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Management's Discussion of Results of Operations (Excerpts)

For purposes of readability, Zenith attempts to strip out all tables in excerpts from the Management Discussion. That information is contained elsewhere in our articles. The idea of this summary is simply to review how well we believe Management does its reporting. Also, this highlights what Management believes is important.

In our Decision Matrix at the end of each article, a company with 0 to 2 gets a "-1", and 3 to 5 gets a "+1."

On a scale of 0 to 5, 5 being best, Zenith rates this company's Management's Discussion as a 4.



THIRD QUARTER REVIEW

Our consolidated pretax income was $427 million during the third quarter of 
2017, compared to $402 million in the third quarter of 2016. The increase in 
pretax income of $25 million was primarily driven by an increase in revenues of 
$554 million, partially offset by a $372 million increase in non-fuel expense 
and a $143 million increase in fuel expense.

As we completed the acquisition of Virgin America on December 14, 2016, our 
results of operations for the three months ended September 30, 2017 include 
those of Virgin America and the impact of purchase accounting. Our results of 
operations for the three months ended September 30, 2016 do not include those 
of Virgin America.

Operations Performance

During the third quarter of 2017, our on-time performance was 85.0% for Alaska, 
73.3% for Virgin America and 78.6% for Horizon. Air traffic control issues and 
airport runway construction have negatively impacted our on-time performance, 
particularly in Seattle, Los Angeles, and San Francisco where we have a large 
concentration of flights. While these challenges negatively impact all airlines 
that operate in the affected markets, we plan to continue working to mitigate 
the impact in 2018. Additionally, pilot shortages at Horizon resulted in 
approximately 1,300 canceled flights and a reduction in scheduled service into 
the fourth quarter and early 2018. As a result of these adjustments to the 
flight schedule and our recent pilot hiring efforts, we anticipate that 
operational headwinds will be behind us by year end.

New Markets

We launched 20 new routes during the quarter, which is the most we have ever 
launched in one quarter. In total, we have announced approximately 40 new 
markets since the acquisition of Virgin America as we begin to realize the 
network and revenue synergies from bringing our two airlines together.

Shareholder Return

During the third quarter of 2017, we paid cash dividends of $37 million and 
repurchased 355,415 shares for $28 million. Subsequent to September 30, 2017, 
we repurchased an additional 369,182 shares for $25 million.

Labor Update

Each of our represented groups, other than aircraft technicians, has been 
certified by the National Mediation Board as having single carrier status which 
allows for Virgin America teammates to be represented by unions that currently 
represent Alaska's work groups and enables work toward single collective 
bargaining agreements.

We were not able to come to an agreement during negotiations or mediation with 
our pilots, so Alaska and the Air Line Pilots Association presented their 
respective positions to a third-party arbitration panel during the third 
quarter. On October 30, 2017, we received a decision from the arbitration panel 
on new wage rates and retirement contributions for pilots of Alaska Airlines 
and Virgin America. This award is binding and is effective November 1, 2017. 
The wage rates equate to an approximately 33% increase for top-of-scale 
captains at Virgin America and approximately 16% for top-of-scale captains at 
Alaska Airlines with a 3% increase in rates effective April 1, 2018 and April 
1, 2019.

The decision increases contribution rates for pilots in defined contribution 
only retirement plans from 13.5% at Alaska and 12% at Virgin America to 15% 
effective immediately and to 15.5% effective January 1, 2019.

We estimate the impact of this new contract over the status quo to be an 
incremental cost of approximately $24 million for the remainder of 2017, $150 
million in 2018, and $180 million in 2019. Over the life of the contract, the 
average annualized impact is approximately $160 million to $165 million 
compared to the $140 million estimate of our proposal at arbitration.

Outlook

We completed the acquisition of Virgin America on December 14, 2016, 
positioning us as the fifth largest airline in the U.S. with a unique ability 
to serve West Coast travelers. The acquisition of Virgin America provides a 
platform for growth of our low-fare, premium product, a powerful West Coast 
network for our guests and enhanced international partnerships. Additionally, 
Virgin America provides access to constrained gates, particularly on the East 
Coast, creating increased utility for our guests.

We are focused on the successful integration of Virgin America, which includes 
obtaining a Single Operating Certificate ("SOC") in early 2018 and a single 
Passenger Service System ("PSS"), or more commonly known as the reservations 
system, in the second quarter of 2018. The single PSS has been accelerated from 
later in 2018 and is expected to bring forward approximately $20 million of 
revenue synergies into 2018. Our priority throughout the integration process is 
to run our airlines well and maintain a safe, compliant and low-cost operation, 
while providing a remarkable experience for our guests. The combined airline 
will adopt Alaska’s name and logo, retiring the Virgin America name sometime in 
late 2019. Over the next several months we will focus on enhancing our guest 
experience and will adopt certain aspects of Virgin America’s brand elements, 
including enhanced inflight connectivity, inflight entertainment content, mood 
lighting, music and the relentless desire to make flying a different experience 
for guests. We will continue to enhance our fresh, healthy, West Coast-inspired 
onboard food and beverage menus and expect our First Class guests on Alaska 
will be able to pre-select meals before they fly starting this year. Alaska’s 
main cabin guests will also be able to pre-pay for their meals in advance in 
2018, with Airbus flights soon to follow. Our onboard Free Chat service and 
free entertainment was added to Airbus flights in August 2017. We also plan to 
expand the premium class offering on our Airbus fleet beginning in 2018 and 
have our entire fleet equipped with high-speed satellite Wi-Fi by early 2020.

In January 2018, Alaska Mileage Plan™ will become our sole loyalty program, 
offering guests more rewards, an expansive global partner network and the only 
major airline loyalty program that still rewards a mile flown with a mile 
earned on Alaska and Virgin America flights.

We intend to minimize any disruption to our guests during the integration 
efforts by being transparent about the progress we are making and how the 
changes may affect them. Employee engagement throughout the integration will 
remain a top priority as well, ensuring that employees remain engaged, informed 
and excited about the changes. We remain focused on capturing the value and 
synergies created by combining these two great airlines.

Currently, we expect to grow our combined network capacity in 2017 by 7.2%. The 
growth rate compares 2017 system-wide capacity to historical Air Group and 
Virgin America combined capacity in 2016. Current schedules indicate 
competitive capacity will increase by approximately 5% in the fourth quarter of 
2017, and approximately 9% in the first quarter of 2018. We believe that our 
product, our operation, our low-cost structure, our engaged employees, our 
award-winning service, and our award-winning Mileage Plan™ program, combined 
with our strong balance sheet, give us the ability to compete effectively in 
our markets.

We currently expect capacity growth of approximately 8% for the full year 2018. 
We expect unit costs to increase in 2018. This increase is driven by increases 
in pilot wages as a result of the pilot arbitration decision, a new engine 
services deal, our growing mix of regional flying, and continued costs 
associated with the integration.

RESULTS OF OPERATIONS

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

We believe disclosure of earnings excluding the impact of merger-related costs, 
mark-to-market gains or losses or other individual special revenues or expenses 
is useful information to investors because:


•

By excluding fuel expense and certain special items (including merger-related 
costs) from our unit metrics, we believe it provides management better 
visibility into the results of operations and our non-fuel cost 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 labor rates and 
productivity, airport costs, maintenance costs, etc., which are more 
controllable by management.


•

Cost per ASM ("CASM") excluding fuel and certain special items, such as 
merger-related costs, is one of the most important measures used by management 
and by the Air Group Board of Directors in assessing quarterly and annual cost 
performance.


•

Adjusted income before income tax and CASM excluding fuel (and other items as 
specified in our plan documents) are important metrics for the employee 
incentive plan, which covers the majority of Air Group employees.


•

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


23



•

Disclosure of the individual impact of certain noted items provides investors 
the ability to measure and monitor performance both with and without these 
special items. We believe that disclosing the impact of certain items, such as 
merger-related costs and mark-to-market hedging adjustments, is important 
because it provides information on significant items that are not necessarily 
indicative of future performance. Industry analysts and investors consistently 
measure our performance without these items for better comparability between 
periods and among other airlines.


•

Although we disclose our passenger unit revenues, we do not (nor are we able 
to) evaluate unit revenues excluding the impact that changes in fuel costs have 
had on ticket prices. Fuel expense represents a large percentage of our total 
operating expenses. Fluctuations in fuel prices often drive changes in unit 
revenues in the mid-to-long term. Although we believe it is useful to evaluate 
non-fuel unit costs for the reasons noted above, we would caution readers of 
these financial statements not to place undue reliance on unit costs excluding 
fuel as a measure or predictor of future profitability because of the 
significant impact of fuel costs on our business.

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


COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2017 TO THREE MONTHS ENDED 
SEPTEMBER 30, 2016

Our consolidated net income for the three months ended September 30, 2017 was 
$266 million, or $2.14 per diluted share, compared to net income of $256 
million, or $2.07 per diluted share, for the three months ended September 30, 
2016. As the acquisition of Virgin America closed on December 14, 2016, our 
financial results include results of Virgin America for the three months ended 
September 30, 2017, but not for the comparable prior period.

Excluding the impact of merger-related costs and mark-to-market fuel hedge 
adjustments, our adjusted net income for the third quarter of 2017 was $278 
million, or $2.24 per diluted share, compared to an adjusted net income of $272 
million, or $2.20 per diluted share, in the third quarter of 2016.

We believe that analysis of specific financial and operational results on a 
combined basis provides more meaningful year-over-year comparisons. The 
discussion below includes "Combined Comparative" results for the three months 
ended September 30, 2016, determined as the sum of the historical consolidated 
results of Air Group and of Virgin America. Virgin America's financial 
information has been conformed to reflect Air Group's historical financial 
statement presentation. This information does not purport to reflect what our 
financial and operational results would have been had the acquisition been 
consummated at the beginning of the periods presented.



COMBINED COMPARATIVE OPERATING REVENUES

Total operating revenues increased $554 million, or 35%, during the third 
quarter of 2017 compared to the same period in 2016. On a Combined Comparative 
basis, total operating revenues increased $108 million or 5%.

Passenger Revenue—Mainline

On a consolidated basis, Mainline passenger revenue for the third quarter of 
2017 increased by $489 million, or 46%, on a 48% increase in capacity driven by 
the acquisition of Virgin America, partially offset by a 2% decrease in unit 
revenues. On a Combined Comparative basis, Mainline passenger revenue for the 
third quarter of 2017 increased by 6%, due to a 7% increase in capacity, 
slightly offset by a 1% decrease in unit revenues compared to the combined 
third quarter of 2016. The increase in capacity was driven by our continued 
network expansion and aircraft added to our fleet since the third quarter of 
2016. The decrease in PRASM was driven by decreased load factors coupled with 
lower ticket yields. The lower yields were impacted by our new market growth 
and by competitor pricing actions felt more acutely in our California markets.

Passenger Revenue—Regional

Regional passenger revenue increased 5% compared to the third quarter of 2016 
primarily, driven by a 12% increase in capacity. The increase in capacity was 
offset by a 6% decrease in PRASM. The decrease in Regional PRASM was largely 
driven by growth and competitive pricing actions. The operational challenges at 
Horizon, due in large part to a shortage of pilots, resulted in a significant 
number of flight cancellations that led us to either refund or re-accommodate 
passengers. We estimate these cancellations resulted in lost revenues for Air 
Group of approximately $25 million to $30 million.

Other—Net

Other—net revenue increased $51 million, or 24%, from the third quarter of 
2016. Frequent flyer revenue contributed $15 million of the increase, primarily 
driven by a significant increase in miles sold to our affinity credit card 
partner in the Mileage Plan program. The remainder of the increase was due to 
higher ancillary revenues. On a Combined Comparative basis, Other—net revenue 
increased $7 million, or 3%.

COMBINED COMPARATIVE OPERATING EXPENSES

Total operating expenses increased $515 million, or 44%, compared to the third 
quarter of 2016. On a Combined Comparative basis, total operating expenses 
increased $159 million, or 10%. 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:

Three Months Ended September 30,


Fuel Expense

Aircraft fuel expense includes both raw fuel expense (as defined below) plus 
the effect of mark-to-market adjustments to our fuel hedge portfolio included 
in our consolidated statement of operations as the value of that portfolio 
increases and decreases. 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 $143 million, or 64% compared to the third 
quarter of 2016. On a Combined Comparative basis, aircraft fuel expense 
increased $62 million or 20%.

On a Combined Comparative basis, raw fuel expense per gallon for the three 
months ended September 30, 2017 increased by 16% 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. The increase in raw fuel price per gallon during the third quarter of 
2017 was primarily driven by a 76% increase in refining margins and an 8% 
increase in crude oil prices, when compared to the prior year. Fuel gallons 
consumed increased by 15 million gallons, or 8%, in line with the increase in 
capacity.

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

We recognized total losses of $5 million and $4 million for hedges that settled 
during the third quarter of 2017 and 2016 as reported. These amounts represent 
the net cash paid, including the premium expense recognized for those hedges.

Non-fuel Expenses and Non-special Items

Wages and Benefits

Wages and benefits increased during the third quarter of 2017 by $135 million, 
or 40%. On a Combined Comparative basis, total wages and benefits increased by 
$63 million, or 15%.

On a Combined Comparative basis, wages increased 16% with an 18% increase in 
FTEs. The increase in FTEs is attributable to the growth in our business, as 
well as the growth in McGee Air Services which has brought certain airport 
ground service positions in-house that were previously reflected in our 
Contracted services expense. Additionally, irregular operations and flight 
cancellations during the third quarter resulted in significant overtime for our 
customer service agents and reservations agents.


Depreciation and Amortization

Depreciation and amortization expense decreased by $6 million, or 6%, during 
the third quarter of 2017 compared to the same period in 2016. On a Combined 
Comparative basis, depreciation and amortization expense decreased by $17 
million, or 15%. This decrease was primarily driven by a change in the 
estimated useful lives of certain B737 operating aircraft and related parts 
from 20 years to 25 years, which was effective October 1, 2016, partially 
offset by aircraft additions since September 30, 2016.

Other Operating Expenses

Other operating expenses increased by $58 million, or 63%, during the third 
quarter of 2017 compared to the same period in 2016. On a Combined Comparative 
basis, other operating expenses increased by $35 million, or 30%. The increase 
is primarily due to additional costs incurred for crew hotel costs, passenger 
disruption costs, training costs for front-line employees, scrapped parts 
inventory, and certain information technology costs. These increases were 
largely driven by the growth in our business and increased costs from flight 
cancellations and delays during the quarter. .

Nonoperating Income (Expense)

During the third quarter of 2017 we recorded nonoperating expense of $12 
million compared to income of $2 million in the same period in 2016. On a 
Combined Comparative basis, nonoperating expense increased by $9 million, 
primarily due to interest expense incurred in the current year on the debt 
issued in 2016 to finance the acquisition of Virgin America.

Additional Segment Information

Refer to Note 9 of the consolidated financial statements for a detailed 
description of each segment. Below is a summary of each segment's 
profitability.

Mainline

Mainline recorded adjusted pretax profit of $422 million in the third quarter 
of 2017 compared to $383 million in the third quarter of 2016. On a Combined 
Comparative basis, Mainline adjusted pretax profit decreased by $48 million.

The $48 million decrease in Combined Comparative pretax profit was primarily 
driven by a $77 million increase in non-fuel operating expenses and a $59 
million increase in economic fuel cost, partially offset by a $95 million 
increase in operating revenues. The increase in non-fuel expense was primarily 
driven by higher wages to support our growth and higher other operating 
expenses as described above. The increase in economic fuel expense was driven 
by higher raw fuel costs and refining margins. The increase in operating 
revenues was primarily driven by higher capacity and an increase in frequent 
flyer revenue as described above.

Regional

Our Regional operations contributed a pretax profit of $20 million in the third 
quarter of 2017 compared to $35 million in the third quarter of 2016. The 
decrease in pretax profit was attributable to higher non-fuel operating 
expense, due to increased capacity and the operational disruptions at Horizon 
during the third quarter. Increased costs were partially offset by a $13 
million increase in operating revenues as described in Passenger 
Revenue—Regional.

Horizon

Horizon incurred a pretax profit of $5 million in the third quarter of 2017 
compared to $9 million in the third quarter of 2016. The change in pretax 
profit was primarily driven by a $4 million increase in operating revenue, 
partially offset by higher non-fuel operating expenses attributable to higher 
wage and pilot training expense as a result of the increase in FTEs, along with 
other increased costs associated with flight cancellations during the current 
quarter.

COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2017 TO NINE MONTHS ENDED 
SEPTEMBER 30, 2016

Our consolidated net income for the nine months ended September 30, 2017 was 
$661 million, or $5.31 per diluted share, compared to net income of $700 
million, or $5.63 per diluted share, for the nine months ended September 30, 
2016. As the acquisition of Virgin America closed on December 14, 2016, our 
financial results include results of Virgin America for the nine months ended 
September 30, 2017, but not for the prior periods.

Excluding the impact of merger-related costs and mark-to-market fuel hedge 
adjustments, our adjusted net income for the nine months ended September 30, 
2017 was $721 million, or $5.79 per diluted share, compared to an adjusted net 
income of $717 million, or $5.77 per diluted share, in the nine months ended 
September 30, 2016.


COMBINED COMPARATIVE OPERATING REVENUES

Total operating revenues increased $1.6 billion, or 35%, during the first nine 
months of 2017 compared to the same period in 2016. On a Combined Comparative 
basis, total operating revenues increased $330 million, or 6%.

Passenger Revenue—Mainline

Mainline passenger revenue for the first nine months of 2017 increased 45% on a 
45% increase in capacity, driven primarily by the acquisition of Virgin 
America, and flat PRASM compared to the same period in 2016. On a Combined 
Comparative basis, mainline passenger revenue for the nine months ended 
September 30, 2017 increased 6%, primarily due to a 6% increase in capacity on 
flat PRASM. The increase in capacity was driven by our network expansion since 
September 30, 2016.

Passenger Revenue—Regional

Regional passenger revenue increased by $43 million, or 6%, compared to the 
first nine months of 2016, due to a 7% increase in capacity on more regional 
flying, partially offset by a 1% decrease in PRASM.

Other—Net

Other—net revenue increased $161 million, or 27%, from the first nine months of 
2016. On a Combined Comparative basis, other—net revenue increased $42 million, 
or 6%. Mileage Plan revenue contributed $40 million of the increase primarily 
driven by an increase in miles sold to our affinity credit card partner.


COMBINED COMPARATIVE OPERATING EXPENSES

Total operating expenses increased $1.6 billion, or 48%, compared to the first 
nine months of 2016. On a Combined Comparative basis, total operating expenses 
increased $533 million, or 12%. 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:


Fuel Expense

Aircraft fuel expense increased $458 million, or 77%, compared to the nine 
months ended September 30, 2016. On a Combined Comparative basis, aircraft fuel 
expense increased $229 million, or 28%.

On a Combined Comparative basis, the raw fuel price per gallon increased 21% 
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. The increase in raw fuel price 
per gallon during the first nine months of 2017 was driven by a 19% increase in 
crude oil prices and a 38% increase in refining margins.

We recognized losses of $14 million and $12 million for hedges that settled in 
the first nine months of 2017 and 2016 as reported. These amounts represent the 
cash paid for premium expense, offset by cash received from those hedges.

We currently expect our economic fuel price per gallon to be higher in the 
fourth quarter of 2017 compared to the fourth quarter of 2016 due to our 
current estimate of higher crude prices and higher refining margins.


Wages and Benefits

Wages and benefits increased during the first nine months of 2017 by $384 
million, or 38%, compared to 2016. On a Combined Comparative basis, total wages 
and benefits increased by $165 million or 13%, compared to 2016. On a Combined 
Comparative basis, wages increased $135 million, or 15%, on a 14% increase in 
FTEs. The increase in FTEs is attributable to the growth of our business and 
increased staffing during irregular operations, as well as the growth in McGee 
Air Services which has brought certain airport ground service positions 
in-house that were previously reflected in our Contracted services expense. The 
remainder of the increase is driven by higher wage rates for certain labor 
groups. The first nine months of 2017 also include $9 million of ratification 
bonus expense in connection with the agreement reached with Horizon's pilots 
during the second quarter.

For the full year, we expect wages and benefits to increase at a rate greater 
than capacity growth on a combined comparative basis, due to higher wage rates 
for certain labor groups and the continued growth of McGee Air Services. Our 
forecast includes the impact of the pilot arbitration decision which was 
received subsequent to quarter end, and results in an estimated $24 million of 
incremental costs in the fourth quarter of 2017.

Variable Incentive Pay

Variable incentive pay expense increased during the first nine months of 2017 
by $3 million, or 3% compared to 2016. On a Combined Comparative basis, 
variable incentive pay decreased $22 million, or 18% due to expectations of 
lower performance-based pay as compared to the prior year based on how we are 
tracking in relation to the current year's goals.

For the full year, we expect variable incentive pay expense to be lower than in 
2016 on a combined comparative basis, due to lower achievement against 
performance-based pay metrics than prior year.

Depreciation and Amortization

Depreciation and amortization expense decreased $6 million, or 2% compared to 
2016. On a Combined Comparative basis, depreciation and amortization decreased 
$35 million, or 11%. This decrease was primarily driven by a change in the 
estimated useful lives of certain B737 operating aircraft and related parts 
from 20 years to 25 years, which was effective October 1, 2016, partially 
offset by aircraft additions since September 30, 2016.

For the full year, we expect depreciation and amortization to be 5-6% lower 
than in 2016 on a combined comparative basis for the same reasons mentioned 
above.

Food and Beverage Service

Food and beverage service expense increased $52 million, or 56%. On a Combined 
Comparative basis, food and beverage service expense increased $13 million, or 
10% due to increased number of passengers, premium class offerings and 
enhancements to our onboard menu offerings to provide higher quality food and 
beverage products.

For the full year, we expect food and beverage expense to be approximately 
11-12% higher than in 2016 on a combined comparative basis, in line with the 
increase in passengers in the current year, and enhancements to our onboard 
menu offerings.

Third-Party Regional Carrier Expense

Third-party regional carrier expense, which represents payments made to SkyWest 
and Pen Air under our CPAs, increased $12 million, or 17% compared to 2016. The 
increase is primarily due to the additional six E175 aircraft operated by 
SkyWest in the current year.

For the full year, we expect Third-party regional carrier expense to increase 
due to increased flying by our regional partners.

Other Operating Expenses

Other operating expenses increased by $157 million, or 59%, compared to the 
first nine months of 2016. On a Combined Comparative basis, other operating 
expenses increased by $85 million, or 25%. The increase was due to higher costs 
associated with irregular operations, crew and training costs, higher IT costs, 
an increase in scrapped parts inventory, and higher property taxes. The first 
nine months of 2016 also included a benefit of an insurance claim reimbursement 
we received in the prior year.

For the full year, we expect other expenses to be higher than in 2016 in line 
with the trends described above.

Special Items—Merger-Related Costs

We recorded special items of $88 million for merger-related costs associated 
with our acquisition of Virgin America in the first nine months of 2017, 
compared to $36 million as reported and $44 million on a Combined Comparative 
basis in the first nine months of 2016. Costs incurred in the first nine months 
of 2017 consisted primarily of severance and retention and IT integration 
costs.

We expect to incur merger-related costs for the remainder of 2017, and 
continuing through 2019.

Nonoperating Income (Expense)

During the first nine months of 2017, we had nonoperating expense of $40 
million, compared to income of $6 million in the same period in 2016. On a 
Combined Comparative basis, nonoperating expense increased by $32 million, 
primarily due to interest expense incurred in the current year on the debt 
issued in 2016 to finance the acquisition of Virgin America.

Additional Segment Information

Refer to Note 9 of the condensed consolidated financial statements for a 
detailed description of each segment. Below is a summary of each segment's 
profitability.

Mainline

Mainline adjusted pretax profit was $1.13 billion in the first nine months of 
2017, compared to $1.05 billion in the same period in 2016. On a Combined 
Comparative basis, Mainline adjusted pretax profit decreased by $111 million.

The $111 million decrease in Combined Comparative pretax profit was driven by a 
$181 million increase in Mainline fuel expense, a $190 million increase in 
Mainline non-fuel operating expenses, and a $27 million increase in 
nonoperating expense. These increases were offset by a $287 million increase in 
Mainline passenger revenue. Higher raw fuel prices and an increase in gallons 
consumed drove the increase in Mainline fuel expense. Non-fuel operating 
expenses increased due to higher wages to support our growth and higher other 
operating expenses as described above. Nonoperating expense increased primarily 
due to increased interest expense. Mainline revenue increased due to higher 
capacity from the new routes we have added over the past twelve months.

Regional

Our Regional operations contributed a pretax profit of $40 million in the first 
nine months of 2017, compared to $72 million in the first nine months of 2016. 
The decrease in pretax profit was attributable to higher non-fuel operating 
expense, due in large part to increased capacity and higher raw fuel costs, 
partially offset by a $43 million increase in operating revenues as described 
in Passenger Revenue—Regional.

Horizon

Horizon incurred a pretax loss of $11 million in the first nine months of 2017, 
compared to pretax profit of $14 million in the same period in 2016. The change 
was driven by higher non-fuel expenses and lower CPA Revenues (100% of which 
are from Alaska and eliminated in consolidation). Non-fuel expenses increased 
primarily due to higher wage and training expense as a result of the increase 
in FTE’s, increased costs associated with flight cancellations primarily due to 
a shortage of pilots necessary to fly the schedule, and a $9 million 
ratification bonus expense in connection with the agreement with Horizon's 
pilots.


LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity are:


•

Our existing cash and marketable securities balance of $1.7 billion, and our 
expected cash from operations;


•

Our 64 unencumbered aircraft in our operating fleet that could be financed, if 
necessary;


•

Our combined bank line-of-credit facilities, with no outstanding borrowings, of 
$400 million. Information about these facilities can be found in Note 5 to the 
condensed consolidated financial statements.

During the nine months ended September 30, 2017, we took free and clear 
delivery of ten B737-900ER aircraft and ten E175 aircraft. We made debt 
payments totaling $265 million and paid dividends totaling $111 million.


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 2017, net cash provided by operating activities 
was $1.4 billion, compared to $1.2 billion during the same period in 2016. The 
$151 million increase in our operating cash flows is primarily attributable to 
increased ticket sales for future travel compared to the prior year resulting 
from the overall growth in our business and the addition of Virgin America. 
This was partially offset by a decrease in our net income, which was impacted 
by higher fuel costs and $88 million of merger-related costs.

We typically generate positive cash flows from operations and expect to use 
that cash flow to purchase aircraft and capital equipment, make scheduled debt 
payments, and return capital to shareholders.

Cash Used in Investing Activities

Cash used in investing activities was $1.1 billion during the first nine months 
of 2017, compared to $641 million during the same period of 2016. Our capital 
expenditures were $841 million in the first nine months of 2017, an increase of 
$332 million compared to the nine months ended September 30, 2016. This is 
primarily driven by more aircraft purchases and higher spend on other equipment 
compared to the same period of 2016. Our net purchases of marketable securities 
increased by $202 million from the prior year, primarily driven by stronger 
operating cash flows in the first nine months of 2017.

The table below reflects our full-year expectation for capital expenditures and 
additional expenditures if options are exercised. Options will be exercised 
only if we believe return on invested capital targets can be met.

We have options to acquire 37 B737 aircraft with deliveries from 2020 through 
2024, and options to acquire 30 E175 aircraft with deliveries in 2019 to 2021. 
Amounts above also include payments toward cancelable purchase commitments for 
30 A320neo aircraft with deliveries from 2020 through 2022.

Cash Used by Financing Activities

Net cash used by financing activities was $399 million during the first nine 
months of 2017 compared to net cash provided by financing activities of $1.2 
billion during the same period in 2016. The change is due to $1.5 billion of 
debt financing cash inflow in the prior period for the Virgin America 
acquisition. During the first nine months of 2017 we made debt payments of $265 
million, dividend payments totaling $111 million, and had $50 million in common 
stock repurchases.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

Aircraft Commitments

As of September 30, 2017, we have firm orders to purchase or lease 93 aircraft. 
We also have cancelable purchase commitments for 30 Airbus A320neo with 
deliveries from 2020 through 2022. We could incur a loss of pre-delivery 
payments and credits as a cancellation fee. We also have options to acquire 37 
B737 aircraft with deliveries from 2020 through 2024 and 30 E175 aircraft with 
deliveries from 2019 through 2021. In addition to the 21 E175 aircraft 
currently operated by SkyWest in our regional fleet, we have options in future 
periods to add regional capacity by having SkyWest operate up to eight more 
E175 aircraft.

Contractual Obligations

Includes minimum obligations under engine and parts management and maintenance 
agreements with third-party vendors. Subsequent to September 30, 2017, the 
Company signed a parts management and maintenance agreement which includes 
minimum obligations of approximately $459 million over a nine-year period.

Includes minimum obligations associated with the SkyWest third-party CPA.

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 below the contractually-specified level, or if our cash and 
marketable securities balance falls below $500 million. Under another such 
agreement, we could be required to maintain a reserve if our cash and 
marketable securities balance falls 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.

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, pending tax reform efforts at the federal level, as well as 
other legislative changes that are beyond our control. We believe that we have 
the liquidity to make our future tax payments.