ALK 10-K 12/31/14

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, 2014
 
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, $0.01 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, 2015, shares of common stock outstanding totaled 131,284,654. The aggregate market value of the shares of common stock of Alaska Air Group, Inc. held by nonaffiliates on June 30, 2014, was approximately $6.4 billion (based on the closing price of $47.29 per share on the New York Stock Exchange on that date). 

DOCUMENTS INCORPORATED BY REFERENCE
Portions of Definitive Proxy Statement relating to 2015 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, 2014
 
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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Table of Contents

PART I
 
ITEM 1.  OUR BUSINESS

Alaska Air Group ("Air Group") operates Alaska Airlines ("Alaska") and Horizon Air ("Horizon"), which together with its partner regional airlines serve more than 100 cities through an expansive network in Alaska, the Lower 48, Hawaii, Canada and Mexico. During 2014, we carried 29 million passengers while earning record full-year adjusted earnings of $571 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. It is important to us that we achieve our objective as a socially responsible company that values not just our performance, but also our people, our community, and our environment.

While aircraft and technology enable us to provide air transportation, we recognize this is fundamentally a people business. Our employees maintain and strengthen our relationships with our customers, and our success depends on our employees working together to successfully execute on our strategy. In 2014, Alaska Airlines ranked "Highest in Customer Satisfaction among Traditional Network Carriers" by J.D. Power for the seventh year in a row. Alaska Airlines also held the No. 1 spot in the Wall Street Journal's "Middle Seat" scorecard for U.S. airlines for two years in a row. We have been the leader in the industry for on-time performance among major airlines for the past five years. For achieving safety, customer service, operational and financial goals, we rewarded our employees with a record $116 million in incentive pay.

In support of the communities that we serve, we strive to be an industry leader in environmental and community stewardship. In 2014, Air Group improved fuel efficiency by 2.1% from the prior year. Air Group donated $9.5 million to approximately 1,200 charitable organizations and our employees volunteered more than 21,000 hours of community service. We pledged $1.5 million in grants to support job training for workers at Seattle-Tacoma airport, voluntarily increased wages to $12 per hour for certain vendors in Seattle, sponsored $2.5 million for Seattle's bike-share program, and pledged $2.5 million to Seattle's Museum of Flight to guide students toward a future in science, technology, engineering, and math. For all of the efforts that we have made in our communities, Seattle Business Magazine awarded Alaska Air Group with the 2014 Community Impact Award.

We earned record financial results in 2014, marking our eleventh consecutive annual profit on an adjusted basis. We achieved an after-tax return on invested capital of 18.6%, more than double our weighted average cost of capital. Strong earnings improved our cash flow and strengthened our balance sheet resulting in a debt-to-capital ratio of 31%, which compares favorably with other high-quality industrial transport companies. Due to our strong financial health, we are now one of only two U.S. airlines with investment grade credit ratings. With the cash generated by the continued success we have had in the past decade, we were able to invest in our business for profitable growth and to enhance the customer experience. All of our 737-800/900/900ER aircraft now feature innovative Recaro seats with power at every seat, and in December 2014, we debuted our Wi-Fi enabled in-flight entertainment system and our branded in-flight experience, Alaska Beyond™. In addition, we have invested in our core market, Seattle, by adding six new non-stop destinations and increasing capacity by 4% in 2014. For 2015, we are committed to increasing capacity in Seattle by 10%.

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, are implementing a Safety Management System (SMS) to better identify and manage risk.  Both airlines are in the final phase of SMS implementation and are on track for completion and final FAA-certification in 2015. During the current year, 100% of our Alaska and Horizon aircraft technicians completed the requirements for the FAA's "Diamond Certificate of Excellence" award. This is the 13th consecutive year Alaska Airlines has received the award and the 13th time in the last 15 years for Horizon. In 2014, we launched Ready, Safe, Go - a safety campaign designed to increase safety awareness across the Air Group System.

People Focus
Our success depends on our employees. Higher employee engagement drives higher productivity, superior execution, and better customer service, which is why we listen to our employees for feedback in shaping our strategy. In 2014, our employee

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engagement was at 82% in our annual employee survey, up from 79% in the prior year. To help develop and train our people on core leadership principles and promote engagement across our airlines, all of Air Group's leaders participated in a multi-day workshop called "Gear Up". We plan to sponsor "Gear Up 2" in 2015 to further increase employee engagement.

We understand that aligning our employees' goals with the company's goals is important in achieving success. All employees participate in our 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 on average, 8.7% of annual pay, or more than one month's pay, for most employees. 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 four long-term agreements with various labor groups during the year, which provide the company, employees, and investors with long-term stability.

Hassle-Free Customer Experience
We want to be the easiest airline to fly. In each step of the customer's journey, from booking a ticket to check-in, from flying in our aircraft to claiming baggage at the final destination, we want to provide a hassle-free experience for our customers. Our industry-leading on-time performance for the past five years make us reliable to our customers, and we are the only airline that guarantees checked baggage delivery to the carousel within 20 minutes. Customers can tag their own bags at airport kiosks, or in some cases at their homes, and we now have fingerprint scan entry to our airport lounges (Boardrooms). We lead the travel industry in mobile innovation with iPhone, Android, and Microsoft apps that allow passengers to purchase tickets, check-in, upgrade seats, and reserve food for the flight - all with helpful notifications that inform customers when there are changes to their flights. The Transportation Security Administration (TSA) Pre-Check Program is available in 28 of our locations, which allows eligible customers to opt-in for reduced screening requirements. We also introduced the Alaska Listens survey with five simple questions designed to get timely feedback from our customers - and we guarantee a response within 72 hours if there is an issue that needs to be resolved. 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.

Energetic and Compelling Brand
We want to be recognized as the preferred airline to fly. With our message, "Calling All Explorers," we want our customers to choose us whether they are exploring new destinations or traveling to familiar cities, because flying on Alaska is an adventure in itself. Our Alaska Beyond™ flight experience, launched in 2014, features Beyond Entertainment™, Beyond Delicious™, Beyond Comfort™, and Beyond Service™, which together create a unique Alaska experience that is designed to go above and beyond customer expectations. Customers can now stream in-flight entertainment to their personal devices, enjoy gourmet Tom Douglas signature entrées, rest comfortably in our Recaro seats with power, enhanced space, and six-way adjustable headrests, and fly with our flight crews that provide J.D. Power award-winning customer service. We will refresh the visuals at our gates to communicate a consistent message to our customers and will roll out more airport and in-flight enhancements in 2015.

Due to the increased competition in 2014, we focused our marketing efforts to defend our Seattle market. We launched our TV advertising campaign in partnership with Russell Wilson, the quarterback for the Seattle Seahawks and Alaska Airline's Chief Football Officer. The Alaska Air blog was introduced in 2014 to better connect with our customers and provide Alaska news stories in an informal and authentic way. We remain focused on strengthening our relationship with our customers in all of our markets through our energetic brand message and exceptional in-flight experience. We are currently planning to refresh all of our airport stations at over 100 destinations with our new brand image in 2015.

Low Fares, Low Costs and Network Growth
We believe that in order to provide low fares for customers in a growing network of destinations, while returning value to our shareholders, we must maintain a competitive cost structure. In 2014, we lowered our unit costs, excluding fuel, by 1.3% on a consolidated basis, representing the fifth consecutive year of annual reduction. We achieved this through a continued focus on productivity, cost management, and network growth. We increased employee productivity by 2.0% in 2014 and will continue to focus on that metric as we leverage growth. We also 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 4.5% over the last five years. Additionally, we have added split-scimitar winglets to 48 aircraft, which are expected to increase fuel efficiency by 1.5% per aircraft. Looking forward, we have committed to purchasing 42 737-900ER and 37 737-MAX aircraft with deliveries from 2015 to 2022, and three Q400 aircraft with deliveries from 2015 to 2017. In addition, we will increase regional capacity by having SkyWest operate seven E-175s with deliveries from 2015 to 2016. The capacity increase with the new B737s, Q400s, and E175s position us for growth and ensure that we will continue to operate the most fuel-efficient aircraft available for the foreseeable future.


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In 2014, we added 16 new markets to our network and exited five as we continued to better match supply with demand. We strengthened our Seattle network in 2014 by offering non-stop flights to markets like Albuquerque, Baltimore, Cancun, Detroit, New Orleans, and Tampa, and began 7 non-stop routes out of Salt Lake City. New routes in 2015 will include Seattle to Milwaukee, Oklahoma City, and Washington D.C. (Dulles), from Las Vegas to Mammoth Lakes, from San Diego to Kona, and from Portland to St. Louis.

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 such that 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. The majority of our revenues are generated by transporting passengers, but in recent years we have focused on growing our ancillary revenues. The percentage of revenues by category is as follows:

 
2014
 
2013
 
2012
 
2011
 
2010
Mainline passenger revenue
70
%
 
70
%
 
71
%
 
69
%
 
68
%
Regional passenger revenue
15
%
 
16
%
 
16
%
 
17
%
 
17
%
Other revenue
13
%
 
12
%
 
11
%
 
12
%
 
12
%
Freight and Mail revenue
2
%
 
2
%
 
2
%
 
2
%
 
3
%
Total
100
%
 
100
%
 
100
%
 
100
%

100
%

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 region is as follows:
 
2014
 
2013
 
2012
 
2011
 
2010
West Coast
36
%
 
34
%
 
35
%
 
37
%
 
41
%
Transcon/midcon
22
%
 
22
%
 
19
%
 
19
%
 
19
%
Hawaii
18
%
 
19
%
 
20
%
 
16
%
 
11
%
Alaska
15
%
 
16
%
 
17
%
 
18
%
 
19
%
Mexico
6
%
 
7
%
 
7
%
 
9
%
 
8
%
Canada
3
%
 
2
%
 
2
%
 
1
%
 
2
%
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 24 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 2014, we carried 21 million revenue passengers in our mainline operations. At December 31, 2014, Alaska’s operating fleet consisted of 137 Boeing 737 jet aircraft, compared to 131 B737 aircraft as of December 31, 2013.


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The percentage of mainline passenger capacity by region and average stage length is presented below:
 
2014
 
2013
 
2012
 
2011
 
2010
West Coast
31
%
 
28
%
 
29
%
 
31
%
 
33
%
Transcon/midcon
25
%
 
25
%
 
22
%
 
21
%
 
24
%
Hawaii
20
%
 
21
%
 
22
%
 
18
%
 
13
%
Alaska
16
%
 
18
%
 
18
%
 
20
%
 
21
%
Mexico
7
%
 
7
%
 
8
%
 
8
%
 
7
%
Canada
1
%
 
1
%
 
1
%
 
2
%
 
2
%
Total
100
%
 
100
%
 
100
%
 
100
%
 
100
%
 
 
 
 
 
 
 
 
 
 
Average Stage Length
1,182

 
1,177

 
1,161

 
1,114

 
1,085


REGIONAL
 
Our regional operations consist of flights operated by Horizon, SkyWest and PenAir. In 2014, our regional operations carried approximately 8.3 million revenue passengers, primarily in the states of Washington, Oregon, Idaho and California. Horizon is the largest regional airline in the Pacific Northwest and carries about 90% of Air Group's regional revenue passengers. In 2014, we increased regional jet flying provided by SkyWest and amended our capacity purchase agreement to start flying Embraer E-175s, which will support new markets such as Seattle-Milwaukee, Seattle-Oklahoma City, and Portland-St. Louis in 2015.

Based on 2014 passenger enplanements on regional aircraft, our leading airports are Seattle and Portland. At December 31, 2014, Horizon’s operating fleet consisted of 51 Bombardier Q400 turboprop aircraft. Horizon flights are listed under Alaska's designator code in airline reservation systems, and in customer-facing locations.

The percentage of regional passenger capacity by region and average stage length is presented below:
 
2014
 
2013
 
2012
 
2011
 
2010
West Coast
66
%
 
66
%
 
68
%
 
68
%
 
71
%
Pacific Northwest
19
%
 
21
%
 
20
%
 
19
%
 
17
%
Canada
8
%
 
9
%
 
9
%
 
9
%
 
9
%
Alaska
4
%
 
2
%
 
2
%
 
2
%
 
2
%
Midcon
2
%
 
1
%
 
%
 
%
 
%
Mexico
1
%
 
1
%
 
1
%
 
2
%
 
1
%
Total
100
%
 
100
%
 
100
%
 
100
%
 
100
%
 
 
 
 
 
 
 
 
 
 
Average Stage Length
339

 
329

 
332

 
329

 
333


MILEAGE PLAN

The Alaska Airlines Mileage Plan™ program provides a comprehensive suite of frequent flier benefits. Miles can be earned by flying on Alaska or on one of our 14 airline partners, or by using the Alaska Airlines Visa Signature card, or through other non-airline partners. Our extensive list of airline partners includes carriers associated with two of the three major global alliances (Oneworld and SkyTeam), making it easier for our members to earn miles and reach preferred status in our Mileage Plan™, and have access to a large network of travel destinations. Further, members can receive 25,000 bonus miles upon signing up for the Alaska Airlines Visa Signature card and earn triple miles on purchases made on Alaska Airlines flights or on alaskaair.com. Alaska Airlines Visa Signature cardholders also receive an annual companion ticket that allows members to purchase an additional ticket for $99 plus tax, with no restrictions or black-out dates. Earned miles can be redeemed for flights on Alaska Airlines or on any of our partner airlines, or for upgrades to First Class on Alaska Airlines for as low as 15,000 miles. All of these benefits give our Mileage Plan™ members more value for their travel on Alaska Airlines, which led to our Mileage Plan™ receiving the highest rank by frequent fliers in the first-ever J.D. Power Airline Loyalty/Rewards Program Satisfaction Report in 2014.

Mileage Plan™ revenues represent approximately 10% of Air Group's total revenues. Furthermore, our Mileage Plan™ helps drive more revenue through attaining new customers and building customer loyalty through the benefits that we provide. The

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Mileage Plan™ provides more value per dollar spent on the Alaska Airlines Visa Signature card, in comparison to other comparable frequent flier programs in the industry. Summary of the benefits provided in comparison to some of our competitors are as follows:
 
 
Alaska Airlines Signature Visa
 
Platinum Select AAdvantage
 
Gold Delta SkyMiles
 
United Mileage Plus Explorer
 
Southwest Rapid Rewards Premier
Bonus miles upon approval
 
Yes
 
No
 
No
 
No
 
No
Bonus miles awarded
 
25,000 upon approval
 
30,000 after spending $1,000 in 3 months
 
30,000 after spending $1,000 in 3 months
 
30,000 after spending $1,000 in 3 months
 
50,000 after spending $2,000 in 3 months
Annual fee
 
$75
 
$95
 
$95
 
$95
 
$99
Miles for "on" spend
 
3x
 
2x
 
2x
 
2x
 
2x
Companion fare
 
Yes - annual companion fare purchased for $99 plus tax.
 
No
 
No
 
No
 
No
First bag free
 
No
 
Yes
 
Yes
 
Yes
 
No bag fees


AGREEMENTS WITH OTHER AIRLINES

Our agreements fall into three different categories: Frequent Flier, Codeshare, and Interline agreements. Frequent Flier Agreements offer mileage credits and redemptions for our Mileage Plan™ members. Alaska offers one of the most comprehensive frequent flier programs for our Mileage Plan™ members through our frequent flier partnerships with 14 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, a 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 fares collected from passengers are prorated and distributed to interline partners according to preexisting agreements between the carriers. Frequent Flier, 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 flier 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 flier programs an opportunity to travel on Alaska and its regional affiliates while earning mileage credit in our partners’ programs.
 

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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 is as follows:
 
Frequent
Flier
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
Yes
 
No
 
Yes
American Airlines/Envoy
Yes
 
Yes
 
Yes
Air France
Yes
 
No
 
Yes
British Airways
Yes
 
No
 
No
Cathay Pacific Airways
Yes
 
No
 
Yes
Delta Air Lines(a)
Yes
 
Yes
 
Yes
Emirates
Yes
 
No
 
No
KLM
Yes
 
No
 
Yes
Korean Air
Yes
 
No
 
Yes
LAN S.A.
Yes
 
No
 
Yes
Fiji Airways(b)
Yes
 
No
 
Yes
Qantas
Yes
 
No
 
Yes
Regional Airlines
 
 
 
 
 
SkyWest(b)
No
 
Yes
 
No
Era Alaska
Yes
 
Yes
 
No
PenAir(b)
Yes
 
Yes
 
No
(a) 
Alaska has codeshare agreements with the Delta Connection carriers SkyWest, ExpressJet, Endeavor, and Compass as part of its agreement with Delta.  
(b) 
These airlines do not have their own frequent flier program. However, Alaska’s Mileage Plan™ members can earn and redeem miles on these airlines’ route systems.

The following is the financial impact of our marketing alliances:
 
2014
 
2013
 
2012
 
2011
 
2010
Air Group Marketed Revenues
90.6%
 
90.0%
 
90.2%
 
89.3%
 
89.9%
 
 
 
 
 
 
 
 
 
 
Codeshare Agreements:
 
 
 
 
 
 
 
 
 
American Airlines
2.9%
 
2.6%
 
2.7%
 
3.4%
 
3.1%
Delta Air Lines
2.3%
 
3.8%
 
3.4%
 
3.6%
 
3.7%
Others
0.9%
 
0.9%
 
0.8%
 
0.8%
 
0.8%
 
 
 
 
 
 
 
 
 
 
Interline Agreements:
 
 
 
 
 
 
 
 
 
Domestic Interline
2.5%
 
1.9%
 
2.1%
 
2.2%
 
1.9%
International Interline
0.8%
 
0.8%
 
0.8%
 
0.7%
 
0.6%
Total Operating Revenue
100.0%
 
100.0%
 
100.0%
 
100.0%
 
100.0%


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OTHER REVENUE

Other revenue consists of freight and mail revenue, and ancillary revenue such as bag fees, change fees, on-board food and beverage, and Boardroom membership. Total other revenue, excluding Mileage Plan™ revenue, represents about 3% of our total revenues. In recent years, we have seen growth in our ancillary revenue as we expand services on-board such as Tom Douglas signature meals, in-flight entertainment, and Wi-Fi. We have increased our bag fees to better match industry average prices, but we also offer a 20-minute bag guarantee so that we deliver value to our customers through fast, reliable service. As we focus on ways to better serve our customers, we expect our ancillary revenues will continue to grow.

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 2014, the airline industry reported record revenues and profits as the global economy continued to recover and oil prices were stable for most of the year, with a significant decline in the fourth quarter. As the industry strengthens, airlines are now making significant investments in airports, in new planes, and in new services to differentiate their customer service offering. Thus, the level of competition is expected to increase.

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 27% 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 average annual price of crude oil in the last five years has increased from a low of $80 per barrel in 2010 to a high of $98 in 2013. Although the price of crude oil was $53 per barrel at the end of 2014, the full-year average was $93 per barrel. For us, a $1 per barrel change in the price of oil equates to approximately $11 million of 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 $5 million per year.

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 $14 per barrel and $36 per barrel in the last five years, and averaged $23 in 2014.

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 operation at a competitive disadvantage. Our average raw fuel cost per gallon decreased 6% in 2014, decreased 4% in 2013, and increased 2% in 2012.


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The percentages 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:
 
2014
 
2013
 
2012
 
2011
 
2010
Crude oil
72
%
 
71
%
 
65
%
 
70
%
 
79
%
Refining margins
18
%
 
19
%
 
25
%
 
24
%
 
14
%
Other(a)
10
%
 
10
%
 
10
%
 
6
%
 
7
%
Total
100
%
 
100
%
 
100
%
 
100
%
 
100
%
 
 
 
 
 
 
 
 
 
 
Aircraft fuel expense
32
%
 
34
%
 
35
%
 
34
%
 
27
%
(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 as hedges to decrease our exposure to the volatility of jet fuel prices. Historically, we have had jet fuel refining margin swap contracts, but we discontinued the use of the refining margin swaps in the third quarter of 2014. Call options effectively cap our pricing for the crude oil, limiting our exposure to increasing fuel prices for about half of our planned fuel consumption. 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. Currently, we hedge approximately 18 months in advance of crude oil consumption.

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 73.6 ASMs/g in 2010 to 76.9 ASMs/g in 2014. 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. Delta significantly increased their capacity at Sea-Tac in 2014, and we expect them to continue to do so in 2015. Based on schedules filed with the U.S. Department of Transportation, we expect the amount of competitive capacity overlap from these carriers to increase more than 12% in 2015, weighted based on our network. We also compete with several other domestic and international carriers, but to a lesser extent than with 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 2014, Alaska Airlines ranked “Highest in Customer Satisfaction among Traditional Network Carriers” by J.D. Power and Associates for the seventh year in a row. All of our 2014 mainline aircraft deliveries included the Boeing Sky Interior, and we launched the new Alaska Beyond™ in-flight experience, which features our streaming in-flight entertainment, gourmet food designed by Tom Douglas, and comfortable seats with additional space and power as part of our exceptional, above and beyond flight experience.

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.


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For example, airlines often discount fares to drive traffic in new markets or to stimulate traffic when necessary to improve load factors. In addition, traditional network 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 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.

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 completed over the past decade has decreased our costs to the point we can offer competitive fares while still earning appropriate pre-tax margins.

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

We also compete with other airlines based on markets served, the frequency of service to those markets, and frequent flier 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 flier 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 flier miles. Our Mileage Plan™ offers one of the most comprehensive benefits to our members with the ability to earn and redeem miles on 14 of our partner carriers.

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.

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: 
 
2014
 
2013
 
2012
 
2011
 
2010
Alaskaair.com
57
%
 
55
%
 
54
%
 
51
%
 
48
%
Traditional agencies
25
%
 
27
%
 
27
%
 
28
%
 
28
%
Online travel agencies
12
%
 
13
%
 
13
%
 
13
%
 
15
%
Reservation call centers
6
%
 
5
%
 
6
%
 
8
%
 
9
%
Total
100
%
 
100
%
 
100
%
 
100
%
 
100
%


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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,
 
increases in competition at our primary airports, 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, 2014, we employed 13,952 (10,846 at Alaska and 3,106 at Horizon) active full-time and part-time employees. Wages and benefits, including variable incentive pay, represented approximately 41% of our total non-fuel operating expenses in both 2014 and 2013.

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 or slowing demand. At December 31, 2014, labor unions represented 83% of Alaska’s and 48% 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.


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Alaska’s union contracts at December 31, 2014 were as follows:
Union
 
Employee Group
 
Number of Employees
 
Contract Status
Air Line Pilots Association International (ALPA)
 
Pilots
 
1,562

 
Amendable 03/31/2018
Association of Flight Attendants (AFA)
 
Flight attendants
 
3,374

 
Amendable 12/17/2019
International Association of Machinists and Aerospace Workers (IAM)
 
Ramp service and stock clerks
 
613

 
Amendable 7/19/2018
IAM
 
Clerical, office and passenger service
 
2,717

 
Amendable 1/1/2019
Aircraft Mechanics Fraternal Association (AMFA)
 
Mechanics, inspectors and cleaners
 
630

 
Amendable 10/17/2016
Mexico Workers Association of Air Transport
 
Mexico airport personnel
 
85

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

 
Amendable 3/24/2015

Horizon’s union contracts at December 31, 2014 were as follows:
Union
 
Employee Group
 
Number of Employees
 
Contract Status
International Brotherhood of Teamsters (IBT)
 
Pilots
 
607

 
Amendable 12/14/2018
AFA
 
Flight attendants
 
550

 
Amendable 07/18/18
IBT
 
Mechanics and related classifications
 
272

 
Amendable 12/16/2020
National Automobile, Aerospace, Transportation and General Workers
 
Station personnel in 
Vancouver and Victoria, BC, Canada
 
50

 
Amendable 2/14/2016

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.
 
54
 
1994
 
 
 
 
 
 
 
Benito Minicucci
 
Executive Vice President/Operations and Chief Operating Officer of Alaska Airlines, Inc.
 
48
 
2004
 
 
 
 
 
 
 
Brandon Pedersen
 
Executive Vice President/Finance and Chief Financial Officer of Alaska Air Group, Inc. and Alaska Airlines, Inc.
 
48
 
2003
 
 
 
 
 
 
 
Andrew Harrison
 
Senior Vice President of Planning and Revenue Management of Alaska Air Group, Inc. and Alaska Airlines, Inc.
 
44
 
2008
 
 
 
 
 
 
 
Dave Campbell
 
President and Chief Operating Officer of Horizon Air Industries, Inc.
 
53
 
2014
 
 
 
 
 
 
 
Herman Wacker
 
Chief Ethics & Compliance Officer, General Counsel, and Vice President of Legal at Alaska Air Group, Inc.
 
66
 
2014
 
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

14




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. 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, and elected as Executive Vice President/Finance and Chief Financial Officer in 2014. He is a member of Air Group's Management Executive Committee.

Mr. Harrison joined Alaska Airlines in 2003 as the Managing Director of Internal Audit and was elected Vice President of Planning and Revenue Management in 2008. He was elected Senior Vice President of Planning and Revenue Management in 2014. He is a member of Air Group's Management Executive Committee.

Mr. Campbell joined Horizon Air in 2014 as President and Chief Operating Officer. Prior to joining Horizon, Mr. Campbell served more than 25 years of experience in maintenance and flight operations. Most recently, he served as the vice president of maintenance and engineering at jetBlue Airways from January 2014 to August 2014, and prior to that, he served as vice president of safety and operational performance at American Airlines. He joined American in 1988 after serving for four years in the U.S. Air Force and has overseen maintenance, quality, technical operations and safety. He is a member of Air Group's Management Executive Committee.

Mr. Wacker has been Chief Ethics & Compliance Officer at Alaska Air Group, Inc. and Alaska Airlines, Inc. since May 2014 and was elected General Counsel in October 2014. Mr. Wacker has been Vice President of Legal at Alaska Air Group, Inc. since February 2014 and served as its Managing Director of Labor & Employment Law from June 2007 to February 2014. He served as an Associate General Counsel of Alaska Airlines Inc. and Alaska Air Group Inc. since June 2007. 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 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

15




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 required to collect a September 11 Security Fee of $5.60 per one-way trip from passengers and remit that sum to the government to fund aviation security measures. Through September 2014, carriers also paid the TSA a security infrastructure fee to cover passenger and property screening costs. These security infrastructure fees amounted to $10 million in 2014 and $13 million each year in 2013 and 2012.

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.

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.  We also have coverage for War and Allied Perils, including hijacking, terrorism, malicious acts, strikes, riots, civil commotion and other identified perils. 

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.
 

16




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.

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;
 

17




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.
 
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;

congestion at airports or air traffic control problems;
 
adverse weather conditions;
 
increased security measures or breaches in security;

contagious illness and fear of contagion;
 
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.


18




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 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 2014, 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 forgo 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.


19




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 flier 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 flier 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.

There is ongoing speculation that further airline consolidation or reorganization could occur in the future. We routinely engage in analysis and discussions regarding our own strategic position, including alliances, codeshare arrangements, interline arrangements, frequent flier program enhancements, and may have future discussions with other airlines regarding similar activities. If other airlines participate in consolidation or reorganization, 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.


20




FINANCIAL CONDITION AND FINANCIAL MARKETS

Our business, financial condition, and results of operations are substantially exposed to the volatility of jet fuel prices. Significant increases in jet fuel costs would harm our business.
 
Fuel costs constitute a significant portion of our total operating expenses, accounting for 32%, 34% and 35% of total operating expenses for the years ended 2014, 2013 and 2012, 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 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.

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, 2014, the average age of our NextGen aircraft (B737-800, -900, -900ERs) was approximately 6.1 years, and the average age of our Q400 aircraft was approximately 8.1 years. Our relatively new aircraft require less maintenance now than they will in the future. 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 41%, 42% and 42% of our non-fuel operating expenses in 2014, 2013 and 2012, 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, 2014, labor unions represented approximately 83% of Alaska’s and 48% 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.


21




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 recent years, there have been pilot shortages in the regional market. Attrition beyond normal levels could negatively impact our operating results and our business prospects could be harmed.

ITEM 1B.     UNRESOLVED STAFF COMMENTS
 
None

ITEM 2.      PROPERTIES
 
AIRCRAFT
 
The following table describes the aircraft we operate and their average age at December 31, 2014:
Aircraft Type
Seats
 
Owned
 
Leased
 
Total
 
Average
Age in
Years
B737 Freighters & Combis
0/72
 
6

 

 
6

 
21.2

B737-400/700
144/124
 
17

 
18

 
35

 
16.9

B737-800/900/900ER
163/181/181
 
86

 
10

 
96

 
6.1

Total Mainline Fleet
 
 
109

 
28

 
137

 
9.5

Q400
76
 
36

 
15

 
51

 
8.1

CRJ-700(a)
70
 
2

 
6

 
8

 
12.3

Total Regional Fleet
 
 
38

 
21

 
59

 
8.7

Total
 
 
147

 
49

 
196

 
9.3

(a) 
We also have eight leased CRJ-700s currently subleased to a third party to be operated for other carriers.

“Management’s Discussion and Analysis of Financial Condition and Results of Operations" discusses future orders and options for additional aircraft.
 
71 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 2015 and 2022. Horizon’s leased Q400 aircraft have expiration dates in 2018, and the leases on the 14 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
 
We own terminal buildings in various cities in the state of Alaska and 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.

We lease ticket counters, gates, cargo and baggage space, ground equipment, office space, and other support areas at the majority of the airports they serve. We also lease 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. Further, we lease call center facilities in Phoenix, AZ and Boise, ID.


22




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.

ITEM 4.       MINE SAFETY DISCLOSURES
 
Not applicable.

PART II
ITEM 5.    MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
 
As of December 31, 2014, there were 131,556,573 shares of common stock of Alaska Air Group, Inc. issued and 131,481,473 shares outstanding and 2,555 shareholders of record. In 2014, we paid quarterly dividends of $0.125 per share in March, June, September, 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: 
 
2014
 
2013
 
High
 
Low
 
High
 
Low
First Quarter
$
46.66

 
$
36.48

 
$
31.98

 
$
21.97

Second Quarter
50.04

 
44.56

 
33.74

 
25.21

Third Quarter
49.64

 
42.60

 
32.11

 
25.83

Fourth Quarter
59.77

 
41.49

 
39.10

 
30.59


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, 2014 – October 31, 2014
853,906

 
$
45.81

 
853,906

 
 
November 1, 2014 – November 30, 2014
584,947

 
55.58

 
584,947

 
 
December 1, 2014 – December 31, 2014
619,851

 
57.08

 
619,851

 
 
Total
2,058,704

 
$
52.82

 
2,058,704

 
$
384


Purchased pursuant to a $650 million repurchase plan authorized by the Board of Directors in May 2014.


23




PERFORMANCE GRAPH
 
The following graph compares our cumulative total stockholder return since December 31, 2009 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, 2009.



24




ITEM 6. SELECTED FINANCIAL AND OPERATING DATA
 
 
 
 
 
 
 
 
 
 
 
2014
 
2013
 
2012
 
2011
 
2010
CONSOLIDATED OPERATING RESULTS (audited)
 
 
 
 
 
 
 
 
 
Year Ended December 31 (in millions, except per-share amounts):
 
 
 
 
 
 
 
 
 
Operating Revenues(a)
$
5,368

 
$
5,156

 
$
4,657

 
$
4,318

 
$
3,832

Operating Expenses
4,406

 
4,318

 
4,125

 
3,869

 
3,361

Operating Income
962

 
838

 
532

 
449

 
471

Nonoperating income (expense), net of interest capitalized(b)
13

 
(22
)
 
(18
)
 
(55
)
 
(65
)
Income before income tax
975

 
816

 
514

 
394

 
406

Net Income
$
605

 
$
508

 
$
316

 
$
245

 
$
251

Average basic shares outstanding
135.445

 
139.910

 
141.416

 
143.510

 
143.288

Average diluted shares outstanding
136.801

 
141.878

 
143.568

 
146.842

 
147.142

Basic earnings per share
4.47

 
3.63

 
2.23

 
1.71

 
1.75

Diluted earnings per share
4.42

 
3.58

 
2.20

 
1.66

 
1.71

Cash dividend declared per share
$
0.50

 
0.20

 

 

 

CONSOLIDATED FINANCIAL POSITION (audited)
 

 
 

 
 

 
 

 
 

At End of Period (in millions):
 

 
 

 
 

 
 

 
 

Total assets
6,181

 
5,838

 
5,505

 
5,167

 
5,017

Long-term debt, including current portion
803

 
871

 
1,032

 
1,307

 
1,534

Shareholders' equity
2,127

 
2,029

 
1,421

 
1,174

 
1,106

OPERATING STATISTICS (unaudited)
 

 
 

 
 

 
 

 
 

Consolidated:(c)
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
29,278

 
27,414

 
25,896

 
24,790

 
23,334

Revenue passenger miles (RPM) (000,000) "traffic"
30,718

 
28,833

 
27,007

 
25,032

 
22,841

Available seat miles (ASM) (000,000) "capacity"
36,078

 
33,672

 
31,428

 
29,627

 
27,736

Load factor
85.1
%
 
85.6
%
 
85.9
%
 
84.5
%
 
82.4
%
Yield

14.91
¢
 

14.80
¢
 

14.92
¢
 

14.81
¢
 

14.30
¢
Passenger revenues per ASM (PRASM)

12.69
¢
 

12.67
¢
 

12.82
¢
 

12.51
¢
 

11.78
¢
Operating revenues per ASM (RASM)(d)

14.88
¢
 

14.74
¢
 

14.82
¢
 

14.57
¢
 

13.82
¢
Operating expenses per ASM, excluding fuel and noted items (CASMex)(d)

8.36
¢
 

8.47
¢
 

8.48
¢
 

8.55
¢
 

8.82
¢
Mainline:
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
20,972

 
19,737

 
18,526

 
17,810

 
16,514

RPMs (000,000) "traffic"
27,778

 
26,172

 
24,417

 
22,586

 
20,350

ASMs (000,000) "capacity"
32,430

 
30,411

 
28,180

 
26,517

 
24,434

Load factor
85.7
%
 
86.1
%
 
86.6
%
 
85.2
%
 
83.3
%
Yield

13.58
¢
 

13.33
¢
 

13.45
¢
 

13.26
¢
 

12.75
¢
PRASM

11.64
¢
 

11.48
¢
 

11.65
¢
 

11.29
¢
 

10.62
¢
CASMex(d)

7.45
¢
 

7.54
¢
 

7.56
¢
 

7.60
¢
 

7.85
¢
Regional:
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
8,306

 
7,677

 
7,371

 
6,980

 
6,820

RPMs (000,000) "traffic"
2,940

 
2,661

 
2,590

 
2,446

 
2,491

ASMs (000,000) "capacity"
3,648

 
3,261

 
3,247

 
3,110

 
3,302

Load factor
80.6
%
 
81.6
%
 
79.8
%
 
78.6
%
 
75.4
%
Yield

27.40
¢
 

29.20
¢
 

28.81
¢
 

29.13
¢
 

26.95
¢
PRASM

22.08
¢
 

23.83
¢
 

22.98
¢
 

22.94
¢
 

20.33
¢
(a) 
In the third quarter of 2013, the Company adopted Accounting Standards Update 2009-13, "Multiple-Deliverable Revenue Arrangements - a consensus of the FASB Emerging Issues Task Force" (ASU 2009-13).
(b) 
Capitalized interest was $20 million, $21 million, $18 million, $12 million, and $6 million for 2014, 2013, 2012, 2011, and 2010, respectively.
(c) 
Includes flights under Capacity Purchase Agreements operated by PenAir and by SkyWest beginning in May 2011.
(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 2014 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 2015
  
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 2014 consolidated pretax income was $975 million compared to $816 million in 2013. The $159 million improvement was primarily due to the net increase of $212 million in revenues, a decrease of $49 million in our fuel expense, and $13 million in non-operating income compared to a non-operating loss of $22 million in the prior year. Partially offsetting these benefits was an increase in non-fuel operating expenses of $167 million, or 6%, to support the increased capacity of 7%.

The growth in revenues of $212 million was primarily due to an increase in passenger revenue of $312 million resulting from a 6.5% increase in traffic and 0.7% higher ticket yields, partially offset by a special mileage plan revenue item of $192 million resulting from the adoption of new accounting standards in the prior year. The increase in operating expenses was primarily due to increases in wages and benefits, contracted services and depreciation expense as we expanded our fleet and entered into new markets where we almost exclusively use vendors for our station operations.

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 2014 include:
Reported record full-year net income, excluding special items, of $571 million, or $4.18 per diluted share, compared to $383 million, or $2.70 per diluted share in 2013.
Reported net income for the full year under GAAP of $605 million, or $4.42 per diluted share, compared to net income of $508 million, or $3.58 per diluted share in 2013.
Declared a $0.20 per share dividend, up 60% from the prior quarter. The dividend will be paid on March 10, to shareholders of record as of February 24, 2015.
Paid $0.125 per-share quarterly cash dividend on December 3, bringing total dividend payments in 2014 to $68 million.

26




Repurchased 7,316,731 shares of common stock for an average price of $47.23 during 2014 for $348 million, or 6.9% of market capitalization at the beginning of 2014. Since 2007, Air Group has used $827 million to repurchase 49 million shares at an average price of $16.85.
Grew passenger revenues by 8% compared to the fourth quarter of 2013, and by 7% compared to full-year 2013.
Generated record full-year adjusted pretax margin of 17.2% in 2014 compared to 12.4% in 2013.
Achieved return on invested capital of 18.6% in 2014, compared to 13.6% in 2013.
Generated over $1.0 billion in operating cash flows and $336 million in free cash flows in 2014.
Lowered adjusted debt-to-total capitalization ratio to 31% as of December 31, 2014.
Held $1.2 billion in unrestricted cash and marketable securities as of December 31, 2014.
Became one of only two U.S. airlines with investment grade credit ratings.
Named "Top Dividend Stock of the Dow Transports" at Dividend Channel with 1.2% yield.

Year-to-date highlights of Alaska Air Group's five-year strategic plan:
Safety & Compliance
Launched Ready, Safe, Go safety campaign designed to increase safety awareness across the Air Group System.
People Focus
Awarded a record $116 million in incentive pay to employees for 2014, or more than one month's pay for most employees. Over the last five years, employees have earned more than $473 million in incentive pay, averaging 8.7% of annual pay.
Signed a five-year agreement with Alaska Airline's Flight Attendants in December 2014.
Signed a six-year contract with Horizon's aircraft technicians and fleet service agents in June 2014.
Signed a five-year contract with Alaska's clerical, office, and passenger service employees in April 2014.
Signed a four-year contract with Horizon's dispatchers in April 2014.
Completed "Gear Up" - an intensive leadership workshop for over 1,200 leaders at Alaska and Horizon.
Hassle-free Customer Experience
Ranked "Highest in Customer Satisfaction Among Traditional Network Carriers" by J.D. Power and Associates for the seventh year in a row.
Ranked as the best airline in the U.S. by The Wall Street Journal's "Middle Seat" scorecard for two consecutive years.
Ranked highest by frequent fliers in the first-ever J.D. Power Airline Loyalty/Rewards Program Satisfaction Report.
Held the top spot in U.S. Department of Transportation on-time performance among largest eight U.S. airlines for the twelve months ended November 2014.
Named No. 1 on-time carrier in North America for the fifth year in a row by FlightStats in January 2015.
Launched online self-tag baggage options for passengers flying from Seattle to San Diego, Anchorage, and Juneau.
Became the launch customer of Boeing's new, innovative, high-capacity 737 Space Bins, which will increase bag capacity in the cabin by 48%.
Energetic & Compelling Brand
Launched Alaska Beyond™ in-flight experience featuring gourmet Tom Douglas signature meals, new streaming in-flight entertainment, and power at every seat on our 737-800/900/900ER aircraft.
Received the 2014 Community Impact Award from Seattle Business Magazine.
Celebrated the opening of the Alaska Airlines Center sports complex at the University of Alaska Anchorage.

27




Committed over $7 million to support local communities, including job training for workers at the Seattle-Tacoma airport, STEM-focused education programs at Seattle's Museum of Flight, and Seattle's new bicycle sharing program.
Flew 13 relief flights to Los Cabos, Loreto, and Mazatlan, Mexico and transported approximately 2,000 passengers to safety following Hurricane Odile.
Low Fares, Low Costs, and Network Growth
Delivered ten additional Boeing 737-900ERs, which will further strengthen Alaska's fuel-efficient fleet.
Exercised options for two Q400 aircraft to be delivered in 2017, and ordered an additional Q400.
Added new Recaro seats and power at every seat for 95 aircraft.
Increased fuel efficiency (as measured by seat-miles per gallon) by 2.1% over 2013.
Added split-scimitar winglets to 48 planned aircraft, which are expected to improve fuel efficiency by 1.5% per aircraft.
Lowered unit costs excluding fuel and special items for the fifth consecutive year, to the lowest level ever.
Grew Seattle departures by 4% in 2014 and expect to grow Seattle departures by 10% in 2015.
New routes launched and announced in 2014 are as follows:
New Non-Stop Routes (Launched)
Frequency
Start Date
Salt Lake City to Portland
2x Daily
6/9/2014
Salt Lake City to San Diego
2x Daily
6/10/2014
Salt Lake City to Los Angeles
Daily
6/11/2014
Salt Lake City to San Jose
Daily
6/12/2014
Salt Lake City to Boise
Daily
6/16/2014
Salt Lake City to Las Vegas
2x Daily
6/16/2014
Salt Lake City to San Francisco
Daily
6/18/2014
Portland to Kalispell
Daily, Seasonal
6/9/2014
Seattle to New Orleans
Daily
6/12/2014
Seattle to Tampa
Daily
6/20/2014
Seattle to Baltimore
Daily
9/2/2014
Seattle to Detroit
Daily
9/4/2014
Seattle to Albuquerque
Daily
9/18/2014
Portland to Puerto Vallarta, Mexico
3x Weekly (Seasonal)
11/4/2014
Seattle to Cancun, Mexico
Daily (Seasonal0
11/6/2014
Portland to Los Cabos, Mexico
4x Weekly (Seasonal)
11/20/2014
New Non-Stop Routes (Announced)
Frequency
Start Date
Las Vegas to Mammoth Lakes
2x Weekly (Seasonal)
1/15/2015
San Diego to Kona
3x Weekly
3/5/2015
Seattle to Washington D.C. (Dulles)
Daily
3/11/2015
Seattle to Milwaukee
Daily
7/1/2015
Seattle to Oklahoma City
Daily
7/1/2015
Portland to St. Louis
Daily
7/1/2015

Capital Allocation

In 2014, we repurchased 7,316,731 shares of our common stock for $348 million under the share repurchase programs authorized by our Board of Directors. Since 2007, we have repurchased 49 million shares of common stock under such programs for $827 million for an average price of approximately $17 per share. In 2014, we increased our quarterly dividend 25% from $0.10 per share to $0.125 per share, and subsequent to December 31, 2014, we announced a 60% increase to $0.20 per share. Overall, we returned $416 million to shareholders during 2014 and expect to exceed that amount in 2015.


28




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 Alaska Beyond™ in-flight experience featuring Tom Douglas signature meals, new streaming in-flight entertainment, comfortable Recaro seats with power at every seat, and our award-winning customer service.

Currently, we see strong demand for 2015, and because of our strong balance sheet and the structure of our fleet, we will flex our fleet to meet demand and allocate capacity in the markets that meet our return objectives. This includes our expectation to grow departures out of Seattle by 10% in 2015. Additionally, competitive capacity is expected to be 15% higher in the first quarter and 12% higher in 2015 based on current schedules. We expect Delta Air Lines, our largest direct competitor, to increase its overlapping capacity from 41% in 2014 to 50% in 2015.

Long-term, we plan to vigorously defend our markets through great customer service, Mileage Plan™ promotions, schedule changes, community events, and additional advertising efforts. We will also continue to focus on lowering unit costs so that we can compete more effectively. Furthermore, the significant decline in fuel prices over the past several months improves our financial outlook as fuel is one of our largest operating expenses.

Given our current fleet plan, we expect capacity to increase approximately 11% in the first quarter of 2015 and between 9% and 10% for the full-year 2015.

RESULTS OF OPERATIONS
 
2014 COMPARED WITH 2013

Our consolidated net income for 2014 was $605 million, or $4.42 per diluted share, compared to net income of $508 million, or $3.58 per diluted share, in 2013. 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 2014, we recognized net mark-to-market adjustments of $23 million ($15 million after tax, or $0.11 per diluted share) compared to gains of $8 million ($5 million after tax, or $0.03 per share) in 2013.

In 2014, we recognized a one-time, non-cash benefit from the curtailment of certain post-retirement benefit plans of $20 million and a one-time gain associated with the settlement of a legal matter of $10 million. The aggregate $30 million ($19 million in aggregate after tax, or $0.13 per diluted share) is included in Special items in the consolidated statement of operations.

In 2013, we recognized a one-time, non-cash Special mileage plan revenue item of $192 million ($120 million after tax, or $0.85 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;


29




Prior year 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 third quarter of 2013, 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 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 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

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, special items, and the one-time Special mileage plan revenue item, our adjusted consolidated net income for 2014 was $571 million, or $4.18 per diluted share, compared to an adjusted consolidated net income of $383 million, or $2.70 per share, in 2013.
 
Twelve Months Ended December 31,
 
2014
 
2013
(in millions, except per-share amounts)
Dollars
 
Diluted EPS
 
Dollars
 
Diluted EPS
Net income and diluted EPS as reported
$
605

 
$
4.42

 
$
508

 
$
3.58

Mark-to-market fuel hedge adjustments, net of tax
(15
)
 
(0.11
)
 
(5
)
 
(0.03
)
Special items, net of tax
(19
)
 
(0.14
)
 

 

Special mileage plan revenue, net of tax

 

 
(120
)
 
(0.85
)
Non-GAAP adjusted income and per-share amounts
$
571

 
$
4.18

 
$
383

 
$
2.70


Revenues adjusted for the one-time Special mileage plan item are as follows:
 
Twelve Months Ended December 31,
 
2014
 
2013
 
% Change
Total operating revenues
$
5,368

 
$
5,156

 
4.1
Less: Special mileage plan revenue

 
192

 
NM
Adjusted Revenue
$
5,368

 
$
4,964

 
8.1
Consolidated ASMs
36,078

 
33,672

 
7.1
RASM

14.88
¢
 

14.74
¢
 
0.9
NM - Not Meaningful


30




Our operating costs per ASM (CASM) are summarized below:
 
Twelve Months Ended December 31,
 
2014
 
2013
 
% Change
Consolidated:
 
 
 
 
 
Total operating expenses per ASM (CASM)

12.21
¢
 

12.82
¢
 
(4.8
)
Less the following components:
 
 
 

 
 

Aircraft fuel, including hedging gains and losses
3.93

 
4.35

 
(9.7
)
     Special items
(0.08
)
 

 
NM

CASM, excluding fuel and fleet transition costs

8.36
¢
 

8.47
¢
 
(1.3
)
 


 
 
 
 
Mainline:
 
 
 
 
 
Total mainline operating expenses per ASM (CASM)

11.15
¢
 

11.77
¢
 
(5.3
)
Less the following components:
 
 
 

 
 

Aircraft fuel, including hedging gains and losses
3.79

 
4.23

 
(10.4
)
Special items
(0.09
)
 

 
NM

CASM, excluding fuel

7.45
¢
 

7.54
¢
 
(1.2
)
NM - Not meaningful


31




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,
 
2014
 
2013
 
Change
 
2012
 
Change
Consolidated Operating Statistics:(a)
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
29,278
 
27,414
 
6.8%
 
25,896
 
5.9%
RPMs (000,000) "traffic"
30,718
 
28,833
 
6.5%
 
27,007
 
6.8%
ASMs (000,000) "capacity"
36,078
 
33,672
 
7.1%
 
31,428
 
7.1%
Load factor
85.1%
 
85.6%
 
(0.5) pts
 
85.9%
 
(0.3) pts
Yield
14.91¢
 
14.80¢
 
0.7%
 
14.92¢
 
(0.8)%
PRASM
12.69¢
 
12.67¢
 
0.2%
 
12.82¢
 
(1.2)%
RASM(b)
14.88¢
 
14.74¢
 
0.9%
 
14.82¢
 
(0.5)%
CASM excluding fuel and fleet transition costs(b)
8.36¢
 
8.47¢
 
(1.3)%
 
8.48¢
 
(0.1)%
Economic fuel cost per gallon(b)
$3.08
 
$3.30
 
(6.7)%
 
$3.37
 
(2.1)%
Fuel gallons (000,000)
469
 
447
 
4.9%
 
422
 
5.9%
ASM's per gallon
76.9
 
75.3
 
2.1%
 
74.5
 
1.1%
Average number of full-time equivalent employees (FTEs)
12,739
 
12,163
 
4.7%
 
11,955
 
1.7%
 
 
 
 
 
 
 
 
 
 
Mainline Operating Statistics:
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
20,972
 
19,737
 
6.3%
 
18,526
 
6.5%
RPMs (000,000) "traffic"
27,778
 
26,172
 
6.1%
 
24,417
 
7.2%
ASMs (000,000) "capacity"
32,430
 
30,411
 
6.6%
 
28,180
 
7.9%
Load factor
85.7%
 
86.1%
 
(0.4) pts
 
86.6%
 
(0.5) pts
Yield
13.58¢
 
13.33¢
 
1.9%
 
13.45¢
 
(0.9)%
PRASM
11.64¢
 
11.48¢
 
1.4%
 
11.65¢
 
(1.5)%
CASM excluding fuel(b)
7.45¢
 
7.54¢
 
(1.2)%
 
7.56¢
 
(0.3)%
Economic fuel cost per gallon(b)
$3.07
 
$3.30
 
(7.0)%
 
$3.36
 
(1.8)%
Fuel gallons (000,000)
407
 
393
 
3.6%
 
368
 
6.8%
ASM's per gallon
79.7
 
77.4
 
3.0%
 
76.6
 
1.0%
Average number of FTE's
9,910
 
9,493
 
4.4%
 
9,178
 
3.4%
Aircraft utilization
10.5
 
10.6
 
(0.9)%
 
10.7
 
(0.9)%
Average aircraft stage length
1,182
 
1,177
 
0.4%
 
1,161
 
1.4%
Mainline operating fleet at period-end
137 a/c
 
131 a/c
 
6 a/c
 
124 a/c
 
7 a/c
 
 
 
 
 
 
 
 
 
 
Regional Operating Statistics:(c)
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
8,306
 
7,677
 
8.2%
 
7,371
 
4.2%
RPMs (000,000) "traffic"
2,940
 
2,661
 
10.5%
 
2,590
 
2.7%
ASMs (000,000) "capacity"
3,648
 
3,261
 
11.9%
 
3,247
 
0.4%
Load factor
80.6%
 
81.6%
 
(1.0) pts
 
79.8%
 
1.8 pts
Yield
27.40¢
 
29.20¢
 
(6.2)%
 
28.81¢
 
1.4%
PRASM
22.08¢
 
23.83¢
 
(7.3)%
 
22.98¢
 
3.7%
(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.


32




OPERATING REVENUES

Total operating revenues increased $212 million, or 4%, during 2014 compared to the same period in 2013.  Adjusted for the Special mileage plan revenue item recognized in 2013, operating revenues increased $404 million, or 8% during 2014. The changes are summarized in the following table:
 
Twelve Months Ended December 31,
(in millions)
2014
 
2013
 
% Change
Passenger
 
 
 
 
 
Mainline
$
3,774

 
$
3,490

 
8
Regional
805

 
777

 
4
Total passenger revenue
$
4,579

 
$
4,267

 
7
Freight and mail
114

 
113

 
1
Other - net
675

 
584

 
16
Special mileage plan revenue

 
192

 
NM
Total operating revenues
$
5,368

 
$
5,156

 
4
NM - Not meaningful

Passenger Revenue – Mainline

Mainline passenger revenue for 2014 increased by 8% on a 6.6% increase in capacity and a 1.4% increase in PRASM compared to 2013. The increase in capacity was driven by new routes, seats added to our existing fleet as part of our cabin improvement project, and delivery of 10 737-900ERs in 2014. The increase in PRASM was driven by a 1.9% increase in ticket yield, partially offset by a 0.4 point decrease in load factor compared to the prior year. Increase in yield was due to reallocation of capacity to markets with stronger demand and by a change in revenue allocation between Mainline and Regional service because of certain industry pricing changes. Without the industry change, Mainline yields would have increased by 0.9%.

We expect competitive pressures on unit revenues to continue into 2015. However, we expect total passenger revenue to increase with the expected 8% growth in our capacity.

Passenger Revenue – Regional

Regional passenger revenue increased by $28 million, or 4%, compared to 2013 on an 11.9% increase in capacity, partially offset by a 7.3% decrease in PRASM compared to 2013. The decrease in PRASM was due to a 6.2% decrease in ticket yield coupled with a 1.0 point decrease in load factor compared to the prior year. The decline in yield was driven mostly by a change in revenue allocation between Mainline and Regional service because of certain industry pricing changes. Without the revenue allocation adjustment, yield would have decreased 1.7%. Additionally, the average trip length for our Regional flights increased 3%, which also put downward pressure on yields.

We expect Regional passenger revenue to increase in 2015, primarily due to our expanded capacity purchase agreement with SkyWest to fly E-175 regional aircraft beginning in the third quarter of 2015. These aircraft will offer three booking classes.

Other – Net

Other—net revenue increased $91 million, or 16%, from 2013. This is primarily due to an increase in our Mileage Plan™ revenues of $39 million or 15%, due to increase in miles sold and an increase in cash received per mile. Additionally, bag fees and ticket change fees are up 23% and 12%, respectively, due to changes in our fee structure that took effect in November 2013.

We expect our Other—net revenue to increase in 2015 as we provide more product offerings and have more passengers.

Special Mileage Plan Revenue

In 2013, we modified and extended our co-branded credit card agreement with Bank of America Corporation (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.

33




OPERATING EXPENSES

Total operating expenses increased $88 million, or 2%, compared to 2013, primarily driven by higher non-fuel costs due to increased capacity. 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:
 
Twelve Months Ended December 31,
(in millions)
2014
 
2013
 
% Change
Fuel expense
$
1,418

 
$
1,467

 
(3
)
Non-fuel expenses
3,018

 
2,851

 
6

Special items
(30
)
 

 
NM

Total Operating Expenses
$
4,406

 
$
4,318

 
2

NM - Not Meaningful

Significant operating expense variances from 2013 are more fully described below.

Wages and Benefits

Wages and benefits increased during 2014 by $50 million, or 5%, compared to 2013. The primary components of wages and benefits are shown in the following table:
 
Twelve Months Ended December 31,
(in millions)
2014
 
2013
 
% Change
Wages
$
862

 
$
788

 
9

Medical and other benefits
150

 
145

 
3

Defined contribution plans
53

 
44

 
20

Pension - Defined benefit plans
9

 
50

 
(82
)
Payroll taxes
62

 
59

 
5

Total wages and benefits
$
1,136

 
$
1,086

 
5


Wages increased 9%, primarily due to annualization of new labor contracts that included higher rates, a 4.7% increase in full-time employee equivalents, and an $8 million signing bonus paid to Alaska's flight attendants in December 2014 when a new collective bargaining agreement was ratified. The increase in FTEs is to support the growth in our business.

Defined contribution plans increased 20% due to an increase in the number of employees participating in the plans and an increase in the employer contribution for non-union employees previously in the pension plan.

Pension expense decreased 82%, 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, a higher discount rate at December 31, 2013 compared to December 31, 2012, and the freezing of plan benefits for our non-union employees beginning January 1, 2014.

We expect wages and benefits to be high