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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, 2003.


OR


|o |  | 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 AIRLINES, INC.

(Exact name of registrant as specified in its charter)


|                                                                      |  |                                                
|--------------------------------------------------------------------- |  | -----------------------------------------------
|Alaska
(State or other jurisdiction of
incorporation or organization) |  | 92-0009235
(I.R.S. Employer
Identification No.)

19300 Pacific Highway South, 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
xNo
o

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes
x   No
o

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 500 common shares, par value $1.00, outstanding at June
30, 2003.





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TABLE OF CONTENTS



|                             |                                                                                               |  |  |  |  |  |  | 
|---------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I. FINANCIAL STATEMENTS
|                             | ITEM 1. Financial Statements                                                                 
|                             | ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                             | ITEM 3. Quantitative and Qualitative Disclosure about Market Risk                            
|                             | PART II. OTHER INFORMATION                                                                   
|                             | ITEM 1. Legal Proceedings                                                                    
|                             | ITEM 6. Exhibits and Reports on Form 8-K                                                     
|                             | Signatures                                                                                   
|EXHIBIT 31.1                
|EXHIBIT 31.2                
|EXHIBIT 32.1                
|EXHIBIT 32.2                



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Cautionary Note regarding
Forward-Looking Statements

In addition to historical information,
this Quarterly Report on Form 10-Q contains forward-looking
statements within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act. 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
similar expressions, although not all forward-looking statements
contain these identifying words. All statements in this report
regarding our future strategy, future operations, projected financial
position, estimated future revenues, projected costs, future
prospects, and results that might be obtained by pursuing
managements current plans and objectives are forward-looking
statements. 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 difference might be significant and materially
adverse to our stockholders. Many important factors that could cause
such a difference are described in Item 1, Business
of our most recent Annual Report on Form 10-K, all of which you
should review carefully. Please consider our forward-looking
statements in light of those risks as you read this report.



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##### Table of Contents



PART I. FINANCIAL STATEMENTS







ITEM 1. Financial
Statements


BALANCE SHEETS (unaudited)
Alaska Airlines, Inc.


ASSETS

|                                               |  |              |         |          |  |   |         | 
|---------------------------------------------- |  | ------------ | ------- | -------- |  | - | ------- | 
|                                               |  | December 31, |         | June 30,
|(In Millions)                                  |  | 2002         |         | 2003    
|                                               |  |              |         |         
|Current Assets                                 |  |              |         |          |  |   |         | 
|Cash and cash equivalents                      |  | $            | 268.9   |          |  | $ | 114.4   | 
|Marketable securities                          |  |              | 366.8   |          |  |   | 606.9   | 
|Receivables from related companies             |  |              | 126.7   |          |  |   | 165.9   | 
|Receivables - net                              |  |              | 81.8    |          |  |   | 98.4    | 
|Inventories and supplies - net                 |  |              | 38.3    |          |  |   | 36.5    | 
|Deferred income taxes                          |  |              | 60.2    |          |  |   | 74.9    | 
|Prepaid expenses and other current assets      |  |              | 47.5    |          |  |   | 40.5    | 
|                                               |  |              |         |          |  |   |         | 
|Total Current Assets                           |  |              | 990.2   |          |  |   | 1,137.5 | 
|                                               |  |              |         |          |  |   |         | 
|Property and Equipment                         |  |              |         |          |  |   |         | 
|Flight equipment                               |  |              | 1,945.5 |          |  |   | 2,150.9 | 
|Other property and equipment                   |  |              | 359.3   |          |  |   | 369.1   | 
|Deposits for future flight equipment           |  |              | 64.7    |          |  |   | 32.8    | 
|                                               |  |              |         |          |  |   |         | 
|                                               |  |              | 2,369.5 |          |  |   | 2,552.8 | 
|Less accumulated depreciation and amortization |  |              | 709.4   |          |  |   | 763.2   | 
|                                               |  |              |         |          |  |   |         | 
|Total Property and Equipment - Net             |  |              | 1,660.1 |          |  |   | 1,789.6 | 
|                                               |  |              |         |          |  |   |         | 
|Intangible Assets                              |  |              | 50.9    |          |  |   | 50.9    | 
|                                               |  |              |         |          |  |   |         | 
|Other Assets                                   |  |              | 49.9    |          |  |   | 55.3    | 
|                                               |  |              |         |          |  |   |         | 
|Total Assets                                   |  | $            | 2,751.1 |          |  | $ | 3,033.3 | 
|                                               |  |              |         |          |  |   |         | 

See accompanying notes to financial statements.

2



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BALANCE SHEETS (unaudited)
Alaska Airlines, Inc.

LIABILITIES AND SHAREHOLDERS EQUITY

|                                                                |                                    |      |              |       |          |   |         |       | 
|--------------------------------------------------------------- | ---------------------------------- | ---- | ------------ | ----- | -------- | - | ------- | ----- | 
|                                                                |                                    |      | December 31, |       | June 30,
|(In Millions)                                                   |                                    | 2002 |              | 2003 
|                                                                |                                    |      |              |      
|Current Liabilities                                             |                                    |      |              |       |          |   |         |      
|Accounts payable                                                |                                    | $    | 118.5        |       |          | $ | 103.6   |      
|Payables to related companies                                   |                                    |      | 1.7          |       |          |   | 2.4     |      
|Accrued aircraft rent                                           |                                    |      | 67.5         |       |          |   | 61.9    |      
|Accrued wages, vacation and payroll taxes                       |                                    |      | 76.3         |       |          |   | 73.1    |      
|Other accrued liabilities                                       |                                    |      | 226.5        |       |          |   | 264.0   |      
|Air traffic liability                                           |                                    |      | 211.1        |       |          |   | 297.7   |      
|Current portion of long-term debt and
capital lease obligations |                                    |      | 48.6         |       |          |   | 62.0    |      
|                                                                |                                    |      |              |       |          |   |         |      
|Total Current Liabilities                                       |                                    |      | 750.2        |       |          |   | 864.7   |      
|                                                                |                                    |      |              |       |          |   |         |      
|Long-Term Debt and Capital Lease Obligations                    |                                    |      | 856.7        |       |          |   | 929.8   |      
|                                                                |                                    |      |              |       |          |   |         |      
|Other Liabilities and Credits                                   |                                    |      |              |       |          |   |         |      
|Deferred income taxes                                           |                                    |      | 153.7        |       |          |   | 164.7   |      
|Deferred revenue                                                |                                    |      | 224.5        |       |          |   | 228.6   |      
|Other liabilities                                               |                                    |      | 196.3        |       |          |   | 225.6   |      
|                                                                |                                    |      |              |       |          |   |         |      
|                                                                |                                    |      | 574.5        |       |          |   | 618.9   |      
|                                                                |                                    |      |              |       |          |   |         |      
|Shareholders Equity                                            |                                    |      |              |       |          |   |         |      
|Common stock, $1 par value                                      |                                    |      |              |       |          |   |         |      
|                                                                | Authorized: 1,000 shares           |      |              |       |          |   |         |       | 
|                                                                | Issued: 2001 and 2002 - 500 shares |      |              |      |          |   |         |      | 
|                                                                | Capital in excess of par value     |      |              | 324.8 |          |   |         | 384.8 | 
|Accumulated other comprehensive income (loss)                   |                                    |      | (82.0        | )     |          |   | (83.5   | )    
|Retained earnings                                               |                                    |      | 326.9        |       |          |   | 318.6   |      
|                                                                |                                    |      |              |       |          |   |         |      
|                                                                |                                    |      | 569.7        |       |          |   | 619.9   |      
|                                                                |                                    |      |              |       |          |   |         |      
|Total Liabilities and Shareholders Equity                      |                                    | $    | 2,751.1      |       |          | $ | 3,033.3 |      
|                                                                |                                    |      |              |       |          |   |         |      

See accompanying notes to financial statements.

3



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STATEMENTS OF OPERATIONS (unaudited)
Alaska Airlines, Inc.

|                                |  |      |       |      |  |   |       |  
|------------------------------- |  | ---- | ----- | ---- |  | - | ----- | -
|Three Months Ended June 30      |  |      |       |      |  |   |       |  
|(In Millions)                   |  | 2002 |       | 2003
|                                |  |      |       |     
|Operating Revenues              |  |      |       |      |  |   |       |  
|Passenger                       |  | $    | 433.6 |      |  | $ | 460.6 |  
|Freight and mail                |  |      | 20.0  |      |  |   | 21.0  |  
|Other - net                     |  |      | 25.1  |      |  |   | 29.0  |  
|                                |  |      |       |      |  |   |       |  
|Total Operating Revenues        |  |      | 478.7 |      |  |   | 510.6 |  
|                                |  |      |       |      |  |   |       |  
|Operating Expenses              |  |      |       |      |  |   |       |  
|Wages and benefits              |  |      | 174.5 |      |  |   | 192.0 |  
|Contracted services             |  |      | 19.4  |      |  |   | 19.7  |  
|Aircraft fuel                   |  |      | 64.2  |      |  |   | 69.1  |  
|Aircraft maintenance            |  |      | 36.1  |      |  |   | 44.6  |  
|Aircraft rent                   |  |      | 31.8  |      |  |   | 31.2  |  
|Food and beverage service       |  |      | 16.2  |      |  |   | 14.9  |  
|Commissions                     |  |      | 14.2  |      |  |   | 12.2  |  
|Other selling expenses          |  |      | 27.8  |      |  |   | 23.3  |  
|Depreciation and amortization   |  |      | 28.5  |      |  |   | 29.6  |  
|Loss on sale of assets          |  |      | 0.2   |      |  |   | 0.2   |  
|Landing fees and other rentals  |  |      | 28.5  |      |  |   | 31.2  |  
|Other                           |  |      | 37.5  |      |  |   | 34.3  |  
|                                |  |      |       |      |  |   |       |  
|Total Operating Expenses        |  |      | 478.9 |      |  |   | 502.3 |  
|                                |  |      |       |      |  |   |       |  
|Operating Income (Loss)         |  |      | (0.2  | )    |  |   | 8.3   |  
|                                |  |      |       |      |  |   |       |  
|Nonoperating Income (Expense)   |  |      |       |      |  |   |       |  
|Interest income                 |  |      | 6.1   |      |  |   | 4.5   |  
|Interest expense                |  |      | (11.6 | )    |  |   | (11.4 | )
|Interest capitalized            |  |      | 0.4   |      |  |   | 0.4   |  
|U.S. government compensation    |  |      | 0.1   |      |  |   | 52.8  |  
|Other - net                     |  |      | 5.1   |      |  |   | 5.0   |  
|                                |  |      |       |      |  |   |       |  
|                                |  |      | 0.1   |      |  |   | 51.3  |  
|                                |  |      |       |      |  |   |       |  
|Income (loss) before income tax |  |      | (0.1  | )    |  |   | 59.6  |  
|Income tax expense              |  |      | 0.7   |      |  |   | 22.8  |  
|                                |  |      |       |      |  |   |       |  
|Net Income (Loss)               |  | $    | (0.8  | )    |  | $ | 36.8  |  
|                                |  |      |       |      |  |   |       |  

See accompanying notes to financial statements.

4



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STATEMENTS OF OPERATIONS (unaudited)
Alaska Airlines, Inc.

|                                                   |  |      |       |      |  |   |       |  
|-------------------------------------------------- |  | ---- | ----- | ---- |  | - | ----- | -
|Six Months Ended June 30                           |  |      |       |      |  |   |       |  
|(In Millions)                                      |  | 2002 |       | 2003
|                                                   |  |      |       |     
|Operating Revenues                                 |  |      |       |      |  |   |       |  
|Passenger                                          |  | $    | 807.6 |      |  | $ | 847.6 |  
|Freight and mail                                   |  |      | 35.9  |      |  |   | 38.4  |  
|Other - net                                        |  |      | 47.4  |      |  |   | 51.6  |  
|                                                   |  |      |       |      |  |   |       |  
|Total Operating Revenues                           |  |      | 890.9 |      |  |   | 937.6 |  
|                                                   |  |      |       |      |  |   |       |  
|Operating Expenses                                 |  |      |       |      |  |   |       |  
|Wages and benefits                                 |  |      | 340.2 |      |  |   | 380.0 |  
|Contracted services                                |  |      | 41.2  |      |  |   | 40.4  |  
|Aircraft fuel                                      |  |      | 119.4 |      |  |   | 146.0 |  
|Aircraft maintenance                               |  |      | 71.7  |      |  |   | 82.5  |  
|Aircraft rent                                      |  |      | 63.6  |      |  |   | 61.7  |  
|Food and beverage service                          |  |      | 30.1  |      |  |   | 27.8  |  
|Commissions                                        |  |      | 28.4  |      |  |   | 20.4  |  
|Other selling expenses                             |  |      | 52.7  |      |  |   | 45.2  |  
|Depreciation and amortization                      |  |      | 56.7  |      |  |   | 58.1  |  
|Loss on sale of assets                             |  |      | 0.2   |      |  |   | 0.5   |  
|Landing fees and other rentals                     |  |      | 52.1  |      |  |   | 59.9  |  
|Other                                              |  |      | 73.8  |      |  |   | 68.4  |  
|                                                   |  |      |       |      |  |   |       |  
|Total Operating Expenses                           |  |      | 930.1 |      |  |   | 990.9 |  
|                                                   |  |      |       |      |  |   |       |  
|Operating Loss                                     |  |      | (39.2 | )    |  |   | (53.3 | )
|                                                   |  |      |       |      |  |   |       |  
|Nonoperating Income (Expense)                      |  |      |       |      |  |   |       |  
|Interest income                                    |  |      | 11.1  |      |  |   | 5.7   |  
|Interest expense                                   |  |      | (23.5 | )    |  |   | (22.7 | )
|Interest capitalized                               |  |      | 0.5   |      |  |   | 1.1   |  
|U.S. government compensation                       |  |      | 0.1   |      |  |   | 52.8  |  
|Other - net                                        |  |      | 9.2   |      |  |   | 5.4   |  
|                                                   |  |      |       |      |  |   |       |  
|                                                   |  |      | (2.6  | )    |  |   | 42.3  |  
|                                                   |  |      |       |      |  |   |       |  
|Loss before income tax and accounting change       |  |      | (41.8 | )    |  |   | (11.0 | )
|Income tax benefit                                 |  |      | (14.1 | )    |  |   | (2.7  | )
|                                                   |  |      |       |      |  |   |       |  
|Loss before cumulative effect of accounting change |  |      | (27.7 | )    |  |   | (8.3  | )
|Cumulative effect of accounting change             |  |      | (12.5 | )    |  |   |      |  
|                                                   |  |      |       |      |  |   |       |  
|Net Loss                                           |  | $    | (40.2 | )    |  | $ | (8.3  | )
|                                                   |  |      |       |      |  |   |       |  

See accompanying notes to financial statements.

5



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STATEMENTS OF SHAREHOLDERS EQUITY (unaudited)
Alaska Airlines, Inc.

|                                                |                                   |                              |   |           |  |               |       |               |  |          |       |             |       |   |       |   |  |   |       |   |  | 
|----------------------------------------------- | --------------------------------- | ---------------------------- | - | --------- |  | ------------- | ----- | ------------- |  | -------- | ----- | ----------- | ----- | - | ----- | - |  | - | ----- | - |  | 
|                                                |                                   |                              |   |           |  |               |       |               |  |          |       | Accumulated |       |   |       |   |  |   |       |  
|                                                |                                   |                              |   |           |  |               |       | Capital in    |  | Other    |       |             |       |   |       |   |  |  
|                                                |                                   |                              |   | Common    |  | Excess of     |       | Comprehensive |  | Retained |       |             |       |  
|(In Millions)                                   |                                   | Stock                        |   | Par Value |  | Income (Loss) |       | Earnings      |  | Total   
|                                                |                                   |                              |   |           |  |               |       |               |  |         
|Balances at December 31, 2002                   |                                   | $                            |  |           |  | $             | 324.8 |               |  | $        | (82.0 | )           |       | $ | 326.9 |   |  | $ | 569.7 |  
|                                                |                                   |                              |   |           |  |               |       |               |  |          |       |             |       |   |       |   |  |   |       |  
|Net loss for the six months
ended June 30, 2003 |                                   |                              |   |           |  |               |       |               |  |          |       |             |       |   | (8.3  | ) |  |   | (8.3  | )
|Other comprehensive income (loss):              |                                   |                              |   |           |  |               |       |               |  |          |       |             |       |   |       |   |  |   |       |  
|                                                | Related to marketable securities: |                              |   |           |  |               |       |               |  |          |       |             |       |   |       |   |  |   |       |   | 
|                                                |                                   | Change in fair value         |   |           |  |               |       |               |  |          |       |             | (3.1  | ) |       |   |  |   |       |   |  | 
|                                                |                                   | Reclassification to earnings |   |           |  |               |       |               |  |          |       |             | 4.3   |   |       |   |  |   |       |   |  | 
|                                                |                                   | Income tax effect            |   |           |  |               |       |               |  |          |       |             | (0.4  | ) |       |   |  |   |       |   |  | 
|                                                |                                   |                              |   |           |  |               |       |               |  |          |       |             |       |   |       |   |  |   |       |  
|                                                |                                   |                              |   |           |  |               |       |               |  |          | 0.8   |             |       |   |       |   |  |   | 0.8   |  
|                                                |                                   |                              |   |           |  |               |       |               |  |          |       |             |       |   |       |   |  |   |       |  
|                                                | Related to fuel hedges:           |                              |   |           |  |               |       |               |  |          |       |             |       |   |       |   |  |   |       |   | 
|                                                |                                   | Change in fair value         |   |           |  |               |       |               |  |          |       |             | 8.9   |   |       |   |  |   |       |   |  | 
|                                                |                                   | Reclassification to earnings |   |           |  |               |       |               |  |          |       |             | (12.6 | ) |       |   |  |   |       |   |  | 
|                                                |                                   | Income tax effect            |   |           |  |               |       |               |  |          |       |             | 1.4   |   |       |   |  |   |       |   |  | 
|                                                |                                   |                              |   |           |  |               |       |               |  |          |       |             |       |   |       |   |  |   |       |  
|                                                |                                   |                              |   |           |  |               |       |               |  |          | (2.3  | )           |       |   |       |   |  |   | (2.3  | )
|                                                |                                   |                              |   |           |  |               |       |               |  |          |       |             |       |   |       |   |  |   |       |  
|Total comprehensive loss                        |                                   |                              |   |           |  |               |       |               |  |          |       |             |       |   |       |   |  |   | (9.8  | )
|Capital contribution from Air Group             |                                   |                              |   |           |  |               | 60.0  |               |  |          |       |             |       |   |       |   |  |   | 60.0  |  
|                                                |                                   |                              |   |           |  |               |       |               |  |          |       |             |       |   |       |   |  |   |       |  
|Balances at June 30, 2003                       |                                   | $                            |  |           |  | $             | 384.8 |               |  | $        | (83.5 | )           |       | $ | 318.6 |   |  | $ | 619.9 |  
|                                                |                                   |                              |   |           |  |               |       |               |  |          |       |             |       |   |       |   |  |   |       |  

See accompanying notes to financial statements.

6



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STATEMENTS OF CASH FLOWS (unaudited)
Alaska Airlines, Inc.

|                                                                                |                                      |                                                       |        |       |       |   |        |        |       |  
|------------------------------------------------------------------------------- | ------------------------------------ | ----------------------------------------------------- | ------ | ----- | ----- | - | ------ | ------ | ----- | -
|Six Months Ended June 30                                                        |                                      |                                                       |        |       |       |   |        |       
|(In Millions)                                                                   |                                      | 2002                                                  |        | 2003 
|                                                                                |                                      |                                                       |        |      
|Cash flows from operating activities:                                           |                                      |                                                       |        |       |       |   |        |       
|Net loss                                                                        |                                      | $                                                     | (40.2  | )     |       | $ | (8.3   | )     
|Adjustments to reconcile net loss to
net cash provided by operating activities: |                                      |                                                       |        |       |       |   |        |       
|                                                                                |                                      | Cumulative effect of accounting change                |        |       | 12.5  |   |        |        |      |  
|                                                                                |                                      | Depreciation and amortization                         |        |       | 56.7  |   |        |        | 58.1  |  
|                                                                                |                                      | Amortization of airframe and engine overhauls         |        |       | 29.6  |   |        |        | 27.8  |  
|                                                                                |                                      | Loss (gain) on marketable securities                  |        |       | 0.2   |   |        |        | (0.8  | )
|                                                                                |                                      | Changes in derivative fair values                     |        |       | (6.8  | ) |        |        | (0.4  | )
|                                                                                |                                      | Loss on sale of assets                                |        |       |      |   |        |        | 0.5   |  
|                                                                                |                                      | Decrease in deferred income taxes                     |        |       | (11.0 | ) |        |        | (2.7  | )
|                                                                                |                                      | Increase in accounts receivable - net                 |        |       | (41.5 | ) |        |        | (55.8 | )
|                                                                                |                                      | Decrease in prepaid expenses and other current assets |        |       | 2.8   |   |        |        | 3.8   |  
|                                                                                |                                      | Increase in air traffic liability                     |        |       | 67.3  |   |        |        | 86.7  |  
|                                                                                |                                      | Increase in other current liabilities                 |        |       | 0.9   |   |        |        | 14.6  |  
|                                                                                |                                      | Increase in deferred revenue and other-net            |        |       | 16.9  |   |        |        | 34.4  |  
|                                                                                |                                      |                                                       |        |       |       |   |        |       
|Net cash provided by operating activities                                       |                                      |                                                       | 87.4   |       |       |   | 157.9  |       
|                                                                                |                                      |                                                       |        |       |       |   |        |       
|Cash flows from investing activities:                                           |                                      |                                                       |        |       |       |   |        |       
|Proceeds from disposition of assets                                             |                                      |                                                       | 1.0    |       |       |   | 0.5    |       
|Purchases of marketable securities                                              |                                      |                                                       | (358.5 | )     |       |   | (593.8 | )     
|Sales and maturities of marketable securities                                   |                                      |                                                       | 93.0   |       |       |   | 354.9  |       
|Property and equipment additions:                                               |                                      |                                                       |        |       |       |   |        |       
|                                                                                | Aircraft purchase deposits           |                                                       |        | (12.6 | )     |   |        | (1.4   | )    
|                                                                                | Capitalized overhauls                |                                                       |        | (29.7 | )     |   |        | (34.6  | )    
|                                                                                | Aircraft                             |                                                       |        | (1.0  | )     |   |        | (157.4 | )    
|                                                                                | Other flight equipment               |                                                       |        | (4.2  | )     |   |        | (10.5  | )    
|                                                                                | Other property                       |                                                       |        | (18.2 | )     |   |        | (12.9  | )    
|Aircraft deposits returned                                                      |                                      |                                                       | 22.4   |       |       |   | 1.2    |       
|Restricted deposits and other                                                   |                                      |                                                       | (6.7   | )     |       |   | (4.8   | )     
|                                                                                |                                      |                                                       |        |       |       |   |        |       
|Net cash used in investing activities                                           |                                      |                                                       | (314.5 | )     |       |   | (458.8 | )     
|                                                                                |                                      |                                                       |        |       |       |   |        |       
|Cash flows from financing activities:                                           |                                      |                                                       |        |       |       |   |        |       
|Proceeds from issuance of long-term debt                                        |                                      |                                                       | 25.5   |       |       |   | 128.6  |       
|Long-term debt and capital lease payments                                       |                                      |                                                       | (18.8  | )     |       |   | (42.2  | )     
|Capital contribution from Air Group                                             |                                      |                                                       | 0.0    |       |       |   | 60.0   |       
|                                                                                |                                      |                                                       |        |       |       |   |        |       
|Net cash provided by financing activities                                       |                                      |                                                       | 6.7    |       |       |   | 146.4  |       
|                                                                                |                                      |                                                       |        |       |       |   |        |       
|Net change in cash and cash equivalents                                         |                                      |                                                       | (220.4 | )     |       |   | (154.5 | )     
|Cash and cash equivalents at beginning of period                                |                                      |                                                       | 490.7  |       |       |   | 268.9  |       
|                                                                                |                                      |                                                       |        |       |       |   |        |       
|Cash and cash equivalents at end of period                                      |                                      | $                                                     | 270.3  |       |       | $ | 114.4  |       
|                                                                                |                                      |                                                       |        |       |       |   |        |       
|Supplemental disclosure of cash paid (refunded) during the period for:          |                                      |                                                       |        |       |       |   |        |       
|                                                                                | Interest (net of amount capitalized) |                                                       | $      | 23.6  |       |   | $      | 22.9   |      
|                                                                                | Income taxes                         |                                                       |        | (15.8 | )     |   |        |       |      
|Noncash investing and financing activities:                                     |                                      | None                                                  |        | None 

See accompanying notes to financial
statements.

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NOTES TO FINANCIAL STATEMENTS (unaudited)
Alaska Airlines, Inc.

Note 1. Basis of Presentation and Significant Accounting Policies

The accompanying unaudited interim financial statements of Alaska Airlines,
Inc. (Alaska) should be read in conjunction with the consolidated financial
statements in our Annual Report on Form 10-K for the year ended December 31,
2002. As used in these Notes to Financial Statements, the terms we, us,
our and similar terms refer to Alaska. In the opinion of management, all
adjustments have been made which are necessary to present fairly our financial
position as of June 30, 2003, as well as the results of our operations for the
three and six months ended June 30, 2002 and 2003. The adjustments made were
of a normal recurring nature. We are a wholly owned subsidiary of Alaska Air
Group, Inc. (Air Group), whose principal subsidiaries are Alaska and Horizon
Air Industries, Inc. (Horizon).

These financial statements have been prepared in conformity with accounting
principles generally accepted in the United States of America (GAAP) and we are
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent liabilities, as well as the
reported amounts of revenues and expenses. Significant estimates made by us
include assumptions used to record liabilities, expenses and revenue associated
with our Mileage Plan, estimated useful lives of property and equipment and the
amounts of certain accrued liabilities. Actual results may differ from our
estimates.

Change in Accounting Principle

Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. In
connection with the adoption of this statement, we determined that all of our
goodwill was impaired. As a result, effective January 1, 2002, we recorded a
one-time, non-cash charge of $12.5 million to write-off all of our goodwill.
This charge is reflected as a cumulative effect of accounting change in our
statement of operations for the six months ended June 30, 2002.

New Accounting Standards

In January 2003, the Financial
Accounting Standards Board (FASB) issued Interpretation No. 46, Consolidation of
Variable Interest Entities which requires the consolidation of variable
interest entities, as defined. This Interpretation is applicable to variable
interest entities created after January 31, 2003. Variable interest entities
created prior to February 1, 2003, must be consolidated effective July 1, 2003.
While we are still evaluating the impact of this Interpretation, we currently
do not believe that any entities will be consolidated as a result of
Interpretation No. 46.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies certain derivative instruments embedded in other contracts, and
certain hedging activities under Statement 133. SFAS No. 149 is effective for
certain contracts entered into or modified by us after June 30, 2003. The
adoption of SFAS No. 149 did not have any impact on our financial condition or
results of operations.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments With Characteristics of both Liabilities and Equity. SFAS No. 150
establishes standards for how we would classify and measure financial
instruments with characteristics of both liabilities and equity and requires us
to classify a financial instrument that is within the scope of SFAS No. 150 as
a liability (or an asset in some circumstances). SFAS No. 150 also revises the
definition of a liability to encompass obligations that we can or must settle
by issuing equity shares, depending on the nature of the relationship
established between us and a holder of our stock. SFAS No. 150 is effective
for financial instruments entered into or modified after May 31, 2003. The
adoption of SFAS No. 150 did not have any impact on our financial condition or
results of operations.

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Note 2. Stock Option Plans

We have three stock option plans that provide for the grant of options to
purchase Air Group common stock at stipulated prices on the date of the grant
to certain officers and key employees of Air Group and its subsidiaries. We
apply the intrinsic value method in accordance with the provisions of
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued
to Employees, and related Interpretations in accounting for stock options.
Accordingly, no compensation cost has been recognized for these plans as the
exercise price of options equals the fair market value on the date of grant.

The following table represents the effect of net income (loss) before
accounting change and net income (loss) if we had applied the fair value based
method and recognition provisions of SFAS No. 123 to our stock-based employee compensation (in millions):

|                                                                                                                                     |  |                             |      |                           |  |      |      |      |  |   |       |   |  |   |       |  
|------------------------------------------------------------------------------------------------------------------------------------ |  | --------------------------- | ---- | ------------------------- |  | ---- | ---- | ---- |  | - | ----- | - |  | - | ----- | -
|                                                                                                                                     |  | Three Months Ended June 30, |      | Six Months Ended June 30,
|                                                                                                                                     |  | 2002                        |      | 2003                      |  | 2002 |      | 2003
|                                                                                                                                     |  |                             |      |                           |  |      |      |     
|Income (loss) before accounting change:                                                                                              |  |                             |      |                           |  |      |      |      |  |   |       |   |  |   |       |  
|As reported                                                                                                                          |  | $                           | (0.8 | )                         |  | $    | 36.8 |      |  | $ | (27.7 | ) |  | $ | (8.3  | )
|Deduct: Total stock-based employee
compensation expense determined
under fair value based methods for
all awards, net of related tax |  |                             | (1.2 | )                         |  |      | (1.2 | )    |  |   | (2.4  | ) |  |   | (2.6  | )
|                                                                                                                                     |  |                             |      |                           |  |      |      |      |  |   |       |   |  |   |       |  
|Pro forma income (loss) before
accounting change                                                                                     |  | $                           | (2.0 | )                         |  | $    | 35.6 |      |  | $ | (30.1 | ) |  | $ | (10.9 | )
|                                                                                                                                     |  |                             |      |                           |  |      |      |      |  |   |       |   |  |   |       |  

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|                                                                                                                                             |  |                             |      |                           |  |      |      |      |  |   |       |   |  |   |       |  
|-------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------- | ---- | ------------------------- |  | ---- | ---- | ---- |  | - | ----- | - |  | - | ----- | -
|                                                                                                                                             |  | Three Months Ended June 30, |      | Six Months Ended June 30,
|                                                                                                                                             |  | 2002                        |      | 2003                      |  | 2002 |      | 2003
|                                                                                                                                             |  |                             |      |                           |  |      |      |     
|Net income (loss):                                                                                                                           |  |                             |      |                           |  |      |      |      |  |   |       |   |  |   |       |  
|As reported                                                                                                                                  |  | $                           | (0.8 | )                         |  | $    | 36.8 |      |  | $ | (40.2 | ) |  |   | (8.3  | )
|Deduct: Total stock-based employee
compensation expense determined
under fair value based methods for
all awards, net of related tax effects |  |                             | (1.2 | )                         |  |      | (1.2 | )    |  |   | (2.4  | ) |  |   | (2.6  | )
|                                                                                                                                             |  |                             |      |                           |  |      |      |      |  |   |       |   |  |   |       |  
|Pro forma net income (loss)                                                                                                                  |  | $                           | (2.0 | )                         |  | $    | 35.6 |      |  | $ | (42.6 | ) |  | $ | (10.9 | )
|                                                                                                                                             |  |                             |      |                           |  |      |      |      |  |   |       |   |  |   |       |  

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure.
SFAS No. 148 amends the transition and disclosure provisions of SFAS No. 123.
During the fourth quarter of 2002, we adopted the disclosure provisions of SFAS
No. 148 and we are currently evaluating SFAS No. 148 to determine if we will
adopt SFAS No. 123 to account for employee stock options using the fair value
method and, if so, when we will transition to that method. If we had adopted
the prospective transition method as prescribed by SFAS No. 148 in the second
quarter of 2003, compensation expense of $0.2 million and $0.3 million would
have been recorded on an after-tax basis for the three and six months ended
June 30, 2003, respectively.

Note 3. Frequent Flyer Program

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

|                               |  |                   |       |               |  |   |       | 
|------------------------------ |  | ----------------- | ----- | ------------- |  | - | ----- | 
|                               |  | December 31, 2002 |       | June 30, 2003
|                               |  |                   |       |              
|Current Liabilities:           |  |                   |       |               |  |   |       | 
|Other accrued liabilities      |  | $                 | 87.0  |               |  | $ | 104.3 | 
|Other Liabilities and Credits: |  |                   |       |               |  |   |       | 
|Deferred revenue               |  |                   | 183.9 |               |  |   | 190.4 | 
|Other liabilities              |  |                   | 32.1  |               |  |   | 24.6  | 
|                               |  |                   |       |               |  |   |       | 
|Total                          |  | $                 | 303.0 |               |  | $ | 319.3 | 
|                               |  |                   |       |               |  |   |       | 

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Note 4. Long-Term Debt and Capital Lease Obligations

At December 31, 2002, and June 30, 2003, long-term debt and capital lease
obligations were as follows (in millions):

|                                             |  |              |       |          |  |   |       |  
|-------------------------------------------- |  | ------------ | ----- | -------- |  | - | ----- | -
|                                             |  | December 31, |       | June 30,
|                                             |  | 2002         |       | 2003    
|                                             |  |              |       |         
|Fixed rate notes payable due through 2015    |  | $            | 439.9 |          |  | $ | 407.0 |  
|Variable rate notes payable due through 2018 |  |              | 453.6 |          |  |   | 511.1 |  
|Senior convertible notes due through 2023    |  |              |      |          |  |   | 63.6  |  
|                                             |  |              |       |          |  |   |       |  
|Long-term debt                               |  |              | 893.5 |          |  |   | 981.7 |  
|Capital lease obligations                    |  |              | 11.8  |          |  |   | 10.1  |  
|Less current portion                         |  |              | (48.6 | )        |  |   | (62.0 | )
|                                             |  |              |       |          |  |   |       |  
|                                             |  | $            | 856.7 |          |  | $ | 929.8 |  
|                                             |  |              |       |          |  |   |       |  

During the second quarter of 2003, we issued $65.0 million of debt secured by
flight equipment, having interest rates that vary with LIBOR and payment terms
of 15 years.

On March 21, 2003, we received $63.6 million under a note with Air Group in
connection with the issuance of senior notes due in 2023 (the Notes). The
Notes bear interest for the first five years from the date of issuance at a
variable rate of 3-month LIBOR plus 2.5% (3.53% at June 30, 2003). This
interest is paid quarterly in arrears. Thereafter, the Notes will cease bearing
cash interest and instead, the principal value of the Notes will increase daily
by the unpaid interest which will be calculated at LIBOR plus 2.5%, up to a
maximum of 5.25%.

We may redeem all or a portion of the Notes for cash at any time on or after
the third anniversary of the issuance of the Notes. In addition, Air Group may
require us to purchase all or a portion of the Notes on the 5th, 10th, and 15th
anniversaries of the issuance of the Notes and upon the occurrence of a change
of control or tax event at principal plus accrued interest.

The Notes are senior unsecured obligations and rank equally with our existing
and future senior unsecured indebtedness.

Note 5. Related Company Transactions

On March 21, 2003, the Company received a capital contribution of $60.0 million
from Air Group that is reflected in capital in excess of par value in our June
30, 2003 balance sheet.

During 2000, Alaska transferred a flight simulator to Alaska Air Group Leasing,
Inc. (AAGL), a subsidiary of Air Group, in exchange for a $2.4 million note
receivable from AAGL and a $0.6 million reduction in its payable to Air Group.
The loan has repayment terms of 12 years at 6.5% interest. AAGL is leasing the
simulator to Alaska for 12 years.

Alaska performs all ticket processing for Horizon. Horizons ticket sales are
recorded by Alaska as air traffic liability and remitted to Horizon when
transportation is provided.

Alaskas Mileage Plan participants may redeem miles on Horizon flights.
Additionally, participants who fly on Horizon may earn miles in Alaskas
Mileage Plan. Alaska does not pay nor receive any amounts from Horizon for its
participation in the plan.

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We periodically loan Horizon funds at varying interest rates. All amounts are
payable on demand. Interest income recognized related to the Horizon loans
totaled $0.5 million and $0.8 million for the quarters ended June 30, 2002 and
2003, respectively, and $1.0 million and $1.3 million for the six months ended
June 30, 2002 and 2003, respectively. At June 30, 2003, receivables from
related companies include $106.3 million from Horizon, $10.0 million from AAGL
and $49.6 million from Air Group.

Alaska has an agreement with Horizon, the Incentive Payment Program (IPP), to
provide revenue sharing on certain markets. Under the IPP, Alaska makes a
monthly payment to Horizon for markets that provide connecting traffic to
Alaska but create losses for Horizon (the incentive markets). The payment is
based on full-allocated cost for Horizon to provide the transportation service,
plus a 5%
mark-up. Incentive markets are analyzed quarterly and the monthly reimbursement
amount is adjusted to reflect the prior quarters actual performance. Alaska
made incentive payments to Horizon of $4.7 million and $9.3 million during each
of the quarters ended June 30, 2002 and 2003, respectively, and $9.0 million
and $14.8 million during the six months ending June 30, 2002 and 2003,
respectively. These amounts are reflected as commission expense in the
statements of operations.

Alaska also provides certain services to Horizon for which Alaska receives
payment from Horizon based on the cost of the services, including personnel
expenses related to development and maintenance of alaskaair.com, the
maintenance of telecommunications lines and related software, personnel and
systems expenses to process Horizons revenue transactions, and printing and
graphics services. Alaska also pays certain leasing and other facilities costs
on Horizons behalf that are reimbursed monthly by Horizon. Total amounts
received by Alaska from Horizon were $1.1 million and $1.8 million for the
quarters ended June 30, 2002 and 2003, respectively. For the six months ending
June 30, 2002 and 2003, total amounts received by Alaska from Horizon were $2.1
million and $3.7 million, respectively.

In the normal course of business, Alaska and Horizon provide certain ground
handling services to the other company. For the quarters ended June 30, 2002
and 2003, charges for ground services provided by Alaska to Horizon totaled
$0.5 million and $0.6 million, respectively. For the six months ending June 30,
2002 and 2003, charges for ground services provided by Alaska to Horizon
totaled $0.8 million and $1.2 million, respectively. For the quarters ended
June 30, 2002 and 2003, charges for ground services provided by Horizon to
Alaska totaled $0.6 million and $1.0 million, respectively. For the six months
ending June 30, 2002 and 2003, charges for ground services provided by Horizon
to Alaska totaled $1.3 million and $1.9 million, respectively.

Note 6. Contingencies

Oakland Maintenance Investigation

In December 1998, the U.S. Attorney for the Northern District of California
initiated a grand jury investigation concerning certain 1998 maintenance
activities at Alaskas Oakland maintenance base. The investigation was
expanded to include the aircraft involved in the loss of Flight 261 in January
2000. The Federal Aviation Administration (FAA) separately proposed a civil
penalty in connection with the 1998 maintenance activities, which Alaska and
the FAA have settled for an agreed amount. In December 2001, the U.S. Attorney
notified Alaska that the evidence it had gathered relative to the 1998
maintenance activities did not warrant the filing of criminal charges, and
closed that part of the investigation. The U.S. Attorney also placed the
portion of its investigation related to Flight 261 on inactive status, with the
possibility of reactivating and reviewing the matter when the National
Transportation Safety Board (NTSB) issued its final report on the accident.
Accordingly, following the final NTSB hearing on the Flight 261 investigation
in December 2002, the U.S. Attorneys Office reactivated the matter in order to
review it in light of the final NTSB report. In July 2003, the U.S. Attorneys
office informed Alaska that, after a review

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of all of the relevant information,
it has concluded that the evidence does not warrant the filing of criminal
charges and it has closed its investigation into the Flight 261 accident.

Flight 261 Litigation

Following the loss of Flight 261 on January 31, 2000, representatives of all 88
passengers and crew on board have filed cases against Alaska, the Boeing
Company, and others. All but one of these lawsuits have been fully and finally
resolved and Alaska continues in its efforts to settle the remaining case. The
remaining lawsuit is scheduled to be sent back for a damages-only trial in
federal court in Los Angeles. Consistent with industry standards, we maintain
insurance against aircraft accidents.

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

We are also a party to other ordinary routine litigation incidental to our
business and with respect to which no material liability is expected.

Note 7. U.S. Government Compensation

On April 16, 2003, the Emergency Wartime Supplemental Appropriations Act (the
Act) was signed into legislation. The Act includes $2.3 billion of one-time
cash payments to air carriers, allocated based on each carriers share of
security fees remitted and carrier fees paid to the Transportation Security
Administration (TSA) since its inception in February 2002. Additionally,
passenger security fees will not be imposed by the TSA during the period July
1, 2003 through September 30, 2003. In May 2003, we received our share of the
one-time cash grant in the amount of $52.8 million.

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Alaska Airlines Financial and Statistical Data

|                                                      |  |                            |        |                          |  |        |        |      |  |         |       |        |       |   |        |   |       |   |        |         |       |   |       |  
|----------------------------------------------------- |  | -------------------------- | ------ | ------------------------ |  | ------ | ------ | ---- |  | ------- | ----- | ------ | ----- | - | ------ | - | ----- | - | ------ | ------- | ----- | - | ----- | -
|                                                      |  | Three Months Ended June 30 |        | Six Months Ended June 30
|                                                      |  |                            |        |                         
|                                                      |  |                            |        |                          |  |        |        |      |  | %       |       |        |       |   |        |   |       |   |        | %      
|Financial Data (in millions):                         |  | 2002                       |        | 2003                     |  | Change |        | 2002 |  | 2003    |       | Change
|                                                      |  |                            |        |                          |  |        |        |      |  |         |       |       
|Operating Revenues:                                   |  |                            |        |                          |  |        |        |      |  |         |       |        |       |   |        |   |       |   |        |         |       |   |       |  
|Passenger                                             |  | $                          | 433.6  |                          |  | $      | 460.6  |      |  |         | 6.2   | %      |       | $ | 807.6  |   |       | $ | 847.6  |         |       |   | 5.0   | %
|Freight and mail                                      |  |                            | 20.0   |                          |  |        | 21.0   |      |  |         | 5.0   | %      |       |   | 35.9   |   |       |   | 38.4   |         |       |   | 7.0   | %
|Other - net                                           |  |                            | 25.1   |                          |  |        | 29.0   |      |  |         | 15.5  | %      |       |   | 47.4   |   |       |   | 51.6   |         |       |   | 8.9   | %
|                                                      |  |                            |        |                          |  |        |        |      |  |         |       |        |       |   |        |   |       |   |        |         |       |   |       |  
|Total Operating Revenues                              |  |                            | 478.7  |                          |  |        | 510.6  |      |  |         | 6.7   | %      |       |   | 890.9  |   |       |   | 937.6  |         |       |   | 5.2   | %
|                                                      |  |                            |        |                          |  |        |        |      |  |         |       |        |       |   |        |   |       |   |        |         |       |   |       |  
|Operating Expenses:                                   |  |                            |        |                          |  |        |        |      |  |         |       |        |       |   |        |   |       |   |        |         |       |   |       |  
|Wages and benefits                                    |  |                            | 174.5  |                          |  |        | 192.0  |      |  |         | 10.0  | %      |       |   | 340.2  |   |       |   | 380.0  |         |       |   | 11.7  | %
|Contracted services                                   |  |                            | 19.4   |                          |  |        | 19.7   |      |  |         | 1.5   | %      |       |   | 41.2   |   |       |   | 40.4   |         |       |   | -1.9  | %
|Aircraft fuel                                         |  |                            | 64.2   |                          |  |        | 69.1   |      |  |         | 7.6   | %      |       |   | 119.4  |   |       |   | 146.0  |         |       |   | 22.3  | %
|Aircraft maintenance                                  |  |                            | 36.1   |                          |  |        | 44.6   |      |  |         | 23.5  | %      |       |   | 71.7   |   |       |   | 82.5   |         |       |   | 15.1  | %
|Aircraft rent                                         |  |                            | 31.8   |                          |  |        | 31.2   |      |  |         | -1.9  | %      |       |   | 63.6   |   |       |   | 61.7   |         |       |   | -3.0  | %
|Food and beverage service                             |  |                            | 16.2   |                          |  |        | 14.9   |      |  |         | -8.0  | %      |       |   | 30.1   |   |       |   | 27.8   |         |       |   | -7.6  | %
|Commissions                                           |  |                            | 14.2   |                          |  |        | 12.2   |      |  |         | -14.1 | %      |       |   | 28.4   |   |       |   | 20.4   |         |       |   | -28.2 | %
|Other selling expenses                                |  |                            | 27.8   |                          |  |        | 23.3   |      |  |         | -16.2 | %      |       |   | 52.7   |   |       |   | 45.2   |         |       |   | -14.2 | %
|Depreciation and amortization                         |  |                            | 28.5   |                          |  |        | 29.6   |      |  |         | 3.9   | %      |       |   | 56.7   |   |       |   | 58.1   |         |       |   | 2.5   | %
|Loss on sale of assets                                |  |                            | 0.2    |                          |  |        | 0.2    |      |  | NM      |       |        | 0.2   |   |        |   | 0.5   |   |        | NM     
|Landing fees and other rentals                        |  |                            | 28.5   |                          |  |        | 31.2   |      |  |         | 9.5   | %      |       |   | 52.1   |   |       |   | 59.9   |         |       |   | 15.0  | %
|Other                                                 |  |                            | 37.5   |                          |  |        | 34.3   |      |  |         | -8.5  | %      |       |   | 73.8   |   |       |   | 68.4   |         |       |   | -7.3  | %
|                                                      |  |                            |        |                          |  |        |        |      |  |         |       |        |       |   |        |   |       |   |        |         |       |   |       |  
|Total Operating Expenses                              |  |                            | 478.9  |                          |  |        | 502.3  |      |  |         | 4.9   | %      |       |   | 930.1  |   |       |   | 990.9  |         |       |   | 6.5   | %
|                                                      |  |                            |        |                          |  |        |        |      |  |         |       |        |       |   |        |   |       |   |        |         |       |   |       |  
|Operating Income (Loss)                               |  |                            | (0.2   | )                        |  |        | 8.3    |      |  | NM      |       |        | (39.2 | ) |        |   | (53.3 | ) |        |         | 36.0  | %
|                                                      |  |                            |        |                          |  |        |        |      |  |         |       |        |       |   |        |   |       |   |        |         |       |   |       |  
|Interest income                                       |  |                            | 6.1    |                          |  |        | 4.5    |      |  |         |       |        |       |   | 11.1   |   |       |   | 5.7    |         |       |   |       |  
|Interest expense                                      |  |                            | (11.6  | )                        |  |        | (11.4  | )    |  |         |       |        |       |   | (23.5  | ) |       |   | (22.7  | )       |       |   |       |  
|Interest capitalized                                  |  |                            | 0.4    |                          |  |        | 0.4    |      |  |         |       |        |       |   | 0.5    |   |       |   | 1.1    |         |       |   |       |  
|U.S. government compensation                          |  |                            | 0.1    |                          |  |        | 52.8   |      |  |         |       |        |       |   | 0.1    |   |       |   | 52.8   |         |       |   |       |  
|Other - net                                           |  |                            | 5.1    |                          |  |        | 5.0    |      |  |         |       |        |       |   | 9.2    |   |       |   | 5.4    |         |       |   |       |  
|                                                      |  |                            |        |                          |  |        |        |      |  |         |       |        |       |   |        |   |       |   |        |         |       |   |       |  
|                                                      |  |                            | 0.1    |                          |  |        | 51.3   |      |  |         |       |        |       |   | (2.6   | ) |       |   | 42.3   |         |       |   |       |  
|                                                      |  |                            |        |                          |  |        |        |      |  |         |       |        |       |   |        |   |       |   |        |         |       |   |       |  
|Income (Loss) Before Income Tax
and Accounting Change |  | $                          | (0.1   | )                        |  | $      | 59.6   |      |  | NM      |       | $      | (41.8 | ) |        | $ | (11.0 | ) |        |         | -73.7 | %
|                                                      |  |                            |        |                          |  |        |        |      |  |         |       |        |       |   |        |   |       |   |        |         |       |   |       |  
|Operating Statistics:                                 |  |                            |        |                          |  |        |        |      |  |         |       |        |       |   |        |   |       |   |        |         |       |   |       |  
|Revenue passengers (000)                              |  |                            | 3,616  |                          |  |        | 3,797  |      |  |         | 5.0   | %      |       |   | 6,809  |   |       |   | 7,055  |         |       |   | 3.6   | %
|RPMs (000,000)                                        |  |                            | 3,372  |                          |  |        | 3,678  |      |  |         | 9.1   | %      |       |   | 6,349  |   |       |   | 6,821  |         |       |   | 7.4   | %
|ASMs (000,000)                                        |  |                            | 4,929  |                          |  |        | 5,209  |      |  |         | 5.7   | %      |       |   | 9,396  |   |       |   | 9,918  |         |       |   | 5.6   | %
|Passenger load factor                                 |  |                            | 68.4   | %                        |  |        | 70.6   | %    |  | 2.2 pts |       |        | 67.6  | % |        |   | 68.8  | % |        | 1.2 pts
|Breakeven load factor                                 |  |                            | 69.5   | %                        |  |        | 70.2   | %    |  | 0.7 pts |       |        | 72.9  | % |        |   | 74.9  | % |        | 2.0 pts
|Yield per passenger mile                              |  |                            | 12.86  | ¢                        |  |        | 12.52  | ¢    |  |         | -2.6  | %      |       |   | 12.72  | ¢ |       |   | 12.43  | ¢       |       |   | -2.3  | %
|Operating revenue per ASM                             |  |                            | 9.71   | ¢                        |  |        | 9.80   | ¢    |  |         | 0.9   | %      |       |   | 9.48   | ¢ |       |   | 9.45   | ¢       |       |   | -0.3  | %
|Operating expenses per ASM (a)                        |  |                            | 9.72   | ¢                        |  |        | 9.64   | ¢    |  |         | -0.8  | %      |       |   | 9.90   | ¢ |       |   | 9.99   | ¢       |       |   | 0.9   | %
|Operating expenses per ASM excluding fuel (a)         |  |                            | 8.41   | ¢                        |  |        | 8.32   | ¢    |  |         | -1.2  | %      |       |   | 8.63   | ¢ |       |   | 8.52   | ¢       |       |   | -1.3  | %
|Fuel cost per gallon                                  |  |                            | 78.0   | ¢                        |  |        | 82.0   | ¢    |  |         | 5.1   | %      |       |   | 75.9   | ¢ |       |   | 90.2   | ¢       |       |   | 18.8  | %
|Fuel gallons (000,000)                                |  |                            | 82.3   |                          |  |        | 84.3   |      |  |         | 2.4   | %      |       |   | 157.3  |   |       |   | 161.9  |         |       |   | 2.9   | %
|Average number of employees                           |  |                            | 10,222 |                          |  |        | 10,136 |      |  |         | -0.8  | %      |       |   | 10,019 |   |       |   | 10,062 |         |       |   | 0.4   | %
|Aircraft utilization (blk hrs/day)                    |  |                            | 10.8   |                          |  |        | 10.5   |      |  |         | -2.8  | %      |       |   | 10.4   |   |       |   | 10.4   |         |       |   | 0.0   | %
|Operating fleet at period-end                         |  |                            | 102    |                          |  |        | 110    |      |  |         | 7.8   | %      |       |   | 102    |   |       |   | 110    |         |       |   | 7.8   | %

NM = Not Meaningful

(a)  See Note 1 on Page 15.

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##### Table of Contents



Note 1:

Pursuant to new guidelines issued by the Securities and Exchange Commission, we are
providing the following reconciliation of non-GAAP
performance indicators to their comparable financial measures reported on a GAAP
basis. Our disclosure of operating expenses and operating expenses per available seat mile, excluding fuel, provides us the ability to measure and
monitor our performance both with and without the cost of
aircraft fuel as both the cost and availability of fuel are subject to economic and
political factors beyond our control. We also believe that
disclosing earnings (loss) and diluted earnings (loss) per share excluding
reimbursements received from the government and the write-off
of goodwill is useful to investors because it helps them see what our results would
have been had these non-recurring items not been present.
The following table reconciles operating expenses excluding fuel and operating expense
per ASM excluding fuel for Alaska Airlines, Inc.:

Alaska Airlines, Inc.:

|                                          |  |                             |       |                           |  |      |       |      |  |   |       |   |  |   |       |  
|----------------------------------------- |  | --------------------------- | ----- | ------------------------- |  | ---- | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                                          |  | Three Months Ended June 30, |       | Six Months Ended June 30,
|                                          |  |                             |       |                          
|($ in millions)                           |  | 2002                        |       | 2003                      |  | 2002 |       | 2003
|                                          |  |                             |       |                           |  |      |       |     
|Operating expenses                        |  | $                           | 478.9 |                           |  | $    | 502.3 |      |  | $ | 930.1 |   |  | $ | 990.9 |  
|ASMs (000,000)                            |  |                             | 4,929 |                           |  |      | 5,209 |      |  |   | 9,396 |   |  |   | 9,918 |  
|Operating expenses per ASM                |  |                             | 9.72  | ¢                         |  |      | 9.64  | ¢    |  |   | 9.90  | ¢ |  |   | 9.99  | ¢
|                                          |  |                             |       |                           |  |      |       |      |  |   |       |   |  |   |       |  
|Operating expenses                        |  | $                           | 478.9 |                           |  | $    | 502.3 |      |  | $ | 930.1 |   |  | $ | 990.9 |  
|Less: aircraft fuel                       |  |                             | 64.2  |                           |  |      | 69.1  |      |  |   | 119.4 |   |  |   | 146.0 |  
|                                          |  |                             |       |                           |  |      |       |      |  |   |       |   |  |   |       |  
|Operating expenses excluding fuel         |  | $                           | 414.7 |                           |  | $    | 433.2 |      |  | $ | 810.7 |   |  | $ | 844.9 |  
|ASMs (000,000)                            |  |                             | 4,929 |                           |  |      | 5,209 |      |  |   | 9,396 |   |  |   | 9,918 |  
|Operating expenses per ASM excluding fuel |  |                             | 8.41  | ¢                         |  |      | 8.32  | ¢    |  |   | 8.63  | ¢ |  |   | 8.52  | ¢
|                                          |  |                             |       |                           |  |      |       |      |  |   |       |   |  |   |       |  

The following table summarizes Alaska Airlines, Inc.s net earnings (loss) during 2002
and 2003 excluding the change in accounting
principle relating to goodwill and the receipt of government compensation and as
reported in accordance with GAAP.

|                                                    |  |                             |     |                           |  |      |      |      |  |    |      |   |  |    |      |  
|--------------------------------------------------- |  | --------------------------- | --- | ------------------------- |  | ---- | ---- | ---- |  | -- | ---- | - |  | -- | ---- | -
|                                                    |  | Three Months Ended June 30, |     | Six Months Ended June 30,
|                                                    |  |                             |     |                          
|                                                    |  | 2002                        |     | 2003                      |  | 2002 |      | 2003
|                                                    |  |                             |     |                           |  |      |      |     
|Net income (loss) excluding non-recurring
items     |  | ($                          | 0.8 | )                         |  | $    | 4.2  |      |  | ($ | 27.7 | ) |  | ($ | 40.9 | )
|Change in accounting principle relating
to goodwill |  |                             |    |                           |  |      |     |      |  | ($ | 12.5 | ) |  |    |     |  
|Government compensation, net of tax                 |  |                             |    |                           |  |      | 32.6 |      |  |    |     |   |  |    | 32.6 |  
|                                                    |  |                             |     |                           |  |      |      |      |  |    |      |   |  |    |      |  
|Reported GAAP amounts                               |  | ($                          | 0.8 | )                         |  | $    | 36.8 |      |  | ($ | 40.2 | ) |  | ($ | 8.3  | )
|                                                    |  |                             |     |                           |  |      |      |      |  |    |      |   |  |    |      |  

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##### Table of Contents






ITEM 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations

The following discussion should be
read in conjunction with our financial statements and the related
notes contained elsewhere in this Quarterly Report on Form 10-Q.
All statements in the following discussion that are not reports 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.

References in this Quarterly Report on
Form 10-Q to Air Group, the Company,
we, us and our refer to Alaska
Air Group, Inc. and its subsidiaries, unless otherwise specified.
Alaska Airlines, Inc. and Horizon Air Industries, Inc. are referred
to as Alaska and Horizon, respectively, and
together as our airlines.

General information about us can be found at www.alaskaair.com. Our annual
reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on
Form 8-K, as well as any amendments to those reports, are available free of
charge through our website as soon as reasonably practicable after we file them
with the SEC.

Summary

Weak economic conditions, continued U.S. involvement in the Middle East and the
negative impact resulting from the 2001 terrorist attacks have adversely
impacted our business and the airline industry. In an attempt to mitigate
these negative impacts, in 2002 and throughout the first and second quarters of
2003, we have engaged in an extensive cost reduction and revenue
enhancement initiatives involving the
review of every aspect of our operations. In June 2003, we met with leaders of
our labor unions to begin a dialog over how we and our labor groups can work
cooperatively to better position us for growth and success. Our meetings
focused on our desire to achieve a cost structure that enables us to offer
customers the services they want at fares they are willing to pay; to earn a
reasonable profit; to grow our business and take advantage of opportunities;
and to secure the futures of as many of our employees as possible. We are
seeking to lower our operating cost per available seat mile, excluding fuel, to
7.25 cents by 2005. However, this is our goal and should not be viewed as a
prediction of future performance.

As discussed in Note 7 to the unaudited interim financial statements, on April
16, 2003, the Emergency Wartime Supplemental Appropriations Act (the Act) was
signed into legislation. The Act includes $2.3 billion of one-time cash
payments to air carriers, allocated based on each carriers share of security
fees remitted and carrier fees paid to the Transportation Security
Administration (TSA) since its inception in February 2002. Additionally,
passenger security fees will not be imposed by the TSA during the period July
1, 2003 through September 30, 2003. In May 2003, we received our share of the
one-time cash grant in the amount of $52.8 million.

Results of Operations

Second Quarter 2003 Compared with Second Quarter 2002

During the second quarter 2003, we reported net income of $36.8 million,
compared to a net loss of $2.0 million in 2002. We received $52.8 million in
government assistance during the second quarter 2003 which positively impacted
our results. Without this assistance, our net income would have been

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$4.2 million. We recorded operating and pre-tax income of $8.3 million and $59.6
million, respectively, in 2003 versus operating and pre-tax losses of
$0.2 million and $0.1 million, respectively, in 2002. Financial and statistical data
is shown on page 14. A discussion of the three month data
follows. On page 15, we have included a reconciliation of reported non-GAAP financial
measures to the most directly comparable GAAP financial measure.
To help enhance the comparability of our financial performance, we use
non-GAAP financial information such as operating expenses excluding
fuel and earnings per share excluding government compensation and
change in accounting principle related to goodwill.

Alaska Airlines Revenues

Operating revenues increased $31.9 million, or 6.7%, during 2003 as compared to
2002. For the quarter, available seat miles (ASMs or Capacity) increased 5.7%
and revenue passenger miles (RPMs or Traffic) increased 9.1% as compared to
the same period in 2002. Capacity increased 3.2% in April, 4.6% in May and
9.1% in June as compared to the same periods in 2002. The capacity increases
are primarily due to the addition of service to new cities (Boston, Denver,
Newark and Miami) and an
increase in service in the Mexico, Pacific Northwest and Intra-California
markets, partially offset by lower capacity in the Bay Area, Arizona and
Northern Alaska. Traffic increases primarily reflect service to new cities and
traffic increases in the Pacific Northwest, Intra-California, Nevada, Mexico
and Arizona markets, partially offset by decreases in traffic in Northern
Alaska, the Bay Area, and Southeast Alaska. Passenger load factor for the
quarter increased 2.2 percentage points, to 70.6%, as compared to the same
period in 2002.

Yield per passenger mile was down 2.6% due to a combination of fewer business
fares and a drop off in demand caused by continued hostilities in the Middle
East and weak economic conditions. Higher traffic combined with lower yields
resulted in a $27.0 million, or 6.2%, increase in passenger revenues.

Freight and mail revenues increased $1.0 million, or 5.0%, due to higher
freight and mail volumes attributable to a reduction of security restrictions.
Other-net revenues increased $3.9 million, or 15.5%, due largely to increased
revenue from the sale of miles in Alaskas frequent flyer program.

Alaska Airlines Expenses

For the quarter, total operating expenses increased $23.4 million, or 4.9%, as
compared to the same period in 2002. This increase is due largely to the 5.7%
increase in capacity combined with higher fuel, maintenance and wages and
benefits costs, partially offset by lower commissions and other selling
expenses. Operating expense per ASM excluding fuel decreased 1.2% as compared
to the same period in 2002. Operating expense per ASM excluding fuel provides
management and investors the ability to measure and monitor our performance
absent the significant price volatility of fuel (see reconciliation of reported
non-GAAP financial measures at page 15). Explanations of significant
period-over-period changes in the components of operating expenses are as
follows:



| |  |  | Wages and benefits increased $17.5 million, or 10.0%, during the
quarter as compared to 2002. Approximately $12.9 million of this
increase reflects higher benefits, resulting from increases in pension
costs of approximately $9.7 million and higher health insurance and
workers compensation costs. The remaining $4.6 million increase
reflects wage rate increases of 4.5%, partially offset by a 0.8%
decrease in the number of employees.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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##### Table of Contents





| |  |  | Aircraft fuel increased $4.9 million, or 7.6%, due to a 5.1%
increase in the fuel cost per gallon and a 2.4% increase in fuel
gallons consumed. Air Groups fuel hedging program resulted in Alaska
recognizing $5.7 million in hedging gains during the second quarter of
2003, of which $4.8 million is reflected in aircraft fuel and $0.9
million is reflected in Other-net. For the remainder of 2003, Air
Group has fuel hedges in place for 35% of its expected fuel
consumption, principally crude oil swaps at prices below $22 per
barrel. In 2004 and 2005, Alaska has crude oil options in place to
hedge 12% and
5%, respectively, of its expected fuel consumption at prices ranging
from $24 to $29 per barrel.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Aircraft maintenance increased $8.5 million, or 23.5%, due to
increases in the number of outside airframe and engine checks and
other outside repairs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  |  | Commissions decreased $2.0 million, or 14.1%, due primarily to
the elimination of travel agent base commissions starting in June
2002, and the continuing shift to direct sales channels, offset by an
increase in incentive payments to Horizon. In 2003, 45.4% of Air
Group ticket sales were made through traditional travel agents,
compared to 51.1% in 2002. In 2003, 26.9% of the ticket sales were made
through Alaskas Internet web site, www.alaskaair.com, compared to
20.5% in 2002.                                                                                                                                                                                                                             
|
| |  |  | Other selling expenses decreased $4.5 million, or 16.2%, due to
less advertising spending in 2003 compared to 2002, partially offset
by increased Mileage Plan redemptions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  |  | Landing fees and other rentals increased $2.7 million, or 9.5%,
due to higher landing fee rates at our new stations and higher rental
rates in several of our large airport locations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  |  | Other expense decreased $3.2 million, or 8.5%, primarily
reflecting lower expenditures for insurance, property taxes, supplies
and passenger remuneration, partially offset by an increase in
expenditures for professional services. Insurance expense decreases
are a
reflection of several factors including lower cost coverage from
government aviation insurance programs and competitive pressures in the
aviation insurance market. However, aviation insurance remains
substantially higher than before September 11, 2001.                                                                                                                                                                                          

Nonoperating Income (Expense)

Net nonoperating items were $0.1 million and $51.3 million income in 2002 and
2003, respectively. The 2003 results include $52.8 million received in
connection with the government reimbursement of security fees remitted and
carrier fees paid under the Act. Interest income decreased $1.6 million due to
lower interest rates in 2003. Interest expense (net of capitalized interest)
decreased $0.2 million, or 1.8%, due to lower variable interest rates in 2003.

Other-net includes $5.0 million and $0.9 million in hedging gains resulting
from hedge ineffectiveness on fuel hedging contracts in 2002 and 2003,
respectively. Also included in 2003 Other-net is an insurance recovery of $3.1
million related to legal fees associated with the U.S. Attorney investigation
in Oakland.

18



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##### Table of Contents



Six Months 2003 Compared with Six Months 2002

Our net loss for the first six months of 2003 was $8.3 million, compared with a
net loss of $3.1 million in 2002. Our 2003 net loss includes $52.8 million
received in connection with government assistance received under the Act. Our
2002 net loss includes $12.5 million related to the write-off of goodwill in
connection with the adoption of SFAS No. 142 (see discussion in Note 1 in the
Notes to Financial Statements). Excluding the government compensation received
in 2003 and the goodwill write-off in 2002, our net loss for the six months
ended 2003 was $40.9 million compared to $27.7 million for 2002.

Our operating loss for the first six months of 2003 was $53.3 million compared
to an operating loss of $39.2 million for 2002. Our pre-tax loss for the first
six months of 2003 was $11.0 million compared with a pre-tax loss before
accounting change of $41.8 million for 2002. Financial and statistical data
comparisons are shown on page 14. A discussion of the six month data follows.
On page 15, we have included a reconciliation of reported non-GAAP financial
measures to the most directly comparable GAAP financial measures.

Alaska Airlines Revenues

Operating revenue increased
$46.7 million, or 5.2%, during the first six months of
2003 as compared to the same period in 2002. For the six months ended June 30,
2003, capacity increased 5.6% and traffic increased 7.4% as compared to the
same period in 2002. The capacity increases are primarily due to the addition
of service to new cities (Boston, Denver, Newark, Washington D.C. and Miami)
and an increase in service in Mexico, Canada and the Intra-Californian markets,
partially offset by lower capacity in virtually all other markets. Traffic
increases primarily reflect service to new cities and traffic increases in the
Pacific Northwest, Intra-California, Mexico, and Nevada, partially offset by
decreases in traffic in the Bay Area, Northern Alaska and Arizona. Passenger
load factor increased 1.2 percentage points to 68.8% during the first six
months of 2003 as compared to 2002.

Yield per passenger mile decreased 2.3% due to a combination of fewer business
travelers and a drop off in demand caused by the continued hostilities in the
Middle East and weak economic conditions. Higher traffic combined with lower
yields resulted in a $40.0 million, or 5.0%, increase in passenger revenues.

Freight and mail revenues increased $2.5 million, or 7.0%, due principally to
higher freight and mail volumes attributable to a reduction of security
restrictions. Other-net revenues increased $4.2 million, or 8.9%, due largely
to increased revenue from the redemption of miles in Alaskas frequent flyer
program.

Alaska Airlines Expenses

For the six months ending June 30, 2003, total operating expenses increased
$60.8 million, or 6.5%, as compared to the same period in 2002. This increase
is due largely to a 5.6% increase in ASMs combined with higher fuel,
maintenance and wages and benefits costs. Operating expense per ASM excluding
fuel decreased 1.3% as compared to the same period in 2002. Explanations of
significant period-over-period changes in the components of operating expenses
are as follows:



| |  |  | Wages and benefits increased $39.8 million, or 11.7%, for the
first six months of 2003 as compared to 2002. Approximately $26.0
million of this increase reflects higher benefits, resulting from
increases in pension costs of approximately $19.0 million and higher
health
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

19



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##### Table of Contents





| |   |  | insurance and workers compensation costs. The remaining $13.8 million
increase reflects wage rate increases and a 0.4% increase in the average
number of employees.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Aircraft fuel increased $26.6 million, or 22.3%, due to an 18.8%
increase in the fuel cost per gallon and a 2.9% increase in fuel
gallons consumed. Air Groups fuel hedging program resulted in Alaska
recognizing $14.2 million in hedging gains during the first half of
2003, of which $12.6 million is reflected in aircraft fuel and $1.6
million is reflected in other-net. For the remainder of 2003, Air
Group has fuel hedges in place for 35% of its expected fuel
consumption, principally crude oil swaps at prices below $22 per
barrel. In 2004 and 2005, Alaska has crude oil options in place to
hedge 12% and
5%, respectively, of its expected fuel consumption at prices ranging
from $24 to $29 per barrel.
|
| |  |  | Aircraft maintenance increased $10.8 million, or 15.1%, due to
increases in the number of outside airframe and engine checks and
other outside repairs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  |  | Commissions decreased $8.0 million, or 28.2%, due primarily to
the elimination of travel agent base commissions starting in June
2002, and the continuing shift to direct sales channels, offset by an
increase in incentive payments to Horizon. In 2003, 45.9% of Air
Group ticket sales were made through traditional travel agents,
compared to 49.8% in 2002. In 2003, 25.9% of the ticket sales were made
through Alaskas Internet web site compared to 19.6% in 2002.                                                                                                                                                                                                                                                   
|
| |  |  | Other selling expenses decreased $7.5 million, or 14.2%, due
principally to lower computer reservation system costs, Mileage Plan
costs and advertising costs, partially offset by an increase in credit
card commissions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| |  |  | Landing fees and other rentals increased $7.8 million, or 15.0%.
The higher rates reflect modest volume growth and an increase in
airports cost of operations, including facility expansion
initiatives, and increased costs for security.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  |  | Other expense decreased $5.4 million, or 7.3%, primarily
reflecting lower expenditures for insurance, data lines and other
communication services and property taxes, partially offset by an
increase in expenditures for professional services and per diems.
Insurance expense decreases are a reflection of several factors
including lower cost coverage from government aviation insurance
programs and competitive pressures in the aviation insurance market.
However, aviation insurance remains substantially higher than before
September 11, 2001.                                                                                                                                                                   

Nonoperating Income (Expense)

Net nonoperating items were $2.6 million expense and $42.3 million income in
2002 and 2003, respectively. The 2003 results include $52.8 million received
in connection with the government reimbursement of security fees remitted and
carrier fees paid under the Act. Interest income decreased $5.4 million due
principally to lower interest rates and an adjustment of premium and
discount amortization on our marketable securities portfolio. Interest expense
(net of capitalized

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interest) increased $1.4 million, or 6.1%, due primarily to
increases in debt (See Note 7 in the Notes to Financial Statements).

Other-net includes $6.8 million and $1.6 million in hedging gains resulting
from hedge ineffectiveness on fuel hedging contracts in 2002 and 2003,
respectively. Also included in 2003 Other-net is an insurance recovery of $3.1
million in connection with legal fees associated with the U.S. Attorney
investigation in Oakland.

Income Tax Benefit

Accounting standards require us to provide for income taxes each quarter based
on our estimate of the effective tax rate for the full year. The volatility of
air fares and fuel prices and the seasonality of our business make it difficult
to accurately forecast full-year pretax results. In addition, a relatively
small change in pretax results can cause a significant change in the effective
tax rate due to the magnitude of nondeductible expenses, such as employee per
diem costs. In estimating the 24.5% tax rate for 2003, we considered a variety
of factors, including the U.S. federal rate of 35%, estimates of nondeductible
expenses and state income taxes, and our forecast of pretax income. We
evaluate this rate each quarter and make adjustments when necessary.

Critical Accounting Policies

For more information on our critical accounting policies, see Item 7 of our
Annual Report on Form 10-K for the year ended December 31, 2002.

Liquidity and Capital Resources

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

|                                                                                                   |  |                                               |        |               |  |        |        |   |  |    |      | 
|-------------------------------------------------------------------------------------------------- |  | --------------------------------------------- | ------ | ------------- |  | ------ | ------ | - |  | -- | ---- | 
|                                                                                                   |  | December 31, 2002                             |        | June 30, 2003 |  | Change
|                                                                                                   |  |                                               |        |               |  |       
|                                                                                                   |  | (In millions, except debt-to-capital amounts)
|Cash and marketable securities                                                                     |  | $                                             | 635.7  |               |  | $      | 721.3  |   |  | $  | 85.6 | 
|Working capital                                                                                    |  |                                               | 240.0  |               |  |        | 272.8  |   |  |    | 32.8 | 
|Long-term debt and
capital lease obligations*                                                      |  |                                               | 856.7  |               |  |        | 929.8  |   |  |    | 73.1 | 
|Shareholders equity                                                                               |  |                                               | 569.7  |               |  |        | 619.9  |   |  |    | 50.2 | 
|Debt-to-capital*                                                                                   |  |                                               | 60%:40 | %             |  |        | 60%:40 | % |  | NA
|Debt-to-capital assuming aircraft
operating leases are capitalized
at seven times annualized rent* |  |                                               | 75%:25 | %             |  |        | 74%:26 | % |  | NA
|*
Excludes current portion of long-term debt and capital lease
obligations                         | 

We have various options available to meet our capital and operating commitments
in 2003, including cash and marketable securities on hand at June 30, 2003 of
$721.3 million. In addition, to supplement cash requirements, we periodically
consider various borrowing or leasing options. In the first quarter of 2003,
we received $60.0 million and $63.6 million, respectfully, from Air Group in
connection with a capital contribution and issuance of senior notes due 2023
(See discussion in Note 4 and Note 5 in the Notes to Financial Statements).
Funds from these transactions are expected to provide additional liquidity to
be used in our operations.

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During the first six months of 2003, our shareholders equity increased $50.2
million, primarily reflecting the $60 million capital contribution from Air
Group, partially offset by out net loss of $8.3 million.

During the first six months of 2003, our cash and marketable securities
increased by $85.6 million to $721.3 million at June 30, 2003. This increase
reflects cash provided by operating and financing activities of $157.9 million
and $146.4 million, respectively, partially offset by cash used in investing
activities, excluding the purchase of marketable securities, of $271.8 million.

Cash Provided by Operating Activities

During the first six months of 2003, operating activities provided $157.9
million of cash, primarily reflecting depreciation and amortization of $85.9
million and increases in air traffic liability, other current liabilities and
deferred revenue and other-net of $86.7 million, $14.6 million and $34.3
million, respectively, partially offset by our net loss of $8.3 million and an
increase in accounts receivable of $55.8 million..

Cash Used in Investing Activities

During the first six months of 2003, cash used in investing activities totaled
$458.8 million, primarily reflecting capital expenditures of $215.6 million,
restricted cash deposits and other of $4.8 million and an increase in
marketable securities of $238.9 million, partially offset by cash provided by
disposition of assets of $0.5 million.

Cash Provided by Financing Activities

In 2003, cash provided by financing activities was $146.4 million, reflecting a
capital contribution received from Air Group of $60.0 million and new debt
issuances of $128.6 million, partially offset by long-term debt and capital
lease payments of $42.2 million. During the second quarter of
2003, we issued $65.0 million of debt secured by flight
equipment, having interest rates that vary with LIBOR and payment
terms of 15 years. On March 21, 2003, we received $63.6 million
from Air Group in connection with the issuance of senior notes due 2023. See
Note 4 in the Notes to the Financial Statements.

Commitments- At June 30, 2003, we had firm orders for 14 aircraft requiring
aggregate payments of approximately $152.1 million, as set forth below. In
addition, we have options to acquire 26 additional B737s. We expect to finance
the new planes with leases, long-term debt or internally generated cash.
During the second quarter of 2003, we deferred the delivery of two Boeing
737-900s from 2004 to 2005. The following table summarizes aircraft
deliveries by year and payments from July 1, 2003 to December 31, 2003, and by
fiscal year thereafter:

|                    |  |                               |      |      |  |      |      |      |  |       |      |  |  |        |   |  |  |   |       | 
|------------------- |  | ----------------------------- | ---- | ---- |  | ---- | ---- | ---- |  | ----- | ---- |  |  | ------ | - |  |  | - | ----- | 
|                    |  | Delivery Period - Firm Orders
|                    |  |                              
|                    |  |                               |      |      |  |      |      |      |  |       |      |  |  | Beyond |   |  |  |  
|Aircraft            |  | 2003                          |      | 2004 |  | 2005 |      | 2005 |  | Total
|                    |  |                               |      |      |  |      |      |      |  |      
|Boeing 737-700      |  |                               | 6    |      |  |      |     |      |  |       |     |  |  |        |  |  |  |   | 6     | 
|Boeing 737-900      |  |                               | 5    |      |  |      | 1    |      |  |       | 2    |  |  |        |  |  |  |   | 8     | 
|                    |  |                               |      |      |  |      |      |      |  |      
|Total               |  |                               | 11   |      |  |      | 1    |      |  |       | 2    |  |  |        |  |  |  |   | 14    | 
|                    |  |                               |      |      |  |      |      |      |  |      
|Payments (Millions) |  | $                             | 46.4 |      |  | $    | 50.6 |      |  | $     | 55.1 |  |  |        |  |  |  | $ | 152.1 | 
|                    |  |                               |      |      |  |      |      |      |  |      

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We are party to a purchase agreement with an aircraft manufacturer. Under
the agreement, upon commitment to purchase the aircraft, we must make deposits
to the manufacturer for a portion of the purchase price of the aircraft, with
the remainder of the purchase price due at delivery. Concurrent with this
agreement, the manufacturer has an agreement with a Trust wherein the Trust
makes deposits to the manufacturer of additional pre-delivery deposits for the
aircraft. Under certain specified events, including default by the Trust, we
may be required to pay the manufacturer the amounts paid by the Trust in order
to retain the right to purchase the aircraft. We make monthly payments to the
Trust related to the advances made by the Trust to the manufacturer, which are
capitalized as part of the aircraft cost. The Trust is reimbursed for its
advances on or before the delivery of the applicable aircraft. As of June 30,
2003, our obligations relating to such advances equaled approximately $17.4
million and $11.6 million for the remainder of 2003 and for 2004, respectively.
These amounts are included as aircraft purchase commitments in the summary of
contractual obligations below.

The following table is a summary of our material contractual obligations for
July 1, 2003 to December 31, 2003 and by fiscal year thereafter:

|                              |  |                                    |       |      |  |      |       |      |  |      |       |      |  |       |       |  |  |   |       |  |  |        |         |  |  |   |         | 
|----------------------------- |  | ---------------------------------- | ----- | ---- |  | ---- | ----- | ---- |  | ---- | ----- | ---- |  | ----- | ----- |  |  | - | ----- |  |  | ------ | ------- |  |  | - | ------- | 
|                              |  | Contractual
Payments Due by Period
|                              |  |                                   
|                              |  |                                    |       |      |  |      |       |      |  |      |       |      |  |       |       |  |  |   |       |  |  | Beyond |         |  |  |  
|(in millions)                 |  | 2003                               |       | 2004 |  | 2005 |       | 2006 |  | 2007 |       | 2007 |  | Total
|                              |  |                                    |       |      |  |      |       |      |  |      |       |      |  |      
|Long-term debt                |  | $                                  | 27.4  |      |  | $    | 194.8 |      |  | $    | 42.0  |      |  | $     | 44.9  |  |  | $ | 47.5  |  |  | $      | 625.2   |  |  | $ | 981.8   | 
|Capital lease obligations     |  |                                    | 1.7   |      |  |      | 8.0   |      |  |      |      |      |  |       |      |  |  |   |      |  |  |        |        |  |  |   | 9.7     | 
|Operating lease commitments   |  |                                    | 74.0  |      |  |      | 136.6 |      |  |      | 124.8 |      |  |       | 115.9 |  |  |   | 98.9  |  |  |        | 658.0   |  |  |   | 1,208.2 | 
|Aircraft purchase commitments |  |                                    | 46.4  |      |  |      | 50.6  |      |  |      | 55.1  |      |  |       |      |  |  |   |      |  |  |        |        |  |  |   | 152.1   | 
|                              |  |                                    |       |      |  |      |       |      |  |      |       |      |  |      
|Total                         |  | $                                  | 149.5 |      |  | $    | 390.0 |      |  | $    | 221.9 |      |  | $     | 160.8 |  |  | $ | 146.4 |  |  | $      | 1,283.2 |  |  | $ | 2,351.8 | 
|                              |  |                                    |       |      |  |      |       |      |  |      |       |      |  |      

New Accounting Standards In January 2003, the FASB issued Interpretation No.
46, Consolidation of Variable Interest Entities which requires the
consolidation of variable interest entities, as defined. This Interpretation
is applicable to variable interest entities created after January 31, 2003.
Variable interest entities created prior to February 1, 2003, must be
consolidated effective July 1, 2003. While we are still evaluating the impact
of this Interpretation, we currently do not believe that any entities will be
consolidated as a result of Interpretation No. 46.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure. SFAS No. 148 amends the transition
and disclosure provisions of SFAS No. 123. During the fourth quarter of 2002,
we adopted the disclosure provisions of SFAS 148 and we are currently
evaluating SFAS No. 148 to determine if we will adopt SFAS No. 123 to account
for employee stock options using the fair value method and, if so, when to
transition to that method.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies certain derivative instruments embedded in other contracts, and
certain hedging activities under Statement 133. SFAS No. 149 is effective for
certain contracts entered into or modified by the Company after June 30, 2003.
The adoption of SFAS No. 149 did not have any impact on our financial
condition or results of operations.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments With Characteristics of both Liabilities and Equity. SFAS No. 150
establishes standards for how we would classify and measure financial
instruments with characteristics of both liabilities and equity and requires us
to classify a financial instrument that is within the scope of SFAS No. 150 as
a liability (or an asset in some circumstances). SFAS No. 150 also revises the
definition of a liability to encompass obligations that we can or must settle
by issuing equity shares, depending on the nature of the relationship
established between us and a holder of our stock. SFAS No. 150 is effective
for financial instruments entered into or modified after May 31, 2003. The
adoption of SFAS No. 150 did not have any impact on our financial condition or
results of operations.

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ITEM 3. Quantitative and Qualitative Disclosure about Market Risk

During the second quarter of 2003, we issued $65.0 million of debt secured by
flight equipment, having interest rates that vary with LIBOR and
payment terms of 15 years.

On March 21, 2003, we received $63.6 million from Air Group in connection with
the issuance of senior notes due 2023. See Note 4 in the Notes to Financial
Statements.

We utilize financial derivative instruments as hedges to decrease our exposure
to jet fuel price changes. We account for our fuel hedge derivative
instruments as cash flow hedges as defined by SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended. At June 30, 2003,
we had crude oil option agreements in place to hedge
approximately 35%, 12% and 5% of our expected jet fuel requirements in 2003,
2004 and 2005, respectively. Prices of these agreements range from $22 to $29
per barrel. Under SFAS No. 133, all changes in fair value that are considered
to be effective are recorded in accumulated other comprehensive income (loss)
until the underlying jet fuel is consumed. The fair value of our hedge
instruments at June 30, 2003 was approximately $11.6 million ($11.1 million in
prepaid expenses and other current assets and $0.6 million in other assets) in
our balance sheet as of June 30, 2003.

During the three months ended June 30, 2002 and 2003, we recognized $1.3
million and $4.8 million in realized hedging gains, respectively. During the
six months ended June 30, 2002 and June 30, 2003, we recognized $0.8 million
and $12.6 million in realized hedging gains, respectively. These amounts are
reflected in aircraft fuel in our statement of operations.

During the three months ended June 30, 2003 and 2003, we recorded $5.0 million
and $0.9 million, respectively, in gains related to the ineffectiveness of our
hedges. During the six months ended June 30, 2002 and June 30, 2003, we
recorded $6.8 million and $1.6 million, respectively, in gains related to the
ineffectiveness of our hedges. These amounts are recorded as non-operating
income (expense) in other-net in our statement of operations.

In the first six months of 2003, we recorded a net loss of $2.3 million, net of
tax, in other comprehensive income (loss) in our balance sheet. This amount
includes the change in effectiveness as related to the change in fair market
value for future derivative hedge instruments and the removal of the effective
portion of derivative hedge instruments that matured during the first six
months.

ITEM 4. Controls and Procedures

As of June 30, 2003, an evaluation was performed under the supervision and with the
participation of our management, including our chief executive
officer and chief financial officer (collectively the
certifying officers), of the effectiveness of the design and operation of our disclosure controls
and procedures. These disclosure controls and procedures are designed to ensure that the information required to be disclosed
by us in our periodic reports filed with the Securities and Exchange Commission
(the SEC) is recorded, processed, summarized and reported within the time
periods specified by the SECs rules and forms, and that the information is
communicated to our certifying officers on a timely basis.

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Our certifying officers concluded, based on their evaluation, that disclosure
controls and procedures were effective taking into consideration the size and
nature of our business and operations.

We have made no significant changes in our internal controls or in other
factors that could significantly affect our internal controls since
the end of the fiscal quarter reported on by this Quarterly Report on
Form 10-Q.

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PART II. OTHER INFORMATION




ITEM 1. Legal Proceedings

Oakland Maintenance Investigation

In December 1998, the U.S. Attorney for the Northern District of California
initiated a grand jury investigation concerning certain 1998 maintenance
activities at our Oakland maintenance base. The investigation was expanded to
include the aircraft involved in the loss of Flight 261 in January 2000. The
Federal Aviation Administration (FAA) separately proposed a civil penalty in
connection with the 1998 maintenance activities, which we and the FAA have
settled for an agreed amount. In December 2001, the U.S. Attorney notified us
that the evidence it had gathered relative to the 1998 maintenance activities
did not warrant the filing of criminal charges, and closed that part of the
investigation. The U.S. Attorney also placed the portion of its investigation
related to Flight 261 on inactive status, with the possibility of reactivating
and reviewing the matter when the National Transportation Safety Board (NTSB)
issued its final report on the accident. Accordingly, following the final NTSB
hearing on the Flight 261 investigation in December 2002, the U.S. Attorneys
Office reactivated the matter in order to review it in light of the final NTSB
report. In July 2003, the U.S. Attorneys office informed us that, after a
review of all of the relevant information, it has concluded that the evidence
does not warrant the filing of criminal charges and it has closed its
investigation into the Flight 261 accident.

Flight 261 Litigation

Following the loss of Flight 261 on January 31, 2000, representatives of all 88
passengers and crew on board have filed cases against us, the Boeing Company,
and others. All but one of these lawsuits have been fully and finally resolved
and Alaska continues in its efforts to settle the remaining case. The
remaining lawsuit is scheduled to be sent back for a damages-only trial in
federal court in Los Angeles. Consistent with industry standards, we maintain
insurance against aircraft accidents.

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

We are also a party to other ordinary routine litigation incidental to our
business and with respect to which no material liability is expected.

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ITEM 6. Exhibits and Reports on Form 8-K

|    |  |                                                                                                                                                                                                           
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | On June 25, 2003, a report on Form 8-K was filed to incorporate a press
release filed on June 24, 2003 announcing Alaska Airlines, Inc.s meetings with
labor unions to discuss its vision for the future.
|    |  |                                                                                                                                                                                                           
|(b) |  | Exhibit 31.1- Section 302 Certification of Chief Executive Officer Pursuant
to 18 U.S.C. Section 1350                                                                                                     
|    |  |                                                                                                                                                                                                           
|(c) |  | Exhibit 31.2- Section 302 Certification of Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350                                                                                                     
|    |  |                                                                                                                                                                                                           
|(d) |  | Exhibit 32.1-Section 906 Certification of Chief Executive Officer Pursuant
to 18 U.S.C. Section 1350                                                                                                      
|    |  |                                                                                                                                                                                                           
|(e) |  | Exhibit 32.2- Section 906 Certification of Chief Financial Officer Pursuant
to 18 U.S.C. Section 1350                                                                                                     

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Signatures

Pursuant to the requirements of the Securities Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.

ALASKA AIRLINES, INC.
Registrant

Date: August 8, 2003

/s/ Terri K. Maupin
Terri K. Maupin
Staff Vice President/Finance and Controller

/s/ Bradley D. Tilden
Bradley D. Tilden
Executive Vice President/Finance and Chief Financial Officer

28