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UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
 FORM 10-Q (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2005. 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.  Delaware
    
    92-0009235(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 19300 International Boulevard, Seattle, Washington 98188
(Address of principal executive offices) Registrants telephone number, including area code: (206) 392-5040 Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). Yes o No þ 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 March 31, 2005.




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TABLE OF CONTENTS  PART I. FINANCIAL INFORMATIONITEM 1. Condensed Financial StatementsITEM 2. Managements Discussion and Analysis of Financial Condition and Results of OperationsITEM 3. Quantitative and Qualitative Disclosures about Market RiskITEM 4. Controls and ProceduresPART II OTHER INFORMATIONITEM 1. Legal ProceedingsITEM 6. ExhibitsSignaturesEXHIBIT INDEXEXHIBIT 10.1EXHIBIT 18.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2    Table of Contents  TABLE OF CONTENTS PART I. FINANCIAL INFORMATIONItem 1. Condensed Financial StatementsItem 2. Managements Discussion and Analysis of Financial Condition and
Results of OperationsItem 3. Quantitative and Qualitative Disclosures About Market RiskItem 4. Controls and ProceduresPART II. OTHER INFORMATIONItem 1. Legal ProceedingsItem 6. ExhibitsSignatures
 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 other similar expressions, although not all forward-looking
statements contain these identifying words. Some of the things that could cause our actual results
to differ from our expectations are: changes in our operating costs including fuel, which can be
volatile; the competitive environment and other trends in our industry; our ability to meet our
cost reduction goals; labor disputes; economic conditions; our reliance on automated systems;
actual or threatened terrorist attacks, global instability and potential U.S. military actions or
activities; changes in laws and regulations; liability and other claims asserted against us;
failure to expand our business; interest rates and the availability of financing; our ability to
attract and retain qualified personnel; changes in our business plans; our significant
indebtedness; downgrades of our credit ratings; and inflation. For a discussion of these and other
risk factors, see Item 7 of the Companys Annual Report for the year ended December 31, 2004 on
Form 10-K under the caption Risk Factors. All of the forward-looking statements are qualified in
their entirety by reference to the risk factors discussed therein. These risk factors may not be
exhaustive. We operate in a continually changing business environment, and new risk factors emerge
from time to time. Management cannot predict such new risk factors, nor can it assess the impact,
if any, of such new risk factors on our business or events described in any forward-looking
statements. We disclaim any obligation to publicly update or revise any forward-looking statements
after the date of this report to conform them to actual results. Over time, our actual results,
performance or achievements will likely differ from the anticipated results, performance or
achievements that are expressed or implied by our forward-looking statements, and such differences
might be significant and materially adverse. 2




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PART I. FINANCIAL INFORMATION 
 BALANCE SHEETS (unaudited)
 ASSETS March 31,
    
    
    December 31,(In Millions)
    
    2005
    
    
    2004Current AssetsCash and cash equivalents
    
    $
    272.2
    
    
    $
    54.1Marketable securities
    
    
    491.1
    
    
    
    819.6Receivables from related companies
    
    
    131.3
    
    
    
    64.9Receivables  net
    
    
    112.4
    
    
    
    91.9Inventories and supplies  net
    
    
    18.6
    
    
    
    17.0Deferred income taxes
    
    
    72.3
    
    
    
    66.6Fuel hedge contracts
    
    
    108.2
    
    
    
    57.9Prepaid expenses and other current assets
    
    
    38.2
    
    
    
    38.9Total Current Assets
    
    
    1,244.3
    
    
    
    1,210.9Property and EquipmentFlight equipment
    
    
    2,023.0
    
    
    
    2,101.7Other property and equipment
    
    
    391.8
    
    
    
    396.6Deposits for future flight equipment
    
    
    61.9
    
    
    
    39.52,476.7
    
    
    
    2,537.8Less accumulated depreciation and amortization
    
    
    833.2
    
    
    
    809.6Total Property and Equipment  Net
    
    
    1,643.5
    
    
    
    1,728.2Intangible Assets
    
    
    38.6
    
    
    
    38.6Fuel Hedge Contracts
    
    
    56.6
    
    
    
    26.6Other Assets
    
    
    79.0
    
    
    
    77.6Total Assets
    
    $
    3,062.0
    
    
    $
    3,081.9
 See accompanying notes to condensed financial statements. 3




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BALANCE SHEETS (unaudited)
Alaska Airlines, Inc. LIABILITIES AND SHAREHOLDERS EQUITY March 31,
    
    
    December 31,(In Millions Except Share Amounts)
    
    2005
    
    
    2004Current LiabilitiesAccounts payable
    
    $
    122.9
    
    
    $
    125.9Payables to related companies
    
    
    7.0
    
    
    
    5.7Accrued aircraft rent
    
    
    64.2
    
    
    
    68.2Accrued wages, vacation and payroll taxes
    
    
    116.1
    
    
    
    119.6Other accrued liabilities
    
    
    309.3
    
    
    
    291.8Air traffic liability
    
    
    339.4
    
    
    
    249.4Current portion of long-term debt and
capital lease obligations
    
    
    51.7
    
    
    
    51.1Total Current Liabilities
    
    
    1,010.6
    
    
    
    911.7Long-Term Debt and Capital Lease Obligations
    
    
    789.0
    
    
    
    798.2Other Liabilities and CreditsDeferred income taxes
    
    
    122.2
    
    
    
    158.9Deferred revenue
    
    
    302.1
    
    
    
    299.2Other liabilities
    
    
    232.8
    
    
    
    237.3657.1
    
    
    
    695.4Commitments and ContingenciesShareholders EquityCommon stock, $1 par valueAuthorized: 1,000 shares
Issued: 2005 and 2004 - 500 shares
    
    
    
    
    
    
    Capital in excess of par value
    
    
    451.4
    
    
    
    451.4Deferred stock-based compensation
    
    
    (2.6
    )
    
    
    (2.9
    )Accumulated other comprehensive loss
    
    
    (83.5
    )
    
    
    (82.7
    )Retained earnings
    
    
    240.0
    
    
    
    310.8605.3
    
    
    
    676.6Total Liabilities and Shareholders Equity
    
    $
    3,062.0
    
    
    $
    3,081.9
 See accompanying notes to condensed financial statements. 4




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CONDENSED STATEMENTS OF OPERATIONS (unaudited)
Alaska Airlines, Inc. Three Months Ended March 31(In Millions)
    
    2005
    
    
    2004Operating RevenuesPassenger
    
    $
    471.3
    
    
    $
    449.3Freight and mail
    
    
    19.3
    
    
    
    17.7Other  net
    
    
    32.7
    
    
    
    24.3Total Operating Revenues
    
    
    523.3
    
    
    
    491.3Operating ExpensesWages and benefits
    
    
    199.7
    
    
    
    200.8Contracted services
    
    
    27.8
    
    
    
    23.1Aircraft fuel
    
    
    127.6
    
    
    
    93.6Aircraft maintenance
    
    
    50.1
    
    
    
    43.5Aircraft rent
    
    
    28.4
    
    
    
    29.5Food and beverage service
    
    
    10.9
    
    
    
    11.2Other selling expenses and commissions
    
    
    32.7
    
    
    
    33.9Depreciation and amortization
    
    
    30.3
    
    
    
    32.8Loss on sale of assets
    
    
    
    
    
    
    0.8Landing fees and other rentals
    
    
    40.6
    
    
    
    33.2Other
    
    
    38.4
    
    
    
    36.9Restructuring charges, primarily write-off of Oakland
leasehold improvements
    
    
    7.4
    
    
    
    Total Operating Expenses
    
    
    593.9
    
    
    
    539.3Operating Loss
    
    
    (70.6
    )
    
    
    (48.0
    )Nonoperating Income (Expense)Interest income
    
    
    6.3
    
    
    
    5.3Interest expense
    
    
    (11.5
    )
    
    
    (10.8
    )Interest capitalized
    
    
    0.7
    
    
    
    0.1Fuel hedging gains
    
    
    93.4
    
    
    
    0.4Other  net
    
    
    (2.9
    )
    
    
    (0.2
    )86.0
    
    
    
    (5.2
    )Income (loss) before income tax and accounting change
    
    
    15.4
    
    
    
    (53.2
    )Income tax expense (benefit)
    
    
    6.1
    
    
    
    (18.8
    )Income (loss) before accounting change
    
    $
    9.3
    
    
    $
    (34.4
    )Cumulative effect on accounting change, net of tax
    
    
    (80.1
    )
    
    
    Net Loss
    
    $
    (70.8
    )
    
    $
    (34.4
    )Pro Forma Results(assuming change in method of
accounting was applied retrospectively):Pro forma net loss
    
    
    
    
    
    $
    (31.3
    )
 See accompanying notes to condensed financial statements. 5




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CONDENSED STATEMENT OF SHAREHOLDERS EQUITY (unaudited)
Alaska Airlines, Inc. Capital in
    
    
    DeferredCommon
    
    
    Excess of
    
    
    Stock-Based
    
    
    Accumulated Other
    
    
    Retained(In Millions)
    
    Stock
    
    
    Par Value
    
    
    Compensation
    
    
    Comprehensive Loss
    
    
    Earnings
    
    
    TotalBalances at December 31, 2004
    
    $
    0.0
    
    
    $
    451.4
    
    
    $
    (2.9
    )
    
    $
    (82.7
    )
    
    $
    310.8
    
    
    $
    676.6Net loss for the three months ended March 31, 2005
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (70.8
    )
    
    
    (70.8
    )Other comprehensive income (loss):Related to marketable securities:Change in fair value
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.5
    )Reclassification to earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2.5Income tax effect
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.7
    )1.3
    
    
    
    
    
    
    
    1.3Related to fuel hedges:Reclassification to earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3.4
    )Income tax effect
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.3(2.1
    )
    
    
    
    
    
    
    (2.1
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (71.6
    )Amortization of deferred stock-based compensation
    
    
    
    
    
    
    
    
    
    
    0.3
    
    
    
    
    
    
    
    
    
    
    
    0.3Balances at March 31, 2005
    
    $
    0.0
    
    
    $
    451.4
    
    
    $
    (2.6
    )
    
    $
    (83.5
    )
    
    $
    240.0
    
    
    $
    605.3
 See accompanying notes to condensed financial statements. 6




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CONDENSED STATEMENTS OF CASH FLOWS (unaudited)
Alaska Airlines, Inc. Three Months Ended March 31 (In Millions)
    
    2005
    
    
    2004Cash flows from operating activities:Net loss
    
    $
    (70.8
    )
    
    $
    (34.4
    )Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:Cumulative effect of accounting change, net of tax effect
    
    
    80.1
    
    
    
    Restructuring charges, primarily write-off of Oakland
leasehold improvements
    
    
    7.4
    
    
    
    Depreciation and amortization
    
    
    30.3
    
    
    
    32.8Amortization of airframe and engine overhauls
    
    
    
    
    
    
    16.9Stock-based compensation
    
    
    0.3Changes in fair values of open fuel hedge contracts
    
    
    (83.7
    )
    
    
    Loss on sale of assets
    
    
    
    
    
    
    0.8Changes in deferred income taxes
    
    
    5.7
    
    
    
    (18.7
    )Increase in receivables  net
    
    
    (86.9
    )
    
    
    (66.7
    )(Increase) decrease in prepaid expenses and other current assets
    
    
    0.7
    
    
    
    (7.2
    )Increase in air traffic liability
    
    
    90.0
    
    
    
    71.8Increase in other current liabilities
    
    
    8.6
    
    
    
    12.1(Decrease) increase in deferred revenue and other-net
    
    
    (1.8
    )
    
    
    18.7Net cash provided by (used in) operating activities
    
    
    (20.1
    )
    
    
    26.1Cash flows from investing activities:Proceeds from disposition of assets
    
    
    1.8
    
    
    
    3.9Purchases of marketable securities
    
    
    (127.0
    )
    
    
    (187.9
    )Sales and maturities of marketable securities
    
    
    457.4
    
    
    
    142.3Property and equipment additions:Aircraft purchase deposits
    
    
    (41.1
    )
    
    
    (3.2
    )Capitalized overhauls
    
    
    
    
    
    
    (10.9
    )Aircraft
    
    
    (32.1
    )
    
    
    (36.9
    )Other flight equipment
    
    
    (1.0
    )
    
    
    (0.9
    )Other property
    
    
    (10.4
    )
    
    
    (4.9
    )Restricted deposits and other
    
    
    (0.7
    )
    
    
    (3.2
    )Net cash provided by (used in) investing activities
    
    
    246.9
    
    
    
    (101.7
    )Cash flows from financing activities:Proceeds from issuance of long-term debt, net
    
    
    
    
    
    
    62.6Proceeds from issuance of intercompany long-term debt
    
    
    
    
    
    
    Long-term debt and capital lease payments
    
    
    (8.6
    )
    
    
    (14.8
    )Capital contribution from Air Group
    
    
    
    
    
    
    Net cash provided by (used in) financing activities
    
    
    (8.6
    )
    
    
    47.8Net change in cash and cash equivalents
    
    
    218.1
    
    
    
    (27.8
    )Cash and cash equivalents at beginning of period
    
    
    54.1
    
    
    
    192.5Cash and cash equivalents at end of period
    
    $
    272.2
    
    
    $
    164.7Supplemental disclosure of cash paid during the period for:Interest (net of amount capitalized)
    
    $
    8.1
    
    
    $
    8.0Income taxes
    
    
    0.7
    
    
    
    -
 See accompanying notes to condensed financial statements. 7




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NOTES TO CONDENSED FINANCIAL STATEMENTS (unaudited)
Alaska Airlines, Inc. Note 1. Basis of Presentation and Significant Accounting Policies Organization and Basis of Presentation The accompanying unaudited condensed financial statements of Alaska Airlines, Inc. (Alaska or the
Company) should be read in conjunction with the financial statements in the Companys Annual Report
on Form 10-K for the year ended December 31, 2004. In the opinion of management, all adjustments
have been made which are necessary to present fairly the Companys financial position as of March
31, 2005, as well as the results of operations for the three months ended March 31, 2005 and 2004.
The adjustments made were of a normal recurring nature. The Company is a wholly owned subsidiary
of Alaska Air Group, Inc. (Air Group) whose principal subsidiaries are Alaska and Horizon Air
Industries, Inc. (Horizon). The financial statements have been prepared in conformity with accounting principles generally
accepted in the United States of America (GAAP). In preparing these condensed financial statements,
the Company is required to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent liabilities, as well as the reported amounts
of revenues and expenses. Significant estimates made include assumptions used to record
liabilities, expenses and revenues associated with the Companys Mileage Plan, amounts to be paid
to lessors upon aircraft lease terminations, the fair market value of surplus or impaired aircraft,
engines and parts, assumptions used in the calculations of pension expense in the Companys Defined
Benefit Plans and the amounts of certain accrued liabilities. Actual results may differ the
Companys estimates. Reclassifications Certain reclassifications have been made to conform the prior years data to the current format. Stock Options The Company applies 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. The following table represents the pro forma net income (loss) before accounting change and pro
forma net loss per share (EPS) had compensation cost for the Companys stock options been
determined in accordance with Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation. In accordance with SFAS No. 123, the fair value of each
stock option grant is estimated on the date of grant using the Black-Scholes option pricing model
and then amortized ratably over the vesting period. 8




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Three Months Ended March 31,2005
    
    
    2004Income (loss) before accounting change (in millions)Income (loss) as reported
    
    $
    9.3
    
    
    $
    (34.4
    )Add: Total stock-based compensation
expense recognized under the intrinsic
value-based method, net
of related tax
    
    
    0.2
    
    
    
    Deduct: Total stock-based compensation
expense determined under fair value-
based methods for all awards, net of
related tax
    
    
    (0.8
    )
    
    
    (0.9
    )Pro forma income (loss)
before accounting change
    
    $
    8.7
    
    
    $
    (35.3
    )Net loss as reported
    
    $
    (70.8
    )
    
    $
    (34.4
    )Add: Total stock-based compensation
expense recognized under the intrinsic
value-based method, net
of related tax
    
    
    0.2
    
    
    
    Deduct: Total stock-based compensation
expense determined under fair value-
based methods for all awards, net of
related tax
    
    
    (0.8
    )
    
    
    (0.9
    )Pro forma net loss
    
    $
    (71.4
    )
    
    $
    (35.3
    )
 During the fourth quarter of 2004, the Financial Accounting Standards Board issued SFAS 123R,
Share Based Payment: An Amendment of SFAS Nos. 123 and 95. The new standard requires companies to
recognize as expense the fair value of stock options and other equity-based compensation issued to
employees as of the grant date. This new standard will apply to both stock options that we grant
to employees and our Employee Stock Purchase Plan, which features a look-back provision and allows
employees to purchase stock at a 15% discount. Our options are typically granted with graded
vesting provisions, and we intend to amortize compensation cost over the service period using the
straight line method. Due to a recent decision by the Securities and Exchange Commission,
implementation of SFAS 123R will be effective January 1, 2006. We intend to use the modified
prospective method upon adoption whereby previously awarded but unvested equity awards are
accounted for in accordance with SFAS 123R and prospective amounts are recognized in the income
statement instead of simply being disclosed. Once adopted, we expect our stock based compensation
expense, as measured under SFAS 123R, will be approximately $6 to $10 million per year on a pre-tax
basis. 9




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Note 2. Change in Accounting Principle Effective January 1, 2005, the Company changed its method of accounting for major airframe and
engine overhauls from the capitalize and amortize method to the direct expense method. Under the
former method, these costs were capitalized and amortized to maintenance expense over the shorter
of the life of the overhaul or the remaining lease term. Under the direct expense method, overhaul
costs are expensed as incurred. The Company believes that the direct expense method is preferable
because it eliminates the judgment and estimation needed to determine overhaul versus repair
allocations in maintenance activities. Additionally, the Companys approved maintenance program for
the majority of its airframes now focuses more on shorter, but more frequent, maintenance visits
that result in a higher portion of the work being repair activity. Management also believes that
the direct expense method is the predominant method used in the airline industry. Accordingly,
effective January 1, 2005, the Company wrote off the net book value of its previously capitalized
airframe and engine overhauls for all aircraft in a charge totaling $128.2 million pre-tax ($80.1
million after tax). The Company does not believe disclosing the effect of adopting the direct
expense method on net income for the period ended March 31, 2005 provides meaningful information
because of changes in the Companys maintenance program, including the execution of a power by
the hour maintenance
agreement with a third party in late 2004. Note 3. Restructuring Charges During March 2005, the Company notified the Port of Oakland of its decision to terminate the lease
for the Oakland hangar as part of its ongoing restructuring efforts. Accordingly, the Company has
recorded an impairment charge for the leasehold improvements that will be abandoned as a result of
the lease termination. Additionally, the Company has recorded a charge for certain costs
associated with the lease termination. The following table displays the activity and balance of the asset impairment and lease termination
costs components of the Companys restructuring reserve as of and for the three months ended March
31, 2005 ($ in millions): Asset Impairment and Lease Termination CostsBalance at December 31, 2004
    
    $
    0.0Asset impairment charge
    
    
    7.7Write-off of impaired assets
    
    
    (7.7
    )Lease termination costs
    
    
    0.3Cash payments
    
    
    (0.1
    )Balance at March 31, 2005
    
    $
    0.2
 During the third quarter of 2004, the Company announced a management reorganization and the closure
of its Oakland heavy maintenance base, contracting out of the Companys fleet service and 10




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ground
support equipment and facility maintenance, as well as other initiatives. In total, these
restructuring activities are expected to result in a reduction of approximately 900 employees. The following table displays the activity and balance of the severance and related costs components
of the Companys restructuring reserve as of and for the three months ended March
31, 2005. The restructuring adjustment relates to our change in estimated costs of medical
coverage extended to impacted employees. We expect to record similar adjustments in future
quarters as actual medical costs become known. There were no restructuring charges during the
first quarter of 2004 ($ in millions): Severance and Related CostsBalance at December 31, 2004
    
    $
    38.7Restructuring adjustment
    
    
    (0.6
    )Cash payments
    
    
    (20.3
    )Balance at March 31, 2005
    
    $
    17.8
 The Company will make the majority of the remaining cash payments during the second quarter of
2005. Note 4. Related Company Transactions The Company periodically loans Horizon funds at varying interest rates. All amounts are payable on
demand. Interest income recognized related to the Horizon loans totaled $0.7 million during each
of the quarters ended March 31, 2005 and 2004, respectively. At March 31, 2005, receivables from
related companies include $113.2 million from Horizon, $9.3 million from Alaska Air Group Leasing
(AAGL) and $8.8 million from Air Group. At March 31, 2005, payables to related companies include
$1.0 million to Horizon, $0.4 million to AAGL and $5.6 million to Air Group. The Company has an agreement with Horizon to provide revenue sharing on certain markets. Under the
arrangement, the Company makes a monthly payment to Horizon for markets that provide connecting
traffic to the Company but create losses for Horizon (the incentive markets). The payment is based
on fully allocated cost for Horizon to provide the transportation service, plus a specified margin
if the Company has an operating profit for the quarter. Incentive markets are analyzed quarterly
and the monthly reimbursement amount is adjusted to reflect the prior quarters actual performance.
The Company made incentive payments to Horizon of $2.0 million during each of the quarters ended
March 31, 2004 and 2005. The Company also provides certain services to Horizon for which the Company 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. The Company also pays certain leasing and other facilities costs on Horizons behalf
that are reimbursed monthly by Horizon. Total amounts received by the 11




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Company from Horizon were
$2.7 million and $2.3 million for the quarters ended March 31, 2005 and 2004, respectively. For the quarters ended March 31, 2005 and 2004, charges for ground services provided by the Company
to Horizon totaled $.4 million and $.6 million, respectively. For the quarters ended
March 31, 2005 and 2004, charges for ground services provided by Horizon to the Company totaled
$1.3 million and $1.2 million, respectively. Note 5. Derivative Financial Instruments The Company records all derivative instruments, all of which are currently fuel hedge contracts, on
the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each
period in earnings or other comprehensive income, depending on the type of hedging instrument and
the effectiveness of the hedges. The Companys operations are inherently dependent upon the price and availability of aircraft fuel,
which accounted for 21.8% and 17.4% of 2005 and 2004 operating expenses (excluding restructuring
charges), respectively. To manage economic risks associated with fluctuations in aircraft fuel
prices, the Company enters into swap agreements and call options for crude oil. Because of variations in the spread between the prices of West Texas Intermediate crude oil and jet
fuel since the second quarter of 2004, the Companys hedge contracts are not highly correlated to
changes in prices of aircraft fuel, as defined in SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. The impacts on the Companys reported results are as follows:  
    All changes in the fair value of fuel hedge contracts that existed as of March 31,
2004 or hedge positions entered into subsequent to March 31, 2004 are reported in other
non-operating income (expense).
    Reported fuel expense includes only the effective portion of gains associated with
hedge positions that settled during the current period on contracts that existed at March
31, 2004 to the extent that mark-to-market gains were already included in Accumulated
Other Comprehensive Loss at March 31, 2004. 12




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The following table summarizes fuel hedging gains and changes in fair value of hedging contracts
outstanding as of March 31, 2005 and 2004 (in millions): Three Months Ended March 312005
    
    
    2004Fuel expense before hedge activities
(raw or into-plane fuel cost)
    
    $
    131.0
    
    
    $
    96.7Less: gains on settled hedges included
in fuel expense
    
    
    (3.4
    )
    
    
    (3.1
    )GAAP fuel expense
    
    $
    127.6
    
    
    $
    93.6Less: gains on settled hedges included
in nonoperating income (expense)
    
    
    (15.7
    )
    
    
    Economic fuel expense
    
    $
    111.9
    
    
    $
    93.6Mark-to-market hedging gains included
in nonoperating income (expense)
    
    $
    77.7
    
    
    $
    0.4
 Fuel hedge positions entered into by Alaska are currently as follows: Approximate % of

    
    
    
    
    
    
    
    Approximate CrudeExpected Fuel

    
    
    Gallons Hedged
    
    
    Oil Price perRequirements

    
    
    (in millions)
    
    
    BarrelSecond Quarter 2005
    
    
    
    50
    %
    
    
    
    45.2
    
    
    
    $
    28.97Third Quarter 2005
    
    
    
    50
    %
    
    
    
    48.5
    
    
    
    $
    28.81Fourth Quarter 2005
    
    
    
    50
    %
    
    
    
    43.8
    
    
    
    $
    31.85First Quarter 2006
    
    
    
    50
    %
    
    
    
    44.2
    
    
    
    $
    35.70Second Quarter 2006
    
    
    
    50
    %
    
    
    
    46.5
    
    
    
    $
    39.76Third Quarter 2006
    
    
    
    40
    %
    
    
    
    39.9
    
    
    
    $
    41.58Fourth Quarter 2006
    
    
    
    30
    %
    
    
    
    27.1
    
    
    
    $
    42.70First Quarter 2007
    
    
    
    20
    %
    
    
    
    18.2
    
    
    
    $
    43.09Second Quarter 2007
    
    
    
    15
    %
    
    
    
    14.4
    
    
    
    $
    43.86Third Quarter 2007
    
    
    
    15
    %
    
    
    
    15.4
    
    
    
    $
    43.50Fourth Quarter 2007
    
    
    
    10
    %
    
    
    
    9.3
    
    
    
    $
    47.29First Quarter 2008
    
    
    
    5
    %
    
    
    
    4.7
    
    
    
    $
    51.56
 The fair values of the Companys fuel hedge positions for the period ended March 31, 2005 and
December 31, 2004 were $164.8 million and $84.5 million, respectively, and are presented as fuel
hedge contracts in the balance sheets. 13




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##### Table of Contents



Note 6. Other Assets Other assets consisted of the following (in millions): March 31, 2005
    
    
    December 31, 2004Restricted deposits (primarily restricted investments)
    
    $
    67.5
    
    
    $
    66.3Deferred costs and other
    
    
    11.5
    
    
    
    11.3$
    79.0
    
    
    $
    77.6
 Note 7. Mileage Plan Alaskas Mileage Plan liabilities are included under the following balance sheet captions (in
millions): 2004
    
    March 31, 2005
    
    
    December 31, 2004Current Liabilities:Other accrued liabilities
    
    $
    149.5
    
    
    $
    136.6Other Liabilities and Credits (non-current):Deferred revenue
    
    
    257.9
    
    
    
    252.9Other liabilities
    
    
    20.1
    
    
    
    19.8$
    427.5
    
    
    $
    409.3
 Note 8. Employee Benefit Plans Pension Plans-Qualified Defined Benefit Net pension expense for the three months ended March 31 included the following components (in
millions): March 31, 2005
    
    
    March 31, 2004Service cost
    
    $
    13.7
    
    
    $
    13.7Interest cost
    
    
    12.9
    
    
    
    12.0Expected return on assets
    
    
    (12.5
    )
    
    
    (10.7
    )Amortization of prior service cost
    
    
    1.2
    
    
    
    1.3Actuarial gain
    
    
    3.6
    
    
    
    3.7Net pension expense
    
    $
    18.9
    
    
    $
    20.0
 The Company made $16.5 million in contributions to its defined benefit pension plans during the
three months ended March 31, 2004. The Company made $19.3 million in contributions during the three
months ended March 31, 2005, and expects to contribute an additional $38.5 million to these plans
during the remainder of 2005. 14




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##### Table of Contents



Pension Plans-Nonqualified Defined Benefit Net pension expense for the unfunded, noncontributory defined benefit plans for the three months
ended March 31 included the following components (in millions): March 31, 2005
    
    
    March 31, 2004Service cost
    
    
    $  0.3
    
    
    
    $  0.3Interest cost
    
    
    0.4
    
    
    
    0.5Actuarial gain
    
    
    0.1
    
    
    
    0.2Net pension expense
    
    
    $  0.8
    
    
    
    $  1.0
 Postretirement Medical Benefits Net periodic benefit cost for the postretirement medical plans for the three months ended March 31
included the following components: March 31, 2005
    
    
    March 31, 2004Service cost
    
    
    $  1.0
    
    
    
    $  1.2Interest cost
    
    
    1.1
    
    
    
    1.3Amortization of prior service cost
    
    
    (0.1
    )
    
    
    (0.1
    )Actuarial gain
    
    
    0.5
    
    
    
    0.7Net periodic benefit cost
    
    
    $  2.5
    
    
    
    $  3.1
 Note 9. Long-term Debt and Capital Lease Obligations At March 31, 2005 and December 31, 2004, long-term debt and capital lease obligations were as
follows (in millions): 2005
    
    
    2004Fixed rate notes payable due through 2015
    
    $
    357.7
    
    
    $
    361.3Variable rate notes payable due through 2018
    
    
    482.7
    
    
    
    487.6Long-term debt
    
    
    840.4
    
    
    
    848.9Capital lease obligations
    
    
    0.3
    
    
    
    0.4Less current portion
    
    
    (51.7
    )
    
    
    (51.1
    )$
    789.0
    
    
    $
    798.2
 During 2004, the Company repaid its $150 million credit facility and, on December 23, 2004, that
facility expired. On March 25, 2005, the Company finalized a $160 million variable rate credit
facility with a syndicate of financial institutions that will expire
in March 2008. The interest rate on the credit facility varies
depending on certain financial ratios specified in the agreement with
a minimum interest rate of LIBOR plus 200 basis points. Any borrowings
will be secured by either aircraft or cash collateral. This credit facility contains contractual
restrictions and requires maintenance of specific levels of net worth, maintenance of certain debt
and leases to net worth, leverage and fixed charge coverage ratios, and limits on liens, asset
dispositions, dividends, and certain other expenditures. Such provisions restrict the Company from
distributing any funds to its parent, Air Group, in the form of dividends and limit the 15




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##### Table of Contents



amount of
funds the Company can loan to Air Group. As of March 31, 2005, $300.0 million was
available to loan to Air Group without violating the covenants in the credit facility. As of March
31, 2005, there are no outstanding borrowings on this credit facility. Note 10. Contingencies The Companys former pilot contract provided that, if a negotiated agreement on the entire contract
was not reached by December 15, 2004, ten contract issues plus wage rates would be submitted to an
interest arbitrator. The arbitration became effective on May 1, 2005 and resulted in an average
pilot wage reduction of approximately 26%, various work rule changes, and higher employee health
care contributions. No changes were made to the pilots pension or profit sharing plans. The Company is a party to routine commercial and employment litigation incidental to its business
and with respect to which no material liability is expected. Management believes the ultimate
disposition of these matters is not likely to materially affect the Companys financial position or
results of operations. However, this belief 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. The Company could potentially be responsible for environmental remediation costs primarily related
to jet fuel and other petroleum contamination that occurs in the normal course of business at
various owned or leased locations in the Companys system. The Company has established an accrual
for estimated remediation costs for known contamination based on information currently available.
The accrual was not significant at March 31, 2005. 16




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##### Table of Contents



Alaska Airlines Financial and Statistical Data (unaudited) Three Months Ended March 31%Financial Data (in millions):
    
    2005
    
    
    2004
    
    
    ChangeOperating Revenues:Passenger
    
    $
    471.3
    
    
    $
    449.3
    
    
    
    4.9Freight and mail
    
    
    19.3
    
    
    
    17.7
    
    
    
    9.0Other  net
    
    
    32.7
    
    
    
    24.3
    
    
    
    34.6Total Operating Revenues
    
    
    523.3
    
    
    
    491.3
    
    
    
    6.5Operating Expenses:Wages and benefits
    
    
    199.7
    
    
    
    200.8
    
    
    
    (0.5
    )Contracted services
    
    
    27.8
    
    
    
    23.1
    
    
    
    20.3Aircraft fuel
    
    
    127.6
    
    
    
    93.6
    
    
    
    36.3Aircraft maintenance
    
    
    50.1
    
    
    
    43.5
    
    
    
    15.2Aircraft rent
    
    
    28.4
    
    
    
    29.5
    
    
    
    (3.7
    )Food and beverage service
    
    
    10.9
    
    
    
    11.2
    
    
    
    (2.7
    )Other selling expenses and commissions
    
    
    32.7
    
    
    
    33.9
    
    
    
    (3.5
    )Depreciation and amortization
    
    
    30.3
    
    
    
    32.8
    
    
    
    (7.6
    )Loss on sale of assets
    
    
    
    
    
    
    0.8
    
    
    NMLanding fees and other rentals
    
    
    40.6
    
    
    
    33.2
    
    
    
    22.3Other
    
    
    38.4
    
    
    
    36.9
    
    
    
    4.1Restructuring charges, primarily write-off of Oakland
leasehold improvements
    
    
    7.4
    
    
    
    
    
    
    NMTotal Operating Expenses
    
    
    593.9
    
    
    
    539.3
    
    
    
    10.1Operating Loss
    
    
    (70.6
    )
    
    
    (48.0
    )
    
    NMInterest income
    
    
    6.3
    
    
    
    5.3Interest expense
    
    
    (11.5
    )
    
    
    (10.8
    )Interest capitalized
    
    
    0.7
    
    
    
    0.1Fuel hedging gains
    
    
    93.4
    
    
    
    0.4Other  net
    
    
    (2.9
    )
    
    
    (0.2
    )86.0
    
    
    
    (5.2
    )Income (Loss) Before Income Tax
    
    $
    15.4
    
    
    $
    (53.2
    )
    
    NMOperating Statistics:Revenue passengers (000)
    
    
    3,851
    
    
    
    3,592
    
    
    
    7.2RPMs (000,000)
    
    
    3,897
    
    
    
    3,580
    
    
    
    8.9ASMs (000,000)
    
    
    5,370
    
    
    
    5,178
    
    
    
    3.7Passenger load factor
    
    
    72.6
    %
    
    
    69.1
    %
    
    3.5 ptsYield per passenger mile
    
    
    12.09
    ¢
    
    
    12.55
    ¢
    
    
    (3.7
    )Operating revenue per ASM
    
    
    9.74
    ¢
    
    
    9.49
    ¢
    
    
    2.6Operating expenses per ASM (a)
    
    
    11.06
    ¢
    
    
    10.42
    ¢
    
    
    6.1Operating expenses per ASM excluding fuel and
restructuring charges (a)
    
    
    8.55
    ¢
    
    
    8.61
    ¢
    
    
    (0.7
    )Raw fuel cost per gallon (a)
    
    
    155.6
    ¢
    
    
    116.6
    ¢
    
    
    33.4GAAP fuel cost per gallon (a)
    
    
    151.5
    ¢
    
    
    112.9
    ¢
    
    
    34.2Economic fuel cost per gallon (a)
    
    
    132.9
    ¢
    
    
    112.9
    ¢
    
    
    17.7Fuel gallons (000,000)
    
    
    84
    
    
    
    83
    
    
    
    1.6Average number of employees
    
    
    9,219
    
    
    
    9,984
    
    
    
    (7.7
    )Aircraft utilization (blk hrs/day)
    
    
    11
    
    
    
    10
    
    
    
    2.9Operating fleet at period-end
    
    
    109
    
    
    
    108
    
    
    
    0.9
 NM = Not Meaningful (a) See Note A on Page 18 17




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##### Table of Contents



Note A: Pursuant to Item 10 of Regulation S-K, we are providing disclosure of the reconciliation of reported non-GAAP financial measures to their most
directly comparable financial measures reported on a GAAP basis. The non-GAAP financial measures provide management the ability to measure and
monitor performance both with and without the cost of aircraft fuel (including the gains and losses associated with our fuel hedging program
where appropriate), restructuring charges, and aircraft impairment charges. Because the cost and availability of aircraft fuel are subject to
many economic and political factors beyond our control and we record changes in the fair value of our hedge portfolio in our income statement,
it is our view that the measurement and monitoring of performance without fuel is important. In addition, we believe the disclosure of financial
performance without impairment and restructuring charges is useful to investors. Finally, these non-GAAP financial measures are also more
comparable to financial measures reported to the Department of Transportation by other major network airlines. The following tables reconcile our non-GAAP financial measures to the most directly comparable GAAP financial measures for Alaska Airlines, Inc.: ($ in millions)
    
    Three Months Ended March 31,2005
    
    
    2004Unit cost reconciliations:Operating expenses
    
    $
    593.9
    
    
    $
    539.3ASMs (000,000)
    
    
    5,370
    
    
    
    5,178Operating expenses per ASM
    
    
    11.06
    ¢
    
    
    10.42
    ¢Operating expenses
    
    $
    593.9
    
    
    $
    539.3Less: aircraft fuel
    
    
    (127.6
    )
    
    
    (93.6
    )Less: restructuring charges
    
    
    (7.4
    )
    
    
    Operating expense excluding fuel & restructuring charges
    
    $
    458.9
    
    
    $
    445.7ASMs (000,000)
    
    
    5,370
    
    
    
    5,178Operating expense per ASM excluding fuel
    
    
    8.55
    ¢
    
    
    8.61
    ¢Reconciliation from GAAP pre-tax income (loss):Pretax income (loss) reported GAAP amounts
    
    $
    15.4
    
    
    $
    (53.2
    )Less: mark-to-market hedging gains included
in nonoperating income (expense)
    
    
    (77.7
    )
    
    
    (0.4
    )Add: Restructuring charges
    
    
    7.4
    
    
    
    Pretax loss excluding restructuring charges and
mark-to-market hedging gains
    
    $
    (54.9
    )
    
    $
    (53.6
    )
 Aircraft fuel reconciliations: Three Months Ended March 31,2005
    
    
    2004(in millions)
    
    
    Cost/Gal
    
    
    (in millions)
    
    
    Cost/GalFuel expense before hedge activities (raw or into-plane fuel cost)
    
    $
    131.0
    
    
    $
    1.56
    
    
    $
    96.7
    
    
    $
    1.17Less: gains on settled hedges included in fuel expense
    
    
    (3.4
    )
    
    
    (0.04
    )
    
    
    (3.1
    )
    
    
    (0.04
    )GAAP fuel expense
    
    $
    127.6
    
    
    $
    1.52
    
    
    $
    93.6
    
    
    $
    1.13Less: gains on settled hedges included in nonoperating
income (expense)
    
    
    (15.7
    )
    
    
    (0.19
    )
    
    
    
    
    
    
    Economic fuel expense
    
    $
    111.9
    
    
    $
    1.33
    
    
    $
    93.6
    
    
    $
    1.13Fuel gallons (000,000)
    
    
    84.2
    
    
    
    
    
    
    
    82.9Mark-to-market gains (losses) included in non-operating income
related to hedges that settle in future periods
    
    $
    77.7
    
    
    
    
    
    
    $
    0.4
 18




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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 condensed 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. Alaskas filings with the Securities and Exchange Commission, including its annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports
are accessible free of charge at www.alaskaair.com. The information contained on our website is
not a part of this quarterly report on Form 10-Q. As used in this Form 10-Q, the terms Alaska,
our, we and the Company refer to Alaska Airlines, Inc. unless the context indicates
otherwise. First Quarter in Review and Current Events In the first quarter of 2005, revenues continued to improve over the first quarter of last year due
to record passenger traffic. Ticket yields, however, continued to decline year over year, although
we began to see some improvement in ticket prices in the latter part of the quarter. Operating
expenses remain an area of focus. Operating expenses per available seat mile increasd 6.1% to
11.06 cents compared to the first quarter of 2004. We continued to show improvement in our unit
costs excluding fuel and restructuring charges during the first quarter of 2005, although the rate
of improvement slowed compared to recent quarters. Our cost per available seat mile excluding fuel
and restructuring charges declined 0.7% to 8.55 cents in the first quarter of 2005. Fuel is a major component of our operating costs and fuel prices reached record highs in the first
quarter. Our operational performance, measured by on-time arrivals and departures, declined from
the first quarter of 2004. In order to improve our operational performance, we have recently
reduced our capacity throughout the remainder of 2005 from our original expectations. Accounting Change Effective January 1, 2005, we changed our method of accounting for major airframe and engine
overhauls from the capitalize and amortizemethod to the direct expensemethod. Accordingly,
effective January 1, 2005, we wrote off the net book value of our previously capitalized airframe
and engine overhauls for all aircraft in a charge totaling $128.2 million pre-tax ($80.1 million
after tax). See Note 2 to our condensed financial statements for further details. Restructuring Charges Asset impairment and rental charges of $8.0 million related to our decision to terminate the lease
at our Oakland heavy maintenance base were recorded in the first quarter of 2005. During the third
quarter of 2004, Alaska announced a management reorganization and the closure of its Oakland heavy
maintenance base, contracting out of related heavy maintenance, contracting out of the Companys
fleet service, ground support equipment and facility maintenance functions, 19




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##### Table of Contents



maintenance shops and other initiatives. In total, we believe these restructuring activities will
result in a reduction of approximately 900 employees when fully implemented through the first half
of 2005. Severance and related costs associated with this restructuring were estimated and
recorded at $53.4 million in 2004. Cash paid during the first quarter of 2005 was $20.3 million
and an adjustment of $0.6 million was recorded to reduce the estimated accrual for related medical
benefits. We expect savings from these job-related initiatives to be approximately $35 million per
year when fully implemented. As part of our ongoing cost saving initiatives, we continue to look at all aspects of our business.
In the remainder of 2005, we may contract out other activities or initiate other restructuring
activities which would result in further restructuring charges. Labor Costs and Negotiations Despite ongoing negotiations in late 2003 and much of 2004, we were unable to reach a new agreement
with the Air Line Pilots Association (ALPA) and, therefore submitted to binding arbitration, the
decision of which became effective on May 1, 2005. The arbitration resulted in an average pilot
wage reduction of approximately 26%, various work rule changes resulting in productivity
improvements, and higher employee health care contributions. No changes were made to the pilots
pension or profit sharing plans. We continue to pursue the restructuring of our other labor agreements so that they are in line with
what we believe to be market. Our objectives as we restructure these agreements are to achieve
market labor costs, productivity and employee benefit costs. For example, we recently presented a
contract offer to the International Association of Machinists (IAM, representing our ramp workers)
and believe that this work group is in the process of voting on our offer. The offer, as presented,
includes a generous voluntary severance package (similar to that used with our mechanics in Oakland
and the voluntary management reductions), wage reductions, and work rule changes. If we are unable
to reach an agreement with the IAM, we may subcontract our Seattle ramp operations to a third party
in the near future. During the first quarter of 2005, we executed an agreement with a third party
that would provide ramp operations in Seattle if we are unable to reach a negotiated agreement. Mark-to-Market Fuel Hedging Gains Beginning in the second quarter of 2004, we lost the ability to defer, as a component of
comprehensive income, recognition of any unrealized gain or loss on our fuel hedge contracts until
the hedged fuel is consumed. We lost this ability because the price correlation between crude oil,
the commodity we use to hedge, and West Coast jet fuel fell below required thresholds. For more
discussion, see Note 5 to our condensed financial statements. The implications of this change are twofold: First, our earnings are more volatile as we mark our
entire hedge portfolio to market each quarter-end and report the gain or loss in other
non-operating income or expense, even though the actual consumption will take place in a future 20




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period. In times of rising fuel prices such as the first quarter of 2005, this will have the
effect of increasing our reported net income or decreasing our reported net loss. Our
mark-to-market gains recorded in the first quarter of 2005 for contracts that settle in future
periods were $77.7 million compared to $0.4 million in the first quarter of 2004. Second, to a
large extent, the impact of our fuel hedge program will not be reflected in fuel expense. In the
first quarter of 2005, we recorded gains from settled fuel hedges totaling $19.1 million, but only
$3.4 million of that gain is reflected as an offset to fuel expense with the balance reported in
other non-operating income. In the first quarter of 2004, gains of $3.1 million on settled hedges
were recorded as an offset to fuel expense and there were no gains recorded in non-operating income
related to settled hedges. We have provided information on mark-to-market gains or losses, as well as calculations of our
economic fuel cost per gallon on page 18. We continue to believe that our fuel hedge program is an important part of our strategy to reduce
our exposure to volatile fuel prices. Outlook For 2005, we expect a capacity increase of slightly under 2% over 2004 capacity. We have recently
reduced our estimated capacity increase because of schedule reductions that are being made to
improve operational reliability. The expected capacity increase is due largely to the
annualization of additional seats added to the B737-400 fleet during the fourth quarter of 2004 and
the addition of three B737-800s, two of which were added in the first quarter of 2005, offset by
the retirement of two B737-200s in 2004. During the first quarter of 2005, we announced service to Dallas/Fort Worth beginning in July 2005. RESULTS OF OPERATIONS Revenues Operating revenues increased $32.0 million, or 6.5%, during the first quarter of 2005 as compared
to the same period in 2004. The increase in revenues resulted from an 8.9% increase in passenger
traffic, offset by a 3.7% decline in ticket yields. For the three months ended March 31, 2005,
capacity increased 3.7% as compared to 2004. The capacity increases are primarily due to the
annualization of additional seats added to the B737-400 fleet during the fourth quarter of 2004 and
the addition of two B737-800s in the first quarter of 2005, partially offset by the retirement of
two B737-200s in 2004. The traffic increase of 8.9% outpaced the capacity increase of 3.7%,
resulting in an increase in load factor from 69.1% to 72.6%. The decline in yield per passenger
mile was a result of continued industry-wide pricing pressure, dropping 3.7% compared to the first
quarter of 2004, although yields improved as the quarter progressed. We expect that load factors
will continue to be strong and that yields and passenger unit revenues will begin to stabilize or
trend slightly higher through the second quarter of 2005. 21




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Freight and mail revenues increased $1.6 million, or 9.0%, because of a new mail contract we have
in the State of Alaska offset by lower freight revenues. Other-net revenues increased $8.4 million, or 34.6%, due largely to an increase in Mileage Plan
revenues, resulting from higher award redemption on our partner airlines and an increase in cash
receipts from miles sold, and, to a lesser extent, higher revenues from our contract flying with
PenAir which started in January 2004. Operating Expenses For the three months ended March 31, 2005, total operating expenses increased $54.6 million, or
10.1%, as compared to the same period in 2004. Operating expenses per ASM increased 6.1% from
10.42 cents in the first quarter of 2004 to 11.06 cents in the first quarter of 2005. The increase
in operating expenses per ASM is due largely to significant increases in fuel costs, contracted
services costs, aircraft maintenance, and landing fees and other rental costs, offset by a decline
in depreciation and amortization, aircraft rent, and other selling expenses and commissions.
Operating expense per ASM excluding fuel and restructuring charges decreased by 0.7% to 8.55 cents
per ASM compared to 8.61 cents per ASM in 2004. Excluding any benefit from labor cost reductions,
our estimates of costs per ASM, excluding fuel and restructuring or impairment charges, for the
second quarter, third quarter, fourth quarter and full year of 2005 are 7.85 cents, 7.20 cents,
7.80 cents and between 7.80 and 7.85 cents, respectively. We are evaluating the impact of the
pilot arbitration results and expect to provide updated cost estimates in May. Explanations of significant period-over-period changes in the components of operating expenses are
as follows:  
    Wages and benefits remained relatively flat, decreasing $1.1 million, or 0.5%, during
the first quarter of 2005. Wages were favorably impacted by the restructuring
initiatives announced in August and September of 2004, largely offset by an increase in
pilot wages, a new performance-based incentive program for all employees, and an increase
in medical and pension benefits. During the first quarter of 2005, there were 9,219
full-time equivalents (FTEs), which is down by 765 FTEs from 2004 on a 3.7% increase in
capacity.
    Contracted services increased $4.7 million, or 20.3%, due largely to the contracting
out of the Companys fleet service and ground service equipment and facility maintenance
and costs associated with the service to Dutch Harbor, Alaska, which was contracted to
PenAir in January 2004 and grew through the first quarter of 2004.
    Aircraft fuel increased $34.0 million, or 36.3%, due to a 34.2% increase in the GAAP
fuel cost per gallon and a 1.6% increase in fuel gallons consumed. The increase in
aircraft fuel expense is inclusive of $3.4 million of gains from settled hedges. During
the first quarter of 2005, Alaska also realized $15.7 million of hedge gains, which are
recorded in other 22




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non-operating income. After including all hedge gains recorded during the quarter, our
economic, or net, fuel expense increased $18.3 million, or 19.6%, over the same period in
2004. Our economic fuel cost per gallon increased 17.7% over the first quarter of 2004 from
$1.13 to $1.33.See page 18 for a table summarizing fuel cost per gallon realized by Alaska (the economic
cost per gallon), the cost per gallon on a GAAP basis (including hedging gains recorded in
aircraft fuel and non-operating income (expense)) and fuel cost per gallon excluding all
hedging activities.
    Aircraft maintenance increased $6.6 million, or 15.2%, due largely to our
power-by-the-hour maintenance agreement, whereby we expense B737-400 engine maintenance
on a block-hour basis, regardless of whether the work was actually performed during the
period. Other factors causing the increase were the contracting out of related heavy
maintenance to third parties, which resulted in a shift of costs from wages and benefits
into aircraft maintenance and the change in our accounting policy regarding engine and
airframe overhauls (see Note 2 to our condensed financial statements). Our current
expectation is that aircraft maintenance costs will be up approximately $3.0 million in
the second quarter, $9.0 million in the third quarter, and $4.0 million in the fourth
quarter compared to the prior year periods.
    Aircraft rent decreased $1.1 million, or 3.7%, due to lower rates on extended leases.
    Other selling expenses and commissions decreased $1.2 million, or 3.5%, due to a
decline in advertising expense, offset by increases in commissions and codeshare fees.
    Depreciation and amortization decreased $2.5 million, or 7.6%. The first quarter of
2004 included accelerated depreciation on the planned retirement of three Boeing
737-200Cs. In the second quarter of 2004, we recorded an impairment charge of $36.8
million to reduce the carrying value of the Boeing 737-200C fleet, which results in lower
depreciation expense in future periods.
    Landing fees and other rentals increased $7.4 million, or 22.3%. The higher rates
primarily reflect higher joint-use fees in Los Angeles and exclusive rental fees at
Seattle and Anchorage (including a $1.3 million adjustment in 2005 from the Port of
Seattle related to 2004), combined with modest volume growth. We expect landing fees and
other rentals to continue to increase as a result of airport facility expansions and
increased costs for security due to unfunded government mandates.
    Other expense increased $1.5 million, or 4.1%, primarily reflecting increases in
professional services costs, personnel and crew costs, passenger remuneration costs, and
supplies costs. 23




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Nonoperating Income (Expense) Net nonoperating income was $86.0 million in the first quarter of 2005 compared to net expense of
$5.2 million during the same period of 2004. Interest income increased $1.0 million due to a
larger average marketable securities portfolio in the first quarter of 2005. Fuel hedging gains include $15.7 million in gains from fuel hedging contracts settled in the first
quarter in 2005 compared to none in 2004. In addition, fuel hedging gains include net
mark-to-market gains on unsettled hedge contracts of $77.7 million in 2005 and $0.4 million in
2004. Income Tax Expense (Benefit) We file a consolidated tax return with Air Group and other Air Group subsidiaries. Each member of
the consolidated group calculations its tax provision and tax liability, if applicable, on a
separate-entity basis. Accounting standards require us to provide for income taxes each quarter
based on either our estimate of the effective tax rate for the full year or the actual year-to-date
effective tax rate if it is our best estimate of our annual expectation. The volatility of
airfares 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, relative to pretax profit or loss. Our effective income
tax rate on pre-tax income before the accounting change for the first quarter of 2005 is 39.6%. We
applied our estimated 2005 year-to-date composite rate of 37.5% for the cumulative effect of the
accounting change. In arriving at these rates, we considered a variety of factors, including
year-to-date pretax results, the U.S. federal rate of 35%, estimated year-to-date nondeductible
expenses and estimated state income taxes. We evaluate our tax rate each quarter and make
adjustments when necessary. Change in Accounting Policy Effective January 1, 2005, the Company changed its method of accounting for major airframe and
engine overhauls from the capitalize and amortizemethod to the direct expensemethod. Under the
capitalize and amortize method, these costs were capitalized and amortized to maintenance expense
over the shorter of the life of the overhaul or the remaining lease term. Under the direct expense
method, overhaul costs are expensed as incurred. The Company believes that the direct expense
method is preferable because it eliminates the judgment and estimation needed to determine overhaul
versus repair allocations in maintenance activities. Additionally, the Companys approved
maintenance program for the majority of its airframes now focuses more on shorter, but more
frequent, maintenance visits that result in a higher portion of the work being repair activity.
Management also believes that the direct expense method is the predominant method used in the
airline industry. Accordingly, effective January 1, 2005, the Company wrote off the net book value
of its previously capitalized airframe and engine overhauls for all aircraft in a charge totaling
$128.2 million pre-tax ($80.1 million after tax). The
Company does not believe disclosing the effect of adopting the direct
expense method on net income for the period ended March 31, 2005
provides meaningful information because of changes in the
Companys maintenance program, including the execution of a
Power by the hour maintenance agreement with a third
party in late 2004. 24




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##### Table of Contents



Critical Accounting Estimates For information on our other critical accounting policies, see Item 7 of our Annual Report on Form
10-K for the year ended December 31, 2004. Liquidity and Capital Resources The table below presents the major indicators of financial condition and liquidity. March 31, 2005
    
    
    December 31, 2004
    
    
    Change(In millions, except per share and debt-to-capital amounts)Cash and marketable securities
    
    $
    763.3
    
    
    $
    873.7
    
    
    $
    (110.4
    )Working capital
    
    
    233.7
    
    
    
    299.2
    
    
    
    (65.5
    )Long-term debt and
capital lease obligations
    
    
    789.0
    
    
    
    798.2
    
    
    
    (9.2
    )Shareholders equity
    
    
    605.3
    
    
    
    676.6
    
    
    
    (71.3
    )Long-term debt-to-capital
    
    
    57%:43
    %
    
    
    54%:46
    %
    
    NALong-term debt-to-capital assuming
aircraft operating leases are capitalized
at seven times annualized rent
    
    
    72%:28
    %
    
    
    70%:30
    %
    
    NA
 During the three months ended March 31, 2005, our cash and marketable securities decreased
$110.4 million to $763.3 million. This decrease reflects cash used for property and equipment
additions, net of proceeds from asset dispositions, of $82.8 million, cash used in financing
activities of $8.6 million, and cash used in operating activities of $20.1 million. Cash Provided by (Used in) Operating Activities During the first quarter of 2005, cash used in operating activities was $20.1 million, compared to
cash provided by operating activities of $26.1 million during the same period of 2004. The decline
was driven by sharp increases in fuel costs, partially offset by higher revenues. Cash Provided by (Used in) Investing Activities Cash provided by investing activities was $246.9 million during the first quarter of 2005, compared
to cash used in investing activities of $101.7 million during the same period of 2004. We had net
sales of marketable securities of $330.4 million and $82.8 million for property and equipment
additions, net of proceeds from asset dispositions. During the three months ended March 31, 2005,
our aircraft related capital expenditures, net of proceeds from asset dispositions, increased $29.9
million as compared to the same period of 2004, primarily as a result of one new aircraft purchase
in 2005. As of January 1, 2005, we no longer have capital expenditures related to overhauls as
those maintenance activities are expensed as incurred under our maintenance accounting policy
adopted on that date. 25




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##### Table of Contents



Cash Provided by (Used in) Financing Activities Net cash used in financing activities was $8.6 million during the first quarter of 2005 compared to
net cash provided by financing activities of $47.8 million during the same period of 2004. There
were no new debt issuances in the first quarter of 2005. There were normal long-term debt payments
of $8.6 million during 2005. We plan to meet our capital and operating commitments through cash flow from operations and from
cash and marketable securities on hand at March 31, 2005 of $763.3 million. Bank Line of Credit Facility During 2004, Alaska repaid its $150 million credit facility and, on December 23, 2004, that
facility expired. On March 25, 2005, Alaska Airlines, Inc. finalized a $160 million variable rate
credit facility with a syndicate of financial institutions that will expire in March 2008. Any
borrowings will be secured by either aircraft or cash collateral. The
interest rate on credit facility varies
depending on certain financial ratios specified in the agreement with a minimum interest rate of
LIBOR plus 200 basis points. This credit facility contains contractual restrictions and requires maintenance of specific levels
of net worth, maintenance of certain debt and leases to net worth, leverage and fixed charge
coverage ratios, and limits on liens, asset dispositions, dividends, and certain other
expenditures. Such provisions restrict us from distributing any funds to Air Group in the form of
dividends and limit the amount of funds we can loan to Air Group. As of March 31, 2005, $300.0
million was available to loan to Air Group without violating the covenants in the credit facility.
As of March 31, 2005, there are no outstanding borrowings on this credit facility and the Company
has no immediate plans to borrow using this credit facility. Contractual Obligations, Commitments and Off-Balance Sheet Arrangements Aircraft Purchase Commitments At March 31, 2005, Alaska had firm orders for 4 aircraft requiring aggregate payments of
approximately $110.4 million, as set forth below. In addition, Alaska had options to acquire 23
additional B737s. Alaska expects to finance the firm orders and, to the extent exercised, the
option aircraft with leases, long-term debt or internally generated cash. We expect to purchase
the B737-800 to be delivered in July with cash on hand. The following table summarizes aircraft purchase commitments and payments by year: Delivery Period - Firm OrdersApril 1  December 31,
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    BeyondAircraft
    
    2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2009
    
    
    TotalBoeing 737-800
    
    
    1
    
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4Payments (Millions)
    
    $
    46.6
    
    
    $
    63.8
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    110.4
 26




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##### Table of Contents



Contractual Obligations The following table provides a summary of our principal payments under current and long-term debt
obligations, operating lease commitments, aircraft purchase commitments and other obligations as of
March 31, 2005. This table excludes contributions to our various pension plans, which we expect to
be approximately $55 million to $65 million per year through 2008. April 1  December 31,
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Beyond(in millions)
    
    2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2009
    
    
    TotalCurrent and long-term debt
and capital lease obligations
    
    $
    42.5
    
    
    $
    54.6
    
    
    $
    57.6
    
    
    $
    60.7
    
    
    $
    64.4
    
    
    $
    560.9
    
    
    $
    840.7Operating lease commitments
    
    
    140.3
    
    
    
    201.0
    
    
    
    118.1
    
    
    
    114.1
    
    
    
    103.9
    
    
    
    496.8
    
    
    $
    1,174.2Aircraft purchase commitments
    
    
    46.6
    
    
    
    63.8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    110.4Interest obligations (1)
    
    
    36.3
    
    
    
    42.9
    
    
    
    39.9
    
    
    
    38.1
    
    
    
    33.1
    
    
    
    99.6
    
    
    $
    289.9Other purchase obligations (2)
    
    
    21.1
    
    
    
    29.1
    
    
    
    29.4
    
    
    
    29.7
    
    
    
    30.0
    
    
    
    154.5
    
    
    $
    293.8Total
    
    $
    286.8
    
    
    $
    391.4
    
    
    $
    245.0
    
    
    $
    242.6
    
    
    $
    231.4
    
    
    $
    1,311.8
    
    
    $
    2,709.0
   (1)
    
    For variable rate debt, future obligations are shown above using interest rates in effect as of
March 31, 2005.(2)
    
    Includes obligations under our long-term power-by-the-hour maintenance agreement. New Accounting Standards During the fourth quarter of 2004, the Financial Accounting Standards Board (FASB) issued SFAS
123R, Share Based Payment: An Amendment of SFAS Nos. 123 and 95. The new standard requires
companies to recognize as expense the fair value of stock options and other equity based
compensation issued to employees as of the grant date. This new standard will apply to both stock
options that we grant to employees and our Employee Stock Purchase Plan, which features a look-back
provision and allows employees to purchase stock at a 15% discount. Our options are typically
granted with graded vesting provisions, and we intend to amortize compensation cost over the
service period using the straight line method. Due to a recent decision by the Securities and
Exchange Commission, implementation of SFAS 123R will be effective January 1, 2006. We intend to
use the modified prospective method upon adoption whereby previously awarded but unvested equity
awards are accounted for in accordance with SFAS 123R and prospective amounts are recognized in the
income statement instead of simply being disclosed. Once adopted, we expect our stock based
compensation expense, as measured under SFAS 123R, will be approximately $6 to $10 million per
year on a pre-tax basis. In March 2005, the FASB issued Interpretation No. 47 (FIN 47), Accounting for Conditional Asset 27




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##### Table of Contents



Retirement Obligations  an interpretation of FASB Statement No. 143. FIN 47 clarifies that an
entity is required to recognize a liability for the fair value of a conditional asset retirement
obligation when incurred if the liabilitys fair value can be reasonably estimated. The FIN also
clarifies when an entity would have sufficient information to reasonably estimate the fair value of
an asset retirement obligation. FIN 47 is effective no later than the end of our fiscal year
ending December 31, 2005. FIN 47 is not expected to have a significant impact on our financial
position, results of operations or cash flows. Effect of Inflation- Inflation and price changes other than for aircraft fuel do not have a
significant effect on our operating revenues, operating expenses and operating income. 
 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk There have been no material changes in market risk from the information provided in Item 7A
Quantitative and Qualitative Disclosure About Market Risk in our 2004 10-K except as follows: Fuel Hedging We purchase jet fuel at prevailing market prices, and seek to manage the risk of price fluctuations
through execution of a documented hedging strategy. We utilize derivative financial instruments as
hedges to decrease our exposure to the volatility of jet fuel prices. We believe there is risk in
not hedging against the possibility of fuel price increases. At March 31, 2005, we had fuel hedge
contracts in place to hedge 137.5 million gallons of our expected jet fuel usage during the
remainder of 2005, 157.7 million gallons in 2006, 57.3 million gallons in 2007, and 4.7 million
gallons in 2008. This represents 50%, 42%, 15%, and 1% of our anticipated fuel consumption in
2005, 2006, 2007, and 2008, respectively. Prices of these agreements range from $28.81 to $51.56
per crude oil barrel. We estimate that a 10% increase or decrease in crude oil prices as of March
31, 2005 would impact the fair value of our hedge portfolio by approximately $47.1 million and
$44.6 million, respectively. As of March 31, 2005 and December 31, 2004, the fair values of our fuel hedge positions were $164.8
million and $84.5 million, respectively. Of these amounts, $108.2 million of the 2005 fair value
amounts and $57.9 million of the 2004 fair value amounts were included in current assets in the
balance sheet based on settlement dates for the underlying contracts. The remaining $56.7 million
2005 fair value and $26.6 million 2004 fair value is reflected as a non-current asset in the
balance sheet. 
 ITEM 4. Controls and Procedures As of March 31, 2005, an evaluation was performed under the supervision and with the participation
of our management, including our chief executive officer and chief financial officer (collectively,
our 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 28




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##### Table of Contents



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. Our certifying officers concluded, based on their evaluation, that disclosure controls and
procedures were effective. We made no changes in our internal controls over financial reporting during the fiscal quarter
ended March 31, 2005, that our certifying officers concluded materially affected, or are reasonably
likely to materially effect, our internal control over financial reporting. We intend to regularly review and evaluate the design and effectiveness of our disclosure controls
and procedures and internal controls over financial reporting on an
ongoing basis and to improve
these controls and procedures over time and to correct any deficiencies that we may discover in the
future. While we believe the present design of our disclosure controls and procedures and internal
controls over financial reporting are effective, future events affecting our business may cause us
to modify our controls and procedures in the future. 
 PART II OTHER INFORMATION 
 ITEM 1. Legal Proceedings Our former pilot contract provided that, if a negotiated agreement on the entire contract could not
be reached by December 15, 2004, ten contract issues plus wage rates would be submitted to an
interest arbitrator. Issues submitted generally related to pension plans, medical insurance, profit
sharing, code sharing and work rules. The parties did not reach an agreement, and the issues were
submitted to binding arbitration, resulting in a decision that became effective on May 1, 2005. The
arbitration resulted in an average pilot wage decrease of approximately 26%, various work rule
changes resulting in productivity improvements and higher employee health care contributions. No
changes were made to the pilots pension or profit sharing plans. We are a party to routine litigation incidental to our business and with respect to which no
material liability is expected. Management believes the ultimate disposition of these 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. 
 ITEM 6. Exhibits See Exhibit Index on page 31. 29




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##### Table of Contents



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 AIR GROUP, INC.RegistrantDate: May 6, 2005By:
    
    /s/ Brandon S. PedersenBrandon S. PedersenStaff Vice President/Finance and ControllerBy:
    
    /s/ Bradley D. TildenBradley D. TildenExecutive Vice President/Finance and Chief Financial Officer
 30




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##### Table of Contents



EXHIBIT INDEX Pursuant to Item 601(a)(2) of Regulation S-K, this Exhibit Index immediately precedes the exhibits. The following exhibits are numbered in accordance with Item 601 of Regulation S-K. Exhibit No.
    
    Description10.1(1)
    
    Credit Agreement dated as of March 25, 2005 among Alaska Airlines, Inc., as borrower, Bank of America,
N.A. as administrative agent, Citicorp USA, Inc. as syndication agent, U.S. Bank National Association as
documentation agent, and other lenders.18.1(1)
    
    Letter from KPMG LLP regarding change in accounting principle31.1(1)
    
    Section 302 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 135031.2(1)
    
    Section 302 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 135032.1(1)
    
    Section 906 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 135031.2(1)
    
    Section 302 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
   (1)
    
    Filed herewith. 31