form10-q.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 September 30, 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ 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 35,255,503 common shares, par value $1.00, outstanding at October 31, 2009.  
 
 

 
 

 


ALASKA AIR GROUP, INC.
Quarterly Report on Form 10-Q for the three months ended September 30, 2009

TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
 
 
 






2


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 current economic environment on customer travel behavior;
·      changes in our operating costs, including fuel, which can be volatile;
·      the competitive environment in our industry;
 
·
our ability to meet our cost reduction goals;
 
·
our significant indebtedness;
 
·
an aircraft accident or incident;
 
·
our ability to achieve or maintain profitability;
 
·
labor disputes and our ability to attract and retain qualified personnel;
 
·
potential downgrades of our credit ratings and the availability of financing;
 
·
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;
 
·
fluctuations in our quarterly results;
 
·
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;
 
·
compliance with our financial covenants;
 
·
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.



3

PART I.      FINANCIAL INFORMATION
            
ITEM 1.      CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
            
             
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
        
Alaska Air Group, Inc.
            
             
ASSETS
            
   
September 30,
    
December 31,
  
(in millions)
  
2009
    
2008
  
Current Assets
            
Cash and cash equivalents
   $ 170.0     $ 283.1  
Marketable securities
     1,059.6       794.3  
  Total cash and marketable securities
     1,229.6       1,077.4  
Receivables - net
     128.3       116.7  
Inventories and supplies - net
     47.4       51.9  
Deferred income taxes
     138.7       164.4  
Fuel hedge contracts
     43.6       16.5  
Prepaid expenses and other current assets
     98.2       82.0  
Total Current Assets
     1,685.8       1,508.9  
                 
Property and Equipment
                
Aircraft and other flight equipment
     3,598.9       3,431.0  
Other property and equipment
     620.2       608.6  
Deposits for future flight equipment
     204.0       309.8  
      4,423.1       4,349.4  
Less accumulated depreciation and amortization
     1,286.8       1,181.7  
                 
Total Property and Equipment - Net
     3,136.3       3,167.7  
                 
Fuel Hedge Contracts
     35.3       35.9  
                 
Other Assets
     148.6       123.1  
                 
Total Assets
   $ 5,006.0     $ 4,835.6  
                 
See accompanying notes to condensed consolidated financial statements.
          


4

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
        
Alaska Air Group, Inc.
            
             
LIABILITIES AND SHAREHOLDERS' EQUITY
            
   
September 30,
    
December 31,
  
(in millions except share amounts)
  
2009
    
2008
  
Current Liabilities
            
Accounts payable
   $ 55.1     $ 59.6  
Accrued aircraft rent
     61.1       64.4  
Accrued wages, vacation and payroll taxes
     136.3       119.5  
Other accrued liabilities
     482.7       475.4  
Air traffic liability
     397.1       372.7  
Fuel hedge contracts liability
     1.7       24.1  
Current portion of long-term debt
    148.5       244.9  
                 
Total Current Liabilities
     1,282.5       1,360.6  
                 
Long-Term Debt, Net of Current Portion
     1,657.5       1,596.3  
                 
Other Liabilities and Credits
                
Deferred income taxes
     93.3       36.7  
Deferred revenue
     454.0       421.3  
Obligation for pension and postretirement medical benefits
     582.7       584.7  
Other liabilities
     162.2       174.1  
      1,292.2       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 - 43,453,355 shares
                
               2008 - 43,171,404 shares
     43.5       43.2  
  Capital in excess of par value
     927.2       915.0  
  Treasury stock (common), at cost: 2009 - 8,202,384 shares
                
                                         2008 - 6,896,506 shares
     (184.8 )     (161.4 )
Accumulated other comprehensive loss
     (303.0 )     (328.3 )
Retained earnings
     290.9       193.4  
      773.8       661.9  
Total Liabilities and Shareholders' Equity
   $ 5,006.0     $ 4,835.6  
                 
See accompanying notes to condensed consolidated financial statements.
          

5

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
              
Alaska Air Group, Inc.
                        
                         
   
Three Months Ended September 30
    
Nine Months Ended September 30
  
(in millions except per-share amounts)
  
2009
    
2008
    
2009
    
2008
  
                         
Operating Revenues
                        
Passenger
   $ 884.8     $ 952.8     $ 2,326.1     $ 2,592.0  
Freight and mail
     27.7       30.5       72.3       80.4  
Other - net
     54.9       39.6       155.3       120.8  
Change in Mileage Plan terms
     -       42.3       -       42.3  
Total Operating Revenues
     967.4       1,065.2       2,553.7       2,835.5  
                                 
Operating Expenses
                                
Wages and benefits
     246.2       232.1       739.3       711.2  
Variable incentive pay
     24.0       6.3       52.2       15.0  
Aircraft fuel, including hedging gains and losses
     199.5       575.6       485.6       1,039.6  
Aircraft maintenance
     49.7       47.4       169.0       159.6  
Aircraft rent
     38.3       40.2       115.4       126.1  
Landing fees and other rentals
     57.3       56.8       165.9       169.7  
Contracted services
     37.4       40.2       112.6       128.3  
Selling expenses
     37.0       41.7       97.3       120.3  
Depreciation and amortization
     55.6       52.1       162.3       152.9  
Food and beverage service
     12.7       13.5       36.7       39.2  
Other
     51.1       52.7       158.2       171.4  
New pilot contract transition costs
     -       -       35.8       -  
Restructuring charges
     -       3.7       -       3.7  
Fleet transition costs - MD-80
     -       21.5       -       47.5  
Fleet transition costs - CRJ-700
     -       0.7       -       6.8  
Fleet transition costs - Q200
     (1.2 )     0.7       8.8       9.7  
Total Operating Expenses
     807.6       1,185.2       2,339.1       2,901.0  
                                 
Operating Income (Loss)
     159.8       (120.0 )     214.6       (65.5 )
                                 
Nonoperating Income (Expense)
                                
Interest income
     8.3       10.7       24.4       31.5  
Interest expense
     (25.9 )     (25.9 )     (77.8 )     (74.3 )
Interest capitalized
     1.4       5.9       6.0       18.5  
Other - net
     (0.8 )     (3.7 )     (6.3 )     (3.4 )
      (17.0 )     (13.0 )     (53.7 )     (27.7 )
Income (loss) before income tax
    142.8       (133.0 )     160.9       (93.2 )
Income tax expense (benefit)
     55.2       (46.5 )     63.4       (32.5 )
                                 
Net Income (Loss)
   $ 87.6     $ (86.5 )   $ 97.5     $ (60.7 )
                                 
Basic Earnings (Loss) Per Share:
   $ 2.48     $ (2.40 )   $ 2.71     $ (1.67 )
Diluted Earnings (Loss) Per Share:
   $ 2.46     $ (2.40 )   $ 2.69     $ (1.67 )
Shares used for computation:
                                
  Basic
    35.275       36.069       35.981       36.383  
  Diluted
     35.681       36.069       36.292       36.383  
                                 
See accompanying notes to condensed consolidated financial statements.
                          


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CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (unaudited)
                    
Alaska Air Group, Inc.
                                          
                                           
                           
Accumulated
              
   
Common
          
Capital in
    
Treasury
    
Other
              
   
Shares
    
Common
    
Excess of
    
Stock,
    
Comprehensive
    
Retained
        
(in millions)
  
Outstanding
    
Stock
    
Par Value
    
at Cost
    
Loss
    
Earnings
    
Total
  
Balances at December 31, 2008
     36.275     $ 43.2     $ 915.0     $ (161.4 )   $ (328.3 )   $ 193.4     $ 661.9  
Net income for the nine months ended September 30, 2009
                                       97.5       97.5  
Other comprehensive income (loss):
                                                        
                                                         
Related to marketable securities:
                                                        
  Change in fair value
                                     22.3                  
  Reclassification to earnings
                                     (1.2 )                
  Income tax effect
                                     (7.9 )                
                                      13.2               13.2  
                                                         
Adjustments related to employee benefit plans:
                                     25.6                  
   Income tax effect
                                     (9.6 )                
                                      16.0               16.0  
                                                         
Related to interest rate derivative instruments:
                                                        
  Change in fair value
                                     (6.2 )                
  Income tax effect
                                     2.3                  
                                      (3.9 )             (3.9 )
Total comprehensive income
                                                     122.8  
                                                         
Purchase of treasury stock
     (1.325 )                     (23.8 )                     (23.8 )
Stock-based compensation
                     10.2                               10.2  
Common stock issued under stock plans
     0.139       0.1       (0.2 )                             (0.1 )
Treasury stock issued under stock plans
     0.019                       0.4                       0.4  
Stock issued for employee stock purchase plan
     0.143       0.2       2.2                               2.4  
Balances at September 30, 2009
     35.251     $ 43.5     $ 927.2     $ (184.8 )   $ (303.0 )   $ 290.9     $ 773.8  
                                                         
                                                         
See accompanying notes to condensed consolidated financial statements.
                                          

7

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
        
Alaska Air Group, Inc.
            
             
    Nine Months Ended September 30,  
(in millions)
  
2009
    
2008
  
Cash flows from operating activities:
            
Net income (loss)
   $ 97.5     $ (60.7 )
Adjustments to reconcile net income (loss) to net cash
               
 provided by operating activities:
                
      Non-cash impact of pilot contract transition costs
     15.5       -  
      Restructuring charges
     -       3.7  
      Fleet transition costs, including impairment charge
     8.8       64.0  
      Depreciation and amortization
     162.3       152.9  
      Stock-based compensation
     10.2       10.8  
      Changes in fair values of open fuel hedge contracts
     (48.9 )     13.8  
      Changes in deferred income taxes
     64.0       (26.4 )
      Increase in receivables - net
     (11.6 )     (5.0 )
      Increase in prepaid expenses and other current assets
     (13.6 )     (42.1 )
      Increase in air traffic liability
     24.4       96.7  
      Increase (decrease) in other current liabilities
     7.1       (19.8 )
      Decrease in deferred revenue and other-net
     (10.1 )     (46.9 )
Net cash provided by operating activities
     305.6       141.0  
                 
Cash flows from investing activities:
                
Property and equipment additions:
                
     Aircraft and aircraft purchase deposits
     (295.0 )     (347.3 )
     Other flight equipment
     (25.1 )     (29.1 )
     Other property and equipment
     (27.2 )     (34.1 )
Total property and equipment additions
     (347.3 )     (410.5 )
Proceeds from disposition of assets
     5.1       6.3  
Purchases of marketable securities
     (767.8 )     (608.4 )
Sales and maturities of marketable securities
     521.8       398.7  
Restricted deposits and other
     (5.1 )     7.1  
Net cash used in investing activities
     (593.3 )     (606.8 )
                 
Cash flows from financing activities:
                
Proceeds from issuance of long-term debt
     191.6       786.0  
Proceeds from sale-leaseback transactions, net
     230.0       -  
Long-term debt payments
     (226.8 )     (218.9 )
Purchase of treasury stock
     (23.8 )     (48.9 )
Proceeds and tax benefit from issuance of common stock
     3.6       2.6  
Net cash provided by financing activities
     174.6       520.8  
                 
Net change in cash and cash equivalents
     (113.1 )     55.0  
Cash and cash equivalents at beginning of year
     283.1       204.3  
Cash and cash equivalents at end of period
   $ 170.0     $ 259.3  
                 
Supplemental disclosure of cash paid (received) during the period for:
                
     Interest (net of amount capitalized)
   $ 77.6     $ 52.3  
     Income taxes
     (8.9 )     (0.2 )
                 
See accompanying notes to condensed consolidated financial statements.
                
                 

8

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 September 30, 2009, as well as the results of operations for the three months and nine months ended September 30, 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
Effective July 2, 2009, the Accounting Standards Codification (ASC) of the Financial Accounting Standards Board (FASB) became the single official source of authoritative, nongovernmental GAAP in the United States.  Although the Company’s accounting policies were not affected by the conversion to ASC, references to specific accounting standards in these notes to the condensed consolidated financial statements have been changed to reference the appropriate section of the ASC.

In March 2008, the 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 and was incorporated into ASC 815, Derivatives and Hedging.  The required disclosures are included in Note 2 and Note 4.  The adoption of this standard did not have a material impact on the disclosures historically provided.

In 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 for assets and liabilities that may be involved in transactions that would not be considered orderly as defined in the position statement.  This position was incorporated into ASC 820, Fair Value Measurements and Disclosures.  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, as incorporated into ASC 320, Investments – Debt and Equity Securities. This position statement provides additional guidance in determining whether a debt security is other-than-temporarily impaired and how entities should record the impairment in the financial statements.  The standard requires 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 were effective for the Company as of June 30, 2009.  See Note 2 for a discussion of the impact of these new positions to the Company’s financial statements. 

9
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 was incorporated into ASC 825, Financial Instruments, and requires companies to provide, on an interim basis, disclosures that were previously only required in annual statements for the fair value of financial instruments.  This staff position was effective for the Company as of June 30, 2009.  See Note 2 for these required disclosures.

In May 2009, the FASB issued statement No. 165, Subsequent Events (SFAS 165), which was incorporated into ASC 855, Subsequent Events. The standard modified the definition of what qualifies as a subsequent event—those events or transactions that occur following the balance sheet date, but before the financial statements are issued—and requires companies to disclose the date through which it has evaluated subsequent events and the basis for determining that date.  The Company adopted the provisions as of June 30, 2009.  The Company has performed an evaluation of subsequent events through November 6, 2009, which is the date these financial statements were issued.

In 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 standard requires the Company to add the fair value hierarchy disclosures required by ASC 820 as it relates to the underlying assets of the pension and postretirement benefit plans.  This position has been incorporated into ASC 715, Compensation – Retirement Benefits, and is effective for 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.

NOTE 2.         FAIR VALUE OF FINANCIAL INSTRUMENTS
 
Fair Value Measurements
Accounting standards define 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. The standards also establish 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. There are 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.


10

Cash, Cash Equivalents and Marketable Securities
The Company uses the “market approach” as defined in the accounting standards 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 September 30, 2009 are as follows (in millions):

   
Level 1
    
Level 2
    
Level 3
    
Total
  
Cash and cash equivalents
   $ 170.0     $ —     $ —     $ 170.0  
Marketable securities
     72.3       987.3       —       1,059.6  
Total
   $ 242.3     $ 987.3     $ —     $ 1,229.6  
                                 
 
All of the Company’s marketable securities are classified as available-for-sale.  The securities are carried at fair value, with the unrealized gains and losses, excluding credit losses, reported in shareholders’ equity under the caption “accumulated other comprehensive loss” (AOCL).  Realized gains and losses are included in other nonoperating income (expense) in the condensed consolidated statements of operations.

The cost of securities sold is based on the specific identification method.  Interest and dividends on marketable securities are included in interest income in the condensed consolidated statements of operations.

Marketable securities consisted of the following (in millions):

   
September 30, 2009
    
December 31, 2008
  
Amortized cost:
            
Government securities/agencies
   $ 386.1     $ 329.1  
Asset-backed obligations
     236.3       198.0  
Other corporate obligations
     420.0       263.7  
    $ 1,042.4     $ 790.8  
Fair value:
                
Government securities/agencies
   $ 392.9     $ 342.8  
Asset-backed obligations
     235.6       187.7  
Other corporate obligations
     431.1       263.8  
    $ 1,059.6     $ 794.3  

Of the marketable securities on hand at September 30, 2009, 8% mature in 2009, 29% in 2010, and 63% thereafter.  Gross realized gains and losses for the three and nine-month periods ended September 30, 2009 and 2008 were not material to the condensed consolidated financial statements.

 

11

The Company determined that credit losses, as defined in the accounting standards, existed as of September 30, 2009 with respect to certain asset-backed obligations.  Based on a future cash flow analysis, the Company determined that it does not expect to recover the full amortized cost basis of certain asset-backed obligations.  This analysis estimated the expected future cash flows by using a discount rate equal to the effective interest rate implicit in the securities at the date of acquisition.  The inputs used to estimate future cash flows included the default, foreclosure, and bankruptcy rates on the underlying mortgages and expected home pricing trends.  The Company also looked at the average credit scores of the individual mortgage holders and the average loan-to-value percentage.  Although management believes the underlying securities are performing well considering the current market, all of the factors mentioned result in expected future cash flows that are less than the current amortized cost of the portfolio of asset-backed obligations.  Therefore, the Company recorded an aggregate credit loss in other nonoperating expense of $1.7 million in the first nine months 2009 to reflect the difference between the present value of future cash flows and the amortized cost basis of the affected securities.  Management does not believe the securities associated with the remaining $3.9 million unrealized loss recorded in AOCL are “other-than-temporarily” impaired, as defined in the accounting standards, based on the current facts and circumstances.  Management currently does not intend to sell these securities prior to their recovery nor does it believe that it will be more-likely-than-not that the Company would need to sell these securities for liquidity or other reasons.

Gross unrealized gains and losses, including credit losses, at September 30, 2009 are presented in the table below (in millions):

         
Unrealized Losses
              
   
Unrealized Gains in AOCL
    
Less than 12 months
    
Greater than 12 months
    
Total Unrealized Losses
    
Less: Credit Loss Recorded in Earnings
    
Net Unrealized Losses in AOCL
    
Net Unrealized Gains/(Losses) in AOCL
    
Fair Value of Securities with Unrealized Losses
  
Government Securities/Agencies
   $ 6.8     $ --     $ --     $ --     $ --     $ --     $ 6.8     $ 35.1  
Asset-backed obligations
     3.1       --       (5.5 )     (5.5 )     (1.7 )     (3.8 )     (0.7 )     25.0  
Other corporate obligations
     11.2       (0.1 )     --       (0.1 )     --       (0.1 )     11.1       35.7  
Total
   $ 21.1     $ (0.1 )   $ (5.5 )   $ (5.6 )   $ (1.7 )     (3.9 )   $ 17.2     $ 95.8  

Interest Rate Swap Agreements
In the third quarter of 2009, the Company entered into interest rate swap agreements with a third party designed to hedge the volatility of the underlying variable interest rate in the Company’s aircraft lease agreements for six B737-800 aircraft.  The agreements stipulate that the Company pay a fixed interest rate over the term of the contract and receive a floating interest rate.  All significant terms of the swap agreement match the terms of the lease agreements, including interest-rate index, rate reset dates, termination dates and underlying notional values.  The agreements expire beginning in June 2020 through March 2021 to coincide with the lease termination dates.

The Company has formally designated these swap agreements as hedging instruments and will record the effective portion of the hedge as an adjustment to aircraft rent in the condensed consolidated statement of operations in the period of contract settlement.  The effective portion of the changes in fair value for instruments that settle in the future are recorded in AOCL in the condensed consolidated balance sheets.

At September 30, 2009, the Company had a liability of $6.2 million associated with these contracts, $5.6 million of which is expected to be reclassified into earnings within the next twelve months and is recorded in other accrued liabilities in the condensed consolidated balance sheets.  The fair value of these contracts is determined based on the difference between the fixed interest rate in the agreements and the observable LIBOR-based interest forward rates at period end, multiplied by the total notional value.  As such, the Company places these contracts in Level 2 of the fair value hierarchy.


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Fair Value of Financial Instruments
The majority of the Company’s financial instruments are carried at fair value.  These include cash, cash equivalents and marketable securities (Note 2); restricted deposits (Note 9); fuel hedge contracts (Note 4); and interest rate swap agreements (Note 2).  The Company’s long-term fixed-rate debt is not carried at fair value.  The estimated fair value of the Company’s long-term debt was as follows (in millions):
             
   
Carrying Amount
    
Fair Value
  
Long-term debt at September 30, 2009
   $ 1,806.0     $ 1,767.5  
Long-term debt at December 31, 2008
   $ 1,841.2     $ 2,006.8  
                 
The fair value of cash and cash equivalents approximates carrying values due to the short maturity of these instruments.  The fair value of marketable securities is based on market prices.  The fair value of fuel hedge contracts is based on commodity exchange prices.  The fair value of restricted deposits approximates the carrying amount.  The fair value of interest rate swap agreements is based on quoted market swap rates.  The fair value of long-term debt is based on a discounted cash flow analysis using the Company’s current borrowing rate.

NOTE 3.         NEW PILOT CONTRACT TRANSITION COSTS AND RESTRUCTURING CHARGES
 
New Pilot Contract Transition Costs
On May 19, 2009, Alaska announced that its pilots, represented by the Air Line Pilots Association, ratified a new four-year contract.  Among other items, the contract has a provision that allows for pilots to receive, at retirement, a cash payment equal to 25% of their accrued sick leave balance multiplied by their hourly rate. The transition expense associated with establishing this sick-leave payout program was $15.5 million.  Pilots also received a one-time cash bonus following ratification of the contract of $20.3 million in the aggregate.  These items have been combined and reported as “New pilot contract transition costs” in the condensed consolidated statements of operations.

Restructuring Charges
In the third quarter of 2008, Alaska announced reductions in work force among union and non-union employees.  The Company recorded a $3.7 million charge in the third quarter of 2008 representing the severance payments and estimated medical coverage obligation for the affected employees.

NOTE 4.         FUEL HEDGE CONTRACTS
 
The Company’s operations are inherently dependent upon the price and availability of aircraft fuel. To manage economic risk associated with fluctuations in aircraft fuel prices, the Company periodically enters into call options for crude oil and swap agreements for jet fuel refining margins, among other initiatives. The Company records these instruments 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.

The following table summarizes the components of aircraft fuel expense for the three and nine months ended September 30, 2009 and 2008 (in millions):
 
   
Three Months Ended September 30
    
Nine Months Ended September 30
  
   
2009
    
2008
    
2009
    
2008
  
Raw or “into-plane” fuel cost
   $ 190.9     $ 401.4     $ 491.3     $ 1,106.7  
Impact of hedging activity
     8.6       174.2       (5.7 )     (67.1 )
Aircraft fuel expense
   $ 199.5     $ 575.6     $ 485.6     $ 1,039.6  


13

The net cash paid for hedges that settled during the period was $3.6 million and $22.9 million during the three and nine months ended September 30, 2009, respectively.  The net cash received for the three and nine months ended September 30, 2008 was $53.7 million and $154.6 million, respectively.

The Company uses the “market approach” in determining the fair value of its hedge portfolio. The Company’s fuel hedge 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 Note 2.

The Company continually monitors its positions with, and the credit quality of, the financial institutions that are counterparties to its fuel-hedging contracts and does not anticipate nonperformance by the counterparties.

Outstanding future fuel hedge positions are as follows:
 
Approximate % of
Expected Fuel Requirements
 
Gallons Hedged
(in millions)
Weighted-Average Crude
Oil Price per Barrel
Fourth Quarter 2009
50%
43.5
$76
  Remainder 2009
50%
43.5
$76
First Quarter 2010
46%
40.0
$68
Second Quarter 2010
47%
43.0
$68
Third Quarter 2010
46%
44.4
$72
Fourth Quarter 2010
34%
30.0
$78
  Full Year 2010
43%
157.4
$71
First Quarter 2011
26%
23.7
$86
Second Quarter 2011
24%
23.0
$79
Third Quarter 2011
22%
21.5
$80
Fourth Quarter 2011
15%
13.5
$81
  Full Year 2011
22%
81.7
$82
First Quarter 2012
10%
9.2
$87
Second Quarter 2012
7%
7.0
$86
  Full Year 2012
4%
16.2
$86

The Company also uses fixed-price physical contracts and financial swaps to fix the refining margin component for approximately 47% and 27% of expected fourth quarter 2009 and first quarter 2010 jet fuel purchases, respectively, at an average price per gallon of 22 cents per gallon and 25 cents per gallon, respectively.

As of September 30, 2009 and December 31, 2008, the net fair values of the Company’s fuel hedge positions were as follows (in millions):
 
   
September 30, 2009
    
December 31, 2008
  
Crude oil call options or “caps”
   $ 78.9     $ 52.4  
Crude oil collar contracts
     ---       (24.1 )
Refining margin swap contracts
     (1.7 )     ---  
   Total
   $ 77.2     $ 28.3  

The Company paid premiums of $81.0 million and $89.1 million to purchase the call options that were in the portfolio at September 30, 2009 and December 31, 2008, respectively.  The Company does have agreements with its counterparties for the refining margin swap contracts requiring cash collateral if certain liability levels are met.  The Company did not have any cash collateral held by these counterparties at September 30, 2009 or December 31, 2008.

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NOTE 5.         FLEET TRANSITION
 
Horizon Transition to All-Q400 Fleet
Horizon’s long-term goal is to transition to an all-Q400 fleet.  As of September 30, 2009, Horizon had five Q200 aircraft remaining, none of which were in the operational fleet.  These aircraft were removed from operation in the first quarter of 2009 and the Company recorded an associated charge of $10.0 million in the first six months of 2009.  In the third quarter, the Company reduced the total expected loss on the disposal of these aircraft by $1.2 million based on recent transactions.  The lease agreements on the five remaining Q200 aircraft were terminated subsequent to September 30, 2009.

During the three months and nine months ended September 30, 2008, Horizon recorded fleet transition costs of $0.7 million and $9.7 million, respectively, associated with the removal of Q200 aircraft from operations.

In the first nine months of 2008, Horizon recorded an impairment charge on its two owned CRJ-700 aircraft and related spare parts as a result of the decision at that time to exit from the CRJ-700 fleet earlier than originally planned.  The total impairment charge in the first nine months of 2008 associated with this decision was $5.5 million.  Horizon also recorded severance charges related to this fleet transition of $0.7 million and $1.3 million in the third quarter and nine-month period of 2008, respectively.

As noted above, Horizon’s long-term goal is to transition to an all-Q400 fleet.  As market conditions have hindered the remarketing efforts on the CRJ-700 aircraft and as Horizon has successfully deferred future Q400 deliveries, the fleet transition plan has been delayed until market conditions improve. Depending on the ultimate disposition of the CRJ-700 aircraft, there may be associated exit charges. The nature, timing or amount of any potential gain or loss associated with these transactions cannot be reasonably estimated at this time.

 
Alaska Transition to All-Boeing 737 Fleet
In 2006, the Company’s Board of Directors approved a plan to accelerate the retirement of its MD-80 fleet and remove those aircraft from service by the end of 2008. All of the MD-80s were removed from operation by the end of the third quarter of 2008.  Two and four of the aircraft were retired during the third quarter and first nine months of 2008, respectively, and placed in temporary storage at an aircraft storage facility. As a result, the Company recorded a $21.5 million and $47.5 million charge in the third quarter and first nine months of 2008, respectively, reflecting the remaining discounted future lease payments and other contract-related costs to be incurred through the remaining lease terms ending in 2012.

NOTE 6.         LONG-TERM DEBT
 
Long-term debt obligations were as follows (in millions):
   
September 30, 2009
    
December 31, 2008
  
Fixed-rate notes payable due through 2024
   $ 1,464.3     $ 1,458.9  
Variable-rate notes payable due through 2019
     341.7       267.4  
16BBank line-of-credit facility expiring in 2010
     17B--       18B75.0  
19BPre-delivery payment facility expiring in 2011
     20B--       21B39.9  
Long-term debt
     1,806.0       1,841.2  
Less current portion      (148.5 )      (244.9 ) 
    $ 1,657.5     $ 1,596.3  
 
During the first nine months of 2009, the Company borrowed $181.2 million using fixed-rate and variable-rate debt secured by flight equipment and another $10.4 million from its pre-delivery payment facility.  Of the $181.2 million borrowings, Alaska and Horizon borrowed $148.9 million and $32.3 million, respectively.  The Company made payments of $226.8 million, including $50.3 million on its pre-delivery payment facility and $75 million on its bank line-of-credit facility.

15
Alaska’s $80 million pre-delivery payment facility expires on August 31, 2011.  During the second quarter of 2009, the available amount on the facility was reduced from $152 million to $90.5 million and then again to $80 million on August 31, 2009.  The reduction was primarily driven by the decline in the remaining future obligations under the purchase agreement with Boeing.

NOTE 7.         SHAREHOLDERS’ EQUITY
 
Common Stock Repurchase
On June 11, 2009, the Board of Directors authorized the Company to repurchase up to $50 million of its common stock, at which time the Company’s stock price was $15.60. Through September 30, 2009, the Company had repurchased 1,324,578 shares of its common stock for approximately $23.8 million under this program.

Delisting of Common Shares
In October 2009, the Company delisted 7,900,000 common shares that had been held in treasury stock on the condensed consolidated balance sheet as of September 30, 2009.  This action did not impact the total number of common shares outstanding.

NOTE 8.         EMPLOYEE BENEFIT PLANS
 
Pension Plans - Qualified Defined Benefit
Net pension expense for the three and nine months ended September 30, 2009 and 2008 included the following components (in millions):
 
   
Three Months Ended September 30
    
Nine Months Ended September 30
  
 
  
2009
    
2008
    
2009
    
2008
  
Service cost
   $ 11.0     $ 11.7     $ 33.2     $ 35.0  
Interest cost
     16.7       15.7       50.1       47.0  
Expected return on assets
     (12.8 )     (18.0 )     (38.4 )     (53.9 )
Amortization of prior service cost
     1.1       1.1       3.3       3.3  
Actuarial loss
     7.2       1.4       21.6       4.2  
Net pension expense
   $ 23.2     $ 11.9     $ 69.8     $ 35.6  

The Company contributed $15.9 million and $47.8 million to its qualified defined-benefit plans during the three and nine months ended September 30, 2009, respectively.  Management is currently evaluating the amount of additional funding for 2009, if any.  The Company made $17.3 million and $51.7 million in contributions to its qualified defined-benefit pension plans during the three and nine months ended September 30, 2008, respectively.

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 September 30, 2009 and 2008, respectively, and $2.3 million and $2.7 million for the nine months ended September 30, 2009 and 2008, respectively.


16

Postretirement Medical Benefits
Net periodic benefit cost for the post-retirement medical plans for the three months ended September 30, 2009 and 2008 was $4.0 million and $2.8 million, respectively.  The net periodic benefit cost for the nine months ended September 30, 2009 and 2008 was $12.9 million and $8.4 million, respectively.

NOTE 9.         OTHER ASSETS
 
Other assets consisted of the following (in millions):
   
September 30, 2009
    
December 31, 2008
  
Restricted deposits (primarily restricted investments)
   $ 83.7     $ 78.6  
Deferred costs and other*
     64.9       44.5  
    $ 148.6     $ 123.1  
*Deferred costs and other includes deferred financing costs, long-term prepaid rent, lease deposits and other items.

NOTE 10.       MILEAGE PLAN
 
Alaska’s Mileage Plan deferrals and liabilities are included under the following balance sheet captions (in millions):
   
September 30, 2009
    
December 31, 2008
  
Current Liabilities:
            
Other accrued liabilities
   $ 268.6     $ 280.4  
Other Liabilities and Credits (non-current):
                
Deferred revenue
     409.7       394.1  
Other liabilities
     12.8       15.9  
    $ 691.1     $ 690.4  

Alaska’s Mileage Plan revenue is included under the following condensed consolidated statement of operations captions for the three and nine months ended September 30 (in millions):

                                                           
  
Three Months Ended September 30
    
Nine Months Ended September 30
  
                                                                                                             
  
2009
    
2008
    
2009
    
2008
  
Passenger revenues
   $ 54.0     $ 39.8     $ 140.9     $ 100.6  
Other - net revenues
     39.5        25.5       109.8       76.6  
Change in Mileage Plan terms
     --       42.3       --       42.3  
                                                                                                  
   $ 93.5     $ 107.6     $ 250.7     $ 219.5  

In the third quarter of 2008, the Company changed the terms of its Mileage Plan program regarding the expiration of award miles.  Beginning in the third quarter of 2008, Mileage Plan accounts with no activity for two years are deleted.  Under the previous policy, accounts with no activity for three years were deleted.  As a result of the deletion of a number of accounts at that time, the Company reduced its liability for future awards by $42.3 million, which was recorded in the condensed consolidated statements of operations as “Change in Mileage Plan terms.”


17

NOTE 11.       STOCK-BASED COMPENSATION PLANS
 
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 or the period between the grant date and the date the employee becomes retirement-eligible as defined in the applicable plan. All stock-based compensation expense is recorded in wages and benefits in the condensed consolidated statements of operations.

Stock Options
During the nine months ended September 30, 2009, the Company granted 389,652 options with a weighted-average fair value of $14.00 per share.  During the same period in the prior year, the Company granted 388,111 options with a weighted-average fair value of $11.13 per share.

The Company recorded stock-based compensation expense related to stock options of $0.8 million and $0.7 million for the three months ended September 30, 2009 and 2008, respectively.  The Company recorded expense of $3.8 million and $4.0 million for the nine months ended September 30, 2009 and 2008, respectively.  As of September 30, 2009, $5.0 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 2.4 years.

As of September 30, 2009, options to purchase 2,630,721 shares of common stock were outstanding with a weighted-average exercise price of $29.51.  Of that total, 1,827,761 were exercisable at a weighted-average exercise price of $29.85.

Restricted Stock Awards
During the nine months ended September 30, 2009, the Company awarded 253,619 restricted stock units (RSUs) to certain employees, with a weighted-average grant date fair value of $27.03.  This amount reflects the value of the RSU awards at the grant date based on the closing price of the Company’s common stock.  The Company recorded stock-based compensation expense related to RSUs of $1.1 million and $1.8 million for the three months ended September 30, 2009 and 2008, respectively, and $4.9 million and $5.5 million for the nine-month periods ended September 30, 2009 and 2008, respectively.

As of September 30, 2009, $6.3 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 two years.

Deferred Stock Awards
In the first nine months of 2009, the Company awarded 12,704 Deferred Stock Unit awards (DSUs) to members of its Board of Directors as a portion of their retainers.  In the first nine months of 2008, the Company awarded 13,976 DSUs to members.  The underlying common shares are issued upon retirement from the Board, but require no future service period.  As a result, the entire intrinsic value of the awards on the date of grant was expensed in the period of grant.  The total amount of compensation expense recorded was $0.3 million in each of the nine-month periods ended September 30, 2009 and 2008.

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Employee Stock Purchase Plan
Compensation expense recognized under the Employee Stock Purchase Plan was $0.4 million and $0.3 million for the three months ended September 30, 2009 and 2008, respectively, and $1.2 million and $1.4 million for the nine months ended September 30, 2009 and 2008, respectively.

Summary of Stock-Based Compensation
The table below summarizes the components of total stock-based compensation for the three and nine months ended September 30 (in millions):
 
                                                            
  
Three Months Ended September 30
    
Nine Months Ended September 30
  
                                                                                                            
  
2009
    
2008
    
2009
    
2008
  
Stock options
   $ 0.8     $ 0.7     $ 3.8     $ 4.0  
Restricted stock units
     1.1       1.8       4.9       5.5  
Performance share units
     ---       ---       ---       (0.4 )
Deferred stock units
     0.3       ---       0.3       0.3  
Employee stock purchase plan
     0.4       0.3       1.2       1.4  
 
   $ 2.6     $ 2.8     $ 10.2     $ 10.8  

NOTE 12.       OPERATING SEGMENT INFORMATION
 
Operating segment information for Alaska and Horizon for the three and nine months ended September 30 was as follows (in millions):
 
   
Three Months Ended September 30
    
Nine Months Ended September 30
  
   
2009
    
2008
    
2009
    
2008
  
Operating revenues:
                        
  Alaska – mainline (1)
   $ 776.9     $ 856.2     $ 2,049.8     $ 2,261.8  
  Alaska – purchased capacity (1)
     81.9       85.7       211.4       233.9  
  Total Alaska
     858.8       941.9       2,261.2       2,495.7  
  Horizon – brand flying
     108.3       123.0       291.7       339.0  
  Horizon – Alaska capacity purchase arrangement
     69.9       81.1       191.2       231.2  
  Total Horizon
     178.2       204.1       482.9       570.2  
  Other (2)
     0.3       0.3       0.8       0.8  
Elimination of intercompany revenues
     (69.9 )     (81.1 )     (191.2 )     (231.2 )
Consolidated
   $ 967.4     $ 1,065.2     $ 2,553.7     $ 2,835.5  
Income (loss) before income tax:
                                
  Alaska
     124.8       (107.4 )     148.6       (59.9 )
  Horizon
     19.1       (25.1 )     15.1       (30.1 )
  Other (2)
     (1.1 )     (0.5 )     (2.8 )     (3.2 )
Consolidated
   $ 142.8     $ (133.0 )   $ 160.9     $ (93.2 )
 
 
   
September 30, 2009
    
December 31, 2008
  
Total assets at end of period:
            
Alaska
   $ 4,605.6     $ 4,428.6  
Horizon
     714.6       692.3  
Other (2)
     956.0       820.3  
Elimination of intercompany accounts
     (1,270.2 )     (1,105.6 )
Consolidated
   $ 5,006.0     $ 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.
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NOTE 13.       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) 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 regarding basic liability in the matter.  In that ruling, the arbitrator found that Alaska had violated the CBA and instructed Alaska and the IAM to attempt to negotiate a remedy. In June 2009, another hearing was conducted, specifically related to the parties’ views on available remedies.  Subsequent to that hearing, there have been additional executive sessions of the arbitration panel.  Further hearings regarding the nature and scope of available remedies are scheduled to commence in December 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.



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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 our Company, our operations and our present business environment.  MD&A is provided as a supplement to – and should be read in conjunction with – our 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:

 
·
Third Quarter in Review – highlights from the third 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 and nine months ended September 30, 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, and an overview of financial position.

Our filings with the Securities and Exchange Commission, including our 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.

THIRD QUARTER IN REVIEW
Our consolidated pretax income was $142.8 million during the third quarter of 2009 compared to a pretax loss of  $133.0 million in the third quarter of 2008.  The increase in our pretax earnings was primarily due to the $376.1 million decline in aircraft fuel costs and the decline in fleet transition costs from the third quarter of 2008, partially offset by a $97.8 million decline in operating revenues.  The decline in fuel cost is primarily due to a 49% reduction in the cost per gallon of raw fuel and a $165.6 million reduction in net losses associated with our fuel-hedging portfolio.  The 9.2% decline in operating revenues is more fully described below.
 
 
·
Passenger revenue declined 7.1% because of continued demand weakness as compared to the prior year.  In the third quarter, capacity across the Air Group network was reduced by just over 4% and consolidated unit operating revenue, excluding the change in Mileage Plan terms, declined by 1.4%.  This compares with a 2.5% year-over-year decline in the second quarter of 2009.  We believe that demand deterioration is moderating compared with the prior-year periods as evidenced by a year-over-year increase in passenger traffic at Alaska in the quarter.  However, ticket yield continues to be under significant pressure.
 
 

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·      As previously announced, we began charging a $15 first bag service charge on July 7, 2009. This fee does not apply to our MVP or MVP Gold Mileage Plan members, for those traveling solely within the state of Alaska, or for certain other passengers.  For the third quarter, the fee generated $23.5 million of incremental revenue.  As previously disclosed, we believe this fee will generate at least $70 million of incremental revenue on an annual basis, and we expect to meet or exceed our estimate of at least $30 million of incremental revenue during the last half of 2009.

 
·
Mileage Plan revenue increased by $14.2 million primarily as a result of an increase in the commission revenue recognized from the sale of Mileage Plan miles.  See further discussion in the Alaska Airlines segment beginning on page 25.

 
·
We recorded $42.3 million in the prior-year quarter associated with a change in our Mileage Plan program terms.
 
 
 
Other significant developments during the third quarter of 2009 and through the filing of this Form 10-Q are described below.

New Markets
In the third quarter, we announced that Alaska would begin daily non-stop service between Portland and Chicago on November 16, 2009.  We launched previously announced service from Seattle to two new cities in Texas - Houston and Austin during the quarter, and our previously announced non-stop service between Seattle and Atlanta began in October.

Horizon also announced expanded seasonal service to Mammoth Lakes from San Jose, Reno, Seattle and Portland.  The flights will operate from December 17, 2009 to April 11, 2010.

Labor Agreements
As previously disclosed, in August 2009, Alaska and its aircraft technicians reached an agreement on a two-year contract extension.  The extended contract, which becomes amendable on October 17, 2011, provides technicians with a 1.5-percent pay scale increase in October 2009 and 2010. In addition, technicians will no longer participate in the company’s Variable Pay Plan. Instead, they will participate in the Performance-Based Pay (PBP) Plan.

In October 2009, the International Association of Machinists presented its membership with two-year contract extension proposals for Alaska’s clerical, office and passenger service employees, and its ramp service and stores agents.  The proposed extension includes participation in the PBP incentive plan and a 1.5-percent pay scale increase in June 2010 and 2011.  The vote by the covered employees is expected to be completed in December 2009.

Horizon Fleet Transition
Horizon’s long-term goal is to transition to an all-Q400 fleet.  In the first quarter of 2009, Horizon removed the final six Q200 aircraft from operations.  We recorded a charge of $10.0 million in the first six months of 2009 associated with removing these aircraft from operation.  In the third quarter, we reduced the total expected loss on the disposal of these aircraft by $1.2 million based on recent transactions.  Subsequent to September 30, 2009, we successfully disposed of the remaining Q200 aircraft and, as such, have terminated the associated lease agreements.

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Although we have been actively pursuing various alternatives to dispose of our 18 CRJ-700 aircraft in the most economically feasible way, the current economic conditions have hindered the remarketing efforts.  As a result, the transition to an all-Q400 fleet will be delayed and we will continue to operate the CRJ-700 aircraft in our operating fleet.  We expect to have three Q400 aircraft delivered in the fourth quarter of 2009, but we have successfully deferred 2010 and 2011 Q400 deliveries into future years to better manage our fleet size and capacity plans.

Outlook
Looking ahead, year-over-year advance booked load factor for November is up about 3.5 points for Alaska mainline flying and about 1.5 points for Horizon brand flying.  December advance booked load factor is up about 1.5 points and down about one point for mainline Alaska and Horizon brand flying, respectively, although the trend has been for the year-over-year comparison to improve as the date of travel approaches.  These advance booked load factors are on relatively flat expected capacity at Alaska and an expected decline of about 3% at Horizon brand flying for the fourth quarter.

We are continuing to see lower year-over-year unit revenues and ticket yields due to the current economic conditions and need to stimulate traffic with low fares and sale activity.  We expect to continue to see year-over-year declines in unit revenue through the fourth quarter based on current bookings and fare sales.  The impacts of our new first bag fee and new affinity card agreement, along with other revenue initiatives such as increases in on-board products, have helped to ease the impact of revenue declines from low ticket yields.

RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2009 TO THREE MONTHS ENDED SEPTEMBER 30, 2008
 
Our consolidated net income for the third quarter of 2009 was $87.6 million, or $2.46 per diluted share, compared to a net loss of $86.5 million, or $2.40 per diluted share, in the third quarter of 2008. Significant items impacting the comparability between the periods are as follows:

 
·
Both periods include adjustments to reflect the timing of net unrealized mark-to-market gains or losses related to our fuel hedge positions.  In the third quarter of 2009 we recognized net mark-to-market gains of $7.3 million ($4.6 million after tax, or $0.13 per share) compared to losses of $218.2 million ($136.7 million after tax, or $3.79 per share) in the third quarter of 2008.
 
 
·
The third quarter of 2008 included fleet transition charges of $22.2 million ($13.9 million after tax, or $0.38 per share) related to the planned transitions out of the MD-80 and CRJ-700 fleets.
 
 
·
The third quarter of 2008 included restructuring charges of $3.7 million ($2.3 million after tax, or $0.06 per share) related to the reduction in work force at Alaska.
 
 
·
 The third quarter of 2008 also included a $42.3 million benefit ($26.5 million after tax, or $0.73 per share) related to a change in terms of our Mileage Plan program.

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;

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·
 our results excluding these items are 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 are 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 reported pretax income of $124.8 million in the third  quarter of 2009, while Horizon reported pretax income of $19.1 million. Financial and statistical data for Alaska and Horizon are shown on pages 25 and 32, respectively. An in-depth discussion of the results of Alaska and Horizon begins on pages 26 and 33, respectively.  

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Alaska Airlines Financial and Statistical Data (unaudited)
                                    
                                     
   
Three Months Ended September 30
    
Nine Months Ended September 30
  
               
%
                
%
  
Financial Data (in millions):
  
2009
    
2008
    
Change
    
2009
    
2008
    
Change
  
Operating Revenues:
                                    
Passenger
   $ 702.0     $ 751.2       (6.5 )   $ 1,844.3     $ 2,041.2       (9.6 )
Freight and mail
     26.5       29.2       (9.2 )     69.0       77.1       (10.5 )
Other - net
     48.4       33.5       44.5       136.5       101.2       34.9  
Change in Mileage Plan terms
     -       42.3    
NM
       -       42.3    
NM
  
Total mainline operating revenues
     776.9       856.2       (9.3 )     2,049.8       2,261.8       (9.4 )
Passenger - purchased capacity
    81.9       85.7       (4.4 )     211.4       233.9       (9.6 )
Total Operating Revenues
     858.8       941.9