UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-K

 

 

OR

 For the transition period from                      to                     

 

Commission File Number 1-8957

 

 

ALASKA AIR GROUP, INC.

 

TABLE OF CONTENTS

 

 

 

Our objectiveacquisition of Virgin America positions us as the fifth largest airline in the U.S., with an unparalleled ability to serve West Coast travelers. Virgin America provides a platform for growth of our low-fare, premium product providing a powerful West Coast network for our guests as well as enhanced international partnerships. Additionally, Virgin America provides an opportunity to grow and improve our loyalty program while gaining access to constrained gates, particularly on the East Coast. The combined company now provides more seats from the West Coast than any other carrier, allowing us to serve our guests better.

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 customers,guests, and our success depends on our employees working together to successfully execute on our strategy. In 2015,2016, Alaska was once again named one of America's Top 100Best Employers by Forbes Magazine. We launched our "Beyond Service" two-day customer service workshop for all of our customer-facingknow that engaged employees to provide them with the framework and tools they need to improve upon our already award-winning customerexcellent service. In that vein, in 2015,2016, Alaska Airlines ranked "Highesthighest in Customer Satisfactioncustomer satisfaction among Traditional Network Carriers"traditional network carriers by J.D. Power and Associates for the eighthninth year in a row and Virgin America was recognized for excellent service by Conde Nast Traveler and Travel + Leisure magazine also for the ninth year in a row. Customer service matters, and we believe the combination of our airlines will only enhance the experience for our guests.

Operationally, Alaska Airlines alsohas held the No. 1 spot in the Wall Street Journal's "Middle Seat" scorecard for U.S. airlines for three years in a row.four consecutive years. We have been the leader in the industry for on-time performance among major airlines for the past sixseven years. For achieving safety, customer service, operational and financial goals, we rewarded our employees with a record $120$127 million in incentive pay during 2015.2016. Including incentives earned during the year prior to the acquisition by Virgin America employees, the total is $159 million.

In support of the communities that we serve, we strive to be an industry leader in environmental and community stewardship. In 2015, Air Group2016, we improved fuel efficiency by 2.2%1.4% from the prior year, as measured by available seat miles flown per gallon. We also flew the first two commercial flights using sustainable alcohol-to-jet biofuel made from U.S. grown corn and alternative jet fuel made from forest residuals, highlighting our commitment to environmental stewardship. Our combined fleet is one of the youngest, most fuel-efficient fleets in North America and we look forward to further enhancements in this area. Air Group donated $12$13 million to approximately 1,050over 1,300 charitable organizations and our employees volunteered more than 27,000 hours of community service. IncludedVirgin America has also been active in this amount are annual contributionscommunity service and charitable giving. Our efforts focus on youth and education, medical research and transportation and community outreach. One of our ongoing multi-year grantsleadership principals is to several organizations -"give back" and we pledged $1.5 million to support job training for workers at Seattle-Tacoma airport through Port Jobs, $2.5 million for Seattle's bike-share program, $1 million forare proud of the Alaska Native Scienceefforts and Engineering Program, and $2.5 million to Seattle's Museumvolunteerism of Flight to guide students toward a future in science, technology, engineering, and math. In 2015, we granted additional support to Washington Information Science Education Consortium, Washington State University, Kupu of Hawaii, University of Hawaii, and pledged $40 million toour employees across the the University of Washington, in part, to increase our impact on education supporting specific programs and scholarships.system.

As we look to the future, we will build on theour success of the past few years by executing our strategic plan —in the Five Focus Areas:following areas:

Our success depends on our employees.people. 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. Employee engagement scores from our annual employee survey are at historical highs. In addition to the "Beyond Service"We have designed customer-service workshops and leadership training that cover virtually all employees and do these on an ongoing basis. As we integrate Alaska and Virgin America, in January 2017 we rolled out "Momentum" training for all Virgin America employees to help bridge the two airlines and blend our customer-facingcultures. For our Horizon employees, allwe are conducting "QX Factor," a program with the goal of Air Group's leaders participated in a multi-day leadership training called "Gear Up 2." This is the second phase of our award-winning leadership training where our leaders spent time focusing on several of our core leadership principles in an effort to give them the tools they need to effectively lead a highly-engaged workforce.improving culture, engagement and communication.

We understand that aligning our employees' goals with the Company'sAir Group's goals is important in achieving success. AllThe majority of Air Group employees, including Virgin America employees starting in 2017, participate in our Performance-Based Pay (PBP)("PBP") and Operational Performance Rewards (OPR)("OPR") programs, which encourage employees to work together to achieve metrics related to safety, profitability, on-time performance, low costs and customer loyalty and satisfaction. Over the last five years, our incentive programs have paid out on average, over 8.6%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 are currently in long-term agreements with all of our major work groups, which provide the Company, employees, and investors with long-term stability.

We continue to invest in a better customer experience. Onboard, customersguests will continue to enjoy more of what they love with free and premium entertainment direct to their devices, Pacific Northwest-inspired food and beverages, and custom leather seats with power outlets for laptops and personal devicesat every seat and larger overhead bins for carry-on bags. In the fall of 2016,As mentioned previously, we will introduce ahave also recently launched our new Premium Class section in the main cabin with increased pitchlegroom and other amenities.amenities and improved our First Class with five additional inches of leg room.

In 2015,During fiscal 2016, we added 2017 new markets to our route structure. We continued to strengthen our Seattle network to offer further utility to our customers by offering non-stop flights to markets like New York (JFK), Charleston, Raleigh-Durham, Nashville, Oklahoma City, and Milwaukee. We also added flying from Los Angeles (LAX) to Liberia and San Jose, Costa Rica and Baltimore. We have grown capacity over 7% annually on average for the past 20 years and we plan to continue to grow between 4% and 8% annually in the next several years.combined network. For 2016,2017, we plan to grow our system-wide capacity approximately 8%.8.5% as compared to the full year 2016 combined capacity of Air Group and Virgin America.

Alaska Air Group is a Delaware corporation incorporated in 1985 and the holding company of Alaska, AirlinesVirgin America, Horizon and Horizon Air.other business units. Although Alaska, Virgin America and Horizon both operate as airlines, theirthe business plans, competition and economic risks differ substantially.substantially for Horizon in comparison to Alaska and Virgin America. Alaska Airlines is an Alaska corporation that was organized in 1932 and incorporated in 1937. HorizonVirgin America is a California corporation that was incorporated in 2004 and acquired by Air IndustriesGroup on December 14, 2016. Horizon is a Washington corporation that first began service and was incorporated in 1981. HorizonIt was acquired by Air Group in 1986. Alaska operates a fleetand Virgin America operate fleets of narrowbody passenger jets (mainline)jets. Together, the operations of Alaska and Virgin America are referred to as "mainline" operations. Alaska also contracts with Horizon, SkyWest Airlines, Inc. (SkyWest)("SkyWest") and Peninsula Airways, Inc. (PenAir)("PenAir") for regional capacity such that Alaska receives all passenger revenue from those flights. Horizon currently operates a fleet of turboprop aircraft and sells all of its capacity to Alaska pursuant to a capacity purchase arrangement.agreement ("CPA"). In 2017, Horizon will begin operating E175 regional jets. The majority of our revenues are generated by transporting passengers. The percentage of revenues by category is as follows:

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:

The mainline operations include Boeing 737 ("B737") and Airbus family ("A319" and "A320") jet service offered by Alaska and Virgin America. We offer extensive north/southpassenger service withinfrom the western U.S., throughout the contiguous United States, Alaska, Hawaii, Canada, Mexico, and Costa Rica as well as passenger and Cuba. Our largest concentration of departures is in Seattle. We also offer cargo service throughout our network and have dedicated cargo servicesaircraft that operate primarily to and within the state of Alaska. We also provide long-haul east/west service to Hawaii and 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.

 

The percentage of mainline passenger capacity by region and average stage length is presented below:

 

The percentage of regional passenger capacity by region and average stage length is presented below:

We currently maintain two frequent flyer plans: the Alaska Airlines Mileage Plan™ programand the Virgin America Elevate®.

Mileage Plan™ provides a comprehensive suite of frequent flierflyer benefits. Miles can be earned by flying on Alaska or on one of our 1624 airline partners, or by using the Alaska Airlines Visa Signaturecredit card, or through other non-airline partners. Our extensive list of airline partners includes carriers associated with twoeach of the three major global alliances, (Oneworld and SkyTeam), making it easier for our members to earn miles and reach preferredelite status in our Mileage Plan™,frequent flyer programs and have access to a large network of over 900 worldwide travel

destinations. Further, members can receive 25,00030,000 bonus miles (30,000 beginning in the Spring of 2016) 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 taxes, with no restrictions or black-out dates, and a free first checked bag for all partiesup to seven people traveling in the same itinerary. Earned miles can be redeemed for flights on Alaska Airlinesour airlines or on any of our partner airlines, or for upgrades to First Class and Premium Class on Alaska Airlines for as low as 15,000 miles.Airlines. All of these benefits give our Mileage Plan™ members more value for their travel on Alaska, Airlines, which ledleading us to our Mileage Plan™ receivingreceive the highest ranking by frequent fliers in the first-evercustomer satisfaction amongst traditional carriers in North America from J.D. Power Airline Loyalty/Rewards Program Satisfaction Report in 2014 and again in 2015.Associates for the last nine consecutive years.

Mileage Plan™ revenues representrepresented approximately 11%12% of Air Group's total revenues. Furthermore, ourrevenues in 2016. Mileage Plan™ helps drive more revenue growth by attainingattracting new customers and building customer loyalty through the benefits that we provide.

The Elevate® program allows guests to earn points for purchasing travel that are redeemable for travel awards throughout our network and the networks of Virgin America's airline partners. Elevate® members have been introduced to the Mileage Plan™ provides more value per dollar spentprogram and, over time, the two programs will become one. Currently, our guests from both airlines enjoy codeshare and reciprocal frequent flyer benefits, including earning and redeeming rewards on the Alaska Airlines Visa Signature card, in comparison to otherboth carriers. Elite members of each frequent flier programs in the industry. Summary of the benefits provided in comparison to some of our competitors are as follows:

Our agreements fall into three different categories: Frequent Flier,Flyer, Codeshare and Interline agreements. Frequent FlierFlyer agreements offer mileage credits and redemptions for our Mileage Plan™ and Elevate® members. Alaska offers one of the most comprehensive frequent flierflyer programs for our Mileage Plan™ members through our frequent flierflyer partnerships with 1624 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 areis 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,flyer, codeshare and Interlineinterline agreements help increase our traffic and revenue by providing more route choices to customers.our guests.

We have marketing alliances with a number of airlines that provide frequent flierflyer and codesharing opportunities. Alliances are an important part of our strategy and enhance our revenues by:

 

 

 

 

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.renegotiation at any time.

The comprehensive summary of Alaska, Horizon and SkyWest alliances with other airlines is as follows:

The following is the financial impact of our marketing alliances:

Other revenue consists of freight and mail, revenue,certain frequent flyer and ancillary revenue. While some of our product features are included in our base pricing, we have unbundled certain ancillary features that our guests separately value. Major ancillary revenue such asproducts include checked bag fees, change fees on-board food and beverage,lounge memberships. We also promote and Boardroom membership.sell products in-flight to enhance the guest experience, including our Tom Douglas signature meals, snacks, alcoholic beverages, in-flight entertainment and Wi-Fi. Total other revenue, excluding Mileage Plan™frequent flyer program revenue, represents about 7% 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. Although we do charge bag fees, we offer a 20-minute bag guarantee so that we deliver value to our customers through fast, reliable service. In 2015, we added a free bag as a permanent feature of our affinity credit card. As we focus on ways to better serve our customers, we expect our ancillary revenues will continue to grow.

The airline industry is highly competitive and subject to various uncertainties, and has historically been characterized by low profit margins. Uncertainties include generalincluding 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, regulation—including taxes and fees 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.

 

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. Average annual refining margin prices have fluctuated between $20$13 per barrel and $36 per barrel in the last five years, and averaged $20$13 in 2015.2016.

Generally, West Coast jet fuel prices are somewhat higher and more volatile than prices in the Gulf Coast or on the East Coast. Our average raw fuel cost per gallon decreased 19% in 2016, 39% in 2015 decreasedand 6% in 2014, and 4% in 2013.2014.

The percentages of our aircraft fuel expense by crude oil and refining margins, as well as the percentage of our aircraft fuel expense of operating expenses are as follows:

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 crude oil, limiting our exposure to increasing fuel prices for about half of our planned fuel consumption. With call options, we are hedged against spikes in crude oil prices, and during a period of decline in crude oil prices, we only forfeit cash previously paid for hedge premiums. Currently, we startWe begin hedging approximately 18 months in advance of crude oil consumption.

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. We compete with other domestic airlines and a limited number of international airlines on nearly all of our scheduled routes. Our largest competitor is Delta, Air Lines, who has significantly increased their capacity in Seattle over the past twofew years. Approximately 60%61% of our capacity to and from Seattle competes with Delta. Based on schedules filed with the U.S. Department of Transportation, we expect the amount of competitive capacity overlap with all carriers to increase by more than 13%5% in the first half of 2016,2017, weighted based on our network.

We believe that the following principal competitive factors are important to our customers:guests:

 

 

EXECUTIVE OFFICERS

 

The executive officers of Alaska Air Group, Inc.Group. and executive officers of Alaska, Virgin America and Horizon who have significant decision-making responsibilities, their positions and their respective ages are as follows: 

 

American Airlines. He joined American in 1988 after serving for four years in the U.S. Air

REGULATION

 

 

The airline industry is highly regulated, most notably by the federal government. The Department of Transportation (DOT), the Federal Aviation Administration (FAA) and the Transportation Security Administration (TSA) exercise significant regulatory authority over air carriers.

 

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.

 

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 expectbelieve there willmay be local or federal legislation in the future to reduce carbon and other greenhouse gas emissions. Alaska and HorizonOver the course of several years, we have transitioned to more fuel-efficient aircraft fleets.fleets and reduced our emissions with the goal of continuing that trend.

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.

We carry insurance of types customary in the airline industry and in amounts deemed adequate to protect our interests and property and to comply both with federal regulations and certain credit and lease agreements. The insurance policies principally provide coverage for Airline Hull, Spares and Comprehensive Legal Liability Insurance, War and Allied Perils, and Workers’ Compensation. In addition, we currently carry a Cyber Liability policy in the event of security breaches from malicious parties.

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

 

 

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.

 

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-standersbystanders 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.such event. 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 it is fully insured and even if it does not involve one of our aircraft, could cause a public perception that our airlines or the aircraft we or our partners fly are less safe or reliable than other transportation alternatives, whichalternatives. This would harm our business.

Like otherAs is the case for all airlines, our operations often are affected by delays, cancellations and other conditions caused by factors largely beyond our control.

Other conditionsFactors that might impact our operations include:

 

 

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.

 

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 andof aircraft, operation of airlines and establishment of consumer protections.protection.

Similarly, there are a number of legislative and regulatory initiatives and reforms at the federal, state and local level, includinglevels. These initiatives include increasingly stringent laws protectingto protect the environment, minimum wage requirements and health care mandates thatmandates. They could affect our relationship with our workforce and the vendors that serve our airlines 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 reflect higher costs of security, costs, increased costs relatedupdates to updated infrastructures and other costs.other. Additional laws, regulations, taxes, and airport rates and airport charges have beenmay be occasionally 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.

Terrorist attacks, the fear of such attacks or other hostilities involving the U.S. could have a significant negative effect on the airline industry, including us, and could:

 

 

 

 

 

 

 

The occurrence of any of these events would harm our business, financial condition and results of operations.

 

 

We have historically reliedrely 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.

 

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.

The U.S. airline industry is characterized by substantial price competition. In recent years, the market share held by low-cost carriers and so-called ultra 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 and in our Seattle hub, therefore increasingresulting in increased competition for those destinations. This increasedIncreased competition in both domestic and international markets may have a material adverse effect on the Company’sour 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 passengersour guests 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 returns on invested capital, we will likely not be able to grow our business in the future or weather industry downturns and thereforedownturns. Therefore, our financial results may suffer.

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 also 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 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, if sustained, could harm our business, financial condition and results of operations.

 

 

Alaska is dependent on Boeing as its sole supplier for aircraft and many aircraft parts. HorizonVirgin America is similarly dependent on Bombardier.Airbus, and Horizon is dependent on Bombardier and soon Embraer. Additionally, each carrier is dependent on sole suppliers for aircraft engines.engines for each aircraft type. As a result, we are more vulnerable to any problemsissues 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.aircraft or instability in the foreign countries, in which the aircraft and its parts are manufactured.

 

Alaska and HorizonOur airlines are parties to marketing agreements with a number of domestic and international air carriers, or “partners,“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 or Virgin America codeshare flights. In addition, the agreements generally provide that members of Alaska’s Mileage Plan™ program, or Virgin America's Elevate® program, can earn milescredit on or redeem milescredit 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 flierflyer arrangements are an important part of our Mileage Plan™ program.frequent flyer programs. 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™, and Elevate® programs, 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 and frequent flierflyer 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.

 

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, mobile devices and other systems. Substantially all of our tickets are issued to passengersour guests as electronic tickets, and the majority of our customers check in using our website, airport kiosks, or our airport kiosks.mobile application. 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 security 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 customersguests to do business with another airline. In addition, we rely on other automated systems for crew scheduling, flight dispatch and other operational needs. In 2016,2017, subsequent to year end, we expect to migratemigrated to a new crew management system. We also plan to move our primary data center location. Disruptions, failed migration, untimely recovery, or a breach of these systems or the data center 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.

We accept, store and transmit information about our customers,guests, 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.

 

Fuel costs constitute a significant portion of our total operating expensesexpenses. 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 services to attempt to recover increasing fuel costs.

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.

As of December 31, 2015,2016, the average age of our NextGen aircraft (B737-800, -900, -900ERs) was approximately 6.47.3 years, and the average age of our Q400 aircraft was approximately 910 years, and the average age of our A319 and A320 aircraft was approximately 6.8 years. Our relatively new aircraft currently 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.

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 improvementsenhancements 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 costs are a significant component of our total expenses. Each of ourAlaska and Horizon's represented employee groups has a separate collective bargaining agreement, andagreement. Through negotiations or transition agreements in the Virgin America integration, each group 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, including wage rate increases, thatwhich could ultimately flow through to us.us under the applicable services agreement.

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'sour strategic vision,

None

“Management’s Discussion and Analysis of Financial Condition and Results of Operations" discusses future orders and options for additional aircraft.

 

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,data center, 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 we serve. Airport leases contain provisions for periodic adjustments of lease rates. We are typically responsible for maintenance, insurance and other facility-related expenses and services under these agreements. We also lease operations, training, data center, and aircraft maintenanceadministrative facilities in Burlingame, CA; Portland, OR; Quincy, WA; and Spokane, WA as well as line maintenance stations in Boise, ID; Bellingham, WA; Eugene, OR; San Jose, CA; Medford, OR; Redmond, OR; Seattle, WA; and Spokane.Spokane, WA. Further, we lease call center facilities in Phoenix, AZ, and Boise.Boise, ID.

 

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.

 

Not applicable.

PART II