example, our members may redeem mileage credits for award travel to various locations or choose between a highly restricted award and an unrestricted award. Our estimates are based on the current requirements in our Mileage Plan program™ and historical and future award redemption patterns. We review significant Mileage Plan™ assumptions on an annual basis, or more frequently should circumstances indicate a need, and change our assumptions if facts and circumstances indicate that a change is necessary. Any such change in assumptions could have a significant effect on our financial position and results of operations.
IMPACT OF COVID-19 ON CRITICAL ACCOUNTING ESTIMATES
There is uncertainty about when the impacts of the COVID-19 pandemic and
economic consequences may be resolved and when demand may return to pre-pandemic
levels. As a result, we have experienced a greater degree of uncertainty than
normal in making judgments and estimates relevant to critical accounting
matters. Further, as the pandemic and related economic impact continues to
develop, information may arise that could result in changes to or refinements of
these estimates, which may have a meaningful impact on our financial position
and results of operations in future periods. Specific discussion around areas of
impact are described below.
48
--------------------------------------------------------------------------------Property and Equipment and Capitalized Operating Leases
Given the impact of the crisis, the projected cash flows used to make future fleet decisions and assess our assets for impairment are subject to greater uncertainty than normal. Assumptions that drive such projected cash flows include expectations of future demand, including total passenger revenues and volume-related costs, as well as future capacity requirements. If expectations for these assumptions were to deteriorate, estimated future cash flow projections could be negatively impacted and could result in further impairment of assets. During the year endedDecember 31, 2020 , we have assessed our property and equipment and capitalized operating leases for impairment, and have recorded$358 million in impairment charges, primarily related to certain leased aircraft being permanently removed from our operating fleet, as well as the write-down to fair value for certain owned aircraft. Refer to Note 2. to the Consolidated Financial Statements for discussion.
Leased Aircraft Return Costs
As a result of the removal of leased aircraft discussed above, the Company is required to record an estimate for future return costs for these leased aircraft. Given many of the permanently parked aircraft have more than a year before the contractual date of return, there is greater uncertainty around the estimated scope and cost of maintenance work that may be necessary for each aircraft to meet contractual return specifications. Unexpected events, new airworthiness directives or maintenance bulletins, or negotiations with lessors could result in material adjustments to our total accrued lease return costs.
During the year ended
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