ALASKA AIR GROUP, INC. (ALK) FY 2021 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand our company, our operations and our present business environment. MD&A is provided as a supplement to – and should be read in conjunction with – our consolidated financial statements and the accompanying notes. All statements in the following discussion that are not statements of historical information or descriptions of current accounting policy are forward-looking statements. Please consider our forward-looking statements in light of the risks referred to in this report’s introductory cautionary note and the risks mentioned in Part I, “Item 1A. Risk Factors.” This overview summarizes the MD&A, which includes the following sections:

•Year in Review—highlights from 2021 outlining some of the major events that happened during the year and how they affected our financial performance.

•Results of Operations—an in-depth analysis of our revenues by segment and our expenses from a consolidated perspective for the most recent two years presented in our consolidated financial statements. To the extent material to the understanding of segment profitability, we more fully describe the segment expenses per financial statement line item. Financial and statistical data is also included here. This section also includes forward-looking statements regarding our view of 2022.

•Liquidity and Capital Resources—an overview of our financial position, analysis of cash flows, sources and uses of cash, contractual obligations and commitments, and off-balance sheet arrangements.

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

This section of the Form 10-K covers discussion of 2021 and 2020 results, and comparisons between those years. For a discussion of the year ended December 31, 2020 compared to the year ended December 31, 2019, please refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2020.

YEAR IN REVIEW

Business Recovery

Our 2021 financial performance demonstrates the strength of our business model and our ability to adapt while facing uneven recovery from the COVID-19 pandemic. With the widespread availability of vaccines and the relaxation of local restrictions in many of the markets we serve, customer demand for air travel increased dramatically in late spring 2021. For the full year, we recorded revenues of $6.2 billion, 70% of 2019 levels, on 79% of our 2019 capacity. Despite volatility caused by the rise of new variants, our measured return of capacity, coupled with solid cost control and operational performance enabled us to return to adjusted pre-tax profitability in the third and fourth quarters of 2021. Although we recorded an adjusted net loss for the full year of $256 million, profitability in the second half of the year indicates our approach to recovery has largely been successful.

With our business stabilizing, we generated $138 million in operating cash flow, excluding $892 million in grants received from the CARES Payroll Support Program. With our mid-year return to profitability and early return to positive cash flow generation, we were well positioned to begin utilizing excess on-hand liquidity to pay down debt and repair our balance sheet. In 2021 we repaid $1.3 billion in debt, offset by $363 million in issuances, which lowered our debt-to-capitalization ratio to 49%, marking a 12 point improvement from December 31, 2020. Additionally, we made a $100 million voluntary pension contribution payment to the defined benefit plan for Alaska's pilots, bringing our pension status to 98% funded at year end. Balance sheet strength combined with our operational model has been critical to our past success, and we believe we are well positioned exiting 2021 to again capitalize on these as we prepare for growth.

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See "Results of Operations" below for further discussion.

Outlook

Our improving financial results and well-managed balance sheet provide a strong foundation for the next phase of recovery. We remain committed to returning capacity in a measured way, and will align our ongoing network restoration with the continued return of demand. We expect to be back to 2019 flying levels by summer 2022, and to grow our airlines from there in the back half of the year.

Recent demand setbacks and operational disruptions stemming from the omicron variant are reflected in our first quarter expectations. While January was acutely impacted, bookings for Presidents Day and beyond remain strong. In response to these conditions, we scaled back our first quarter capacity plans. As a result, in Q1 2022 we expect to fly approximately 10% to 13% below the same period in 2019, and expect total revenue to be 14% to 17% below the same period in 2019. Our unit costs for the period are expected to be up 15% to 18% versus 2019, with 7 points of pressure attributable to lower than expected levels of flying given the recent schedule adjustments.

For full year 2022, we expect capacity to increase 2% to 6% versus 2019, dependent on demand. This guidance reflects first half capacity that is flat to slightly up, and second half capacity that could be as much as 10% higher versus 2019.

Throughout the pandemic we have stated our commitment to returning to 2019 unit costs levels even if we were to remain a smaller airline for some time. While we no longer expect to be a smaller airline, as signaled by our growth plans in the back half of the year, we are still fundamentally committed to returning to our pre-COVID cost performance. For the full year, we expect CASMex to be up 3% to 6% versus 2019 levels, which includes the impact of lease return costs associated with our Airbus aircraft. Excluding those costs, we expect CASMex to be up 1% to 3% versus 2019. This guidance implies we will return to our pre-COVID cost levels in the second half of 2022.

The guidance we have provided and our outlook more broadly are sensitive to health trends, exposure to variants of the COVID-19 virus, and regulations and restrictions imposed by state, local and federal authorities. Our plans will be responsive to emerging information and the guidance we have provided is subject to greater uncertainty than we have historically experienced. Our people continue to focus on keeping costs low, running a great operation, and welcoming guests back to travel with Next-Level Care to ensure they are safe and comfortable when they fly. These are competitive advantages we have cultivated over many years that will continue to serve us well in 2022 and beyond. We are confident that we are prepared to meet the challenges ahead and that we will emerge from the pandemic a stronger and more resilient airline.

RESULTS OF OPERATIONS

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

We believe disclosure of earnings excluding the impact of the Payroll Support Program wage offset, special items, mark-to-market gains or losses or other individual special revenues or expenses is useful information to investors because:

•By excluding fuel expense and certain special items (including the Payroll Support Program wage offset, impairment and restructuring charges and merger-related costs) from our unit metrics, we believe that we have better visibility into the results of operations as we focus on cost-reduction initiatives emerging from the COVID-19 pandemic. Our industry is highly competitive and is characterized by high fixed costs, so even a small reduction in non-fuel operating costs can 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 and certain special items, such as the Payroll Support Program wage offset, impairment and restructuring charges and merger-related costs, is one of the most important measures used by management and by our Board of Directors in assessing quarterly and annual cost performance.

•CASM excluding fuel and certain special items is a measure commonly used by industry analysts and we believe it is an important metric by which they have historically compared our airline to others in the industry. The measure is also the subject of frequent questions from investors.

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•Adjusted income before income tax and other items as specified in our plan documents is an important metric for the employee annual cash 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 revenues, we do not (nor are we able to) evaluate unit revenues excluding the impact that changes in fuel costs have had on ticket prices. Fuel expense represents a large percentage of our total operating expenses. Fluctuations in fuel prices often drive changes in unit revenues in the mid-to-long term. Although we believe it is useful to evaluate non-fuel unit costs for the reasons noted above, we would caution readers of these financial statements not to place undue reliance on unit costs excluding fuel as a measure or predictor of future profitability because of the significant impact of fuel costs on our business.

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

2021 COMPARED WITH 2020

Our consolidated net income for 2021 was $478 million, or $3.77 per diluted share, compared to a net loss of $1.3 billion, or $10.72 per share, in 2020.

Excluding the impact of the Payroll Support Program wage offset, special items and mark-to-market fuel hedge adjustments, our adjusted consolidated net loss for 2021 was $256 million, or $2.03 per share, compared to an adjusted consolidated net loss of $1.3 billion, or $10.17 per share, in 2020. The following table reconciles our adjusted net loss per share (EPS) during the full year 2021 and 2020 to amounts as reported in accordance with GAAP.

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CASMex is reconciled to CASM below:

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OPERATING STATISTICS SUMMARY (unaudited)

Below are operating statistics we use to measure performance.

(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.

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Given the unusual nature of 2020, we believe that some analysis of specific financial and operational results compared to 2019 provides meaningful insight. The table below includes comparative results from 2021 to 2019.

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OPERATING REVENUES

Total operating revenues increased $2.6 billion, or 73%, during 2021 compared to the same period in 2020. The changes are summarized in the following table:

Passenger Revenue

On a consolidated basis, Passenger revenue for 2021 increased by $2.5 billion, or 82%, on a 41% increase in capacity, and an 18 point increase in load factor. Recovery from the pandemic is the driver of these changes as demand for travel increased in 2021, primarily led by leisure travelers. There were setbacks to the improvement late in the fourth quarter as absenteeism driven by the omicron variant and severe winter weather on the West Coast led to canceled flights and lost passenger revenue.

We anticipate Passenger revenue for 2022 will increase as compared to 2021 consistent with our overall growth plan. Although we face headwinds in the first quarter due to continuing impacts of the omicron variant, we anticipate full year capacity will grow 2% to 6% versus 2019.

Mileage Plan Other Revenue

On a consolidated basis, Mileage Plan other revenue increased $87 million, or 23%, as compared to 2020, largely due to an increase in commission revenue from our affinity card partner stemming from growing consumer spend and an increase in cardholders.

Cargo and Other

On a consolidated basis, Cargo and other revenue increased $43 million, or 25%, from 2020. The increase is primarily due to the return of all three freighters back to full capacity in the second quarter of 2021, coupled with increased belly cargo activity on increased scheduled departures.

We expect that our cargo revenues will increase in 2022 as compared to 2021 on a full year of freighter capacity and incremental belly cargo availability as we increase our capacity.

OPERATING EXPENSES

Total operating expenses increased $150 million, or 3%, compared to 2020. We consider it useful to summarize operating expenses as follows, which is consistent with the way expenses are reported internally and evaluated by management:

Significant operating expense variances from 2020 are more fully described below.

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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 increased $556 million, or 77%, compared to 2020. The elements of the change are illustrated in the following table:

The raw fuel price per gallon increased 37% due to higher West Coast jet fuel prices. West Coast jet fuel prices are impacted by both the price of crude oil, as well as refining margins associated with the conversion of crude oil to jet fuel. Increased fuel costs were also driven by a 42% increase in gallons consumed compared to 2020, consistent with a 41% increase in capacity.

Gains recognized for hedges that settled during the year were $57 million in 2021, compared to losses of $18 million in 2020. These amounts represent cash received from settled hedges, offset by cash paid for the premium cost on related call options.

We expect our economic fuel cost per gallon in the first quarter of 2022 to range between $2.45 and $2.50 per gallon based on current market West Coast jet fuel prices.

Non-fuel Expenses

The table below provides the reconciliation of the operating expense line items, excluding fuel, the Payroll Support Program wage offset and special items. Significant operating expense variances from 2020 are more fully described below.

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Wages and Benefits

Wages and benefits increased during 2021 by $165 million, or 8%, compared to 2020, excluding the impact of the Payroll Support Program wage offset. The primary components of Wages and benefits are shown in the following table:

Wages and payroll taxes increased by a combined $172 million, or 10%, on a 10% increase in FTEs. Increased FTEs as compared to the prior period are primarily the result of pilots and employees returning from leaves of absence and incentive lines accepted in 2020. Higher wage rates from incentives paid to certain employees in the summer and holiday periods in response to increasing demand were largely offset by a lower average wage rate from the growth in newly hired employees who have a lower wage base than more senior employees.

We expect wages and benefits expense to be higher in 2022 compared to 2021 given our expected growth in overall FTEs needed to support our expected capacity growth. Our guidance does not include the impacts of any future agreements we may reach in 2022, most notably with our mainline pilots whose contract became amendable in April 2020.

Variable Incentive Pay

Variable incentive pay expense increased to $151 million in 2021 from $130 million in 2020. The increase is primarily due to higher payouts achieved under the Performance Based Pay Plan by meeting or exceeding certain cash flow, safety, emissions and productivity targets.

Aircraft Maintenance

Aircraft maintenance costs increased by $43 million compared to 2020. The increase is primarily due to increased component repairs which were deferred in 2020, as well as increased power-by-the-hour expense driven by increased utilization of covered aircraft.

We expect aircraft maintenance expense to be higher in 2022 due to increased aircraft utilization and expected lease return costs that are expected to be incurred over the next 24 to 36 months as we prepare to return Airbus aircraft to lessors.

Aircraft Rent

Aircraft rent expense decreased $45 million, or 15%, compared to 2020, primarily as a result of full impairment taken on certain leased Airbus aircraft in 2020.

We expect aircraft rent to increase in 2022 on the annualization of expense and incremental deliveries of leased 737-9 aircraft as well as incremental SkyWest lease deliveries.

Landing Fees and Other Rentals

Landing fees and other rental expenses increased $138 million, or 33%, compared to 2020, primarily due to a significant increase in departures, combined with increased rates at certain of our hub airports.

We expect landing fees and other rental expense to increase in 2022 as we continue to increase capacity and departures across our network, combined with higher rates at many of our hub airports.

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Contracted Services

Contracted services increased by $54 million, or 30%, compared to 2020, primarily driven by increased departures and passengers at stations where we outsource our ground operations.

We expect contracted services to increase in 2022 as we continue to increase capacity and departures throughout our network.

Selling Expenses

Selling expenses increased by $72 million, or 71%, compared to 2020 primarily driven by a significant increase in distribution costs and credit card commissions stemming from increased revenues. Increased marketing spend and sponsorship costs related to the return of professional sports and events also contributed to the year-over-year increase.

We expect selling expense to increase in 2022, due primarily to higher sales as demand for air travel returns and an increase in marketing costs as we expand our network.

Food and Beverage Service

Food and beverage service increased by $49 million, or 54%, compared to 2020, consistent with the overall increase in revenue passengers, as well as the return and expansion of many of our on-board products in 2021.

We expect food and beverage service to increase in 2022 as we continue to increase capacity and departures throughout our network and return to full service aboard our aircraft.

Third-party Regional Carrier Expense

Third-party regional carrier expense, which represents payments made to SkyWest under our CPA agreements, increased $19 million, or 15%, in 2021 compared to 2020. The increase in expense is primarily due to increases in departures flown by SkyWest as compared to the prior-year period, offset by the final pass through of CARES Act PSP funding for SkyWest pilot and flight attendant wages.

We expect third-party regional carrier expense to be higher in 2022 on the addition of 10 aircraft flown by SkyWest under a CPA.

Other Expense

Other expense increased $100 million, or 25%, compared to 2020 primarily driven by incremental crew hotel stays and per diem, consistent with the overall increase in departures and capacity, as well as additional expense for professional services.

We expect other expense to increase in 2022 as we increase departures and hire more employees, resulting in incremental crew costs.

Special Items - Impairment charges

We recorded an impairment benefit of $1 million in 2021. The benefit consisted of adjustments associated with leased aircraft that have been retired and removed from the operating fleet but not yet returned to the lessor. We continue to evaluate total estimated costs to return these permanently parked aircraft, and make updates to total expense when necessary.

Special Items - Restructuring charges

We recorded a restructuring benefit of $10 million in 2021 primarily as a result of issuing recall notices to pilots on incentive lines for periods earlier than were previously anticipated. As all employees expected to return to work have been recalled, we do not anticipate further restructuring charges in 2022.

ADDITIONAL SEGMENT INFORMATION

Refer to Note 13 of the consolidated financial statements for a detailed description of each segment. Below is a summary of each segment's profitability.

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Mainline

Mainline adjusted pretax loss was $179 million in 2021 compared to adjusted pretax loss of $1.4 billion in 2020. The $1.2 billion improvement in pretax loss was driven by a $2.2 billion increase in Mainline operating revenue, offset by a $471 million increase in Mainline non-fuel operating expense and a $496 million increase in Mainline fuel expense.

As compared to the prior year, higher Mainline revenues are primarily attributable to a 94% increase in traffic on a 46% increase in capacity, driven by the recovery seen in demand in 2021. Non-fuel operating expenses and fuel expenses rose given the increase in traffic and capacity, as well as higher raw fuel prices.

Regional

Regional adjusted pretax loss was $210 million in 2021 compared to an adjusted pretax loss of $421 million in 2020. The $211 million improvement in pretax loss was primarily attributable to a $413 million increase in Regional operating revenues, offset by a $103 million increase in Regional non-fuel operating expense and a $99 million increase in Regional fuel expense.

As compared to the prior year, higher Regional revenues are primarily attributable to a 59% increase in traffic on a 17% increase in capacity, driven by the recovery seen in demand in 2021. Non-fuel operating expenses and fuel expenses rose given the increase in traffic and capacity, as well as higher raw fuel prices.

Horizon

Horizon achieved an adjusted pretax profit of $12 million in 2021 compared to $41 million in 2020, primarily as a result of higher operating expenses in 2021. The increased expenses were primarily related to flight operations and maintenance costs as the business began to recover during the year.

LIQUIDITY AND CAPITAL RESOURCES

Improved results and increased demand in 2021 allowed us to begin the process of returning our balance sheet and available liquidity to pre-pandemic levels. During the year, we made the following meaningful progress:

•Generated positive operating cash flow in excess of $1 billion, bolstered by improved advance bookings as demand returns, and the receipt of $892 million in Payroll Support Program funding from the U.S. Treasury under extensions of CARES Act programs;

•Repaid $1.3 billion in debt, including the termination of the CARES Act secured loan, full repayment of two outstanding lines of credit, and prepayment of the $425 million 364-day term loan facility;

•Decreased debt-to-capitalization ratio to 49% at December 31, 2021 from 61% at December 31, 2020;

•Made a $100 million voluntary contribution to the defined benefit plan for Alaska's pilots, boosting estimated combined funded status of all defined benefit plans to 98%, and;

•Restored pool of unencumbered aircraft in the operating fleet to 42 as of December 31, 2021, which could be financed, if necessary.

As the business continues to recover to sustained profitability, reducing outstanding debt, normalizing our on-hand liquidity, and strengthening our balance sheet remain high priorities. We anticipate funding our planned 2022 capital expenditures of $1.5 billion to $1.6 billion with cash on-hand.

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.

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

Debt-to-capitalization, adjusted for operating leases

(a) To best reflect our leverage at December 31, 2020, we included the short-term borrowings stemming from the COVID-19 pandemic which were classified as current liabilities in the consolidated balance sheets.

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

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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

Net cash provided by operating activities was $1 billion in 2021 compared to net cash used of $234 million in 2020. Cash provided by ticket sales is the primary source of our operating cash flow. In 2021, we also had material cash inflows of $892 million from the receipt of PSP grants. 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. Changes in demand that resulted from the pandemic recovery and the changes we made to our operations in response had a dramatic impact on our operating cash flows in 2021.

In 2021, revenues increased $2.6 billion when compared to 2020, driven by improved demand described more fully below, and incremental cash from our affinity card partners on increased miles purchased. Operating expenses increased $150 million versus prior year, driven by significantly higher fuel costs and increased operating costs as we returned capacity to meet demand, offset by a reduction of $858 million in non-cash impairment and restructuring charges recorded in 2020.

In 2021, Air Traffic Liability (ATL) increased $90 million, driven by new ticket purchases primarily at the end of the year, offset by credits redeemed for travel. Although ATL was a source of working capital in 2021, as of December 31, 2021 the balance includes $234 million in travel credits issued to guests. These credits are expected to be redeemed by guests for travel in future periods and will represent a working capital headwind.

Cash Used in Investing Activities

Cash used in investing activities was $1 billion during 2021 compared to $593 million in 2020. Increased cash used in investing activities is primarily driven by the 2020 sale-leaseback transaction for ten owned A320 aircraft, with no comparative transaction in 2021. Cash used also increased due to a $70 million increase in capital expenditures, as well as net purchases of marketable securities of $706 million in 2021, compared to net purchases of $644 million in 2020. Increased net purchases are primarily driven by additional cash on hand from borrowings and the PSP, which allowed the Company to invest additional funds.

Cash Used in Financing Activities

Cash used in financing activities was $914 million during 2021, compared to net cash provided of $2 billion in 2020. During the year, we utilized cash on hand to make $1.3 billion in debt payments, compared to $565 million in the prior year. These payments were offset by proceeds from debt issuances of $363 million, compared to $2.6 billion issued in 2020 in response to the COVID-19 pandemic.

MATERIAL CASH COMMITMENTS

Material cash requirements include the following contractual and other obligations:

Aircraft Commitments

As of December 31, 2021, Alaska has firm orders to purchase 74 Boeing 737-9 aircraft with deliveries in 2022 through 2024 and firm commitments to lease eight Boeing 737-9 aircraft with deliveries between 2023 and 2034. Alaska also has an agreement with SkyWest Airlines to expand our long-term capacity purchase agreement by three aircraft in 2022 and two aircraft in 2023. Horizon also has commitments to purchase seven E175 aircraft with deliveries in 2023 through 2025. Alaska has options to acquire up to 52 additional 737-9 aircraft and Horizon has options to acquire 15 E175 aircraft. Options will be exercised only if we believe return on invested capital targets can be met over the long term.

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The following table summarizes our anticipated fleet count by year, as of the date of this filing:

(a)Anticipated fleet activity reflects intended early retirement and extensions or replacement of certain leases, not all of which have been contracted yet.

(b)Actual fleet at December 31, 2021, excluding Airbus aircraft that were removed from operating service in 2020 in response to COVID-19 capacity reductions. Of these, nine have since been returned to service in 2021 and three are planned to return in 2022.

(c)Retirements in 2022 and 2023 are contractual lease expirations of Horizon Q400 aircraft in each respective year.

(d)Aircraft are either owned or leased by Horizon or operated under a capacity purchase agreement with a third party. Under the terms of our capacity purchase agreement with a third party, in 2023 an additional spare aircraft will be leased to support the operational integrity of the network.

For future firm orders and option exercises, we may finance the aircraft through cash flow from operations or long-term debt.

Future Fuel Hedge Positions

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

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Contractual Obligations

The following table provides a summary of our obligations as of December 31, 2021. For agreements with variable terms, amounts included reflect our minimum obligations. Discussion of these obligations follow the table below.

(a)Future minimum lease payments for aircraft includes commitments for aircraft which have been removed from operating service, as we have remaining obligations under existing terms.

(b)Includes non-cancelable contractual commitments for aircraft and engines, buyer furnished equipment, and contractual aircraft maintenance obligations.

(c)For variable-rate debt, future obligations are shown above using LIBOR forward curve as of December 31, 2021.

(d)Primarily comprised of non-aircraft lease costs associated with capacity purchase agreements.

Debt Obligations and Interest Obligations

The Company primarily issues debt to fund purchases of aircraft or other capital expenditures. In response to the COVID-19 pandemic, in 2020, we issued $2.6 billion in debt to withstand the downturn and prepare for recovery. In 2021, we repaid $1.3 billion in debt, including prepayments of $923 million, which was partially offset by issuances of $363 million. At December 31, 2021, our debt portfolio carries a weighted average interest rate of 3.3%. Interest is paid with regular debt service. Debt service obligations in 2022 is expected to be $456 million, inclusive of interest and principal. Refer to Note 6 to the consolidated financial statement for further discussion of our debt and interest balances.

Leased Aircraft Return Costs

For many of our leased aircraft, we are required under the contractual terms to return the aircraft in a specified state. As a result of these contractual terms, we may incur significant costs at the termination of the lease. Costs of returning leased aircraft are accrued when the costs are probable and reasonably estimable, usually beginning at least 12 months prior to the lease return, unless the leased asset is removed from operation. If the leased aircraft is removed from the operating fleet, the estimated cost of return is accrued at the time of removal. Such estimates are 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. We anticipate recording material expenses and cash outflows to return aircraft beginning in 2022, as all Airbus A319 and A320 aircraft are expected to be removed from operating service by 2023.

Credit Card Agreements

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

Deferred Income Taxes

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

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

In 2021, we made tax payments, net of refunds, totaling $48 million. The Company had an effective tax rate of 24%. We believe that we have the liquidity available to make our future tax payments.

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CRITICAL ACCOUNTING ESTIMATES

The discussion and analysis of our financial position and results of operations in this MD&A are based upon our consolidated financial statements. The preparation of these financial statements requires us to make estimates and judgments that affect our financial position and results of operations. See Note 1 to the consolidated financial statements for a description of our significant accounting policies.

Critical accounting estimates are defined as those that reflect significant management judgment and uncertainties and that potentially may lead to materially different results under varying assumptions and conditions. Management has identified the following critical accounting estimate and has discussed the development, selection and disclosure of these policies with our audit committee.

FREQUENT FLYER PROGRAMS

Alaska's Mileage Plan loyalty program awards mileage credits, referred to as miles, to members who fly on our airlines and our airline partners. We also sell services, including miles for transportation, Companion Fare™ certificates, bag fee waivers, and access to our brand and customer lists to major banks that offer Alaska co-brand credit cards. To a lesser extent, miles for transportation are also sold to other non-airline partners, such as hotels, and car rental agencies. Outstanding miles may be redeemed for travel on our airlines or eligible airline partners, and for non-airline products such as hotels. As long as Mileage Plan is in existence, we have an obligation to provide future travel.

Mileage credits and the various other services we sell under our loyalty program represent performance obligations that are part of a multiple deliverable revenue arrangement. Accounting guidance requires that we use a relative standalone selling price model to allocate consideration received to the material performance obligations in these contracts. Our relative standalone selling price models are refreshed when contracts originate or are materially modified. We also update our model annually based on observed volumes.

At December 31, 2021, we had approximately 301 billion miles outstanding, resulting in an aggregate deferred revenue balance of $2.4 billion. The deferred revenue resulting from our relative selling price allocations requires significant management judgment. There are uncertainties inherent in these estimates. Therefore, different assumptions could affect the amount and/or timing of revenue recognition or expenses. The most significant assumptions are described below.

1.The rate at which we defer sales proceeds related to services sold:

We estimate the standalone selling price for each performance obligation, including mileage credits, by considering multiple inputs and methods, including but not limited to, the estimated selling price of comparable travel, discounted cash flows, brand value, published selling prices, number of miles awarded, and the number of miles redeemed. We estimate the selling prices and volumes over the terms of the agreements in order to determine the allocation of proceeds to each of the multiple deliverables.

2.The number of miles that will not be redeemed for travel (breakage):

We estimate how many miles will be used per award. For example, our members may redeem mileage credits for award travel to various locations or choose between a highly restricted award and an unrestricted award. Our estimates are based on the current requirements in our Mileage Plan program and historical and future award redemption patterns.

We review significant Mileage Plan assumptions on an annual basis, or more frequently should circumstances indicate a need, and change our assumptions if facts and circumstances indicate that a change is necessary. Any such change in assumptions could have a significant effect on our financial position and results of operations.