from10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 (Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2009.
 
OR
 
¨        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                      to ___________
 
Commission file number 1-8957
ALASKA AIR GROUP, INC.
(Exact name of registrant as specified in its charter)
 
   
Delaware
91-1292054
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
19300 International Boulevard, Seattle, Washington 98188
(Address of principal executive offices)
 
Registrant’s telephone number, including area code: (206) 392-5040
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x   No  ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  x
Accelerated filer  ¨
Non-accelerated filer  ¨
Smaller reporting company  ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes  ¨    No  x 
APPLICABLE ONLY TO CORPORATE ISSUERS:
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
The registrant has 36,386,119 common shares, par value $1.00, outstanding at March 31, 2009.
 

 
 

ALASKA AIR GROUP, INC.
Quarterly Report on Form 10-Q for the three months ended March 31, 2009

TABLE OF CONTENTS

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As used in this Form 10-Q, the terms “Air Group,” “our,” “we” and the “Company” refer to Alaska Air Group, Inc. and its subsidiaries, unless the context indicates otherwise.  Alaska Airlines, Inc. and Horizon Air Industries, Inc. are referred to as “Alaska” and “Horizon,” respectively, and together as our “airlines.”

Cautionary Note Regarding Forward-Looking Statements
In addition to historical information, this Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995.   Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. You can generally identify forward-looking statements as statements containing the words "believe," "expect," "will," "anticipate," "intend," "estimate," "project," "assume" or other similar expressions, although not all forward-looking statements contain these identifying words.  Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from historical experience or the Company’s present expectations. Some of the things that could cause our actual results to differ from our expectations are:
 
 
·
general economic conditions, including the impact of the economic recession on customer travel behavior;
·      changes in our operating costs, including fuel, which can be volatile;
·      the competitive environment in our industry;
 
·
labor disputes and our ability to attract and retain qualified personnel;
 
·
the amounts of potential lease termination payments with lessors for our remaining CRJ-700 and Q200 leased aircraft and related sublease payments from sublessees, if applicable;
 
·
our significant indebtedness;
 
·
compliance with our financial covenants;
 
·
potential downgrades of our credit ratings and the availability of financing;
 
·
our ability to meet our cost reduction goals;
 
·
operational disruptions;
 
·
the concentration of our revenue from a few key markets;
 
·
actual or threatened terrorist attacks, global instability and potential U.S. military actions or activities;
 
·
insurance costs;
 
·
our inability to achieve or maintain profitability;
 
·
fluctuations in our quarterly results;
 
·
an aircraft accident or incident;
 
·
liability and other claims asserted against us;
 
·
our reliance on automated systems and the risks associated with changes made to those systems;
 
·
our reliance on third-party vendors and partners;
 
·
changes in laws and regulations; and
 
·
increases in government fees and taxes.

You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control.  Our forward-looking statements are based on the information currently available to us and speak only as of the date on which this report was filed with the SEC.  We expressly disclaim any obligation to issue any updates or revisions to our forward-looking statements, even if subsequent events cause our expectations to change regarding the matters discussed in those statements.  Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such differences might be significant and materially adverse to our shareholders.  For a discussion of these and other risk factors, see "Item 1A: Risk Factors” of the Company’s annual report on Form 10-K for the year ended December 31, 2008.  Please consider our forward-looking statements in light of those risks as you read this report.



PART I.   FINANCIAL INFORMATION
            
Item 1:        Condensed Consolidated Financial Statements
            
             
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
            
Alaska Air Group, Inc.
            
             
ASSETS
            
   
March 31,
    
December 31,
  
(in millions)
  
2009
    
2008
  
Current Assets
            
Cash and cash equivalents
   $ 237.1     $ 283.1  
Marketable securities
     805.9       794.3  
  Total cash and marketable securities
     1,043.0       1,077.4  
Receivables - net
     113.5       116.7  
Inventories and supplies - net
     43.4       51.9  
Deferred income taxes
     170.3       164.4  
Fuel hedge contracts
     13.4       16.5  
Prepaid expenses and other current assets
     82.3       82.0  
Total Current Assets
     1,465.9       1,508.9  
                 
Property and Equipment
                
Aircraft and other flight equipment
     3,481.7       3,431.0  
Other property and equipment
     618.2       608.6  
Deposits for future flight equipment
     253.3       309.8  
      4,353.2       4,349.4  
Less accumulated depreciation and amortization
     1,226.0       1,181.7  
Total Property and Equipment - Net
     3,127.2       3,167.7  
Fuel Hedge Contracts
     27.5       35.9  
Other Assets
     158.4       123.1  
Total Assets
   $ 4,779.0     $ 4,835.6  
                 
See accompanying notes to condensed consolidated financial statements.
                
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
            
Alaska Air Group, Inc.
            
             
LIABILITIES AND SHAREHOLDERS' EQUITY
            
   
March 31,
    
December 31,
  
(in millions except share amounts)
  
2009
    
2008
  
Current Liabilities
            
Accounts payable
   $ 63.8     $ 59.6  
Accrued aircraft rent
     52.2       64.4  
Accrued wages, vacation and payroll taxes
     100.1       119.5  
Other accrued liabilities
     499.8       475.4  
Air traffic liability
     399.6       372.7  
Fuel hedge contracts liability
     5.7       24.1  
Current portion of long-term debt
     164.4       244.9  
Total Current Liabilities
     1,285.6       1,360.6  
                 
Long-Term Debt, Net of Current Portion
     1,619.3       1,596.3  
                 
Other Liabilities and Credits
                
Deferred income taxes
     37.2       36.7  
Deferred revenue
     424.7       421.3  
Obligation for pension and postretirement medical benefits
     589.4       584.7  
Other liabilities
     165.5       174.1  
      1,216.8       1,216.8  
Commitments and Contingencies
                
Shareholders' Equity
                
Preferred stock, $1 par value
                
  Authorized:     5,000,000 shares, none issued or outstanding
     -       -  
Common stock, $1 par value
                
  Authorized:     100,000,000 shares
                
  Issued:  2009 - 43,263,925 shares
                
                 2008 - 43,171,404 shares
     43.3       43.2  
  Capital in excess of par value
     921.7       915.0  
  Treasury stock (common), at cost: 2009 - 6,877,806 shares
                
                                                               2008 - 6,896,506 shares
     (161.0 )     (161.4 )
Accumulated other comprehensive loss
     (320.9 )     (328.3 )
Retained earnings
     174.2       193.4  
      657.3       661.9  
Total Liabilities and Shareholders' Equity
   $ 4,779.0     $ 4,835.6  
                 
See accompanying notes to condensed consolidated financial statements.
                



CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
            
Alaska Air Group, Inc.
            
             
   Three Months Ended March 31,  
(in millions except per share amounts)
  
2009
    
2008
  
Operating Revenues
            
Passenger
   $ 684.1     $ 775.7  
Freight and mail
     19.4       22.2  
Other - net
     38.9       41.6  
Total Operating Revenues
     742.4       839.5  
Operating Expenses
                
Wages and benefits
     246.0       244.7  
Variable incentive pay
     9.3       3.6  
Aircraft fuel, including hedging gains and losses
     157.7       282.0  
Aircraft maintenance
     59.7       58.0  
Aircraft rent
     38.0       43.6  
Landing fees and other rentals
     54.2       56.0  
Contracted services
     38.4       44.5  
Selling expenses
     25.0       34.5  
Depreciation and amortization
     52.8       49.3  
Food and beverage service
     11.6       12.3  
Other
     56.8       57.2  
Fleet transition costs - Q200
     4.8       5.8  
Total Operating Expenses
     754.3       891.5  
Operating Loss
     (11.9 )     (52.0 )
Nonoperating Income (Expense)
                
Interest income
     8.3       10.3  
Interest expense
     (26.8 )     (23.4 )
Interest capitalized
     2.8       6.5  
Other - net
     (2.0 )     0.2  
      (17.7 )     (6.4 )
Loss before income tax
     (29.6 )     (58.4 )
Income tax benefit
     (10.4 )     (21.1 )
Net Loss
   $ (19.2 )   $ (37.3 )
                 
Basic and Diluted Loss Per Share:
   $ (0.53 )   $ (1.01 )
Shares used for computation:
                
  Basic and Diluted
     36.326       37.024  
                 
See accompanying notes to condensed consolidated financial statements.
                



CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (unaudited)
                                
Alaska Air Group, Inc.
                                          
                                           
                                         
   
Common
          
Capital in
    
Treasury
    
 
              
   
Shares
    
Common
    
Excess of
    
Stock,
    
Accumulated Other
    
Retained
        
(in millions)
  
Outstanding
    
Stock
    
Par Value
    
at Cost
    
Comprehensive Loss
    
Earnings
    
Total
  
Balances at December 31, 2008
     36.275     $ 43.2     $ 915.0     $ (161.4 )   $ (328.3 )   $ 193.4     $ 661.9  
Net loss for the three months ended March 31, 2009
                                             (19.2 )     (19.2 )
Other comprehensive income (loss):
                                                        
                                                         
Related to marketable securities:
                                                        
  Change in fair value
                                     3.9                  
  Reclassification to earnings
                                     (0.6 )                
  Income tax effect
                                     (1.2 )                
                                      2.1               2.1  
                                                         
  Adjustments related to employee benefit plans:
                                     8.5                  
   Income tax effect
                                     (3.2 )                
                                      5.3               5.3  
Total comprehensive loss
                                                     (11.8 )
                                                         
Stock-based compensation
                     5.4                               5.4  
Treasury stock issued under stock plans
     0.018                       0.4                       0.4  
Stock issued for employee stock purchase plan
     0.043       -       0.8                               0.8  
Stock issued under stock plans
     0.050       0.1       0.5                               0.6  
Balances at March 31, 2009
     36.386     $ 43.3     $ 921.7     $ (161.0 )   $ (320.9 )   $ 174.2     $ 657.3  
                                                         
                                                         
See accompanying notes to condensed consolidated financial statements.
                                            




CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
            
Alaska Air Group, Inc.
            
             
     Three Months Ended March 31,  
(in millions)
  
2009
    
2008
  
Cash flows from operating activities:
            
Net loss
   $ (19.2 )   $ (37.3 )
Adjustments to reconcile net loss to net cash
                
 provided by operating activities:
                
   Fleet transition costs - Q200
     4.8       5.8  
   Depreciation and amortization
     52.8       49.3  
   Stock-based compensation
     5.4       5.5  
   Increase in air traffic liability
     26.9       109.1  
   Changes in other assets and liabilities-net
     (55.4 )     (98.0 )
Net cash provided by operating activities
     15.3       34.4  
Cash flows from investing activities:
                
Property and equipment additions:
                
  Aircraft and aircraft purchase deposits
     (199.5 )     (117.4 )
  Other flight equipment
     (17.0 )     (16.9 )
  Other property and equipment
     (9.7 )     (9.8 )
Total property and equipment additions
     (226.2 )     (144.1 )
Proceeds from disposition of assets
     2.3       5.4  
Purchases of marketable securities
     (160.5 )     (259.2 )
Sales and maturities of marketable securities
     151.9       175.1  
Restricted deposits and other
     (3.3 )     1.2  
Net cash used in investing activities
     (235.8 )     (221.6 )
Cash flows from financing activities:
                
Proceeds from issuance of long-term debt
     64.0       291.6  
Proceeds from sale-leaseback transaction, net
     230.0       -  
Long-term debt payments, including line of credit
     (121.5 )     (57.1 )
Purchase of treasury stock
     -       (40.6 )
Proceeds from issuance of common stock
     2.0       0.9  
Net cash provided by financing activities
     174.5       194.8  
Net change in cash and cash equivalents
     (46.0 )     7.6  
Cash and cash equivalents at beginning of year
     283.1       204.3  
Cash and cash equivalents at end of period
   $ 237.1     $ 211.9  
Supplemental disclosure of cash paid during the period for:
                
  Interest (net of amount capitalized)
   $ 28.7     $ 14.3  
  Income taxes
   $ -     $ 3.9  
                 
See accompanying notes to condensed consolidated financial statements.
                


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Alaska Air Group, Inc.

Note 1.
Basis of Presentation and Significant Accounting Policies
Organization and Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of Alaska Air Group, Inc. (Air Group or the Company) include the accounts of the parent company, Alaska Air Group, Inc., and its principal subsidiaries, Alaska Airlines, Inc. (Alaska) and Horizon Air Industries, Inc. (Horizon), through which the Company conducts substantially all of its operations. These interim condensed consolidated financial statements are unaudited and should be read in conjunction with the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. In the opinion of management, all adjustments have been made that are necessary to present fairly the Company’s financial position as of March 31, 2009, as well as the results of operations for the three months ended March 31, 2009 and 2008. The adjustments made were of a normal recurring nature.
 
The Company’s interim condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). In preparing these statements, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities, as well as the reported amounts of revenues and expenses. Significant estimates made include assumptions used to record liabilities; expenses and revenues associated with the Company’s Mileage Plan; amounts paid to lessors upon aircraft lease terminations; the fair market value of surplus or impaired aircraft, engines and parts; assumptions used in the calculations of pension expense in the Company’s defined-benefit plans; and the amounts of certain accrued liabilities. Actual results may differ from the Company’s estimates.

New and Proposed Accounting Pronouncements
In March 2008, the Financial Accounting Standards Board (FASB) issued Statement of Financial Standards (SFAS) No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133.  SFAS 161 requires entities that use derivative instruments to provide certain qualitative disclosures about their objectives and strategies for using such instruments, amounts and location of the derivatives in the financial statements, among other disclosures. SFAS 161 was adopted as of January 1, 2009.  The required disclosures are included in Note 3.  The adoption of SFAS 161 did not have a material impact on the disclosures historically provided.

1BIn December 2008, the FASB issued Staff Position No. FAS 132(R)-1 amending SFAS 132(R), Employers’ Disclosures about Pensions and Other Postretirement Benefits, which, among other things, expands the disclosure regarding assets in an employer’s pension and postretirement benefit plans.  The primary change would be to add the fair value hierarchy disclosures required by SFAS No. 157 as it relates to the underlying assets of the pension and postretirement benefit plans.  The disclosures required by this position are effective in annual financial statements for fiscal years ending after December 15, 2009.  This position will impact the Company’s financial statement disclosures, but will have no impact on its financial position or results of operations.

2BIn April 2009, the FASB issued Staff Position No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, which clarifies the determination of fair value in SFAS 157 for assets and liabilities that may be involved in transactions that would not be considered orderly as defined in the position statement.  In April 2009, the FASB also issued FASB Staff Position No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. This position statement provides additional guidance in determining whether a debt


3Bsecurity is other-than-temporarily impaired and how entities should record the impairment in the financial statements.  The standard would require credit losses, as defined, to be recorded through the statement of operations and the remaining impairment loss to be recorded through accumulated other comprehensive income.  Both of these staff positions are effective for annual and interim periods ending after June 15, 2009.  Management does not expect these positions will have a material impact on the Company’s financial position or results of operations.

In April 2009, the FASB issued Staff Position No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments.  This position will require companies to provide, on an interim basis, disclosures that are currently required in annual statements for the fair value of financial instruments.  This position will be effective for interim periods ending after June 15, 2009.  The position will impact the Company’s financial statement disclosures, but will have no impact on its financial position or results of operations.

Fair Value Measurements
SFAS No. 157, Fair Value Measurements, defines fair value, establishes a framework for measuring fair value and expands disclosure about fair-value measurements required under other accounting pronouncements. The Company partially adopted this standard for financial assets and liabilities as of January 1, 2008 and, in accordance with FASB Staff Position No. 157-2, adopted the standard as it relates to nonfinancial assets and liabilities as of January 1, 2009. The adoption of this aspect of the standard had no impact on our financial position, statements of operations, or cash flows.

SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
 
Level 1 - Quoted prices in active markets for identical assets or liabilities.
 
Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Cash, Cash Equivalents and Marketable Securities
The Company uses the “market approach” under SFAS 157 in determining the fair value of its cash, cash equivalents and marketable securities. The securities held by the Company are valued based on observable prices in active markets and considered to be liquid and easily tradable.    Amounts measured at fair value as of March 31, 2009 are as follows (in millions):
   
 
Level 1
    
Level 2
    
Level 3
    
Total
  
Cash and cash equivalents
   $ 237.1     $ —     $ —     $ 237.1  
Marketable securities
     116.1       689.8       —       805.9  
Total
   $ 353.2     $ 689.8     $ —     $ 1,043.0  


4BThe Company’s marketable securities portfolio consists of US government securities, asset-backed obligations and other corporate obligations.  As of March 31, 2009, the Company had net unrealized losses of $0.7 million in its $1.04 billion cash and marketable securities balance portfolio, which management believes is not “other-than-temporarily” impaired as defined by FASB Staff Position FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.  Gross unrealized gains were $13.4 million and gross unrealized losses were $14.1 million at March 31, 2009.  Further details of the securities that composed the gross unrealized losses are as follows (in millions):

   
Unrealized Losses
          
   
Less than 12 months
    
Greater than 12 months
    
Total
    
Fair Value of Securities with Unrealized Losses
U.S. Government Securities
   $ --     $ --     $ --     $ --  
Asset-backed obligations
     (1.3 )     (8.0 )     (9.3 )     73.9  
Other corporate obligations
     (3.4 )     (1.4 )     (4.8 )     104.2  
     Total
   $ (4.7 )   $ (9.4 )   $ (14.1 )   $ 178.1  


5BNote 2.                Fleet Transition
 
26BHorizon Transition to All-Q400 Fleet
Horizon is in the process of transitioning to an all-Q400 fleet.  As of March 31, 2009, Horizon had six Q200 aircraft remaining, none of which were in the operational fleet.  The total charge associated with removing these aircraft from operation in the first quarter of 2009 was $4.8 million.  This charge represents the estimated loss under potential disposal transactions.

In the first quarter of 2008, three of Horizon’s Q200 aircraft were subleased to a third-party carrier under a sublease arrangement that ultimately covered 16 of the Q200 aircraft.  The charge associated with the sublease loss on these three aircraft in the first quarter of 2008 was $5.8 million.

6BNote 3.                Fuel Hedge Contracts
 
The Company’s operations are inherently dependent upon the price and availability of aircraft fuel. To manage economic risks associated with fluctuations in aircraft fuel prices, the Company periodically enters into call options, collar structures and swap agreements for crude oil, among other initiatives.
 
The Company records derivative instruments, all of which are currently fuel hedge contracts, on the balance sheet at their fair value.  Changes in the fair value of these fuel hedge contracts are recorded each period in aircraft fuel expense as the Company has not designated these instruments as hedge transactions under SFAS 133, Accounting for Derivative Instruments and Hedging Activities.

The following table summarizes the components of aircraft fuel expense for the three months ended March 31, 2009 and 2008 (in millions):
   
2009
    
2008
  
Raw or “into-plane” fuel cost
   $ 141.9     $ 311.9  
(Gains) or losses in value and settlement of fuel hedge contracts
     15.8        (29.9 )
Aircraft fuel expense
   $ 157.7     $ 282.0  

The Company realized losses of $25.8 million and gains of $29.2 million in the three months ended March 31, 2009 and 2008, respectively, on fuel hedge contracts that settled during the period.

The Company uses the “market approach” in determining the fair value of its hedge portfolio. The Company’s fuel hedging contracts consist of over-the-counter contracts, which are not traded on an exchange.  The fair value of these contracts is determined based on observable inputs that are readily available in active markets or can be derived from information available in active quoted markets.  Therefore, the Company has categorized these contracts as Level 2 in the fair value hierarchy described in SFAS 157.

Outstanding future fuel hedge positions are as follows:

 
Approximate % of Expected Fuel Requirements
Gallons Hedged
(in millions)
Approximate Crude Oil Price per Barrel
Second Quarter 2009
50%
44.8
$71
Third Quarter 2009
50%
48.1
$76
Fourth Quarter 2009
50%
43.5
$76
   Remainder of 2009
50%
136.4
$74
First Quarter 2010
47%
40.0
$68
Second Quarter 2010
43%
38.7
$67
Third Quarter 2010
29%
28.3
$67
Fourth Quarter 2010
24%
20.5
$78
   Full Year 2010
36%
127.5
$69
First Quarter 2011
17%
14.9
$91
Second Quarter 2011
15%
13.8
$73
Third Quarter 2011
11%
11.3
$74
Fourth Quarter 2011
5%
4.5
$67
   Full Year 2011
12%
44.5
$78

As of March 31, 2009 and December 31, 2008, the net fair values of the Company’s fuel hedge positions were as follows (in millions):
   
March 31, 2009
    
December 31, 2008
  
Call options or “caps”
   $ 40.9     $ 52.4  
Collar contracts
     (5.7 )     (24.1 )
   Total
   $ 35.2     $ 28.3  

The Company paid premiums of $85.9 million and $89.1 million, respectively, to purchase the call options that were in the portfolio at March 31, 2009 and December 31, 2008, respectively.  The Company does have agreements with its counterparties for the collar contracts requiring cash collateral if certain liability levels are met.  The Company did not have any cash collateral held by these counterparties at March 31, 2009 or December 31, 2008.

7BNote 4.                Restructuring Charges
 
In the third quarter of 2008, Alaska announced reductions in work force among union and non-union employees.  The Company recorded a $12.9 million charge in 2008 representing the severance payments and estimated medical coverage obligation for the affected employees.


The following table displays the activity and balance of the severance and related cost components of the Company’s restructuring accrual as of and for the three-months ended March 31, 2009 and 2008 (in millions):

Accrual for Severance and Related Costs
  
2009
    
2008
  
Balance at December 31, 2008 and 2007
   $ 7.2     $ 0.7  
Cash payments
     (6.2 )     (0.5 )
Balance at March 31
   $ 1.0     $ 0.2  

The Company will make the majority of the remaining cash payments in the second and third quarters of 2009. The accrual for severance and related costs is included in accrued wages, vacation and payroll taxes in the consolidated balance sheets.

8BNote 5.                Long-term Debt
 
Long-term debt obligations were as follows (in millions):
   
March 31, 2009
    
December 31, 2008
  
Fixed-rate notes payable due through 2024
   $ 1,489.7     $ 1,458.9  
Variable-rate notes payable due through 2019
     264.9       267.4  
16BBank line-of-credit facility expiring in 2010
     17B--       18B75.0  
19BPre-delivery payment facility expiring in 2011
     20B29.1       21B39.9  
Long-term debt
     1,783.7       1,841.2  
Less current portion      (164.4 )     (244.9 )
    $ 1,619.3     $ 1,596.3  
 
During the first three months of 2009, Alaska borrowed $29.0 million using fixed-rate debt secured by flight equipment and another $2.7 million from its pre-delivery payment facility.  Alaska made payments of $114.6 million, including $13.5 million on its pre-delivery payment facility and $75 million on its bank line-of-credit facility.  Horizon financed two of its recently delivered Q400 aircraft using fixed-rate debt arrangements with proceeds totaling $32.3 million and made scheduled debt payments of $6.9 million.

9BNote 6.                Employee Benefit Plans
 
Pension Plans - Qualified Defined Benefit
Net pension expense for the three months ended March 31 included the following components
(in millions):
   
2009
    
2008
  
Service cost
   $ 11.1     $ 12.2  
Interest cost
     16.7       15.7  
Expected return on assets
     (12.8 )     (17.9 )
Amortization of prior service cost
     1.1       1.1  
Actuarial loss
     7.2       1.4  
Net pension expense
   $ 23.3     $ 12.5  

25BAlthough there is no required minimum funding in 2009, the Company contributed $10.6 million to its qualified defined-benefit plans during the three months ended March 31, 2009, and expects to contribute an additional $37.2 million to these plans during the remainder of 2009.  The Company made $17.2 million in contributions to its defined-benefit pension plans during the three months ended March 31, 2008.



Pension Plans - Nonqualified Defined Benefit
Net pension expense for the unfunded, noncontributory defined-benefit plans was $0.8 million and $0.9 million for the three months ended March 31, 2009 and 2008, respectively.

Postretirement Medical Benefits
Net periodic benefit cost for the post-retirement medical plans for the three months ended March 31, 2009 and 2008 was $3.3 million and $2.8 million, respectively.

10BNote 7.                Other Assets
 
Other assets consisted of the following (in millions):
   
March 31, 2009
    
December 31, 2008
  
Restricted deposits (primarily restricted investments)
   $ 81.9     $ 78.6  
Deferred costs and other*
     76.5       44.5  
    $ 158.4     $ 123.1  
*Deferred costs and other includes deferred financing costs, long-term prepaid rent, lease deposits and other items.

11BNote 8                 Mileage Plan
 
Alaska’s Mileage Plan deferrals and liabilities are included under the following balance sheet captions
(in millions):
   
March 31, 2009
    
December 31, 2008
  
Current Liabilities:
            
Other accrued liabilities
   $ 285.5     $ 280.4  
Other Liabilities and Credits (non-current):
                
Deferred revenue
     397.5       394.1  
Other liabilities
     13.2       15.9  
    $ 696.2     $ 690.4  

Alaska’s Mileage Plan revenue is included under the following condensed consolidated statements of operations captions for the three months ended March 31 (in millions):
   
2009
    
2008
  
Passenger revenues
   $ 38.8     $ 25.3  
Other - net revenues
     24.5       26.7  
    $ 63.3     $ 52.0  

0BNote 9.                Stock-Based Compensation Plans
The Company accounts for stock-based awards using Statement of Financial Accounting Standards SFAS No. 123R, Share-Based Payment: An Amendment of SFAS Nos. 123 and 95. All stock-based compensation expense is recorded in wages and benefits in the condensed consolidated statements of operations.  See Note 11 for discussion of an error in prior periods related to stock-based compensation.

The Company has stock awards outstanding under a number of long-term incentive equity plans, one of which continues to provide for the grant of stock awards to directors, officers and employees of the Company and its subsidiaries.  Compensation expense is recorded over the shorter of the vesting period between the grant date and the date the employee becomes retirement-eligible as defined in the applicable plan.


Stock Options
During the three months ended March 31, 2009, the Company granted 384,268 options with a weighted-average fair value of $14.00 per share.  During the same period in the prior year, the Company granted 302,854 options with a weighted-average fair value of $12.05 per share.

12BThe Company recorded stock-based compensation expense related to stock options of $2.3 million ($1.4 million after tax) for the three months ended March 31, 2009 and 2008.  As of March 31, 2009, $6.2 million of compensation cost associated with unvested stock option awards attributable to future service had not yet been recognized.  This amount will be recognized as expense over a weighted-average period of 2.7 years.

As of March 31, 2009, options to purchase 2,893,038 shares of common stock were outstanding with a weighted-average exercise price of $30.43.  Of that total, 1,956,213 were exercisable at a weighted-average exercise price of $30.97.

13BRestricted Stock Awards
During the three months ended March 31, 2009, the Company awarded 241,489 restricted stock units (RSUs) to certain employees, with a weighted-average grant date fair value of $27.56.  This amount reflects the value of the total RSU awards at the grant date based on the closing price of the Company’s common stock.

Compensation cost for RSUs is recognized over three years from the date of grant as the awards “cliff vest” after three years.  The Company recorded stock-based compensation expense related to RSUs of $2.8 million ($1.8 million after tax) and $2.3 million ($1.4 million after tax) for the three-month ended March 31, 2009 and 2008, respectively.

As of March 31, 2009, $8.3 million of compensation cost associated with unvested restricted stock awards attributable to future service had not yet been recognized.  This amount will be recognized as expense over a weighted-average period of 2.3 years.

27BEmployee Stock Purchase Plan
35BCompensation expense recognized under the Employee Stock Purchase Plan was $0.3 million and $0.7 million for the three months ended March 31, 2009 and 2008, respectively.

28BSummary of Stock-Based Compensation
The table below summarizes the components of total stock-based compensation for the three months ended March 31, 2009 and 2008 (in millions):
   
2009
    
2008
  
Stock options
   $ 2.3     $ 2.3  
Restricted stock units
     2.8       2.3  
Performance share units
     --       0.2  
Employee stock purchase plan
     0.3       0.7  
Total stock-based compensation
   $ 5.4     $ 5.5  



Note 10.             Operating Segment Information

Operating segment information for Alaska and Horizon for the three months ended March 31 was as follows (in millions):
   
Three Months Ended March 31,
  
   
2009
    
2008
  
Operating revenues:
            
Alaska – mainline (1)
   $ 591.3     $ 663.0  
Alaska – purchased capacity (1)
     U61.8       U70.4  
Total Alaska
     653.1       733.4  
Horizon
     146.8       177.2  
Other (2)
     0.3       0.3  
Elimination of intercompany revenues
     (57.8 )     (71.4 )
29BConsolidated
   $ 30B742.4     $ 31B 839.5  
Loss before income tax:
                
Alaska – mainline
   $ (17.4 )   $ (33.5 )
    Alaska – purchased capacity     (0.9 )      (6.3 ) 
Total Alaska
     (18.3 )     (39.8 )
Horizon
     (10.5 )     (17.6 )
    Other (2)     (0.8 )      (1.0 ) 
Consolidated   $  (29.6 )    $  (58.4 ) 
                 
   
March 31, 2009
    
December 31, 2008
  
Total assets at end of period:
                
Alaska
   $ 4,370.6     $ 4,428.6  
Horizon
     731.3       692.3  
Other (2)
     815.1       820.3  
Elimination of intercompany accounts
     (1,138.0 )     (1,105.6 )
Consolidated
   $ 4,779.0     $ 4,835.6  
(1) Alaska mainline revenue represents revenue from passengers aboard Alaska jets, freight and mail revenue, and all other revenue.  Purchased capacity revenue represents that revenue earned by Alaska on capacity purchased from and provided by Horizon and a small third party under a capacity purchase arrangement.
(2) Includes the parent company, Alaska Air Group, Inc., including its investments in Alaska and Horizon, which are eliminated in consolidation.

14BNote 11.             Adjustment to Prior-Period Results
 
In the third quarter of 2008, the Company discovered an error in its calculation of stock-based compensation expense under SFAS No. 123R for certain awards granted after January 1, 2006.  The error related to the time period over which compensation expense was recorded.  The company had been recording compensation expense over the vesting period, which was deemed to be the service period.  However, many employees that receive award grants are eligible for retirement or will be eligible for retirement prior to the end of the vesting period.  The award plans allow for continued vesting subsequent to retirement.  As such, the related compensation expense should have been recorded over the shorter of the vesting period or the period from the date of grant to the date the employee is eligible for retirement.  The error resulted in a $2.3 million understatement of wages and benefits expense in the first quarter of 2008.  The Company concluded that this item was not material, and in accordance with SAB 108, adjusted wage and benefits expense for the three months ended March 31, 2008.  There was no impact to the first quarter of 2009.  See the tables below for further details.


Reconciliation Between Amounts Previously Reported and Corrected Amounts
 
The impact of the stock-based compensation expense correction on financial statement line items is presented below (in millions):

UCCondensed Consolidated Statement of Operations:
                   
   
Three Months Ended March 31, 2008
  
   
As Originally
Reported
    
Adjustment
    
As Corrected
  
Wages and benefits
   $ 242.4     $ 2.3     $ 244.7  
Total Operating Expenses
     889.2       2.3       891.5  
Operating Loss
     (49.7 )     (2.3 )     (52.0 )
Loss before income tax
     (56.1 )     (2.3 )     (58.4 )
Net Loss
   $ (35.9 )   $ (1.4 )   $ (37.3 )
Basic and Diluted Loss Per Share
   $ (0.97 )   $ (0.04 )   $ (1.01 )

15BNote 12.             Contingencies
 
Grievance with International Association of Machinists
In June 2005, the International Association of Machinists (IAM) filed a grievance under its Collective Bargaining Agreement (CBA) with Alaska alleging that Alaska violated the CBA by, among other things, subcontracting the ramp service operation in Seattle.  The dispute was referred to an arbitrator and hearings on the grievance commenced in January 2007, with a final hearing date in August 2007.  In July 2008, the arbitrator issued a final decision in the matter.  In that decision, the arbitrator found that Alaska had violated the CBA and instructed Alaska and the IAM to negotiate a remedy.  The parties have met, but the matter has not yet been resolved.  Another arbitration hearing has been set for June 2009, with a preliminary hearing in May 2009.  Management currently does not believe that any final remedy will materially impact our financial position or results of operations.

Other items
The Company is a party to routine litigation matters incidental to its business and with respect to which no material liability is expected.

Management believes the ultimate disposition of the matters discussed above is not likely to materially affect the Company’s financial position or results of operations. This forward-looking statement is based on management’s current understanding of the relevant law and facts, and it is subject to various contingencies, including the potential costs and risks associated with litigation and the actions of arbitrators, judges and juries.




ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand the Company, our operations and our present business environment.  MD&A is provided as a supplement to – and should be read in conjunction with – our condensed 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 the Company’s filings with the Securities and Exchange Commission including those listed in Part I, “Item 1A.  Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2008.  This overview summarizes MD&A, which includes the following sections:

 
·
First Quarter in Review – highlights from the first quarter of 2009 outlining some of the major events that happened during the period and how they affected our financial performance.

 
·
Results of Operations – an in-depth analysis of the results of operations of Alaska and Horizon for the three months ended March 31, 2009.  We believe this analysis will help the reader better understand our condensed consolidated statements of operations.  This section also includes forward-looking statements regarding our view of the remainder of 2009.

 
·
Liquidity and Capital Resources – an analysis of cash flows, sources and uses of cash, contractual obligations, commitments and off-balance sheet arrangements, an overview of financial position and the impact of inflation and changing prices.

Air Group’s filings with the Securities and Exchange Commission, including its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are accessible free of charge at www.alaskaair.com.  The information contained on our website is not a part of this quarterly report on Form 10-Q.

FIRST QUARTER IN REVIEW
Our consolidated pretax loss was $29.6 million for the first quarter of 2009 compared to $58.4 million in the first quarter of 2008.  The improvement in our pretax earnings was primarily due to a significant decline in aircraft fuel cost from the first quarter of 2008, offset by lower revenues.
 
 
·
Economic fuel averaged $1.91 per gallon in the first quarter of 2009, compared to $2.73 in 2008.  This, along with a decline in consumption, resulted in a $115 million reduction in our economic fuel expense for the quarter.
 
 
·
Partially offsetting this decline in fuel cost was the 11.6% reduction in operating revenues driven by softening demand in the midst of the current economic turmoil.  In the first quarter, mainline Alaska traffic and Horizon traffic fell by 7.7% and 20.4%, respectively.

Other significant developments during the first quarter of 2009 and through the filing of this Form 10-Q are described below.

Mileage Plan Award
Our Mileage Plan program won the 2008 “Program of the Year” award at the Freddie Awards held in April 2009.  This is the fifth time that we have won this highest award and the second year in a row.  We also won the top prizes for “Best Web Site,” “Best Elite-Level Program,” and “Best Member Communications.”

Update on Labor Negotiations
Alaska recently reached a tentative agreement with the Air Line Pilots Association (ALPA) on a new four-year contract representing Alaska’s pilots.  The financial terms of the agreement will not be disclosed until the vote has been completed, which is expected in late May 2009.  We would note, however, that our objectives were to improve both wage rates and productivity, to close the defined benefit pension plan to new entrants, and to move toward a common profit-sharing program for all of our employees.  We believe this tentative agreement meets these objectives.

Alaska and the Alaska flight attendants agreed on a two-year extension of the current contract.  The new contract will become amendable in April 2012.  As part of the new contract, flight attendants will receive a 1.5% pay increase on May 1, 2010 and May 1, 2011 and will now participate in the same performance-based incentive plan as Alaska’s non-union and dispatch employees.  The flight attendants received a bonus upon ratification of the contract totaling $2.0 million in the aggregate.  This has been recorded in wages and benefits in the condensed consolidated statement of operations for the three months ended March 31, 2009.

Horizon is in negotiations with the following work groups – pilots, flight attendants, technicians and dispatchers.  Horizon’s aircraft technicians recently voted to be represented by the International Brotherhood of Teamsters.  They were previously represented by the Aircraft Mechanics Fraternal Association.

H1N1 Virus
The H1N1 influenza virus, or “swine flu,” is currently impacting travel behavior, specifically travel to and from Mexico where the virus originated.  The World Health Organization has stated that this virus poses a Level 5 threat, which indicates that the outbreak is capable of widespread human infection.  The Centers for Disease Control and Prevention has advised that nonessential travel to and from Mexico be delayed or cancelled until further notice.  However, recent media reports indicate that the virus is milder than originally reported and that the situation appears to be stabilizing.
 
In response to the decline in passenger demand for travel in the affected markets, we recently announced that we will be reducing our capacity to Mexico destinations beginning July 2, 2009 by 37%, with some selective cancellations beginning immediately.  The capacity will be redeployed to other leisure destination markets, primarily Hawaii.  Flights to and from Mexico represented approximately 13% of Alaska’s total passenger traffic in the first quarter of 2009, generally the highest quarter of the year, and 8% of total traffic in the full year of 2008.  We will be monitoring the situation closely and will make any further changes to our schedule if necessary.
 
Horizon Fleet Transition
Horizon is in the process of transitioning to an all-Q400 fleet.  As of March 31, 2009, Horizon had six Q200 aircraft remaining, none of which were in the operational fleet.  The total charge associated with removing these aircraft from operation in the first quarter of 2009 was $4.8 million.  This charge represents the estimated loss under potential disposal transactions and may change when the final transactions are complete.

In the first quarter of 2008, our Board of Directors approved the plan to remove Horizon’s CRJ-700 fleet from operations, in addition to the Q200 transition described above.  We are currently evaluating various alternatives to dispose of the remaining 18 CRJ-700 aircraft in the most economically feasible way.  The current economic conditions are hindering the remarketing effort and could result in further delays of the timeline to transition completely to an all-Q400 fleet.  The nature, timing or amount of any potential gain or loss associated with transactions on the remaining aircraft cannot be reasonably estimated at this time.

New Markets
In the first quarter, we announced that Alaska would begin daily non-stop service between Seattle and Austin, Texas beginning August 3, 2009; between Portland, Ore. and Maui beginning July 3, 2009; between Seattle and Houston beginning September 23, 2009; between Seattle and Atlanta beginning October 23, 2009; and between Bellingham, Wash. to Las Vegas beginning June 25, 2009. Alaska also announced new service between Oakland, Calif. and Maui beginning November 9, 2009 four times a week and thrice-weekly service between Oakland and Kona beginning November 10, 2009.

First Bag Service Charge
We recently announced that we will join nearly all major domestic carriers in charging for a first checked bag.  The $15 service charge is effective for tickets purchased beginning May 1, 2009 for travel commencing July 7, 2009.  This fee will not apply to our MVP or MVP Gold Mileage Plan members, for those traveling solely within the state of Alaska, and for certain other passengers.  We believe this fee will generate at least $70 million of incremental revenue on an annual basis and $30 million of incremental revenue for the remainder of 2009.  Our desire is to keep our base ticket prices competitive and to allow our customers to pay only for the added services that they use.

New Luggage Guarantee
We have also introduced a guarantee to compensate passengers if their bags are not at the baggage claim within 25 minutes after their flight parks at the gate.  Passengers will have the choice of 2,500 Mileage Plan miles or a $25 voucher that can be used on a future flight.  This guarantee is for all passengers with luggage, including those that were not subject to the service charge. We believe that we are the only airline to offer this guarantee to customers.

On-Board Wi-Fi
Alaska began testing its in-flight Wi-Fi service during the first quarter of 2009.  The initial customer feedback has been positive, and we expect to retrofit approximately half of Alaska’s fleet in 2009 and the remaining half in 2010.  We are now evaluating pricing models for use of the service.

Impact of Mt. Redoubt Eruptions
The eruptions of Mt. Redoubt in Alaska significantly impacted our operations during the first quarter.  As the safety of our passengers and employees is our highest priority, we cancelled more than 300 flights in and out of the state of Alaska affecting more than 20,000 passengers.  Most of those passengers were re-accommodated on other flights.  The overall financial impact of the operational disruption was not material to our financial results.

Outlook
Looking ahead, advance bookings for May and June 2009 are down at both Alaska and Horizon compared to the same period of 2008.  We believe the advance booking trends show signs of weakness in demand, which will have a negative impact on ticket yields and unit revenues.  If demand continues to deteriorate, we are prepared to reduce capacity further in the fall of 2009.  We will continue to focus on reducing and/or redeploying our capacity to optimize load factors and revenue performance.  We currently expect Alaska mainline capacity to decline 6% and Horizon total system capacity to decline by 9% in 2009 compared to 2008.



RESULTS OF OPERATIONS
COMPARISON OF QUARTER ENDED MARCH 31, 2009 TO QUARTER ENDED MARCH 31, 2008
Our consolidated net loss for the first quarter of 2009 was $19.2 million, or $0.53 per share, compared to a net loss of $37.3 million, or $1.01 per share, in 2008.  Both periods include adjustments to reflect the timing of gain or loss recognition resulting from mark-to-market accounting related to our fuel hedge portfolio.  In the first quarter of 2009, we recognized net mark-to-market gains of $10.0 million ($6.2 million after tax, or $0.17 per share), compared to gains of $0.7 million ($0.4 million after tax, or $0.01 per share) in the first quarter of 2008.  These gains offset aircraft fuel expense.

We believe disclosure of the impact of these individual charges is useful information to investors and other readers because:  
 
•
it is useful to monitor performance without these items as it improves a reader’s ability to compare our results to the results of other airlines;  
 
•
our results excluding these adjustments related to fuel hedge accounting and other items serve as the basis for our various employee incentive plans, thus the information allows investors to better understand the changes in variable incentive pay expense in our condensed consolidated statements of operations;  
 
•
our results excluding these items is most often used in internal management and board reporting and decision-making; and  
 
•
we believe it is the basis by which we are evaluated by industry analysts.

Our consolidated results are primarily driven by the results of our two operating carriers. Alaska and Horizon reported pretax losses of $18.3 million and $10.5 million, respectively, in the first quarter of 2009. Financial and statistical data for Alaska and Horizon are shown on pages 22 and 29, respectively. An in-depth discussion of the results of Alaska and Horizon begins on pages 23 and 30, respectively.
Alaska Airlines Financial and Statistical Data (unaudited)
                  
                   
      Three Months Ended March 31  
Financial Data (in millions):
  
2009
    
2008
    
% Change
  
Operating Revenues:
                  
Passenger
   $ 539.8     $ 607.3       (11.1 )
Freight and mail
     18.3       21.3       (14.1 )
Other - net
     33.2       34.4       (3.5 )
Total mainline operating revenues
     591.3       663.0       (10.8 )
Passenger - purchased capacity
     61.8       70.4       (12.2 )
Total Operating Revenues
     653.1       733.4       (10.9 )
                         
Operating Expenses:
                        
Wages and benefits
     197.4       192.1       2.8  
Variable incentive pay
     7.1       2.6       173.1  
Aircraft fuel, including hedging gains and losses
     131.9       233.7       (43.6 )
Aircraft maintenance
     46.3       42.1       10.0  
Aircraft rent
     26.5       28.2       (6.0 )
Landing fees and other rentals
     40.8       41.9       (2.6 )
Contracted services
     30.5       34.7       (12.1 )
Selling expenses
     19.1       26.5       (27.9 )
Depreciation and amortization
     43.3       38.8       11.6  
Food and beverage service
     11.0       11.7       (6.0 )
Other
     42.8       41.8       2.4  
Total mainline operating expenses
     596.7       694.1       (14.0 )
Purchased capacity costs
     62.7       76.7       (18.3 )
Total Operating Expenses
     659.4       770.8       (14.5 )
                         
Operating Loss
     (6.3 )     (37.4 )  
NM
  
                         
Interest income
     10.1       13.1          
Interest expense
     (23.0 )     (21.8 )        
Interest capitalized
     2.5       5.9