Edgar Filing: ALASKA AIR GROUP INC

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 June 30, 2010.

¨ 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 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 35,817,109 common shares, par value $1.00, outstanding at July 31, 2010.

ALASKA AIR GROUP, INC.

Quarterly Report on Form 10-Q for the three months ended June 30, 2010

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PART I. FINANCIAL INFORMATION	4
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS	4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	46
ITEM 4. CONTROLS AND PROCEDURES	46

PART II. OTHER INFORMATION	47
ITEM 1. LEGAL PROCEEDINGS	47
ITEM 1A. RISK FACTORS	47
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	47
ITEM 3. DEFAULTS UPON SENIOR SECURITIES	48
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	48
ITEM 5. OTHER INFORMATION	48
ITEM 6. EXHIBITS	48

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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;

our significant indebtedness;

· the competitive environment in our industry;

our ability to meet our cost reduction goals;

an aircraft accident or incident;

labor disputes and our ability to attract and retain qualified personnel;

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;

our reliance on automated systems and the risks associated with changes made to those systems;

our reliance on third-party vendors and partners; and

changes in laws and regulations.

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, 2009. Please consider our forward-looking statements in light of those risks as you read this report.

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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
Alaska Air Group, Inc.

ASSETS
(in millions)	June 30, 2010		December 31, 2009
Current Assets
Cash and cash equivalents	$	108.1	$	164.2
Marketable securities		1,164.6		1,027.9
Total cash and marketable securities		1,272.7		1,192.1
Receivables - net		145.2		111.8
Inventories and supplies - net		48.5		45.8
Deferred income taxes		137.4		120.3
Fuel hedge contracts		31.7		66.2
Prepaid expenses and other current assets		103.7		98.1
Total Current Assets		1,739.2		1,634.3

Property and Equipment
Aircraft and other flight equipment		3,810.8		3,660.1
Other property and equipment		628.4		631.3
Deposits for future flight equipment		147.6		215.5
		4,586.8		4,506.9
Less accumulated depreciation and amortization		1,422.9		1,339.0
Total Property and Equipment - Net		3,163.9		3,167.9

Fuel Hedge Contracts		41.2		50.8

Other Assets		162.7		143.2

Total Assets	$	5,107.0	$	4,996.2

See accompanying notes to condensed consolidated financial statements.

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CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
Alaska Air Group, Inc.

LIABILITIES AND SHAREHOLDERS' EQUITY

(in millions except share amounts)	June 30, 2010			December 31, 2009
Current Liabilities
Accounts payable	$	58.0		$	63.3
Accrued aircraft rent		43.4			54.0
Accrued wages, vacation and payroll taxes		137.8			155.4
Other accrued liabilities		518.2			474.5
Air traffic liability		529.0			366.3
Current portion of long-term debt		154.3			156.0
Total Current Liabilities		1,440.7			1,269.5

Long-Term Debt, Net of Current Portion		1,570.0			1,699.2

Other Liabilities and Credits
Deferred income taxes		207.8			151.1
Deferred revenue		407.1			435.1
Obligation for pension and postretirement medical benefits		409.7			421.0
Other liabilities		131.8			148.2
		1,156.4			1,155.4
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: 2010 - 36,457,646 shares
2009 - 35,843,092 shares		36.5			35.8
Capital in excess of par value		792.0			767.0
Treasury stock (common), at cost: 2010 - 747,411 shares
2009 - 252,084 shares		(27.8	)		(5.7	)
Accumulated other comprehensive loss		(239.7	)		(240.0	)
Retained earnings		378.9			315.0
		939.9			872.1
Total Liabilities and Shareholders' Equity	$	5,107.0		$	4,996.2

See accompanying notes to condensed consolidated financial statements.

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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Alaska Air Group, Inc.

	Three Months Ended June 30						Six Months Ended June 30
(in millions except per-share amounts)	2010			2009			2010			2009

Operating Revenues
Passenger	$	881.5		$	757.2		$	1,629.9		$	1,441.3
Freight and mail		28.1			25.2			51.1			44.6
Other - net		66.8			61.5			125.3			100.4
Total Operating Revenues		976.4			843.9			1,806.3			1,586.3
Operating Expenses
Wages and benefits		239.6			247.1			478.9			493.1
Variable incentive pay		21.6			18.9			39.5			28.2
Aircraft fuel, including hedging gains and losses		255.0			128.4			462.3			286.1
Aircraft maintenance		53.8			59.6			110.8			119.3
Aircraft rent		35.4			39.1			72.4			77.1
Landing fees and other rentals		57.9			54.4			113.8			108.6
Contracted services		41.1			36.8			80.7			75.2
Selling expenses		38.2			35.3			71.8			60.3
Depreciation and amortization		58.0			53.9			114.2			106.7
Food and beverage service		14.3			12.4			26.6			24.0
Other		48.2			50.3			96.0			107.1
New pilot contract transition costs		-			35.8			-			35.8
Fleet transition costs - CRJ-700		3.4			-			3.4			-
Fleet transition costs - Q200		-			5.2						10.0
Total Operating Expenses		866.5			777.2			1,670.4			1,531.5
Operating Income		109.9			66.7			135.9			54.8
Nonoperating Income (Expense)
Interest income		7.6			7.8			15.1			16.1
Interest expense		(26.3	)		(25.1	)		(51.9	)		(51.9	)
Interest capitalized		1.6			1.8			3.3			4.6
Other - net		1.2			(3.5	)		1.8			(5.5	)
		(15.9	)		(19.0	)		(31.7	)		(36.7	)
Income before income tax		94.0			47.7			104.2			18.1
Income tax expense		35.4			18.6			40.3			8.2
Net Income	$	58.6		$	29.1		$	63.9		$	9.9

Basic Earnings Per Share:	$	1.64		$	0.80		$	1.79		$	0.27
Diluted Earnings Per Share:	$	1.60		$	0.79		$	1.74		$	0.27
Shares used for computation:
Basic		35.698			36.354			35.683			36.340
Diluted		36.697			36.591			36.631			36.742

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, 2009		35.591		$	35.8	$	767.0	$	(5.7	)	$	(240.0	)	$	315.0	$	872.1
Net income for the six months ended June 30, 2010															63.9		63.9
Other comprehensive income (loss):

Related to marketable securities:
Change in fair value												8.3
Reclassification to earnings												(3.7	)
Income tax effect												(1.8	)
												2.8					2.8

Adjustments related to employee benefit plans:												10.8
Income tax effect												(3.7	)
												7.1					7.1
Related to interest rate derivative instruments:
Change in fair value												(15.5	)
Income tax effect												5.9
												(9.6	)				(9.6	)
Total comprehensive income																	64.2

Purchase of treasury stock		(0.646	)						(26.3	)							(26.3	)
Stock-based compensation							8.7										8.7
Treasury stock issued under stock plans		0.150							4.2								4.2
Stock issued for employee stock purchase plan		0.016			0.1		0.3										0.4
Stock issued under stock plans		0.599			0.6		16.0										16.6
Balances at June 30, 2010		35.710		$	36.5	$	792.0	$	(27.8	)	$	(239.7	)	$	378.9	$	939.9


See accompanying notes to condensed consolidated financial statements.

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Alaska Air Group, Inc.

	Six Months Ended June 30
(in millions)	2010			2009
Cash flows from operating activities:
Net income	$	63.9		$	9.9
Adjustments to reconcile net income to net cash
provided by operating activities:
Fleet transition costs		3.4			10.0
Non-cash impact of pilot contract transition costs		-			15.5
Depreciation and amortization		114.2			106.7
Stock-based compensation		8.7			7.6
Increase in air traffic liability		162.7			48.8
Changes in other assets and liabilities - net		(19.3	)		(75.3	)
Net cash provided by operating activities		333.6			123.2
Cash flows from investing activities:
Property and equipment additions:
Aircraft and aircraft purchase deposits		(45.3	)		(269.1	)
Other flight equipment		(52.6	)		(19.6	)
Other property and equipment		(13.9	)		(19.8	)
Total property and equipment additions		(111.8	)		(308.5	)
Proceeds from disposition of assets		3.3			4.2
Purchases of marketable securities		(578.1	)		(515.0	)
Sales and maturities of marketable securities		446.2			361.0
Restricted deposits and other		0.5			(4.3	)
Net cash used in investing activities		(239.9	)		(462.6	)
Cash flows from financing activities:
Proceeds from issuance of long-term debt		-			162.6
Proceeds from sale-leaseback transactions, net		-			230.0
Long-term debt payments		(130.9	)		(166.8	)
Purchase of treasury stock		(26.3	)		(11.8	)
Proceeds and tax benefit from issuance of common stock		21.0			2.8
Other financing activities		(13.6	)		2.8
Net cash provided by (used for) financing activities		(149.8	)		219.6
Net change in cash and cash equivalents		(56.1	)		(119.8	)
Cash and cash equivalents at beginning of year		164.2			283.1
Cash and cash equivalents at end of period	$	108.1		$	163.3
Supplemental disclosure of cash paid (received) during the period for:
Interest (net of amount capitalized)	$	50.1		$	48.3
Income taxes		(4.8	)		(8.9	)

See accompanying notes to condensed consolidated financial statements.

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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, 2009. In the opinion of management, all adjustments have been made that are necessary to present fairly the Company’s financial position as of June 30, 2010, as well as the results of operations for the three and six months ended June 30, 2010 and 2009. 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 expenses and revenues associated with the Company’s Mileage Plan; 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.

Reclassifications

Certain reclassifications have been made to conform the prior year’s data to the current format.

Prospective Accounting Pronouncements

New accounting standards on Revenue Arrangements with Multiple Deliverables were issued in September 2009 and update the current guidance pertaining to multiple-element revenue arrangements. This new guidance will be effective for contracts with effective dates beginning January 1, 2011. Management is currently evaluating the impact of this new standard on the Company’s financial position, results of operations, cash flows, and disclosures.

Recently, the Financial Accounting Standards Board (FASB) has issued a number of proposed Accounting Standards Updates (ASUs). Those proposed ASUs are as follows:

Proposed ASU – Comprehensive Income – was issued in May 2010 and will change the way comprehensive income is reported in the financial statements. The new standard will require a continuous statement of comprehensive income be reported combining the Company’s current statement of operations with comprehensive income. Comprehensive income or loss will be removed from the statement of shareholders’ equity.

Proposed ASU – Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities – was issued in May 2010. This proposed standard will make significant changes to accounting for financial instruments. It is expected that more financial instruments will be measured at fair value with subsequent changes recognized in net income. The proposed standard also simplifies the requirements for assessing hedge effectiveness for cash flow

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hedges and modifies the threshold to initially qualify as an effective hedge. Management believes this standard may have an impact on the Company’s results of operations and disclosures, although the significance of that impact cannot be estimated at this time.

Proposed ASU – Revenue Recognition – was issued in June 2010. This proposed standard will completely replace all existing revenue recognition accounting literature. Generally, the proposed standard would require an entity to identify separate performance obligations under a contract, determine the transaction price, allocate that price to the separate components based on relative fair value, and recognize revenue when each performance obligation is satisfied. This proposed standard could significantly impact the Company’s financial position, results of operations, and disclosures specifically in the accounting for the Company’s Mileage Plan revenue components.

Proposed ASU – Fair Value Measurements and Disclosures – was issued in June 2010. This proposed standard changes how fair value is determined for certain assets and liabilities and requires additional disclosures about fair value instruments. Management is currently evaluating the impact of this new standard on the Company’s financial position, results of operations, cash flows, and disclosures.

Proposed ASU – Disclosure of Certain Loss Contingencies – was issued in July 2010. This proposed standard enhances financial statement disclosure surrounding certain loss contingencies such as legal disputes, environmental remediation liabilities, self-insurance liabilities, among others. The proposed standard primarily focuses on asserted claims and assessments and will require more robust disclosure of amounts, court or agency where legal proceedings are pending, principal parties, and other details not historically required. As the proposed standard impacts disclosure only, management does not expect this proposed standard to impact the Company’s financial position or results of operations.

These proposed ASUs are currently in comment period and are subject to change. There are no effective dates assigned to these proposals.

In July 2010, the FASB also issued an initial draft of new financial statement presentation requirements. These new requirements, as currently drafted, would substantially change the way financial statements are presented by disaggregating information in financial statements to explain the components of its financial position and financial performance. These changes will impact the presentation of the financial statements only and are not expected to impact the Company’s overall financial position, results of operations, or cash flows.

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.

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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” 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 June 30, 2010 are as follows (in millions):

	Level 1		Level 2		Level 3		Total
Cash and cash equivalents	$	76.8	$	31.3	$	—	$	108.1
Marketable securities		176.1		988.5		—		1,164.6
Total	$	252.9	$	1,019.8	$	—	$	1,272.7

All of the Company’s marketable securities are classified as “available for sale” as defined in the accounting standards. 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):

	June 30, 2010		December 31, 2009
Amortized cost:
Government securities/agencies	$	462.8	$	376.7
Asset-backed obligations		211.3		215.4
Other corporate obligations		471.9		421.8
	$	1,146.0	$	1,013.9
Fair value:
Government securities/agencies	$	470.6	$	381.2
Asset-backed obligations		211.0		214.7
Other corporate obligations		483.0		432.0
	$	1,164.6	$	1,027.9

Of the marketable securities on hand at June 30, 2010, 14% mature in 2010, 27% in 2011 and 59% thereafter. Gross realized gains and losses for the three months ended June 30, 2010 and 2009 were not material to the condensed consolidated financial statements.

Some of the Company’s asset-backed securities held at June 30, 2010 had credit losses, as defined in the accounting standards. These credit losses total $2.2 million and were recorded through earnings in 2009 and represent the difference between the present value of future cash flows and the amortized cost basis of the affected securities. No additional credit losses were recorded in the first six months of 2010.

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Management does not believe the securities associated with the remaining $2.8 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 June 30, 2010 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 Previously Recorded in Earnings			Net Unrealized Losses in AOCL			Net Unrealized Gains/(Losses) in AOCL			Fair Value of Securities with Unrealized Losses
Government Securities/Agencies	$	7.8	$	--		$	--		$	--		$	--		$	--		$	7.8		$	22.6
Asset-backed obligations		2.1		(0.5	)		(4.1	)		(4.6	)		(2.2	)		(2.4	)		(0.3	)		80.7
Other corporate obligations		11.5		(0.4	)		--			(0.4	)		--			(0.4	)		11.1			57.4
Total	$	21.4	$	(0.9	)	$	(4.1	)	$	(5.0	)	$	(2.2	)	$	(2.8	)	$	18.6		$	160.7

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 7); fuel hedge contracts (Note 3); and interest rate swap agreements (Note 3). 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 is as follows (in millions):


	Carrying Amount		Fair Value
Long-term debt at June 30, 2010	$	1,724.3	$	1,748.5
Long-term debt at December 31, 2009	$	1,855.2	$	1,821.3

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. DERIVATIVE INSTRUMENTS

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. 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.

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The following table summarizes the components of aircraft fuel expense for the three and six months ended June 30, 2010 and 2009 (in millions):

	Three Months Ended June 30					Six Months Ended June 30
	2010		2009			2010		2009
Raw or “into-plane” fuel cost	$	222.9	$	158.5		$	418.1	$	300.4
Impact of hedging activity		32.1		(30.1	)		44.2		(14.3	)
Aircraft fuel expense	$	255.0	$	128.4		$	462.3	$	286.1

The net benefit from hedges that settled during the period was $5.5 million and $5.9 million during the three and six months ended June 30, 2010, respectively. The net cost of settled hedges in the three and six months ended June 30, 2009 was $9.7 million and $35.5 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.

Outstanding future fuel hedge positions are as follows:

	Approximate % of Expected Fuel Requirements			Gallons Hedged (in millions)		Average Crude Oil Price per Barrel		Average Premium Cost per Barrel
Third Quarter 2010		50	%		48.3	$	74	$	10
Fourth Quarter 2010		50	%		44.5	$	83	$	11
Remainder of 2010		50	%		92.8	$	78	$	11
First Quarter 2011		50	%		44.9	$	87	$	11
Second Quarter 2011		50	%		47.2	$	86	$	11
Third Quarter 2011		43	%		42.7	$	86	$	11
Fourth Quarter 2011		36	%		32.9	$	87	$	10
Full Year 2011		45	%		167.7	$	86	$	11
First Quarter 2012		30	%		27.7	$	87	$	12
Second Quarter 2012		21	%		20.9	$	89	$	13
Third Quarter 2012		19	%		19.2	$	92	$	12
Fourth Quarter 2012		17	%		15.7	$	89	$	12
Full Year 2012		22	%		83.5	$	89	$	12
First Quarter 2013		11	%		10.5	$	87	$	12
Second Quarter 2013		5	%		5.5	$	83	$	15
Full Year 2013		4	%		16.0	$	86	$	13

The Company pays a premium to enter into crude oil call option contracts. In order to receive economic benefit from the contract, the market price of crude oil must exceed the total of the contract strike price and the premium cost per barrel at the time of contract settlement.

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The Company also has financial swap agreements in place to fix the refining margin component for approximately 50% and 10% of third and fourth quarter 2010 jet fuel purchases, respectively, at an average price per gallon of 30 cents per gallon and 31 cents per gallon, respectively.

As of June 30, 2010 and December 31, 2009, the net fair values of the Company’s fuel hedge positions were as follows (in millions):

	June 30, 2010		December 31, 2009
Crude oil call options or “caps”	$	71.7	$	115.9
Refining margin swap contracts		1.2		1.1
Total	$	72.9	$	117.0

The balance sheet amounts include capitalized premiums paid to enter into the contracts of $94.8 million and $88.9 million at June 30, 2010 and December 31, 2009, respectively.

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 records 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 is recorded in AOCL in the condensed consolidated balance sheets.

At June 30, 2010, the Company had a liability of $13.2 million associated with these contracts, $6.4 million of which is expected to be reclassified into earnings within the next twelve months. 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.

NOTE 4. LONG-TERM DEBT

Long-term debt obligations were as follows (in millions):

	June 30, 2010			December 31, 2009
Fixed-rate notes payable due through 2024	$	1,381.4		$	1,440.2
Variable-rate notes payable due through 2024		342.9			415.0
Long-term debt		1,724.3			1,855.2
Less current portion		(154.3	)		(156.0	)
	$	1,570.0		$	1,699.2

During the first six months of 2010, the Company had no new debt borrowings and made scheduled debt payments of $76.9 million. The Company also prepaid the full debt balance on two outstanding aircraft debt agreements totaling $54.0 million. Subsequent to June 30, 2010, the Company paid off the outstanding balance on a third aircraft debt agreement of $27.1 million.

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Bank Lines of Credit

The Company terminated its previous $185 million credit facility effective March 30, 2010. That facility was replaced with two new $100 million credit facilities. Both facilities have variable interest rates based on LIBOR plus a specified margin. Borrowings on one of the $100 million facilities, which expires in March 2013, are secured by aircraft. Borrowings on the other $100 million facility, which expires in March 2014, are secured by certain accounts receivable, spare engines, spare parts and ground service equipment. The Company has no immediate plans to borrow using either of these facilities. These facilities have a requirement to maintain a minimum unrestricted cash and marketable securities balance of $500 million. The Company is in compliance with this covenant at June 30, 2010.

Pre-delivery Payment Facility

Effective March 31, 2010, the Company terminated its variable-rate pre-delivery payment facility that had been used to provide a portion of the pre-delivery funding requirements for the purchase of new Boeing 737-800 aircraft. There were no borrowings on this facility as of December 31, 2009 or June 30, 2010.

NOTE 5. COMMON STOCK REPURCHASE

In June 2009, the Board of Directors authorized the Company to repurchase up to $50 million of its common stock. Under the program, the Company repurchased 1,970,326 shares of its common stock. In the first six months of 2010, 645,748 shares were purchased for $26.3 million.

In June 2010, the Board of Directors authorized the Company to repurchase up to an additional $50 million of its common stock. There were no share repurchases under this program in the second quarter of 2010. This program expires in June 2011.

NOTE 6. EMPLOYEE BENEFIT PLANS

Pension Plans - Qualified Defined Benefit

Net pension expense for the three and six months ended June 30, 2010 and 2009 included the following components (in millions):

	Three Months Ended June 30						Six Months Ended June 30
	2010			2009			2010			2009
Service cost	$	8.1		$	11.1		$	16.2		$	22.2
Interest cost		16.9			16.7			33.8			33.4
Expected return on assets		(17.7	)		(12.8	)		(35.4	)		(25.6	)
Amortization of prior service cost		(0.2	)		1.1			(0.4	)		2.2
Actuarial loss		5.5			7.2			11.0			14.4
Net pension expense	$	12.6		$	23.3		$	25.2		$	46.6

The Company contributed $15.2 million and $30.4 million to its qualified defined-benefit plans during the three and six months ended June 30, 2010, respectively, and expects to contribute an additional $15.2 million to these plans during the remainder of 2010. The Company made $21.3 million and $31.9 million in contributions to its qualified defined-benefit pension plans during the three and six months ended June 30, 2009, respectively.

Pension Plans - Nonqualified Defined Benefit

Net pension expense for the unfunded, noncontributory defined-benefit plans was $0.8 million and $0.7 million for the three months ended June 30, 2010 and 2009 and $1.6 million and $1.5 million for the six months ended June 30, 2010 and 2009.

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Post-retirement Medical Benefits

Net periodic benefit cost for the post-retirement medical plans for the three months ended June 30, 2010 and 2009 was $3.1 million and $5.6 million, respectively. The net periodic benefit cost for the six months ended June 30, 2010 and 2009 was $6.2 million and $8.9 million, respectively.

NOTE 7. OTHER ASSETS

Other assets consisted of the following (in millions):

	June 30, 2010		December 31, 2009
Restricted deposits (primarily restricted investments)	$	86.2	$	86.7
Deferred costs and other*		76.5		56.5
	$	162.7	$	143.2

*Deferred costs and other includes deferred financing costs, long-term prepaid rent, lease deposits and other items.

NOTE 8. MILEAGE PLAN

Alaska’s Mileage Plan deferrals and liabilities are included under the following balance sheet captions (in millions):

	June 30, 2010		December 31, 2009
Current Liabilities:
Other accrued liabilities	$	286.0	$	267.9
Other Liabilities and Credits (non-current):
Deferred revenue		384.0		410.6
Other liabilities		12.2		13.2
	$	682.2	$	691.7

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

	Three Months Ended June 30				Six Months Ended June 30
	2010		2009		2010		2009
Passenger revenues	$	51.0	$	48.2	$	92.1	$	86.9
Other - net revenues		48.6		45.8		90.6		70.3
	$	99.6	$	94.0	$	182.7	$	157.2

NOTE 9. 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 six months ended June 30, 2010, the Company granted 129,970 options with a weighted-average fair value of $18.05 per share. During the same period in the prior year, the Company granted 384,268 options with a weighted-average fair value of $14.00 per share.

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The Company recorded stock-based compensation expense related to stock options of $1.0 million and $0.7 million for the three months ended June 30, 2010 and 2009, respectively. The Company recorded expense of $2.8 million and $3.0 million for the six months ended June 30, 2010 and 2009, respectively. As of June 30, 2010, $2.5 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 1.6 years.

As of June 30, 2010, options to purchase 1,703,828 shares of common stock were outstanding with a weighted-average exercise price of $29.94. Of that total, 992,309 were exercisable at a weighted-average exercise price of $30.28.

Restricted Stock Awards

During the six months ended June 30, 2010, the Company awarded 131,646 restricted stock units (RSUs) to certain employees, with a weighted-average grant date fair value of $33.87. 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.

The Company recorded stock-based compensation expense related to RSUs of $1.3 million and $1.1 million for the three-month period ended June 30, 2010 and 2009, respectively, and $3.8 million in both six-month periods ended June 30, 2010 and 2009.

As of June 30, 2010, $5.8 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 1.8 years.

Performance Stock Awards

From time to time, the Company issues performance stock unit awards (PSUs) to certain executives. PSUs are similar to RSUs, but vesting is based on performance or market conditions.

Currently outstanding PSUs were issued in 2008 and in 2010. There are several tranches of PSUs that vest based on differing performance conditions including achieving a specified pretax margin, a market condition tied to the Company’s total shareholder return relative to an airline peer group, and based on certain performance goals established by the Compensation Committee of the Board of Directors. The total grant-date fair value of PSUs issued in 2010 was $3.6 million.

The Company recorded $1.1 million and $1.7 million of compensation expense related to PSUs in the second quarter and first six months of 2010, respectively. No expense was recorded in 2009.

Deferred Stock Awards

In the second quarter of 2010, the Company awarded 6,328 Deferred Stock Unit awards (DSUs) to members of its Board of Directors as a portion of their retainers. 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 quarter granted. The total amount of compensation expense recorded in the second quarter of 2010 was $0.3 million.

Employee Stock Purchase Plan

Compensation expense recognized under the Employee Stock Purchase Plan was $0.5 million for the three months ended June 30, 2009, and $0.1 million and $0.8 million for the six months ended June 30, 2009 and 2008, respectively. There was no compensation expense recognized under the Plan for the three months ended June 30, 2010 as the Plan was discontinued in February 2010. A new Employee Stock Purchase Plan was approved by the shareholders at the Company’s 2010 annual meeting and will begin later in 2010.

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Summary of Stock-Based Compensation

The table below summarizes the components of total stock-based compensation for the three and six months ended June 30 (in millions):

	Three Months Ended June 30				Six Months Ended June 30
	2010		2009		2010		2009
Stock options	$	1.0	$	0.7	$	2.8	$	3.0
Restricted stock units		1.3		1.1		3.8		3.8
Performance share units		1.1		---		1.7		---
Deferred stock units		0.3		---		0.3		---
Employee stock purchase plan		--		0.5		0.1		0.8
	$	3.7	$	2.3	$	8.7	$	7.6

NOTE 10. FLEET TRANSITION

Horizon Transition to All-Q400 Fleet

Horizon’s long-term goal is to transition to an all-Q400 fleet. As of June 30, 2010, Horizon operated 17 CRJ-700 aircraft, which the Company plans to remove from its fleet in the future. Market conditions have hindered the remarketing efforts for these CRJ-700 aircraft resulting in a delay of the fleet transition plan. The Company did remove one of the CRJ-700 aircraft from operations and subleased it to a third party during the second quarter of 2010, resulting in a sublease loss of $3.4 million. Management expects to remove four additional CRJ-700 aircraft from operations in the third quarter of 2010 and dispose of them, either through sublease or lease assignment. Management expects this will result in a total charge of approximately $7 million to $9 million to be recorded when Horizon ceases use of the aircraft. Two of these aircraft were delivered to a third party in July 2010 and the other two are expected to be delivered in August. Depending on the ultimate disposition of the 13 CRJ-700 aircraft remaining in the operating fleet after the removal of the aforementioned aircraft, there may be further associated exit charges. The nature, timing or amount of any potential gain or loss on any future potential transactions on the remaining aircraft cannot be reasonably estimated at this time. Including the second quarter transaction, Horizon subleases three CRJ-700 aircraft to a third-party carrier.

During 2009, Horizon had either terminated its remaining Q200 leases or subleased Q200 aircraft to a third party. The total charge associated with removing these aircraft from operation in the first quarter of 2009 was $4.8 million with an additional $5.2 million charge in the second quarter of 2009. This charge represented the losses under the disposal transactions.

Horizon has 16 Q200 aircraft that are subleased to a third-party carrier, for which an accrual for the estimated sublease loss has been recorded. The Company is evaluating alternatives to the existing sublease arrangements for these aircraft. The Company may be required to record a charge if the original lease or sublease arrangements are modified in the future. However, the nature, timing or amount of any such charge cannot be reasonably estimated at this time.

NOTE 11. 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.

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NOTE 12. OPERATING SEGMENT INFORMATION

Operating segment information for Alaska and Horizon for the three- and six-month periods ended June 30 was as follows (in millions):

	Three Months Ended June 30						Six Months Ended June 30
	2010			2009			2010			2009
Operating revenues:
Alaska – mainline (1)	$	789.4		$	681.6		$	1,450.5		$	1,272.9
Alaska – purchased capacity (1)		83.1			67.7			159.6			129.5
Total Alaska		872.5			749.3			1,610.1			1,402.4
Horizon		171.1			157.9			329.5			304.7
Other (2)		0.2			0.2			0.5			0.5
Elimination of intercompany revenues		(67.4	)		(63.5	)		(133.8	)		(121.3	)
Consolidated	$	976.4		$	843.9		$	1,806.3		$	1,586.3
Income (loss) before income tax:
Alaska – mainline	$	87.7		$	43.3		$	100.9		$	25.9
Alaska – purchased capacity		8.8			(1.2	)		12.8			(2.1	)
Total Alaska		96.5			42.1			113.7			23.8
Horizon		(1.2	)		6.5			(7.4	)		(4.0	)
Other (2)		(1.3	)		(0.9	)		(2.1	)		(1.7	)
Consolidated	$	94.0		$	47.7		$	104.2		$	18.1

	June 30, 2010			December 31, 2009
Total assets at end of period:
Alaska	$	4,708.9		$	4,541.3
Horizon		721.7			735.3
Other (2)		1,145.7			1,052.4
Elimination of intercompany accounts		(1,469.3	)		(1,332.8	)
Consolidated	$	5,107.0		$	4,996.2

(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.

NOTE 13. CONTINGENCIES

Other items

The Company is a party to routine litigation matters incidental to its business. 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 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, 2009. This overview summarizes MD&A, which includes the following sections:

Second Quarter in Review – highlights from the second quarter of 2010 outlining 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 six months ended June 30, 2010. 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 2010.

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.

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.

SECOND QUARTER IN REVIEW

Our consolidated pretax income was $94.0 million during the second quarter of 2010 compared to $47.7 million in the second quarter of 2009. The increase in our pretax earnings was primarily due to the $132.5 million increase in operating revenues and a $35.8 million charge in the second quarter of 2009 related to the new pilot contract, partially offset by an increase in aircraft fuel cost on relatively flat non-fuel operating costs.

Consolidated unit revenues increased 11% over the second quarter of 2009, stemming from significant increases in passenger unit revenues that were driven by higher load factors at both Alaska and Horizon. Baggage fees contributed over $27 million to the revenue improvement, reflecting the benefit of our first bag fee that was introduced during the third quarter of 2009.

Economic fuel averaged $2.31 per gallon in the second quarter of 2010, compared to $1.84 in 2009. This resulted in a $49.2 million increase in our economic fuel expense compared to the second quarter of 2009.

In the second quarter of 2009, Alaska entered into a new four-year agreement with their pilots. Among other contract items, the pilots received a one-time bonus of approximately $20.3 million, including taxes, and transitioned to a new sick-leave payment program resulting in a transition charge of $15.5 million.

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Other significant developments during the second quarter of 2010 and through the filing of this Form 10-Q are described below.

Recent Awards

For the third year in a row, Alaska Airlines ranked “Highest in Customer Satisfaction among Traditional Network Carriers” in 2010 by J.D. Power & Associates.

In July 2010, Aviation Week Magazine named Alaska Airlines the “Top-Performing Airline” in the world among mainline/legacy carriers.

Common Stock Repurchase

On June 15, 2010, our Board of Directors authorized the Company to repurchase up to $50 million of our common stock. Through June 30, 2010, we had not yet repurchased any shares of our common stock under this new program. Purchases began in July 2010 and we have repurchased 14,000 shares for approximately $0.7 million through August 3, 2010. Since 2007, we have repurchased approximately $160 million of our common stock through similar programs. The repurchased shares have been recorded as treasury shares in our condensed consolidated balance sheets.

Operational Performance

Our operational results continue to be among the best in the industry. Alaska has held the No. 1 spot in the U.S. Department of Transportation on-time performance among the 10 largest U.S. airlines for 13 of the 14 months ended May 2010. Horizon also continues to rank at the top of the industry in on-time performance.

New Markets

Alaska recently announced new non-stop service between San Jose, Calif. and Los Cabos, Mexico three times weekly beginning November 20, 2010 and daily non-stop service between Bellingham, Wash. and Honolulu beginning January 7, 2011. In the second quarter, Alaska also announced daily non-stop service between Seattle and St. Louis beginning on September 27, 2010 and service from San Jose and Oakland to Kauai beginning March 2011. This is in addition to new service announced previously to the Hawaiian Islands from Portland, San Diego, San Jose and Sacramento, beginning this fall.

Changes to Certain Fees

We previously announced changes to certain fees effective June 16, 2010. We now charge $20 for each of the first three checked bags, which is an increase from the previous $15 charge for the first bag, but a decrease in the charge for the second and third bags. We also reduced and simplified fees for unaccompanied minors and eliminated free same-day standby travel and courtesy holds on tickets purchased through reservations or our websites. We expect these changes to provide incremental revenue of approximately $30 million annually.

Horizon Fleet Transition

Horizon has a long-term plan to transition to an all-Q400 fleet. The market for regional aircraft has been weak in the past two years resulting in difficulty marketing the CRJ-700 regional jet aircraft. In the second quarter, Horizon did sublease one additional CRJ-700 aircraft to a third-party carrier. We recorded a charge of $3.4 million associated with this sublease agreement. We now have three CRJ-700 aircraft subleased to a third-party carrier.

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We expect further charges in the third quarter as Horizon disposes of an additional four CRJ-700 aircraft to a third-party carrier through sublease or lease assignment. We expect these charges to total approximately $7 million to $9 million.

Outlook

We have a positive outlook for the last half of 2010. Advance bookings across the Air Group network are up, on average, for August through October as compared to 2009. We are experiencing a very good summer season thus far as we focus on operating safe, compliant and on-time airlines.

Horizon Changes

We recently announced our decision to outsource the remaining heavy maintenance functions for Horizon aircraft. All of the CRJ-700 aircraft heavy maintenance is currently provided by an outside vendor. We believe this change will result in approximately $3 million in cost savings annually. As a result of this decision, we will be eliminating a number of positions in the maintenance division. This will be done through either acceptance of early-out packages or voluntary and involuntary furloughs. These events will result in an estimated third-quarter charge of less than $3 million associated with severance pay and continuing medical benefits.

Over the course of the next several months, we will evaluate further changes in Horizon’s business model and operational structure as we focus on improving profitability. A number of alternatives and strategies are being considered, including:

accelerating our transition to an all-Q400 fleet;

further consolidation of operational functions with Alaska;

finalizing the agreement in principle to lower pilot costs to better match current market costs;

evaluating the benefits of moving to an all-capacity-purchase model instead of our current mixed model that includes both capacity-purchase flying and Horizon brand flying; and

evaluating the costs and benefits of maintaining the Horizon brand from an external marketing perspective.

Many of these activities or strategies could result in additional costs in the coming quarters related to disposing of the CRJ aircraft, employee furloughs or other events. These costs cannot be reasonably estimated at this time, except for the expected charges mentioned previously related to the four CRJ-700 aircraft to be disposed of in the third quarter.

RESULTS OF OPERATIONS

COMPARISON OF THREE MONTHS ENDED JUNE 30, 2010 TO THREE MONTHS

ENDED JUNE 30, 2009

Our consolidated net income for the second quarter of 2010 was $58.6 million, or $1.60 per diluted share, compared to net income of $29.1 million, or $0.79 per diluted share, in the second quarter of 2009. Items that impact the comparability between the periods are as follows:

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 second quarter of 2010 we recognized net mark-to-market losses of $37.6 million ($23.3 million after tax, or $0.63 per share), compared to gains of $39.8 million ($24.9 million after tax, or $0.68 per share) in the second quarter of 2009.

The second quarter of 2010 includes CRJ-700 fleet transition costs of $3.4 million ($2.1 million after tax, or $0.06 per share).

The second quarter of 2009 includes new pilot contract transition costs of $35.8 million ($22.3 million after tax, or $0.61 per share).

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We believe disclosure of the impact of these individual charges is useful information to investors and other readers because:

It is consistent with how we present information in our quarterly earnings press releases;

We believe it is the basis by which we are evaluated by industry analysts;

Our results excluding these items are most often used in internal management and board reporting and decision-making;

Our results excluding these adjustments 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; and

It is useful to monitor performance without these items as it improves a reader’s ability to compare our results to those of other airlines.

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

Excluding the mark-to-market adjustments and other noted items and as shown in the following table, our consolidated net income for the second quarter of 2010 was $84.0 million, or $2.29 per diluted share, compared to an adjusted consolidated net income of $26.5 million, or $0.72 per share, in the second quarter of 2009.

	Three Months Ended June 30,
	2010						2009
(in millions except per-share amounts)	Dollars			Diluted EPS			Dollars			Diluted EPS
Net income and diluted EPS, excluding noted items	$	84.0		$	2.29		$	26.5		$	0.72
New pilot contract transition costs, net of tax		-			-			(22.3	)		(0.61	)
Fleet transition costs - CRJ-700, net of tax		(2.1	)		(0.06	)		-			-
Mark-to-market fuel hedge adjustments, net of tax		(23.3	)		(0.63	)		24.9			0.68
Net income and diluted EPS as reported	$	58.6		$	1.60		$	29.1		$	0.79

Our consolidated results are primarily driven by the results of our two operating carriers. Alaska reported pretax income of $96.5 million in the second quarter of 2010, while Horizon reported a pretax loss of $1.2 million. Financial and statistical data for Alaska and Horizon and an in-depth discussion of their results follow.

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Alaska Airlines Financial and Statistical Data (unaudited)

	Three Months Ended June 30							Six Months Ended June 30

Financial Data (in millions):	2010		2009		% Change			2010		2009		% Change
Operating Revenues:
Passenger	$	702.3	$	602.5		16.6		$	1,289.3	$	1,142.3		12.9
Freight and mail		26.9		24.2		11.2			48.9		42.5		15.1
Other - net		60.2		54.9		9.7			112.3		88.1		27.5
Total mainline operating revenues		789.4		681.6		15.8			1,450.5		1,272.9		14.0
Passenger - purchased capacity		83.1		67.7		22.7			159.6		129.5		23.2
Total Operating Revenues		872.5		749.3		16.4			1,610.1		1,402.4		14.8

Operating Expenses:
Wages and benefits		190.9		198.4		(3.8	)		382.1		395.8		(3.5	)
Variable incentive pay		17.9		16.1		11.2			32.7		23.2		40.9
Aircraft fuel, including hedging gains and losses		214.5		107.4		99.7			386.2		239.3		61.4
Aircraft maintenance		40.0		46.6		(14.2	)		82.1		92.9		(11.6	)
Aircraft rent		24.3		28.1		(13.5	)		50.2		54.6		(8.1	)
Landing fees and other rentals		43.1		40.6		6.2			84.8		81.4		4.2
Contracted services		31.5		28.4		10.9			62.1		58.9		5.4
Selling expenses		30.7		28.3		8.5			57.4		47.4		21.1
Depreciation and amortization		47.6		44.2		7.7			93.3		87.5		6.6
Food and beverage service		13.7		11.9		15.1			25.5		22.9		11.4
Other		36.7		38.5		(4.7	)		71.5		81.3		(12.1	)
New pilot contract transition costs		-		35.8	NM				-		35.8	NM
Total mainline operating expenses		690.9