Alaska Air Group, Inc.: Form 10-Q for the period ended Sep 30, 2023

OVERVIEW

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand our company, segment operations and the 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 "Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2022. This overview summarizes the MD&A, which includes the following sections:

• *Third Quarter Review—*highlights from the third quarter of 2023 outlining some of the major events that occurred during the period.
• *Results of Operations—*an in-depth analysis of our revenue by segment and our expenses from a consolidated perspective for the three and nine months ended September 30, 2023. To the extent material to the understanding of segment profitability, we more fully describe the segment expenses per financial statement line item. Financial and statistical data is also included here. This section includes forward-looking statements regarding our view of the remainder of 2023.
• *Liquidity and Capital Resources—*an overview of our financial position, analysis of cash flows, and relevant contractual obligations and commitments.

THIRD QUARTER REVIEW

Third Quarter Results

We recorded consolidated pretax income for the third quarter of 2023 under GAAP of $193 million, compared to consolidated pretax income of $65 million in the third quarter of 2022. Increased pretax income is primarily the result of a $183 million decrease in aircraft fuel costs, and an $81 million decrease in special operating and non-operating charges. These decreases were partially offset by a $134 million increase in other operating expense categories.

See “Results of Operations” below for further discussion of changes in revenue and operating expenses as compared to 2022, and our reconciliation of non-GAAP measures to the most directly comparable GAAP measure. A glossary of financial terms can be found at the end of this Item 2.

Operational Milestones

In the third quarter, our airlines leveraged our foundational strength of operational excellence, leading the industry in completion rate and finishing with an on-time performance higher than 80%. Additionally, Alaska completed its transition back to a single-fleet operator following the retirement of its A321neo aircraft in September. Subsequent to quarter end, Alaska reached an agreement with American Airlines to sell all ten A321neos, with sales expected to be completed by the first quarter of 2024.

Labor Update

Under the terms of the existing collective bargaining agreement with the Air Line Pilots Association (ALPA), Alaska's pilots' wages underwent a market review in the third quarter. Following this review, Alaska executed a Letter of Agreement with ALPA for a one-time market rate adjustment to increase pay rates effective September 1, 2023.

Alaska is actively negotiating for new contracts with its mainline flight attendants represented by the Association of Flight Attendants, whose contract became amendable in December 2022, and its mainline mechanics represented by the Aircraft Mechanics Fraternal Association, whose contract became amendable in October 2023. Horizon is actively negotiating for a new contract with its pilots, represented by the International Brotherhood of Teamsters, whose contract becomes amendable in December 2024.

Outlook

For the fourth quarter of 2023, we anticipate our cost discipline and operational excellence will continue to benefit unit costs, with CASMex expected to be down 3% to 5% on capacity up 11% to 14% as compared to the prior year. Although we have seen some slowing in the demand environment, we expect our diversified product offerings and Mileage Plan revenue streams will lift total revenue up 1% to 4% over 2022. For the full year, headwinds from fuel prices which were not previously contemplated, coupled with decreased revenue expectations, have led us to reduce our expected full year adjusted pretax margin to 7% to 8%.

We continue to remain focused on setting intentional targets and taking the appropriate steps to deliver on those targets. Changes to the operating environment and industry trends could lead to adjustments to the guidance provided as management aligns our business to be appropriately responsive. As we leverage our network and diversified revenue offerings for growth, our people are focused on keeping costs low and running a strong operation. These are competitive advantages we have cultivated over many years that will continue to serve us in the remainder of 2023 and beyond.

RESULTS OF OPERATIONS

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

We believe disclosure of earnings excluding the impact of aircraft fuel and special items is useful information to investors because:

• By excluding fuel expense and special items from our unit metrics, we believe that we have better visibility into the results of operations as we focus on cost-reduction and productivity initiatives. Our industry is highly competitive and is characterized by high fixed costs, so even a small reduction in non-fuel operating costs can lead to 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 productivity, airport costs, maintenance costs, etc., which are more controllable by management.
• Cost per ASM (CASM) excluding fuel expense and special items is one of the most important measures used by management and by our Board of Directors in assessing quarterly and annual cost performance.
• CASM excluding fuel expense and special items is a measure commonly used by industry analysts and we believe it is an important metric by which they have historically compared our airline to others in the industry. The measure is also the subject of frequent questions from investors.
• Adjusted income before income tax (and other items as specified in our plan documents) is an important metric for the employee annual incentive plan, which covers the majority of employees within the Alaska Air Group organization.
• Disclosure of the individual impact of certain noted items provides investors the ability to measure and monitor performance both with and without these special items. We believe that disclosing the impact of these items as noted above is important because it provides information on significant items that are not necessarily indicative of future performance. Industry analysts and investors consistently measure our performance without these items for better comparability between periods and among other airlines.
• Although we disclose our unit revenue, we do not, nor are we able to, evaluate unit revenue excluding the impact that changes in fuel costs have had on ticket prices. Fuel expense represents a large percentage of our total operating expenses. Fluctuations in fuel prices often drive changes in unit revenue in the mid-to-long term. Although we believe it is useful to evaluate non-fuel unit costs for the reasons noted above, we would caution readers of these financial statements not to place undue reliance on unit costs excluding fuel as a measure or predictor of future profitability because of the significant impact of fuel costs on our business.

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

OPERATING STATISTICS SUMMARY (unaudited)

Below are operating statistics we use to measure operating performance. We often refer to unit revenue and adjusted unit costs, which are non-GAAP measures.

(a) Except for FTEs, data includes information related to third-party regional capacity purchase flying arrangements.

(b) See reconciliation of this non-GAAP measure to the most directly related GAAP measure in the accompanying pages.

(c) Data presented includes information related to flights operated by Horizon and third-party carriers.

(d) Excludes all aircraft removed from operating service.

COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2023 TO THREE MONTHS ENDED SEPTEMBER 30, 2022

Our consolidated net income for the three months ended September 30, 2023 was $139 million, or $1.08 per share, compared to a consolidated net income of $40 million, or $0.31 per share, for the three months ended September 30, 2022.

Excluding the impact of special items and mark-to-market fuel hedge adjustments, our adjusted net income for the third quarter of 2023 was $237 million, or $1.83 per share, compared to an adjusted net income of $325 million, or $2.53 per share, for the third quarter of 2022. The following table reconciles our adjusted net income per share (EPS) to amounts as reported in accordance with GAAP:

(in millions, except per share amounts)

CASM excluding fuel and special items reconciliation is summarized below:

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OPERATING REVENUE

Total operating revenue was approximately flat in the third quarter of 2023 compared to the same period in 2022. The changes are summarized in the following table:

(in millions)

Passenger revenue

On a consolidated basis, Passenger revenue for the third quarter of 2023 was approximately flat compared to the same period in 2022. While passenger traffic rose 11% due to increased departures flown by larger aircraft in our Mainline fleet, softening of the demand environment led to a 10% decrease in yield following record highs in the prior year. Additionally, cancellations for travel to Maui following wildfires in August resulted in approximately $20 million in decreased passenger revenue for the third quarter compared to the prior year.

Mileage Plan other revenue

On a consolidated basis, Mileage Plan other revenue for the third quarter of 2023 increased by $13 million, or 9%. The increase was driven by higher commissions from our bank card partners due to increased spend levels and annual membership fees.

OPERATING EXPENSES

Total operating expenses decreased $138 million, or 5%, compared to the third quarter of 2022. 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:

(in millions)

Fuel expense

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

Aircraft fuel expense decreased $183 million, or 21%, compared to the third quarter of 2022. The elements of the change are illustrated in the following table:

(in millions, except for per gallon amounts)

Raw fuel expense decreased 8% in the third quarter of 2023 compared to the third quarter of 2022, due to lower per gallon costs, partially offset by increased fuel consumption. Raw fuel expense per gallon decreased by 16% due to lower all-in jet fuel prices. Jet fuel prices are impacted by the price of crude oil and refining margins associated with the conversion of crude oil to jet fuel, both of which have decreased in the third quarter of 2023 compared to the prior year. Fuel gallons consumed increased 10%, driven by increased capacity.

We also evaluate economic fuel expense, which we define as raw fuel expense adjusted for the cash we receive from hedge counterparties for hedges that settle during the period and for the premium expense that we paid for those contracts. A key difference between aircraft fuel expense and economic fuel expense is the timing of gain or loss recognition on our hedge portfolio. Economic fuel expense includes gains and losses only when they are realized for those contracts that were settled during the period based on their original contract terms. We believe this is the best measure of the effect that fuel prices are currently having on our business as it most closely approximates the net cash outflow associated with purchasing fuel for our operations. Accordingly, many industry analysts evaluate our results using this measure, and it is the basis for most internal management reporting and incentive pay plans.

Losses recognized for hedges that settled during the third quarter were $18 million in 2023, compared to gains of $29 million in the same period in 2022. These amounts represent cash paid for premium expense, offset by any cash received from those hedges at settlement.

Non-fuel expenses

The table below provides the reconciliation of the operating expense line items, excluding fuel and other special items. Significant operating expense variances from 2022 are more fully described below.

(in millions)

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Wages and benefits

Wages and benefits increased by $96 million, or 14%, in the third quarter of 2023. The primary components of Wages and benefits are shown in the following table:

(in millions)

Wages increased $88 million, or 17%, on 4% growth in FTEs. When combined with FTE increases, higher wage rates stemming from market adjustments and annual step increases were the primary driver for incremental year-over-year expense for wages.

Incremental expense for defined contribution plans was driven by the change in wages as well as higher matching contributions for several labor groups. Decreased defined benefit expense was driven by changes in actuarial assumptions.

Aircraft maintenance

Aircraft maintenance expense increased by $26 million, or 28%, in the third quarter of 2023. The increase was primarily driven by the new B737-900ER power-by-the-hour contract in 2023, as well as increased aircraft utilization.

Aircraft rent

Aircraft rent expense decreased by $28 million, or 37%, in the third quarter of 2023. The decrease was primarily driven by the retirement of 23 leased A320 aircraft. The A321neo fleet retirement also contributed to the decrease, as seven aircraft were reclassified from operating leases to finance leases and three aircraft were purchased during 2023. These decreases were partially offset by delivery of four leased B737-9 aircraft since the third quarter of 2022.

Landing fees and other rentals

Landing fees and other rentals increased by $22 million, or 14%, in the third quarter of 2023. The increase was driven primarily by higher terminal rent costs resulting from both rate and volume increases at many of our facilities. Landing fees also increased due to higher rates and larger landing weights due to a shift in the mix of flying from Regional to Mainline and upgauging our fleet.

Contracted services

Contracted services increased by $17 million, or 20%, in the third quarter of 2023. The increase was driven primarily by higher rates charged by vendors for services as well as an increase in passengers.

Food and beverage service

Food and beverage service increased by $10 million, or 19%, in the third quarter of 2023. The increase was driven by a combination of 7% growth in revenue passengers and higher costs for food, food service supplies, and transportation.

Other expense

Other expense decreased by $22 million, or 11%, in the third quarter of 2023. The decrease was primarily driven by one-time employee recognition costs of $28 million recorded in the third quarter of 2022, partially offset by increases to miscellaneous variable costs in 2023 consistent with increased capacity.

Special items - fleet transition and other

We recorded expenses associated with the Company's fleet transition of $156 million in the third quarter of 2023. Refer to Note 2 to the consolidated financial statements for additional details.

ADDITIONAL SEGMENT INFORMATION

Refer to Note 10 to the consolidated financial statements for a detailed description of each segment. Below is a summary of each segment's results.

Mainline

Mainline operations reported an adjusted pretax profit of $326 million in the third quarter of 2023, compared to a profit of $446 million in the same period in 2022. The $120 million decrease was driven primarily by a $132 million increase in non-fuel operating expenses. Compared to the prior year, non-fuel operating expenses increased primarily due to higher wage rates across various labor groups. Higher variable costs, largely consistent with the overall growth in capacity and departures, also contributed to the increase.

Regional

Regional operations reported adjusted pretax profit of $1 million in the third quarter of 2023, compared to a loss of $2 million in the same period in 2022. The $3 million improvement was driven by decreased fuel expense on less capacity and a lower price per gallon, partially offset by decreased revenue on less capacity and higher wage rates.

Horizon

Horizon reported an adjusted pretax profit of $4 million in the third quarter of 2023, compared to a loss of $6 million in the same period in 2022. The $10 million improvement was driven by updates to internal rates under Horizon's CPA with Alaska and cost savings following Horizon’s transition to a single fleet. These improvements were partially offset by higher interest expense associated with debt financing of new E175 deliveries in 2023.

COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2023 TO NINE MONTHS ENDED SEPTEMBER 30, 2022

Our consolidated net income for the nine months ended September 30, 2023 was $237 million, or $1.84 per share, compared to consolidated net income of $36 million, or $0.28 per share, for the nine months ended September 30, 2022.

Our adjusted net income for the nine months ended September 30, 2023 was $545 million, or $4.22 per share, compared to adjusted net income of $438 million, or $3.42 per share, for the nine months ended September 30, 2022. The following table reconciles our adjusted net income and adjusted EPS to amounts as reported in accordance with GAAP:

(in millions, except per share amounts)

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CASM excluding fuel and special items reconciliation is summarized below:

OPERATING REVENUE

Total operating revenue increased $706 million, or 10%, during the first nine months of 2023 compared to the same period in 2022. The changes are summarized in the following table:

(in millions)

Passenger revenue

On a consolidated basis, Passenger revenue for the first nine months of 2023 increased by $656 million, or 10%, on a 12% increase in passenger traffic, partially offset by a 2% decrease in yield. The increase was primarily driven by increased departures flown by larger aircraft in our Mainline fleet. Redemptions by Mileage Plan members also provided a benefit over the prior year, with greater redemption on both Alaska and partner airlines.

We expect to see fourth quarter Passenger revenue consistent with the prior year due to increases in passenger traffic being offset by decreased yields.

Mileage Plan other revenue

On a consolidated basis, Mileage Plan other revenue increased $50 million, or 12%, in the first nine months of 2023. The increase was driven by higher commissions from our bank card partners due to increased spend levels, annual membership fees, and credit card acquisitions.

We expect to see continued strength in Mileage Plan other revenue for the remainder of 2023, enabled by higher commissions from increased card spend.

OPERATING EXPENSES

Total operating expenses increased $391 million, or 5%, compared to the first nine months of 2022. 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:

(in millions)

Fuel expense

Aircraft fuel expense decreased $68 million, or 3%, compared to the nine months ended September 30, 2022. The elements of the change are illustrated in the table:

(in millions, except for per gallon amounts)

Raw fuel expense decreased 10% in the first nine months of 2023 compared to the first nine months of 2022, due to lower per gallon costs, partially offset by increased fuel consumption. Raw fuel expense per gallon decreased by approximately 17% due to lower all-in jet fuel prices. Jet fuel prices are impacted by the price of crude oil and refining margins associated with the conversion of crude oil to jet fuel, both of which have decreased in the first nine months of 2023 compared to the prior year. Fuel gallons consumed increased 8%, driven by increased capacity.

Economic fuel expense includes losses recognized for hedges that settled in the first nine months of 2023 of $47 million, compared to gains of $167 million in the same period in 2022. These amounts represent cash paid for premium expense, offset by any cash received from those hedges at settlement.

We expect our economic fuel cost per gallon in the fourth quarter to range between $3.30 to $3.40 per gallon.

Non-fuel expenses

(in millions)

Wages and benefits

Wages and benefits increased by $328 million, or 17%, in the first nine months of 2023. The primary components of wages and benefits are shown in the following table:

(in millions)

Wages increased $269 million, or 18%, on 5% growth in FTEs. When combined with FTE increases, higher wage rates stemming from market adjustments and annual step increases were the primary driver for incremental year-over-year expense for wages and related taxes. Higher stock-based compensation also contributed to the increase in wages, driven by additional stock award grants within the period.

Incremental expense for defined contribution plans was driven by the change in wages as well as higher matching contributions for several labor groups. Increased expense for medical and other benefits was primarily driven by an increase in claims compared to the prior year and incremental FTEs. Decreased defined benefit expense was driven by changes in actuarial assumptions.

We expect to see higher wages and benefits for the remainder of 2023 due to the increase in wage rates. Wages and benefits could also increase further in 2023 due to agreements we may reach in the fourth quarter with represented labor groups.

Aircraft maintenance

Aircraft maintenance expense increased by $36 million, or 11%, in the first nine months of 2023. The increase was primarily driven by the new B737-900ER power-by-the-hour contract and increased aircraft utilization, partially offset by $35 million of lease return costs in the first quarter of 2022 that did not recur in 2023 as all lease return costs associated with the Company's fleet transition have been recorded to Special items - fleet transition and other since the announcement of our fleet transition plan in the second quarter of 2022.

We expect aircraft maintenance to increase for the remainder of 2023 as compared to 2022 due primarily to the B737-900ER power-by-the-hour contract, which will total approximately $100 million for the year. Higher aircraft utilization will also contribute to an increase in aircraft maintenance.

Aircraft rent

Aircraft rent expense decreased by $61 million, or 27%, in the first nine months of 2023. The decrease was driven by the retirement of 23 leased A320 aircraft. The A321neo fleet retirement also contributed to the decrease, as seven aircraft were reclassified from operating leases to finance leases and three aircraft were purchased during 2023. These decreases were partially offset by delivery of four leased B737-9 aircraft since the third quarter of 2022.

We expect aircraft rent will remain below 2022 levels for the remainder of 2023, due to the net reduction in overall leased aircraft described above.

Landing fees and other rentals

Landing fees and other rentals increased by $67 million, or 15%, in the first nine months of 2023. The increase was driven primarily by higher terminal rent costs resulting from both rate and volume increases at many of our facilities. Landing fees also increased due to higher rates and larger landing weights due a shift in the mix of flying from Regional to Mainline and upgauging our fleet.

We expect landing fees and other rentals to increase for the remainder of 2023 as compared to 2022 due to increased capacity and higher rates at airports.

Contracted services

Contracted services increased by $47 million, or 19%, in the first nine months of 2023. The increase was primarily driven by higher rates charged by vendors for services as well as an increase in passengers.

We expect contracted services to increase for the remainder of 2023 as compared to 2022 due to the reasons described above.

Food and beverage service

Food and beverage service increased by $33 million, or 23%, in the first nine months of 2023. The increase was driven by a combination of 8% growth in revenue passengers and higher costs for food, food service supplies, and transportation.

We expect the factors described above will continue to have a similar impact on food and beverage service for the remainder of 2023 as compared to 2022.

Third-party regional carrier expense

Third-party regional carrier expense, which represents payments made to SkyWest under the CPA with Alaska, increased $19 million, or 13%, in the first nine months of 2023. The increase in third-party regional carrier expense is driven by incremental SkyWest-operated departures. SkyWest departures have risen due to the annualization of ten E175 aircraft operating under the CPA which were delivered during the first half of 2022. Higher wage rates for flight crews have also contributed to the increase.

We expect third-party regional carrier expense will continue to be higher for the remainder of 2023 as compared to 2022 due to incremental departures and block hours, as well as higher wage rates for flight crews.

Other expense

Other expense increased $8 million, or 1%, in the first nine months of 2023. Costs increased as a result of crew-related expenses due to contract improvements for Alaska pilots, coupled with additional professional services and software expenses. These increases were partially offset by one-time employee recognition costs of $28 million recorded in the third quarter of 2022.

We expect other expense will continue to be higher for the remainder of 2023 as compared to 2022 due to overall growth throughout our network.

Special items - fleet transition

We recorded expenses associated with the Company's fleet transition of $355 million in the first nine months of 2023. Refer to Note 2 to the consolidated financial statements for additional details.

Special items - labor and other

We recorded a nonrecurring expense of $51 million in the first quarter of 2023 due to a Letter of Agreement with Alaska pilots, represented by ALPA. The charge is a one-time adjustment of accrued benefits related to expected future cash payments of pilots' unused sick leave upon retirement.

ADDITIONAL SEGMENT INFORMATION

Refer to Note 10 to the consolidated financial statements for a detailed description of each segment. Below is a summary of each segment's results.

Mainline

Mainline operations reported an adjusted pretax profit of $757 million in the first nine months of 2023, compared to a profit of $647 million in the same period in 2022. The $110 million improvement was driven by a $708 million increase in operating revenue, partially offset by a $534 million increase in non-fuel operating expense and a $49 million increase in fuel expense.

As compared to the prior year, higher revenue is primarily attributable to a 15% increase in traffic driven by the increase in capacity. Non-fuel operating expenses increased, driven by higher wage rates and higher variable costs, largely consistent with the overall growth in capacity and departures. Additional gallons consumed and prior year gains from settled hedges drove the increase in fuel expense.

Regional

Regional operations reported an adjusted pretax loss of $13 million in the first nine months of 2023, compared to a loss of $59 million in the same period in 2022. The $46 million improvement was primarily driven by decreased fuel expense due to a lower price per gallon and fewer gallons consumed.

Horizon

Horizon reported an adjusted pretax loss of $15 million in the first nine months of 2023, compared to a loss of $18 million in the same period in 2022. The $3 million improvement was driven by decreased operating expenses consistent with less flying and other cost savings following Horizon’s transition to a single fleet, as well as updates to internal rates under Horizon’s CPA with Alaska. These improvements were partially offset by lower overall CPA revenue consistent with less flying, as well as higher interest expense associated with debt financing of new E175 deliveries in 2023.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity are:

• Existing cash and marketable securities of $2.5 billion;
• Cash flows from operations of $1.1 billion;
• 62 unencumbered aircraft that could be financed, if necessary;
• Combined bank line-of-credit facilities, with no outstanding borrowings, of $550 million.

During the three months ended September 30, 2023, we took free and clear delivery of five owned Boeing 737-9 aircraft. We incurred new of debt of $361 million and made debt payments totaling $93 million. We ended the quarter with a debt-to-capitalization ratio of 48%, within our target range of 40% to 50%. We continued share repurchases, spending $13 million in the third quarter, pursuant to the $1 billion repurchase plan authorized by the Board of Directors in August 2015.

We believe that our current cash and marketable securities balance, combined with available sources of liquidity, will be sufficient to fund our operations, meet our debt payment obligations, and remain in compliance with the financial debt covenants in existing financing arrangements for the foreseeable future.

In our cash and marketable securities portfolio, we invest only in securities that meet our primary investment strategy of maintaining and securing investment principal. The portfolio is managed by reputable firms that adhere to our investment policy that sets forth investment objectives, approved and prohibited investments, and duration and credit quality guidelines. Our policy, and the portfolio managers, are continually reviewed to ensure that the investments are aligned with our strategy.

The table below presents the major indicators of financial condition and liquidity:

(in millions)

(in millions)

(a) To best reflect our leverage at September 30, 2023, we included our capitalized finance lease balances, which are recognized within the Current portion of long-term debt and finance leases line in the condensed consolidated balance sheets.

Adjusted net debt to earnings before interest, taxes, depreciation, amortization, special items, and rent

(in millions)

(a) Operating Income can be reconciled using the trailing twelve month operating income as filed quarterly with the SEC.

The following discussion summarizes the primary drivers of the increase in our cash and marketable securities balance and our expectation of future cash requirements.

ANALYSIS OF OUR CASH FLOWS

Cash Provided by Operating Activities

For the first nine months of 2023, net cash provided by operating activities was $1.1 billion, compared to $1.4 billion in 2022. Cash provided by ticket sales and from our co-branded credit card agreement are the primary sources of our operating cash flow. Our primary use of operating cash flow is for operating expenses, including payments for employee wages and benefits, payments to suppliers for goods and services, and payments to lessors and airport authorities for rents and landing fees. Operating cash flow also includes payments to, or refunds from, federal, state, and local taxing authorities.

The $306 million net decrease in our operating cash flows was due to a combination of factors. 2022 operating cash flows included federal income tax refunds of $260 million. Additionally, growth in our air traffic liability decreased $125 million and payments made in 2023 for our 2022 performance-based pay program were approximately $110 million higher than payments in 2022 for our 2021 program. These amounts were partially offset by an improved net income compared to the prior year.

Cash Used in Investing Activities

Cash used in investing activities was $810 million during the first nine months of 2023, compared to $888 million in 2022. The change was due to a combination of factors. Marketable securities activity was $287 million of net sales during the first nine months of 2023, compared to $61 million in 2022. This amount was partially offset by an increase in capital expenditures, which were $44 million higher compared to 2022. Cash used in investing during the first nine months of 2023 was also impacted by the purchase of three previously leased A321neo aircraft, included in Other investing activities, which are expected to be sold to American Airlines in the fourth quarter of 2023 and first quarter of 2024.

Cash Provided by (Used in) Financing Activities

Cash provided by financing activities was $12 million during the first nine months of 2023, compared to cash used in financing activities of $296 million in 2022. The change was largely driven by $313 million in new debt proceeds and $91 million less in payments for outstanding long-term debt compared to 2022. These amounts were partially offset by common stock repurchases of $70 million in 2023 and a decrease of cash flows from other financing activities of $26 million.

MATERIAL CASH COMMITMENTS

Material cash requirements include the following contractual and other obligations:

Aircraft Commitments

As of September 30, 2023, Alaska has firm orders to purchase 89 B737 aircraft with deliveries between 2023 and 2027 and a firm commitment to lease one B737-9 aircraft with delivery in 2023. Alaska has rights for 105 additional B737-10 aircraft between 2026 and 2030. Alaska also has commitments to lease two B737-800 freighters with deliveries in 2023 and 2024.

Boeing has communicated to Alaska that certain B737 deliveries contracted in 2023 are expected to be delayed into 2024. The anticipated fleet delivery schedule outlined below reflects the expected impact of these delays. Alaska continues to work with Boeing to structure delivery timelines in a manner that supports Alaska's capacity growth plans.

As of September 30, 2023, Horizon has commitments to purchase nine E175 aircraft with deliveries between 2024 and 2026. Horizon has options to acquire 13 E175 aircraft between 2025 and 2026. The E175 deliveries expected through the end of 2024 are covered under a financing agreement executed in the second quarter of 2023. Capital expenditures for these deliveries, which are included within aircraft-related commitments in the contractual obligations table below, will be reflected as a non-cash transaction in the condensed consolidated statements of cash flows. Subsequent to quarter end, two of Horizon's 13 E175 options expired.

Options will be exercised only if we believe return on invested capital targets can be met over the long term. We intend to finance future aircraft deliveries and option exercises using cash flow from operations or long-term debt.

To best reflect our expectations of future fleet activity, we have incorporated anticipated delivery delays and other modifications of our order book as agreed to in principle with Boeing into the following table, which summarizes our expected fleet count by year, as of November 2, 2023:

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Fuel Hedge Positions

All of our future oil positions are call options, which are designed to effectively cap the cost of the crude oil component of our jet fuel purchases. With call options, we are hedged against volatile crude oil price increases and, during a period of decline in crude oil prices, we only forfeit cash previously paid for hedge premiums. We typically hedge up to 50% of our expected consumption. Our crude oil positions are as follows:

Contractual Obligations

The following table provides a summary of our obligations as of November 2, 2023 and reflects anticipated delivery delays and other modifications of our order book as agreed to in principle with Boeing. For agreements with variable terms, amounts included reflect our minimum obligations.

(in millions)

(a) Lease commitments include minimum payments for aircraft operated under operating leases and aircraft removed from operating service which remain under operating and finance leases, as we have remaining cash obligations under existing terms. It also includes minimum lease payments for facilities.

(b) Includes contractual commitments for aircraft, engines, and aircraft maintenance. Option deliveries are excluded from minimum commitments until exercise.

(c) For variable-rate debt, future obligations are shown above using interest rates forecast as of September 30, 2023.

Debt Obligations and Interest Obligations

The Company primarily issues debt to fund purchases of aircraft or other capital expenditures. During the nine months ended September 30, 2023, the Company incurred new debt of $495 million and repaid $242 million in existing debt. At September 30, 2023, our debt portfolio carries a weighted average interest rate of 4.3%. Interest is paid with regular debt service. Refer to Note 5 to the consolidated financial statements for further discussion of our debt and interest balances.

CPA and Other Obligations

We have obligations primarily associated with the non-lease components of our capacity purchase agreement between Alaska and SkyWest, as well as other various sponsorship agreements and investment commitments.

Leased Aircraft Return Costs

For many of our leased aircraft, contractual terms require us to return the aircraft in a specified state. As a result of these contractual terms, we will incur significant costs to return these aircraft at the termination of the lease. Costs to return leased aircraft are accrued when the costs are probable and reasonably estimable, usually over the twelve months prior to the lease return, unless a determination is made to remove the leased asset from operation. If the leased aircraft is removed from the operating fleet, the estimated cost to return is accrued at the time of removal. If a leased aircraft has a known early retirement date in the future, the estimated cost to return is accrued through the retirement date. Any accrual is based on the time remaining on the lease, planned aircraft usage, and the provisions included in the lease agreement, although the actual amount due to any lessor upon return may not be known with certainty until lease termination. A total of $165 million is accrued for upcoming lease returns at September 30, 2023, including costs recorded in prior year periods.

Credit Card Agreements

Alaska has agreements with a number of credit card companies to process the sale of tickets and other services. Under these agreements, there are material adverse change clauses that, if triggered, could result in the credit card companies holding back a reserve from our credit card receivables. Under one such agreement, we could be required to maintain a reserve if our credit rating is downgraded to or below a rating specified by the agreement or our cash and marketable securities balance fell below $500 million. Under another such agreement, we could be required to maintain a reserve if our cash and marketable securities balance fell below $500 million. We are not currently required to maintain any reserve under these agreements, but if we were, our financial position and liquidity could be materially harmed.

Sustainability Commitments

As part of our efforts to reach net-zero carbon emissions by 2040, we have outlined a five-part path that we expect to include operational efficiency, fleet renewal, sustainable aviation fuel (SAF), enabling new technologies including zero emission aircraft in the future, and using credible offsetting and removal technologies to close the gaps to our emissions target in future years. We anticipate these efforts will require cash outlays, not all of which are reflected in our contractual commitments. Finding and establishing relationships with suppliers to meet these commitments is in process. Currently, Alaska has agreements to purchase approximately 200 million gallons of neat SAF to be delivered through 2030. These agreements are dependent on suppliers' ability to obtain all required governmental and regulatory approvals, achieve commercial operation, and produce sufficient quantities of SAF. Financial commitments that have been contractually established and have met defined minimum obligations, including those related to Alaska Star Ventures, are included within the CPA and other obligations row in the above table.

Income Taxes

For federal income tax purposes, the majority of our property and equipment are fully depreciated over a seven-year life using an accelerated depreciation method or bonus depreciation, if available. For financial reporting purposes, the majority of our assets are depreciated over 15 to 25 years to an estimated salvage value using the straight-line basis. This difference has created a significant deferred tax liability. At some point in the future, the property and equipment difference will reverse into taxable income, potentially resulting in an increase in income taxes payable.

While it is possible that we could have material cash obligations for this deferred liability at some point in the future, we cannot estimate the timing of long-term cash flows with reasonable accuracy. Taxable income and cash taxes payable in the short term are impacted by many items, including the amount of book income generated (which can be volatile depending on revenue and fuel prices, among other factors out of our control), whether bonus depreciation provisions are available, as well as other legislative changes beyond our control. We believe we have the liquidity to make our future tax payments.

CRITICAL ACCOUNTING ESTIMATES

There have been no material changes to our critical accounting estimates during the three and nine months ended September 30, 2023. For information regarding our critical accounting estimates, see Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the year ended December 31, 2022.

GLOSSARY OF AIRLINE TERMS

Adjusted net debt - long-term debt, including current portion, plus capitalized operating and finance leases, less cash and marketable securities

Adjusted net debt to EBITDAR - represents adjusted net debt divided by EBITDAR (trailing twelve months earnings before interest, taxes, depreciation, amortization, special items and rent)

Aircraft Utilization - block hours per day; this represents the average number of hours per day our aircraft are in transit

Aircraft Stage Length - represents the average miles flown per aircraft departure

ASMs - available seat miles, or “capacity”; represents total seats available across the fleet multiplied by the number of miles flown

CASM - operating costs per ASM; represents all operating expenses including fuel and special items

CASMex - operating costs excluding fuel and special items per ASM, or "unit cost"; this metric is used to help track progress toward reduction of non-fuel operating costs since fuel is largely out of our control

Debt-to-capitalization ratio - represents adjusted debt (long-term debt plus capitalized operating and finance leases) divided by total equity plus adjusted debt

Diluted Earnings per Share - represents earnings per share (EPS) using fully diluted shares outstanding

Diluted Shares - represents the total number of shares that would be outstanding if all possible sources of conversion, such as stock options, were exercised

Economic Fuel - best estimate of the cash cost of fuel, net of the impact of settled fuel-hedging contracts in the period

Load Factor - RPMs as a percentage of ASMs; represents the number of available seats that were filled with paying passengers

Mainline - represents flying Boeing 737, Airbus A320, and Airbus A321neo jets and all associated revenue and costs

Productivity - number of revenue passengers per full-time equivalent employee

RASM - operating revenue per ASMs, or "unit revenue"; operating revenue includes all passenger revenue, freight & mail, Mileage Plan and other ancillary revenue; represents the average total revenue for flying one seat one mile

Regional - represents capacity purchased by Alaska from Horizon and SkyWest. In this segment, Regional records actual on-board passenger revenue, less costs such as fuel, distribution costs, and payments made to Horizon and SkyWest under the respective capacity purchased arrangement (CPA). Additionally, Regional includes an allocation of corporate overhead such as IT, finance, and other administrative costs incurred by Alaska and on behalf of Horizon.

RPMs - revenue passenger miles, or "traffic"; represents the number of seats that were filled with paying passengers; one passenger traveling one mile is one RPM

Yield - passenger revenue per RPM; represents the average revenue for flying one passenger one mile

There have been no material changes in market risk from the information provided in Item 7A. “Quantitative and Qualitative Disclosure About Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2022.

Evaluation of Disclosure Controls and Procedures

As of September 30, 2023, an evaluation was performed under the supervision and with the participation of our management, including our chief executive officer and chief financial officer (collectively, our “certifying officers”), of the effectiveness of the design and operation of our disclosure controls and procedures. These disclosure controls and procedures are designed to ensure that the information required to be disclosed by us in our periodic reports filed with or submitted to the Securities and Exchange Commission (the SEC) is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, and includes, without limitation, controls and procedures designed to ensure that such information is accumulated and communicated to our management, including our certifying officers, as appropriate, to allow timely decisions regarding required disclosure. Our certifying officers concluded, based on their evaluation, that disclosure controls and procedures were effective as of September 30, 2023.

Changes in Internal Control over Financial Reporting

There have been no changes in the Company’s internal controls over financial reporting during the quarter ended September 30, 2023, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

Our internal control over financial reporting is based on the 2013 framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Framework).

See Part I, Item 1A. "Risk Factors," in our 2022 Form 10-K for a detailed discussion of risk factors affecting Alaska Air Group.