##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION  FORM 10-K/A
 (Amendment No. 1)
 (Mark One)[X]
    
    ANNUAL REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 [NO FEE REQUIRED]
   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
  Commission File Number 0-19978 ALASKA AIRLINES, INC.  Alaska
    
    92-0009235(State or other jurisdiction of incorporation or organization)
    
    (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 Securities registered pursuant to Section 12(g) of the Act: Title of Class 
  As of December 31, 2003, common shares outstanding totaled 500. Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [   ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2)
Yes [X] No [   ] The registrant meets the
conditions set forth in General Instructions I of Form 10-K and
is therefore filing this Form 10-K/A with the reduced disclosure format.
Items 4, 6, 10, 11, 12 and 13 have been omitted in accordance with such
Instruction I. The registrants parent, Alaska Air Group, Inc. (File No. 1-8957), files
reports with the Commission pursuant to the Securities Exchange Act of 1934, as
amended.




---



##### Table of Contents



Revision to Previously Filed Financial Statements and SEC Filings We previously recorded unrealized gains and losses related to the ineffective
portion of changes in fair value of our fuel hedge positions as nonoperating
income (expense) and then reclassified those gains and losses to fuel expense
as those hedges were settled. This practice was not consistent with our stated
policy, which was to record the ineffective portion in nonoperating income
(expense). This Amendment No. 1 on Form 10-K/A corrects and amends our
financial statements previously filed with the Securities and Exchange
Commission in our Form 10-K for the year ended December 31, 2003 in order to
adjust our historical presentation of such items. Such revisions have resulted
in reclassification between operating income (loss) and nonoperating income
(expense) in the statements of operations. The revisions have no impact on
previously reported pretax income (loss), net income (loss), the balance
sheets, the statement of shareholders equity or the statements of cash flows
for any prior periods. They also have no impact on operating cost per
Available Seat Mile excluding fuel, a non-GAAP measure we believe is important
to some users of our financial statements. See Managements Discussion and
Analysis of Financial Condition and Results of Operations, and the Financial
Statements including the Notes to Financial Statements, for the impact of the
reclassifications. This amendment to the Companys Annual Report on Form 10-K
for the fiscal year ended December 31, 2003 amends and reclassifies those items
of the previously filed Form 10-K which have been affected by the
revisions. For additional information regarding the revisions,
see Note 13 to Financial Statements included in Part II, Item 14. In addition, on March 11, 2004, Alaska Air Group, Inc. filed Post-Effective
Amendment No. 1 to Form S-1 Registration Statement on Form S-3 with the
Securities and Exchange Commission (SEC file No. 333-107117). In connection
with the review of that filing, the Securities and Exchange Commission also
reviewed the Companys Annual Report on Form 10-K for the year ended December
31, 2003. In response to certain suggestions put forth by the Securities and
Exchange Commission that would not otherwise require the filing of this 10-K/A,
the Company has elected to amend certain of its disclosures based on the
suggestions of the Securities and Exchange Commission to enhance the Companys
overall disclosure. While the content of these disclosures remains essentially
unchanged, these modifications serve to provide additional detail and
clarification. In order to preserve the nature and character of the
disclosures set forth in such items as originally filed, other than as
indicated above and except as required to reflect the effects of the
revisions, no attempt has been made to modify or update such
disclosures. 1




---



ALASKA AIRLINES, INC.
Annual Report on Form 10-K/A for the year ended December 31, 2003 TABLE OF CONTENTS PART I
    
    
    
    

    
    3ITEM 1.
    
    BUSINESS
    
    

    3ITEM 2.
    
    PROPERTIES
    
    
    22ITEM 3.
    
    LEGAL PROCEEDINGS
    
    
    23PART II.
    
    
    
    

    
    23ITEM 5.
    
    MARKET PRICE FOR
THE REGISTRANTS COMMON STOCK AND RELATED STOCKHOLDER MATTERS
    
    
    23ITEM 7.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
    
    
    26ITEM 7A.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
    
    
    40ITEM 8.
    
    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
    
    
    42ITEM 9.
    
    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
    
    
    43ITEM 9A.
    
    CONTROLS AND PROCEDURES
    
    
    43PART IV
    
    
    
    

    
    44ITEM 15.
    
    EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
    
    
    44SIGNATURES
    
    

    
    
    45EXHIBIT 12.1EXHIBIT 23EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  Cautionary Note regarding Forward-Looking Statements In addition to historical information, this Amendment No. 1 on Form 10-K/A
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. 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
differences might be significant and materially adverse to our stockholders.
Many important factors that could cause such a difference are described in this
Annual Report under the caption Business  Business Risks, which you should
review carefully. Please consider our forward-looking statements in light of
those risks as you read this report. 2




---



##### Table of Contents



PART I 
 ITEM 1.BUSINESS GENERAL INFORMATION Alaska Airlines, Inc. (Alaska or the Company), an Alaska corporation, is a
wholly owned subsidiary of Alaska Air Group, Inc. (Air Group), a Delaware
corporation. Air Group is also the parent company of Alaska Air Group Leasing
(AAGL) and Horizon Air Industries, Inc. (Horizon). Alaska is a major airline
that was organized in 1932 and incorporated in the state of Alaska in 1937.
Alaska became a wholly owned subsidiary of Air Group in 1985 pursuant to a
reorganization of Alaska into a holding company structure. Air Group is a
registrant pursuant to Section 12(b) of the Securities and Exchange Act of 1934
(Commission File No. 1-8957). Air Groups filings with the Securities and
Exchange Commission, including its annual report on Form 10-K/A, 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. Alaskas executive
offices are located at 19300 Pacific Highway South, Seattle, Washington 98188.
In 2003, Alaska accounted for 83% of Air Groups total operating revenues. As used in this Form 10-K/A, the terms our and we refer to Alaska, unless
the content indicates otherwise. Operations Alaska is a major airline, operates an all-jet fleet, and its average passenger
trip length is 967 miles. Alaska principally serves 39 cities in six western
states (Alaska, Washington, Oregon, California, Nevada, and Arizona) and Canada
and 7 cities in Mexico. Alaska also provides non-stop service between Seattle
and five eastern cities (Washington, D.C., Boston, Miami, Orlando, and
Newark), between Seattle and Denver, and between Anchorage and Chicago. In
each year since 1973, Alaska has carried more passengers between Alaska and the
U.S. mainland than any other airline. In 2003, Alaska carried 15.0 million
revenue passengers. Passenger traffic within Alaska and between Alaska and the
U.S. mainland accounted for 21% of Alaskas 2003 revenue passenger miles, West
Coast traffic (including Canada) accounted for 57%, the Mexico markets
accounted for 10% and other markets accounted for 12%. Based on passenger
enplanements, Alaskas leading airports are Seattle, Portland, Los Angeles, and
Anchorage. Based on 2003 revenues, its leading nonstop routes are
Seattle-Anchorage, Seattle-Los Angeles, and Seattle-San Diego. At December 31,
2003, Alaskas operating fleet consisted of 109 jet aircraft. We believe we distinguish ourselves from competitors by providing a higher
level of customer service in the form of attention to customer needs, advance
seat assignments, expedited check-in, well-maintained aircraft, a first-class
section aboard our aircraft, and other amenities. 3




---



##### Table of Contents



Industry Conditions The airline industry is both seasonal and cyclical. Our operating income is
generally lowest during the first and fourth quarters, gradually increases in
the second quarter and reaches its highest level during the third quarter. Our
industry has been negatively impacted by weak economic conditions in 2001
through the first half of 2003, the September 11, 2001 terrorist attacks and
continued hostilities in the Middle East. Economic conditions in the second
half of 2003 improved slightly, resulting in strong summer demand and higher
than expected fourth quarter traffic. However, industry demand levels, as
measured by passenger traffic, have not returned to pre- 2001 levels. Due to the industrys high fixed costs in relation to revenue, a small change
in load factors or fare levels has a large impact on profits. For most
airlines, including Alaska, labor and fuel account for almost half of operating
expenses. Our wage and benefit costs increased 11% in 2001, 10% in 2002 and
11% in 2003. Fuel prices have been volatile in the last three years. Our fuel
cost per gallon decreased 15% and 9% in 2001 and 2002, respectively, and increased 15% in 2003. As discussed in Note 10, in April 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 were not imposed by the TSA and
carrier fees were not paid during the period June 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. On September 11, 2001, the United States was attacked by terrorists using
hijacked jets of two U.S. airlines. The FAA shut down all commercial airline
flight operations for September 11 and 12. Airlines resumed flight operations
at reduced levels on September 13. Throughout the industry, airlines have
recently instituted a variety of cost-saving measures including renegotiation
of collective bargaining agreements, scaling back the receipt of planned
airplane deliveries and renegotiation of vendor agreements. At several
airlines and related entities, credit rating agencies have downgraded long-term
credit ratings, including that of our parent, Alaska Air Group, Inc. MARKETING AND COMPETITION Alliances with Other Airlines Alaska has marketing alliances with other airlines that provide reciprocal
frequent flyer mileage accrual and redemption privileges and code sharing on
certain flights as set forth below. Alliances enhance Alaskas revenues by
offering our customers more travel destinations and better mileage
accrual/redemption opportunities, gaining us access to more connecting traffic
from other airlines, and providing members of our alliance partners frequent
flyer programs an opportunity to travel on Alaska while earning mileage credit
in our partners programs. Alaskas marketing agreements have various
termination dates and at any time, one or more may be in the process of
renegotiation. If a significant agreement were terminated, it could adversely
impact revenues and increase the costs of our other marketing agreements. Most
of our code share relationships are free-sell code shares, where the marketing
carrier sells seats on the operating carriers flights from the operating 4




---



##### Table of Contents



carriers inventory, but takes no inventory risk. The table below identifies
our marketing alliances with other airlines as of December 31, 2003. Codesharing 
    
    Codesharing Frequent
    
    Alaska Flight #
    
    Other Airline Flight #Flyer
    
    on Flights Operated
    
    On Flights OperatedAgreement
    
    by Other Airline
    
    by Alaska/HorizonMajor U.S. orInternational AirlinesAmerican Airlines/American Eagle
    
    Yes
    
    Yes
    
    NoBritish Airways
    
    Yes
    
    No
    
    NoCathay Pacific Airways
    
    Yes
    
    No
    
    NoContinental Airlines
    
    Yes
    
    Yes
    
    YesFrontier Airlines
    
    No
    
    No
    
    YesHawaiian Airlines
    
    Yes
    
    Yes
    
    YesKLM
    
    Yes
    
    No
    
    YesLan Chile
    
    Yes
    
    No
    
    YesNorthwest Airlines
    
    Yes
    
    Yes
    
    YesQantas
    
    Yes
    
    No
    
    YesCommuter AirlinesEra Aviation
    
    Yes*
    
    Yes
    
    NoPenAir
    
    Yes*
    
    Yes
    
    NoBig Sky Airlines
    
    Yes*
    
    Yes
    
    NoHelijet International
    
    Yes*
    
    Yes
    
    No
 * This airline does not have its own frequent flyer program. However, Alaskas
Mileage Plan members can accrue and redeem miles on this airlines route
system. Competition Competition in the airline industry is intense. We believe the principal
competitive factors in the industry that are important to customers are:  
    
    safety record and reputation;
    
    fares;
    
    customer service;
    
    routes served;
    
    flight schedules;
    
    frequent flyer programs;
    
    on time arrivals;
    
    on-board amenities;
    
    type of aircraft;
    
    code-sharing relationships; Any domestic air carrier issued a certificate of public convenience and
necessity by the Department of Transportation is allowed to operate scheduled
passenger service in the United States. Alaska carries approximately 2.7% of
all U.S. domestic passenger traffic. Alaska competes with one or more domestic
or foreign airlines on most of their routes, including Southwest Airlines,
United Airlines, Northwest Airlines, Continental Airlines, American Airlines
and Delta Airlines. Some of these competitors are substantially larger than
Alaska, have greater financial resources, and have more extensive route
systems. In addition, continuing growth of low-cost 5




---



##### Table of Contents



carriers, including
Southwest Airlines, AirTran Airways, American Trans Air, Frontier Airlines and
JetBlue Airways in the United States places significant competitive pressures
on us and other network carriers since they have the ability to charge a lower fare for travel
between similar cities and thus exert downward pressure on yields. We also compete with other airlines for skilled employees such as pilots and
airplane mechanics. Most major U.S. carriers have developed, independently or in partnership with
others, large global distribution systems. Airlines, including Alaska, are
charged fees to have their flight schedules included in the various computer
reservation systems used by travel agencies and airlines. These systems have
historically been the predominant means of distributing airline tickets and
have been subject to regulation by the Department of Transportation. Air
carriers are increasingly distributing their services on the Internet through
various airline joint venture or independent websites. We currently
participate in a number of these distribution channels, but we cannot predict
the terms on which we may be able to continue to participate in these or other
sites, or their effect on our ability to compete with other airlines. REGULATION General The Airline Deregulation Act of 1978, as amended, eliminated most domestic
economic regulation of passenger and freight transportation. However, the
Department of Transportation and the Federal Avaition Administration (FAA)
still exercise regulatory authority over air carriers. In order to provide
passenger and cargo air transportation in the U.S., a domestic airline is
required to hold a certificate of public convenience and necessity issued by
the Department of Transportation. Subject to certain individual airport
capacity, noise and other restrictions, this certificate permits an air carrier
to operate between any two points in the U.S. A certificate is of unlimited
duration, but may be revoked for failure to comply with federal aviation
statutes, regulations, orders or the terms of the certificate itself. In
addition, the Department of Transportation maintains jurisdiction over the
approval of international code share agreements, alliance agreements between
domestic major airlines, international route authorities and certain consumer
protection matters, such as advertising, denied boarding compensation and
baggage liability. The FAA regulates aircraft operations generally, including establishing
personnel, maintenance and flight operation standards. Domestic airlines are
required to hold a valid air carrier operating certificate issued by the FAA.
Pursuant to these regulations, we have established, and the FAA has approved, a
maintenance program for each type of aircraft we operate that provides for the
ongoing maintenance of such aircraft, ranging from frequent routine inspections
to major overhauls. In addition, the FAA has issued a number of directives
that we are incorporating into our aircraft. These relate to, among other
things, enhanced ground proximity warning systems, cockpit door security
enhancements, McDonnell Douglas MD-80 insulation blanket replacement, MD-80
main landing gear piston improvements and Boeing 737 rudder and elevator
improvements. Based on our current implementation schedule, we are or expect to
be in compliance with the applicable requirements within the required time
periods. The Department of Justice has jurisdiction over airline antitrust matters. The
U.S. Postal Service 6




---



##### Table of Contents



has jurisdiction over certain aspects of the transportation of mail and related services. Labor relations in the air transportation
industry are regulated under the Railway Labor Act, which vests in the National
Mediation Board (NMB) certain functions with respect to disputes between
airlines and labor unions relating to union representation and collective
bargaining agreements. To the extent we continue to pursue alliances with
international carriers, we may be subject to certain regulations of foreign
agencies. In November 2001, the Aviation and Transportation Security Act (the Security
Act) was enacted. The Security Act created a new government agency, the
Transportation Security Administration (TSA), which is now part of the
Department of Homeland Security and is responsible for aviation security. The
Security Act mandates that the TSA shall provide for the screening of all
passengers and property, including U.S. mail, cargo, carry-on and checked
baggage, and other articles that will be carried aboard a passenger aircraft.
The TSA performs these functions with its own federal employees. On December
31, 2002, the TSA began explosive detection screening of all checked baggage.
The TSA also provides for increased security on flight decks of aircraft and
requires federal air marshals to be present on certain flights. Effective February 1, 2002, the Security Act imposed a $2.50 per enplanement
security service fee (maximum $5.00 one-way fee) which is collected by the air
carriers and submitted to the government to pay for these enhanced security
measures. Additionally, to the extent the TSA determines that such fee is
insufficient to pay for the cost of providing the security measures as
mentioned in the previous paragraph, in each of the years 2002, 2003 and 2004,
air carriers may be required to submit to the government an amount equal to the
amount the air carriers paid for screening passengers and property in 2000.
After that, this fee may be assessed based on the air carriers market share.
In 2002, the TSA began assessing payments under this feature of the Security
Act. We paid $7.1 million and $8.4 million to the TSA for this security
charge in 2002 and 2003, respectively. Effective June 1, 2003, Congress
suspended the security fee until September 30, 2003, and authorized a partial
refund of security fees that the airlines paid before that time. In addition, the Security Act requires air carriers to honor tickets, on a
standby basis, from other air carriers that are insolvent or bankrupt and
suspend service within 18 months of the passage of the Security Act. This
deadline was extended to April 30, 2002. To be eligible, a passenger must make
arrangements with the air carrier within 60 days after the date on which the
passengers air transportation was suspended. To date, this provision has not
had a substantial impact on our airlines. If a major U.S. air carrier were to
declare bankruptcy and cease or suspend operations, this feature of the
Aviation and Transportation Security Act could have an impact on our airlines.
To the extent we are not fully reimbursed for the costs of honoring such
tickets, the impact could be materially adverse. The Department of Transportation, under its authority to prevent unfair
competitive practices in the industry, has considered the issuance of pricing
and capacity rules that would limit major air carriers competitive response to
new entrant carriers. Although the Department of Transportation as recently as
2001 declined to issue specific competitive guidelines, it reiterated its
intent to prevent what it considers to be unfair competitive practices in the
industry, and to pursue enforcement actions on a case-by-case basis. To the
extent that future Department of 7




---



##### Table of Contents



Transportation enforcement actions either directly or indirectly impose restrictions upon our ability to respond to
competitors, our business may be adversely impacted. Conversely, a relaxation
in either unfair competition enforcement or restrictions could limit our
ability to enter new markets or harm our operating results for markets that we
have recently entered. Airline Fares Airlines are permitted to establish their own domestic fares without
governmental regulation, and the industry is characterized by vigorous price
competition. The Department of Transportation maintains authority over
international (generally outside of North America) fares, rates and charges.
International fares and rates are also subject to the jurisdiction of the
governments of the foreign countries we serve. While air carriers are required
to file and adhere to international fare and rate tariffs, substantial
commissions, overrides and discounts to travel agents, brokers and wholesalers
characterize many international markets. Legislation, sometimes referred to as the Passengers Bill of Rights, has
been discussed in Congress and state legislatures. This legislation could, if
enacted, place various limitations on airline fares and/or affect operating
practices such as baggage handling and overbooking. Effective December 15,
1999, we, as well as other domestic airlines, implemented a Customer Service
Plan to address a number of service goals, including, but not limited to goals
relating to:  1)
    
    lowest fare availability;2)
    
    delays, cancellations and diversions;3)
    
    baggage delivery and liability;4)
    
    guaranteed fares;5)
    
    ticket refunds;6)
    
    accommodation of customers with special needs;7)
    
    essential customer needs during extraordinary delays;8)
    
    flight oversales;9)
    
    frequent flyer program;10)
    
    other travel policies;11)
    
    service with domestic code share partners; and12)
    
    handling of customer issues. In February 2001, the Department of Transportation Inspector General issued a
report on the various air carriers performance of their Customer Service
Plans. The report included a number of recommendations which could limit our
flexibility with respect to various operational practices. In February 2001, a
bill proposing an Airline Customer Service Improvement Act was introduced in
the U.S. Senate. In addition, other items of legislation have been introduced
that would limit hub concentration, reallocate slots at certain airports and
impose higher landing fees at certain hours. To the extent legislation is
enacted that would inhibit our flexibility with respect to fares, our revenue
management system, our operations or other aspects of our customer service
operations, our financial results could be adversely affected. Fare discounting by competitors has historically had a negative effect on our
financial results because we are generally required to match competitors fares
to maintain passenger traffic. During recent years, a number of new low-cost
airlines have entered the domestic market and 8




---



##### Table of Contents



several major airlines, including Alaska and Horizon, implemented efforts to lower their cost structures. Further
fare reductions, domestic and international, may occur in the future. If fare
reductions are not offset by increases in passenger traffic, cost reductions or
changes in the mix of traffic that improves yields, our operating results will
be negatively impacted. In February 2004, Alaska initiated a fare rationalization plan whereby a number
of restrictions were eliminated and the gap between the highest and lowest
fares was reduced. The goal of this initiative is to increase customer value
and simplify the customers purchase decision. Airport Access Heavily used airports may have restrictions with respect to the number of
permitted take-offs and landings, the total permitted annual seat capacity to
be operated at an airport, the use or allocation of airport slots, or other
restrictions. We currently have sufficient authorizations to operate our
existing flights and have generally been able to obtain gates to expand our
operations and change our schedules. However, we cannot assure you that we
will be able to obtain authorizations for these purposes in the future, or be
able to do so on economical terms. Environmental Matters We are subject to various laws and government regulations concerning
environmental matters and employee safety and health in the U.S. and other
countries. U.S. federal laws that have a particular impact on us include the
Airport Noise and Capacity Act of 1990, the Clean Air Act, the Resource
Conservation and Recovery Act, the Clean Water Act, the Safe Drinking Water
Act, and the Comprehensive Environmental Response, Compensation and Liability
Act, or Superfund Act. We are also subject to the oversight of the Occupational
Safety and Health Administration, known as OSHA, concerning employee safety and
health matters. The U.S. Environmental Protection Agency, or EPA, OSHA, and
other federal agencies have been authorized to promulgate regulations that have
an impact on our operations. In addition to these federal activities, various
states have been delegated certain authorities under the aforementioned federal
statutes. Many state and local governments have adopted environmental and
employee safety and health laws and regulations, some of which are similar to
federal requirements. We maintain our own continuing safety, health and
environmental programs in order to meet or exceed these requirements. The Air Noise and Capacity Act recognizes the rights of airport operators with
noise problems to implement local noise abatement programs so long as they do
not interfere unreasonably with interstate or foreign commerce or the national
air transportation system. Authorities in several cities have promulgated
aircraft noise reduction programs, including the imposition of nighttime
curfews. The Air Noise and Capacity Act generally requires FAA approval of
local noise restrictions on aircraft. While we have had sufficient scheduling
flexibility to accommodate local noise restrictions imposed to date, our
operations could be adversely affected if such regulations become more
restrictive or widespread. Although we do not currently anticipate that these regulatory matters,
individually or collectively, will have a material impact on our financial
condition, results of operations or cash flows, we cannot assure you that new
regulations or compliance issues that we do not currently anticipate will not
harm our financial condition, results of operations or cash flows in future 9




---



##### Table of Contents



periods. EMPLOYEES The airline business is labor intensive. Alaska had 10,996, active full-time
and part-time employees at December 31, 2003. Wages, salaries and benefits
represented approximately 38% of our total operating expenses in 2003. At December 31, 2003, labor unions represented 84% of Alaskas employees. Our
relations with such labor organizations are governed by the Railway Labor Act.
Under this act, the collective bargaining agreements between Air Group and
these organizations do not expire but instead become amendable as of a stated
date. If either party wishes to modify the terms of any such agreement, it
must notify the other party in the manner described in the agreement. After
receipt of such notice, the parties must meet for direct negotiations, and if
no agreement is reached, either party may request the National Mediation Board
to appoint a federal mediator. If no agreement is reached in mediation, the
National Mediation Board may declare at some time that an impasse exists, at
which point the National Mediation Board proffers binding arbitration to the
parties. Either party may decline to submit to arbitration. If arbitration is
rejected by either party, a 30-day cooling off period commences. During that
period, a Presidential Emergency Board may be established, which examines the
parties positions and recommends a solution. The Presidential Emergency Board
process lasts for 30 days and is followed by a cooling off period of 30 days.
At the end of a cooling off period, unless an agreement is reached or action
is taken by Congress, the labor organization may strike and the airline may
resort to self-help, including the imposition of any or all of its proposed
amendments and the hiring of workers to replace strikers. A number of Alaskas collective bargaining agreements contain provisions for
interest arbitration. Under interest arbitration, if the parties have not
negotiated the contract by a predetermined date, each side may submit a limited
number of issues to binding arbitration. The arbitrators decision on those
open points then becomes part of the collective bargaining agreement, and no
strike or company self-help will occur. The union contract with the Alaska
pilots, among others, contains an interest arbitration provision. Alaska is
currently in negotiations with the Association of Flight Attendants and the
International Association of Machinists and Aerospace Workers Union,
representing its ramp service and stock clerks. Additionally, Alaska is in
negotiations with the Air Line Pilots Association International outside of the
normal contractual cycle. A final decision on interest arbitration, if it
occurs, would be made by April 30, 2005. 10




---



##### Table of Contents



Alaskas union contracts at December 31, 2003 were as follows: Number ofUnion
    
    Employee Group
    
    Employees
    
    Contract StatusAir Line Pilots
    
    Pilots
    
    
    1,479
    
    
    In Negotiations*Association International
    
    
    
    
    
    
    
    Amendable 5/1/05Association of
    
    Flight attendants
    
    
    2,145
    
    
    In NegotiationsFlight Attendants (AFA)International
    
    Ramp service
    
    
    1,257
    
    
    In NegotiationsAssociation of
    
    and stock clerksMachinists and
    
    Clerical, office and
    
    
    2,951
    
    
    Amendable 3/31/04Aerospace Workers
    
    passenger serviceAircraft Mechanics
    
    Mechanics, inspectors
    
    
    1,270
    
    
    Amendable 12/25/04Fraternal Association (AMFA)
    
    and cleanersMexico Workers
    
    Mexico airport
    
    
    80
    
    
    Amendable 9/29/06Association
    
    personnelof Air TransportTransport Workers
    
    Dispatchers
    
    
    31
    
    
    Amendable 6/30/07*Union of America (TWU)
 * Collective bargaining agreement contains interest arbitration provision. FUEL Our operations are significantly affected by the availability and price of jet
fuel. Fuel costs were 15.2% of our total operating expenses in 2003 and 13.6%
in 2002. Fuel prices, which can be volatile and which are outside of our
control, can have a significant impact on our operating results. Currently, a
one-cent change in the fuel price per gallon affects annual fuel costs by
approximately $3.4 million. We believe that operating fuel-efficient aircraft
helps to mitigate the effect of high fuel prices. We also purchase fuel hedge
contracts to reduce our exposure to fluctuations in the price of jet fuel. Due
to the competitive nature of the airline industry, in the event of continuing
increases in the price of jet fuel, there can be no assurance that we will be
able to pass on increased fuel prices to our customers by increasing our fares.
Conversely, any potential benefit of lower fuel prices may be offset by
increased fare competition and lower revenues. While we do not currently anticipate a significant reduction in fuel
availability, dependency on foreign imports of crude oil and the possibility of
changes in government policy on jet fuel production, transportation and
marketing make it impossible to predict the future availability of jet fuel.
In the event of significant hostilities or other conflicts in oil producing
areas, there could be reductions in the production and/or importation of crude
oil. If there were major reductions in the availability of jet fuel, our
business would be adversely affected. See Item 7, Managements Discussion and
Analysis of Financial Condition and Results of Operations, for a discussion of
our fuel hedging activities. 11




---



##### Table of Contents



FREQUENT FLYER PROGRAM All major airlines have developed frequent flyer programs as a way of
increasing passenger loyalty. Alaskas Mileage Plan allows members to earn
mileage by flying on Alaska, Horizon and other participating airlines, and by
using the services of non-airline partners, which include a credit card
partner, telephone companies, hotels, and car rental agencies. Alaska is paid
by non-airline partners for the miles it credits to member accounts. With
advance notice, Alaska has the ability to change the Mileage Plan terms,
conditions, partners, mileage credits, and award levels. Mileage can be redeemed for free or discounted travel and for other travel
industry awards. Upon accumulating the necessary mileage, members notify
Alaska of their award selection. Over 75% of the free flight awards on Alaska
and Horizon are subject to blackout dates and capacity-controlled seating.
Mileage Plan accounts may be deleted after three years of inactivity in that
members account. As of December 31, 2002 and 2003, Alaska estimated that
2,067,000 and 2,353,000, respectively, round-trip flight awards were eligible
for redemption by Mileage Plan members who have mileage credits exceeding the
20,000-mile free round-trip domestic ticket award threshold. Of those eligible
awards, Alaska estimated that 1,931,000 and 2,073,000, respectively, would
ultimately be redeemed. For the years 2001, 2002 and 2003, approximately
310,000, 441,000, and 606,000 round-trip flight awards were redeemed and flown
on Alaska and Horizon. Those awards represent approximately 5.2% for 2001,
6.8% for 2002 and 8.7% for 2003 of the total passenger miles flown for each
period. For the years 2001, 2002 and 2003, approximately 154,000, 174,000 and
174,000, respectively, round-trip flight awards were redeemed and flown on
airline partners. For miles earned by flying on Alaska and travel partners, the estimated
incremental cost of providing free travel awards is recognized as a selling
expense and accrued as a liability as miles are accumulated. The incremental
cost does not include a contribution to overhead, aircraft cost, or profit.
Alaska also sells mileage credits to non-airline partners, such as hotels, car
rental agencies, and a credit card company. Alaska defers a majority of the
sales proceeds, and recognizes these proceeds as revenue when the award
transportation is provided on Alaska or other airline. The deferred proceeds
are recognized as passenger revenue for awards issued on Alaska and as other
revenue-net for awards issued on other airlines. At December 31, 2002 and
2003, the deferred revenue and the total liability for providing free travel on
Alaska and for estimated payments to partner airlines was $303.0 million and
$336.0 million, respectively. OTHER INFORMATION Seasonality and Other Factors Our results of operations for any interim period are not necessarily indicative
of those for the entire year, because the air transportation business is
subject to seasonal fluctuations. Our business is somewhat seasonal. Our
operating income is generally lowest during the first and fourth quarters,
generally increases in the second quarter and reaches its highest level during
the third quarter. The airline industry is characterized generally by low profit margins and high
fixed costs, primarily for personnel, aircraft fuel, debt service and rent. The
expenses of an aircraft flight do not vary significantly with the number of
passengers carried and, as a result, a relatively small change in the number of
passengers or in pricing has a disproportionate effect on an airlines 12




---



##### Table of Contents



operating and financial results. Accordingly, a minor shortfall in expected
revenue levels could cause a disproportionately negative impact on our operating results. In
addition to passenger loads, factors that could cause our quarterly operating
results to vary include:  
    
    the timing and success of our growth plan as we
increase flights in existing markets and enter new markets,
    
    changes in fuel, security and insurance costs,
    
    increases in personnel, marketing, aircraft ownership
and other operating expenses to support our anticipated growth,
and
    
    the timing and amount of maintenance expenditures. In addition, seasonal variations in traffic, various expenditures and weather
affect our operating results from quarter to quarter. We tend to experience the
highest levels of traffic and revenue during the third quarter of each year.
Given our high proportion of fixed costs, seasonality can affect our
profitability from quarter to quarter. Many of our areas of operations
experience inclement weather conditions in the winter, causing increased costs
associated with deicing aircraft, canceled flights and accommodating displaced
passengers. Due to our geographic area of operations, we can be more
susceptible to adverse weather conditions than some of our competitors, who may
be better able to spread weather-related risks over larger route systems. The results of operations in the air transportation business have also
significantly fluctuated in the past in response to general economic
conditions. In addition, fare initiatives, fluctuations in fuel prices, labor
actions and other factors could impact this seasonal pattern. No material part of our business or that of our subsidiaries is dependent upon
a single customer or very few customers. Consequently, the loss of our largest
few customers would not have a materially adverse effect upon our financial
condition, results of operations or cash flows. Insurance We carry insurance for passenger liability, property damage and hull insurance
for damage to our aircraft, in amounts that, in the opinion of management, are
adequate. As a result of the events of September 11, 2001, aviation insurers have
significantly reduced the maximum amount of insurance coverage available to
commercial air carriers for third-party liability for claims resulting from
acts of terrorism, war or similar events. At the same time, they significantly
increased the premiums for such coverage as well as for aviation insurance in
general. Pursuant to authority granted in the Air Transportation Safety and System
Stabilization Act, the Homeland Security Act of 2002, and the Emergency Wartime
Supplemental Appropriations Act of 2003, the Government has offered, and we
have accepted, war risk insurance to replace commercial war risk insurance
through August 31, 2004. Other Government Matters We have elected to participate in the Civil Reserve Air Fleet program, whereby
we have agreed to 13




---



##### Table of Contents



make available to the federal government a certain number of
aircraft in the event of a military call-up. The government would reimburse us
for the use of such aircraft. BUSINESS RISKS Our operations and financial results are subject to various uncertainties, such
as global and industry instability, intense competition, volatile fuel prices,
a largely unionized labor force, the need to finance large capital
expenditures, government regulation, potential aircraft incidents and general
economic conditions. The airline industry is highly competitive and subject to rapid environmental
change. We may be unable to compete effectively against other airlines with
greater financial resources or lower operating costs, or to adjust rapidly
enough in the event the basis of competition in our markets changes. The airline industry is highly competitive as to fares, flight frequency,
frequent flyer benefits, routes and service. The industry is particularly
susceptible to price discounting because airlines incur only nominal costs to
provide service to passengers occupying otherwise unsold seats. We currently
compete with one or more other airlines on all of our routes. Many of these
airlines are larger and have significantly greater financial resources and name
recognition or lower operating costs than our company. Some of these
competitors have chosen from time to time to add service, reduce their fares,
or both, in our markets. We may be unable to compete effectively against other
airlines that introduce service or discounted fares in the markets that we
serve. Our strategy is to focus on serving a few key markets, including Seattle,
Portland, Los Angeles and Anchorage. A significant portion of our flights
occur to and from our Seattle hub. In 2003, this traffic to and from Seattle
accounted for 63% of 2003 traffic. We believe that concentrating our service
offerings in this way assists us to maximize our investment in personnel,
aircraft and ground operations, as well as to gain greater advantage from sales
and marketing efforts in these regions. As a result, we remain highly dependent
upon our key markets. Our business would be harmed by any circumstances causing
a reduction in demand for air transportation in our key markets, such as
adverse changes in local economic conditions, negative public perception of a
key market and significant price increases linked to increases in airport
access costs and fees imposed on passengers. An increase in competition in our
key markets could also cause us to reduce fares or take other competitive
measures that harm our operating results. Many airlines, including ours, have marketing alliances with other airlines.
Among other things, they share the use of two-letter flight designator codes to
identify their flights and fares in the computerized reservation systems and
permit reciprocity in their frequent flyer programs. Internet distribution
arrangements either in conjunction with other airlines or with independent
travel websites are also becoming an important means for selling airline
travel. Any consolidation or significant alliance activity within the airline
industry, or our loss of key alliance or distribution relationships, could
result in our competitors having access to increased route networks and
resources, which, in turn, would increase the risks of competition described
above. The airline industry, particularly the regional airlines, also faces
competition from ground transportation alternatives, such as the bus, train or
automobile. Video teleconferencing and 14




---



##### Table of Contents



other methods of electronic communication may add a new dimension of competition to the industry as
business travelers seek lower-cost substitutes for air travel. Weakness in the general economy, and in the airline industry in particular,
could have an adverse effect on our business. We believe that airline traffic, including business traffic, is particularly
sensitive to changes in economic growth and expectations. Weak economic growth
contributed to the airline industry suffering significant losses in 2001, 2002
and the first half of 2003. During 2002, both US Airways and United Airlines
filed for bankruptcy. Because airlines operating under bankruptcy protection
receive increased flexibility to reduce their costs by voiding contracts and
renegotiating existing business obligations, current and future airline
bankruptcies could have a substantial impact on industry competition. In the
event airlines who have received bankruptcy protection choose to apply some or
all of the cost savings they obtain toward reduced fares, bankruptcy by
airlines who compete with us may cause us to reduce our fares and result in a
substantial reduction in revenue and operating margin. Continued weakness in
the airline industry may also result in additional industry consolidation,
greater reliance on industry alliances, such as code sharing and frequent flyer
reciprocity arrangements, and increased price competition among existing
carriers, each of which could dramatically alter the competitive environment in
the markets we serve and harm our operating results. Continued weak economic
performance in the airline industry may also result in a further reduction in
our credit rating and make it more difficult for us to raise capital on
economical terms. Any general reduction in airline passenger traffic as a
result of a soft economy would harm our business. We rely heavily on automated systems to operate our business and any failure of
these systems could harm our business. We depend on automated systems to operate our business, including our
computerized airline reservation system, our telecommunication systems and our
website. We also issue a substantial number of our tickets to passengers as
electronic tickets. We depend on our computerized reservation system to be able
to issue, track and accept these electronic tickets. In order for our
operations to work efficiently, our website and reservation system must be able
to accommodate a high volume of traffic and deliver important flight
information. Substantial or repeated website, reservations system or
telecommunication systems failures could reduce the attractiveness of our
services and cause our customers to purchase tickets from another airline. Any
disruption in these systems could result in the loss of important data,
increase our expenses and generally harm our business. The September 11, 2001 terrorist attacks negatively impacted our industry and
our business and further threatened or actual terrorist attacks, or other
hostilities involving the U.S., may significantly harm our industry and our
business in the future. The terrorist attacks of September 11, 2001 and their aftermath have negatively
impacted the airline industry, including our company. Since a substantial
portion of airline travel, for both business and leisure, is discretionary,
further terrorist activity connected with air travel, or the threat of further
terrorist activity, could result in travelers canceling or deferring their
plans for 15




---



##### Table of Contents



air travel and have a material adverse effect on our revenues. In
the fourth quarter of 2001, the temporary shutdown of domestic passenger air
travel and reduced demand for air travel led Alaska to reduce its flight
schedule by approximately 13%. Because a substantial portion of our costs are
fixed in the short term, however, we were unable to offset the reduction in
customer demand through cost savings, and operating results were harmed to a
proportionately greater degree. Additional terrorist attacks, the fear of such
attacks or other hostilities involving the U.S. could have a further
significant negative impact on the airline industry, including us, and could:  
    
    result in a grounding of commercial air traffic by the
FAA,
    
    significantly reduce passenger traffic and yields due
to a potentially dramatic drop in demand for air travel,
    
    increase security and insurance costs,
    
    increase fuel costs and the volatility of fuel prices,
    
    make it more difficult for us to obtain war risk or other insurance, and
    
    increase costs from airport shutdowns, flight
cancellations and delays resulting from security breaches and
perceived safety threats. If we are unable to meet our cost reduction goals, our results of operations
and financial condition may suffer. We, along with other airlines, have announced aggressive cost reduction goals
that are an important part of our business strategy. The aim of these cost
reduction initiatives is to improve our profitability without requiring a
substantial increase in current fares and to better position us to be able to
grow our business and take advantage of market opportunities. We believe that
we have already implemented initiatives that will reduce our annual operating
costs by approximately $80 million and plan on achieving approximately $230
million in additional savings through a combination of additional product and
other cost-management initiatives, market-based wage adjustments, a common
health and retirement benefits package for every work group, and work rule
changes focusing on greater efficiency in operations. Although we plan to work
cooperatively with labor groups and employees to achieve these targets,
operating changes are not yet in place to generate this level of cost savings.
We cannot be certain that we will be able to implement changes in our
operations sufficient to generate this level of savings, or that if such
changes are implemented, that forecasted savings will be achieved. In the
event that we are unable to achieve our cost reduction goals, or our efforts
prove less successful than those of our competitors, our results of operations
will likely be below our own expectations and may be below those of outside
financial analysts, and our financial condition may be harmed. Many of our employees are covered by collective bargaining agreements. A
failure to negotiate new agreements, or to do so on terms competitive with the
labor costs and practices of our competitors, could disrupt our business and
increase our costs. As of December 31, 2003, labor unions represented 84% of Alaskas employees.
Alaska is currently in negotiations with the International Association of
Machinists and Aerospace Workers union, which represents its ramp service and
stock clerk work group. Labor costs generally are a significant component of
our total expenses, comprising 38% of our total operating expenses in 16




---



##### Table of Contents



2003. Each of our different employee groups may require separate collective
bargaining agreements, and may make demands that would increase our operating
expenses and adversely affect our profitability. If we were unable to reach
agreement on the terms of any collective bargaining agreement with any group of
our employees or were to experience widespread employee dissatisfaction, we could be subject to work slowdowns or stoppages.
We could also become subject to protests or picketing by organized labor groups
representing our employees. Any of these events would be disruptive to our
operations and could harm our business. In the event any agreement we reach
with an organized labor group requires us to pay wages or to incur costs that
are materially higher than those we currently pay or we are unable to fully
offset such increased costs through fare increases, our expenses would increase
and our operating margin would be harmed. Our business, financial condition, and results of operations are substantially
exposed to the current high prices and variability of jet fuel. Further
increases in jet fuel costs would harm our business. Fuel costs constitute a significant portion of our total operating expenses,
comprising 15.2% of total operating expenses for the year ended December 31,
2003. Significant increases in fuel costs would harm our financial condition
and results of operations. We estimate that during the year ended December 31,
2003 and during the year ended December 31, 2002, a one-cent increase in the
price per gallon of fuel would have increased our fuel expenses by $3.4 million
and $3.2 million, respectively. Average fuel prices during 2003 were 11.9
cents higher than in 2002. Historically, fuel costs have been unpredictable and subject to wide price
fluctuations based on geopolitical issues and supply and demand. Fuel
availability is also subject to periods of market surplus and shortage and is
affected by demand for both home heating oil and gasoline. Because of the
effect of these events on the price and availability of fuel, the cost and
future availability of fuel cannot be predicted with any degree of certainty.
In the event of a fuel supply shortage, higher fuel prices or the curtailment
of scheduled service could result. Some of our competitors may have more
leverage in obtaining fuel. We may be unable to offset increases in the price
of fuel through higher fares. We utilize our fuel hedges as a form of
insurance against significant increases in fuel prices. To hedge our exposure
to fuel price fluctuations, we began purchasing hedging instruments, primarily
crude oil swaps during 2000. At December 31, 2003, we had swap and cap
agreements for crude oil contracts in place to hedge approximately 33% of 2004
expected jet fuel requirements. Even with hedges, we are substantially exposed
to increases in jet fuel costs. Our insurance costs have increased substantially as a result of the September
11, 2001 terrorist attacks, and further increases in insurance costs would harm
our business, financial condition and results of operations. Following the September 11, terrorist attacks, aviation insurers dramatically
increased airline insurance premiums and significantly reduced the maximum
amount of insurance available to airlines for third-party claims resulting from
acts of terrorism, war or similar events to $50 million per event and in the
aggregate. In light of this development, under the Air Transportation Safety
and Stabilization Act, the Homeland Security Act of 2002, and the Emergency
Wartime 17




---



##### Table of Contents



Supplemental Appropriations Act of 2003, the government is currently
offering domestic airlines either (i) third-party liability war risk coverage
above $50 million, or (ii) in lieu of commercial war risk insurance, full hull,
comprehensive and third-party liability war risk coverage. This coverage
provides for the same limits of hull and comprehensive insurance and twice the
limits of third-party liability insurance carried by the airline on September
11, 2001. Aviation insurers could increase their premiums even further in the event of
additional terrorist attacks, hijackings, airline accidents or other events
adversely affecting the airline industry. Furthermore, the full hull,
comprehensive and third-party war risk insurance provided by the government is
mandated through August 31, 2004, with the possibility of an extension through
December 31, 2004. While the government may extend the deadline for when it
will stop providing such coverage, we cannot be certain that any extension will
occur, or if it does, how long the extension will last. It is expected that,
should the government stop providing such coverage to the airline industry, the
premiums charged by aviation insurers for this coverage will be substantially
higher than the premiums currently charged by the government. Significant
increases in insurance premiums would adversely impact our business, financial
condition and results of operations. Changes in government regulation imposing additional requirements and
restrictions on our operations could increase our operating costs and result in
service delays and disruptions. Airlines are subject to extensive regulatory and legal requirements, both
domestically and internationally, that involve significant compliance costs.
In the last several years, Congress has passed laws, and the DOT and the FAA
have issued regulations, relating to the operation of airlines that have
required significant expenditures. For example, on November 19, 2001, the
President signed into law the Aviation and Transportation Security Act (the
Security Act). This law federalizes substantially all aspects of civil
aviation security and requires, among other things, the implementation of
certain security measures by airlines and airports, such as the requirement
that all passenger bags be screened for explosives. Funding for airline and
airport security under the law is primarily provided by a new $2.50 per
enplanement ticket tax, with authority granted to the TSA to impose additional
fees on the air carriers if necessary to cover additional federal aviation
security costs. Implementation of the requirements of the Security Act will
result in increased costs for our company and our passengers. In addition to
increased costs, the security measures required to be implemented under the
Security Act, as well as additional security measures issued by the FAA, have
on occasion resulted in a longer check-in process for passengers and caused
delays and disruptions in airline service, which has led to customer
frustration and may reduce the demand for airline travel. Additional laws,
regulations, taxes and airport rates and charges have been proposed from time
to time that could significantly increase the cost of airline operations or
reduce the demand for air travel. If adopted, these measures could have the
effect of raising ticket prices, reducing revenue and/or increasing costs. Our reputation and financial results could be harmed in the event of an airline
accident or incident. An accident or incident involving one of our aircraft, such as the loss of
Alaska Flight 261 off the coast of California in January 2000, could involve a
significant loss of life and result in a loss of 18




---



##### Table of Contents



faith in our airlines by the flying public. In addition, we could experience significant potential claims
from injured passengers and surviving relatives, as well as costs for the
repair or replacement of a damaged aircraft and its consequential temporary or
permanent loss from service. Airlines are required by the DOT to carry
liability insurance. Although we believe that we currently maintain liability
insurance in amounts and of the type generally consistent with industry
practice, the amount of such coverage may not be adequate and we may be forced
to bear substantial losses from an accident. Substantial claims resulting from an
accident in excess of our related insurance coverage would harm our business
and financial results. Moreover, any aircraft accident or incident, even if
fully insured and even if it does not involve one of our airlines, could cause
a public perception that our airlines or the equipment they fly is less safe or
reliable than other transportation alternatives, which would harm our business. Our operations are often affected by factors beyond our control, including
traffic congestion at airports, weather conditions and increased security
measures, any of which could harm our financial condition and results of
operations. Like other airlines, our operations are subject to delays caused by factors
beyond our control, including air traffic congestion at airports, adverse
weather conditions and increased security measures. Delays frustrate
passengers, reduce aircraft utilization and increase costs, all of which in
turn affect our profitability. During periods of fog, snow, rain, freezing
rain, storms or other adverse weather conditions, flights may be canceled or
significantly delayed. Due to our geographic area of operations, we believe our
operations are more susceptible to adverse weather conditions than many of our
competitors. Cancellations or delays due to weather conditions, traffic control
problems and breaches in security could harm our financial condition and
results of operations. Our failure to successfully expand our business could harm our financial
condition and results of operations. A part of our current profitability strategy involves increasing the frequency
of flights in markets we currently serve, expanding the number of markets
served and increasing flight connection opportunities. We believe that growth
will allow us to achieve additional economies of scale and to manage unit
costs. Increasing the number of markets we serve depends on our ability to
access suitable airports, facilities and in some cases regulatory approvals in
targeted markets. Any condition that would deny, limit or delay access to such
airports, facilities or approvals would constrain our ability to grow. In
addition, successful growth depends on our ability to maintain yields and load
factors at profitable levels. Inadequate revenues in new markets may require us
to revise our current growth strategy. We cannot be certain that we will be
able to successfully expand our existing markets or establish new markets, and
the failure to do so could harm our financial condition and results of
operations. If Alaska fails to comply with financial covenants, some of its financing
agreements may be terminated. Alaska is required to comply with specific financial covenants in certain
agreements, primarily its $150 million revolving credit facility. We cannot
ensure that Alaska will be able to comply with 19




---



##### Table of Contents



these covenants or provisions or that these requirements will not limit our ability to finance our future
operations or capital needs. Alaskas inability to comply with the required
financial maintenance covenants or provisions could result in default under
these financing agreements and would result in a cross default under Alaskas
other financing agreements. In the event of any such default and our inability
to obtain a waiver of the default, all amounts outstanding under the agreements
could be declared to be immediately due and payable. If Alaska did not have
sufficient available cash to pay all amounts that became due and payable, Air
Group or Alaska would have to seek additional debt or equity financing, which may not be
available on acceptable terms, or at all. If such financing were not available,
Alaska would have to sell assets in order to obtain the funds required to make
accelerated payments or risk its aircraft becoming subject to repossession,
which could harm our business. Our business could be harmed if we are unable to attract and retain qualified
personnel at reasonable costs. Our business is labor intensive, with labor costs representing 38% of our
operating expenses for the year ended December 31, 2003. We expect salaries,
wages and benefits to increase on a gross basis and that these costs could
increase as a percentage of our overall costs, which could harm our business.
We compete against the major U.S. airlines for labor in many highly skilled
positions. If we are unable to hire, train and retain qualified employees at a
reasonable cost, or if we lose the services of key personnel we may be unable
to grow or sustain our business and our operating results and business
prospects could be harmed. We may also have difficulty replacing management or
other key personnel who leave and, therefore, the loss of any of these
individuals could harm our business. We have incurred operating losses in each year since 2000 and may incur
substantial operating losses in the future. In addition, our quarterly results
can fluctuate substantially. For the year ended December 31, 2003, we incurred an operating loss of $19.4
million. Prior to that, we incurred operating losses of $77.6 million and
$71.6 million for the years ended December 31, 2002 and 2001, respectively.
The inability to achieve or sustain profitability may hinder our ability to
honor our existing obligations as they become due, to obtain future equity or
debt financing or to do so on economical terms, and to sustain and expand our
business. In addition, our quarterly results can fluctuate substantially due to a variety
of factors including seasonal variations in traffic, the timing of various
expenditures, and weather. Because expenses of an aircraft flight do not vary
significantly with the number of passengers carried, a relatively small change
in the number of passengers or in pricing has a disproportionate effect on an
airlines operating and financial results. Accordingly, a minor shortfall in
expected revenue levels could cause a disproportionately negative impact on our
operating results. Due to these factors, as well as other risk factors
described in this Form 10-K/A, quarter-to-quarter comparisons of our results
may not be good indicators of our future performance. In addition, it is
possible that in any future quarter our operating results could be below
expectations of investors and any published reports or analyses regarding our
company. In that event, the price of Air Groups common stock could decline,
perhaps substantially. 20




---



##### Table of Contents



Our indebtedness could increase the volatility of earnings and otherwise
restrict our activities. We have and will continue to have for the foreseeable future a significant
amount of indebtedness. Due to our high fixed costs, including aircraft lease
commitments and debt service, a decrease in revenues results in a
disproportionately greater decrease in earnings. As of December 31, 2003, we
had approximately $963.5 million of indebtedness outstanding, approximately
$955.1 million of which was secured by flight equipment and real property and
approximately $8.4 million of capital lease obligations. Our outstanding indebtedness could have important consequences. For example, it
could:  
    
    limit our ability to obtain additional financing for
funding our growth strategy, capital expenditures, acquisitions,
working capital or other purposes,
    
    require us to dedicate a material portion of our operating
cash flow to fund interest payments on indebtedness, thereby
reducing funds available for other purposes, and
    
    limit our ability to withstand competitive pressures and
reduce our flexibility in responding to changing business and
economic conditions, including reacting to any economic slowdown in
the airline industry. In addition, we have an ongoing need to finance new aircraft deliveries, and
there is no assurance that such financing will be available to us in sufficient
amounts or on acceptable terms. 21




---



##### Table of Contents



ITEM 2.PROPERTIES Aircraft The following tables describe the aircraft we operate and their average age at
December 31, 2003: Passenger
    
    
    
    
    
    
    
    
    
    
    
    
    
    Average AgeAircraft Type
    
    Capacity
    
    Owned
    
    Leased
    
    Total
    
    in YearsBoeing 737-200C
    
    
    111
    
    
    
    8
    
    
    
    1
    
    
    
    9
    
    
    
    22.9Boeing 737-400
    
    
    138
    
    
    
    9
    
    
    
    31
    
    
    
    40
    
    
    
    8.7Boeing 737-700
    
    
    120
    
    
    
    17
    
    
    
    5
    
    
    
    22
    
    
    
    2.8Boeing 737-900
    
    
    172
    
    
    
    11
    
    
    
    
    
    
    
    11
    
    
    
    1.5Boeing MD-80
    
    
    140
    
    
    
    15
    
    
    
    12
    
    
    
    27
    
    
    
    12.260
    
    
    
    49
    
    
    
    109
    
    
    
    8.8
 Part II, Item 7, Managements Discussion and Analysis of Financial Condition
and Results of Operations, discusses future orders and options for additional
aircraft. 51 of the 60 aircraft owned by Alaska as of December 31, 2003 are subject to
liens securing long-term debt. Alaskas leased 737-200C, 737-400, 737-700 and
MD-80 aircraft have lease expiration dates in 2004, between 2004 and 2016, and
between 2004 and 2013, respectively. Alaska has the option to extend most of
the leases for additional periods, or the right to purchase the aircraft at the
end of the lease term, usually at the then fair market value of the aircraft.
For information regarding obligations under capital leases and long-term
operating leases, see Note 6. At December 31, 2003, all of our aircraft met the Stage 3 noise requirements
under the Airport Noise and Capacity Act of 1990. However, special noise
ordinances restrict the timing of flights operated by Alaska and other airlines
at Burbank, Orange County, San Diego, San Jose and Palm Springs. In addition,
Orange County, Reagan National and Long Beach airports restrict the type of
aircraft and number of flights. Ground Facilities and Services Alaska leases ticket counters, gates, cargo and baggage space, office space,
and other support areas at the majority of the airports they serve. We also
own terminal buildings in various cities in the state of Alaska. Alaska has centralized operations in several buildings located at or near
Seattle-Tacoma International Airport (Sea-Tac) in Seattle, Washington. The
owned buildings, including land unless located on leased airport property,
include a three-bay hangar facility with maintenance shops, a flight operations
and training center, an air cargo facility, an information processing center,
several office buildings, its corporate headquarters, and two storage
warehouses. Alaska also leases a two-bay hangar/office facility at Sea-Tac, a
reservation and office facility in Kent, WA, and a reservation center in Boise,
ID. Alaskas other major facilities include a regional headquarters building,
an air cargo facility, and a leased hangar/office facility in Anchorage; a
Phoenix reservations center; and a leased two-bay maintenance facility in
Oakland. 22




---



##### Table of Contents



ITEM 3.LEGAL PROCEEDINGS 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. 
 PART II 
 ITEM 5.MARKET PRICE FOR THE REGISTRANTS COMMON STOCK AND RELATED STOCKHOLDER MATTERS All of Alaskas outstanding common stock is held by Air Group and such stock is
not traded in any market. No cash dividend has been paid since 1989 and Alaska
does not expect to pay regular dividends to Air Group. 23




---



##### Table of Contents



Alaska Airlines Financial and Statistical Data Quarter Ended December 31
    
    Year Ended December 31%
    
    
    
    
    
    
    
    
    
    %Financial Data (in millions):
    
    2002*
    
    2003*
    
    Change
    
    2002*
    
    2003*
    
    ChangeOperating Revenues:Passenger
    
    $
    392.2
    
    
    $
    460.3
    
    
    
    17.4
    
    
    $
    1,667.7
    
    
    $
    1,840.4
    
    
    
    10.4Freight and mail
    
    
    16.5
    
    
    
    17.5
    
    
    
    6.1
    
    
    
    72.1
    
    
    
    77.3
    
    
    
    7.2Other - net
    
    
    21.1
    
    
    
    26.7
    
    
    
    26.5
    
    
    
    93.3
    
    
    
    109.7
    
    
    
    17.6Total Operating Revenues
    
    
    429.8
    
    
    
    504.5
    
    
    
    17.4
    
    
    
    1,833.1
    
    
    
    2,027.4
    
    
    
    10.6Operating Expenses:Wages and benefits
    
    
    179.4
    
    
    
    199.9
    
    
    
    11.4
    
    
    
    703.4
    
    
    
    778.6
    
    
    
    10.7Employee profit sharing
    
    
    
    
    
    
    2.9
    
    
    NM
    
    
    
    
    
    
    2.9
    
    
    NMContracted services
    
    
    20.3
    
    
    
    20.7
    
    
    
    2.0
    
    
    
    80.1
    
    
    
    81.6
    
    
    
    1.9Aircraft fuel
    
    
    68.2
    
    
    
    79.9
    
    
    
    17.2
    
    
    
    260.7
    
    
    
    312.1
    
    
    
    19.7Aircraft maintenance
    
    
    41.9
    
    
    
    35.7
    
    
    
    (14.8
    )
    
    
    145.2
    
    
    
    153.4
    
    
    
    5.6Aircraft rent
    
    
    32.4
    
    
    
    31.1
    
    
    
    (4.0
    )
    
    
    128.2
    
    
    
    123.9
    
    
    
    (3.4
    )Food and beverage service
    
    
    15.6
    
    
    
    13.9
    
    
    
    (10.9
    )
    
    
    63.5
    
    
    
    58.7
    
    
    
    (7.6
    )Other selling expenses and commissions
    
    
    31.8
    
    
    
    39.0
    
    
    
    22.6
    
    
    
    154.6
    
    
    
    148.0
    
    
    
    (4.3
    )Depreciation and amortization
    
    
    28.3
    
    
    
    31.7
    
    
    
    12.0
    
    
    
    114.0
    
    
    
    119.5
    
    
    
    4.8Loss on sale of assets
    
    

    1.0
    
    
    
    2.1
    
    
    NM
    
    
    1.7
    
    
    
    3.4
    
    
    NMLanding fees and other rentals
    
    
    28.3
    
    
    
    34.3
    
    
    
    21.2
    
    
    
    110.5
    
    
    
    127.8
    
    
    
    15.7Other
    
    
    37.5
    
    
    
    34.0
    
    
    
    (9.3
    )
    
    
    148.8
    
    
    
    136.9
    
    
    
    (8.0
    )Total Operating Expenses
    
    
    484.7
    
    
    
    525.2
    
    
    
    8.4
    
    
    
    1,910.7
    
    
    
    2,046.8
    
    
    
    7.1Operating Loss
    
    
    (54.9
    )
    
    
    (20.7
    )
    
    
    (62.3
    )
    
    
    (77.6
    )
    
    
    (19.4
    )
    
    
    (75.0
    )Interest income
    
    
    5.7
    
    
    
    4.9
    
    
    
    
    
    
    
    23.2
    
    
    
    15.2Interest expense
    
    
    (11.6
    )
    
    
    (11.3
    )
    
    
    
    
    
    
    (46.6
    )
    
    
    (45.2
    )Interest capitalized
    
    
    1.0
    
    
    
    0.2
    
    
    
    
    
    
    
    2.1
    
    
    
    1.5U.S. government compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.3
    
    
    
    52.8Other - net
    
    
    1.2
    
    
    
    (0.4
    )
    
    
    
    
    
    
    11.3
    
    
    
    6.9(3.7
    )
    
    
    (6.6
    )
    
    
    
    
    
    
    (9.7
    )
    
    
    31.2Income (Loss) Before Income Tax
and Accounting Change
    
    $
    (58.6
    )
    
    $
    (27.3
    )
    
    NM
    
    $
    (87.3
    )
    
    $
    11.8
    
    
    NMOperating Statistics:Revenue passengers (000)
    
    
    3,367
    
    
    
    3,712
    
    
    
    10.2
    
    
    
    14,154
    
    
    
    15,047
    
    
    
    6.3RPMs (000,000)
    
    
    3,164
    
    
    
    3,608
    
    
    
    14.0
    
    
    
    13,186
    
    
    
    14,554
    
    
    
    10.4ASMs (000,000)
    
    
    4,758
    
    
    
    5,194
    
    
    
    9.2
    
    
    
    19,360
    
    
    
    20,804
    
    
    
    7.5Passenger load factor
    
    
    66.5
    %
    
    
    69.5
    %
    
    3.0
    pts
    
    
    68.1
    %
    
    
    70.0
    %
    
    1.9
    ptsBreakeven load factor
    
    
    78.4
    %
    
    
    74.4
    %
    
    (4.0
    )pts
    
    
    73.1
    %
    
    
    72.3
    %
    
    (0.8
    )ptsYield per passenger mile
    
    
    12.40
    ¢
    
    
    12.76
    ¢
    
    
    2.9
    
    
    
    12.65
    ¢
    
    
    12.65
    ¢
    
    
    (0.0
    )Operating revenue per ASM
    
    
    9.03
    ¢
    
    
    9.71
    ¢
    
    
    7.5
    
    
    
    9.47
    ¢
    
    
    9.74
    ¢
    
    
    2.9Operating expenses per ASM (a)
    
    
    10.19
    ¢
    
    
    10.11
    ¢
    
    
    (0.7
    )
    
    
    9.87
    ¢
    
    
    9.84
    ¢
    
    
    (0.3
    )Expense per ASM excluding fuel (a)
    
    
    8.75
    ¢
    
    
    8.57
    ¢
    
    
    (2.1
    )
    
    
    8.52
    ¢
    
    
    8.34
    ¢
    
    
    (2.1
    )Fuel cost per gallon
    
    
    86.0
    ¢
    
    
    95.8
    ¢
    
    
    11.4
    
    
    
    80.6
    ¢
    
    
    92.5
    ¢
    
    
    14.7Fuel gallons (000,000)
    
    
    79.3
    
    
    
    83.4
    
    
    
    5.2
    
    
    
    323.3
    
    
    
    337.3
    
    
    
    4.3Average number of employees
    
    
    10,065
    
    
    
    9,921
    
    
    
    (1.4
    )
    
    
    10,142
    
    
    
    10,040
    
    
    
    (1.0
    )Aircraft utilization (blk hrs/day)
    
    
    10.3
    
    
    
    10.3
    
    
    
    0.0
    
    
    
    10.6
    
    
    
    10.5
    
    
    
    (0.9
    )Operating fleet at period-end
    
    
    102
    
    
    
    109
    
    
    
    6.9
    
    
    
    102
    
    
    
    109
    
    
    
    6.9
 NM = Not Meaningful (a) See Note A on page
25.
* As revised, See Note 13 to our financial statements. Note 1: Certain reclassifications have been made to the December 31, 2002 statement of operations to conform to
the December 31, 2003 presentation. Note 2: Operating loss for the three months and year ended December 31, 2003 includes adjustments to increase
operating expenses by $2.4 million (pretax) and $3.1 million (pretax), respectively, related to prior years.
Operating loss for the three months ended December 31, 2003 also includes adjustments to increase operating
expenses by $1.8 million (pretax) and increase operating revenues by $6.3 million (pretax), both related to
previous quarters in 2003. These adjustments to operating expenses represent corrections to maintenance
expense ($3.6 million) and wages and benefits ($1.0 million) in the aggregate. The adjustment to operating
revenues resulted from a correction to deferred revenue as a result of planned deletions of certain accounts
with expired miles. In addition, interest income for the 2003 year includes a correction to investment premium
amortization recorded in the first quarter that reduced interest income by $2.8 million (pretax) related to
the previous year. Management does not believe that these amounts are material to the periods affected.  24




---



##### Table of Contents



Note A: Pursuant to Item 10 of Regulation S-K, the Company is 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 the Companys performance both with and without the cost of aircraft fuel. As both the cost and availability of aircraft fuel are subject to many economic and political factors beyond the Companys control, it is the Companys view that the measurement and monitoring of performance without this factor is important. 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 table reconciles operating expenses excluding fuel and operating expenses per ASM excluding fuel for Alaska Airlines, Inc.: Quarter Ended December 31
    
    Year Ended December 31($ in millions)
    
    2002
    
    2003
    
    2002
    
    2003Total GAAP Operating Expenses (in millions)
    
    $
    484.7
    
    
    $
    525.2
    
    
    $
    1,910.7
    
    
    $
    2,046.8ASMs (000,000)
    
    
    4,758
    
    
    
    5,194
    
    
    
    19,360
    
    
    
    20,804GAAP Operating Expenses per ASM
    
    
    10.19
    ¢
    
    
    10.11
    ¢
    
    
    9.87
    ¢
    
    
    9.84
    ¢Total GAAP Operating Expenses (in millions)
    
    $
    484.7
    
    
    $
    525.2
    
    
    $
    1,910.7
    
    
    $
    2,046.8Less: Aircraft Fuel
    
    
    68.2
    
    
    
    79.9
    
    
    
    260.7
    
    
    
    312.1$
    416.5
    
    
    $
    445.3
    
    
    $
    1,650.0
    
    
    $
    1,734.7Operating expense per ASM excluding fuel
    
    
    8.75
    ¢
    
    
    8.57
    ¢
    
    
    8.52
    ¢
    
    
    8.34
    ¢
 25




---



##### Table of Contents



ITEM 7.MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Managements Discussion and Analysis of Financial Condition and Results of
Operations presented below reflects certain revisions to our previously
reported operating results for the years ended December 31, 2001, 2002 and
2003. We previously recorded unrealized gains and losses related to the ineffective
portion of changes in fair value of our fuel hedge positions as nonoperating
income (expense) and then reclassified those gains and losses to fuel expense
as those hedges were settled. This practice was not consistent with our stated
policy, which was to record the ineffective portion in nonoperating income
(expense). We have revised our financial statements to adjust our historical
presentation of such items. Such revisions have resulted in reclassification
between operating income (loss) and nonoperating income (expense) in the
statements of operations. The revisions have no impact on previously reported
pretax income (loss), net income (loss), the balance sheets, the statement of
shareholders equity or the statements of cash flows for any prior periods.
They also have no impact on cost per ASM excluding fuel, a non-GAAP measure we
believe is important to some users of our financial statements. See Note 13 to
the financial statements for further discussion of this matter. The following discussion should be read in conjunction with our financial
statements and the related notes contained elsewhere in this Annual Report on
Form 10-K/A. All statements in the following discussion which are not reports
of historical information or descriptions of current accounting policies are
forward-looking statements. Please consider our forward-looking statements in
light of the risks referred to in this reports introductory cautionary note.
There can be no assurance that actual developments will be those anticipated by
us. Actual results could differ materially from those projected as a result of
a number of factors, some of which we cannot predict or control. For a
discussion of these factors, see Item 1, Business-Business Risks. General Alaska is a major airline serving primarily Alaska; the U.S. West Coast; five
cities on the U.S. East Coast; Vancouver, Canada; and Mexico. We operate an
all jet fleet and our average passenger trip is 967 miles. Year in Review and Current Events Overall, economic conditions in 2003 improved slightly over 2001 and 2002,
resulting in strong summer demand and higher than expected fourth quarter
revenue passenger miles (RPMs or traffic). However, industry demand levels, as
measured by passenger traffic, remained below pre- 2001 levels. In an attempt
to mitigate negative impacts on our business resulting from the terrorist
attacks of September 11, 2001 and the economic downturn in 2001, and 2002 and
the first half of 2003, our business strategy focused on extensive cost
reductions and revenue enhancement initiatives involving the review of every
aspect of our operations. We experienced increases in both traffic and
available seat miles (ASMs or capacity), however our yields (passenger fare
divided by distance traveled) remained flat year over year. Our unit costs
including and 26




---



##### Table of Contents



excluding fuel declined, although fuel prices increased roughly 15% year over
year. We expect capacity to increase 6% in 2004 compared to 2003. In February 2004, we initiated a fare rationalization plan whereby a number of
restrictions were eliminated and the gap between the highest and lowest fares
was reduced. The goal of this initiative is to increase customer value and
simplify the customers purchase decision. In June 2003, we met with leaders of our labor unions to begin a dialog over
how Alaska and our labor groups can work cooperatively to better position the
airline for growth and success. These 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. To reach our goal of achieving success, our
goal is to reduce our cost per available seat mile excluding fuel to 7.25 cents
by 2005. However, this is a goal and should not be viewed as a prediction of
future performance. As discussed in Note 10 in the Notes to Financial Statements, in April 2003,
the Emergency Wartime Supplemental Appropriations 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 since its
inception in February 2002. Additionally, passenger security fees were not
imposed by the TSA and carrier fees were not paid during the period June 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. In the fourth quarter of 2003, we made a decision to retire three 737-200C
aircraft when they become due for their scheduled maintenance heavy checks in
2004. As a result of this decision, we revised our estimates of the useful
lives on these aircraft, which resulted in increased depreciation and
amortization of approximately $1.6 million in the fourth quarter of 2003. We
expect to record an additional $9.3 million in 2004. RESULTS OF OPERATIONS 2003 Compared with 2002 Our net income for 2003 was $3.0 million, compared with a net loss of $69.5
million in 2002. Our 2003 results include $52.8 million received related to
assistance from the government under the Emergency Wartime Supplemental
Appropriations Act. Our 2002 net loss includes $0.3 million received from the
government and $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 2002 and the goodwill write-off in 2002, our net loss for 2003 was
$29.6 million compared to $57.2 million for 2002. Our operating loss for 2003 was $19.4 million compared to $77.6 million for
2002. Our pre-tax income for 2003 was $11.8 million compared with a pre-tax
loss before accounting change of $87.3 million for 2002. Financial and
statistical data comparisons are shown on page 24. On page 25, we have
included a reconciliation of reported non-GAAP financial measures to the most
directly comparable GAAP financial measures. 27




---



##### Table of Contents



Revenues Operating revenues increased $194.3 million, or 10.6%, during 2003 as compared
to the same period in 2002, reflecting stronger summer demand and higher than
expected fourth quarter traffic as compared to 2002. For the twelve months
ended December 31, 2003, capacity increased 7.5% and traffic increased 10.4% 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., Orlando and Miami) and an increase in service in the Pacific Northwest,
Mexico, and Canada markets, partially offset by lower capacity in the Bay Area,
Arizona and Northern Alaska. During 2003, roughly 75% of our ASM growth came
from expansion in the Transcontinental and Denver markets. Traffic increases
primarily reflect service to new cities and traffic increases in the Pacific
Northwest, Mexico and Nevada, partially offset by decreases in traffic in the
Bay Area, Northern Alaska and Arizona. Higher traffic resulted in a $172.7
million, or 10.4%, increase in passenger revenues. Our passenger load factor
(RPMs divided by ASMs) increased 1.9 percentage points to 70.0% during 2003 as
compared to 2002. Our yield per passenger mile remained constant compared to 2002 due to a
combination of longer average stage lengths, fewer business travelers, a drop
off in demand and continued pricing pressure by low cost carriers, partially
offset by an increase in revenue from expired Mileage Plan accounts. Freight and mail revenues increased $5.2 million, or 7.2%, due principally to
higher freight and mail volumes attributable to a reduction of security
restrictions. Other-net revenues increased $16.4 million, or 17.6%, due
largely to cash received from the sale of miles in our frequent flyer program
(impacting other revenue currently as a portion is recognized immediately) and
redemption of miles on partner airlines. Expenses For the twelve months ended December 31, 2003, total operating expenses
increased $136.1 million, or 7.1%, as compared to the same period in 2002.
This increase is due largely to a 7.5% increase in ASMs combined with higher
fuel, maintenance, wages and benefits costs and landing fees and other rentals.
Operating expense per ASM decreased 0.3% as compared to the same period in
2002 from 9.87 cents to 9.84 cents. Operating expense per ASM excluding fuel

decreased 2.1% as compared to the same period in 2002 from 8.52 cents to 8.34
cents. Explanations of significant period-over-period changes in the
components of operating expenses are as follows:  
    
    Wages and benefits increased $75.2 million, or 10.7%, during 2003
as compared to 2002. Approximately $52.8 million of this increase
reflects higher benefit costs, mainly increases in pension costs of
approximately $34.1 million and higher health insurance and workers
compensation costs. The remaining $22.4 million increase reflects
scale and step increases, partially offset by a 1.0% decrease in the
number of full time equivalent employees.In May of 2004, under terms of our union contract, our pilots will
receive a 4% wage rate increase. 28




---



##### Table of Contents




    
    Alaska recorded employee profit sharing of $2.9 million in 2003,
which will be paid in 2004. No profit sharing occurred in 2002.  
    
    Aircraft fuel increased $51.4 million, or 19.7%, due to a 14.8%
increase in the fuel cost per gallon and a 4.3% increase in fuel
gallons consumed. Air Groups fuel hedging program resulted in Alaska
recognizing a $19.6 million reduction in aircraft fuel expense for
hedging gains realized on hedge positions settled during 2003. Fuel
prices remain high and can be volatile. At December 31, 2003, we have
fuel hedge contracts in place to hedge 33%, 28% and 2% of our expected
fuel usage in 2004, 2005 and 2006, respectively.
    
    Aircraft maintenance increased $8.2 million, or 5.6%, due to
increases in the number of outside airframe and engine checks and
other outside repairs and additional depreciation that was recorded
following our decision in the fourth quarter to retire three Boeing
737-200Cs in 2004.
    
    Aircraft rent decreased $4.3 million, or 3.4%, due to new lease
extensions at lower rates, partially offset by five new 737-700
leases.
    
    Other selling expenses and commissions decreased $6.6 million, or
4.3%. This decrease was due principally to lower computer reservation
system costs, the elimination of travel agency base commissions and
lower Mileage Plan costs, partially offset by an increase in credit
card commissions, advertising costs, and incentive payments made to
Horizon. In 2003, 43.0% of Air Group ticket sales were made through
traditional travel agents, compared to 48.2% in 2002. In 2003, 27.4%
of the ticket sales were made through Alaskas Internet web site
compared to 21.0% in 2002.
    
    Depreciation and amortization increased $5.5 million, or 4.8%
reflecting a year over year increase in the depreciable asset base and
$0.7 million in accelerated depreciation on three 737-200s that will
be retired in 2004.In 2004, we expect to record an additional $9.3 million of depreciation
and maintenance expense as a result of the projected retirement.
    
    Landing fees and other rentals increased $17.3 million, or 15.7%.
The higher rates reflect modest volume growth and an increase in
airports cost of operations, including facility expansion
initiatives, and increased costs for security.We expect landing fees and other rentals to continue to increase as a
result of airport facility expansions and increased costs for security.
    
    Other expense decreased $11.9 million, or 8.0%, primarily
reflecting lower expenditures for insurance, supplies, communication
services and property taxes, partially offset by increases in
expenditures for professional services and per diems. Insurance
expense decreases are a reflection of several factors including a $3.7
million insurance reimbursement received during the latter part of
2003 resulting from a clarification of liability related to Flight
261, lower cost coverage from a government aviation war risk 29




---



##### Table of Contents



insurance program and competitive pressures in the aviation war risk
insurance market. However, aviation insurance remains substantially higher than
before September 11, 2001. Nonoperating Income (Expense) Net nonoperating items were $9.7 million expense in 2002 compared to $31.2
million income in 2003. 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 $8.0 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 interest) increased $0.8 million, due primarily to increases in
debt (See Note 5 in the Notes to Financial Statements). Other-net includes $8.5 million and $6.8 million in gains resulting from hedge
ineffectiveness on fuel hedging contracts in 2002 and 2003, respectively. In
2003, we received an insurance recovery of $3.1 million in connection with
legal fees associated with the U.S. Attorney investigation in
Oakland. In 2002, we received a $1.4 million insurance recovery
and a $0.9 million gain on conversion of Equint N.V. shares (a
telecommunications network company owned by many airlines). 2002 Compared with 2001 The loss before accounting change for 2002 was $57.0 million compared with a
loss of $11.8 million in 2001. The operating loss was $77.6 million in 2002
compared with an operating loss of $71.6 million in 2001. Results in 2001 and
2002 include $71.6 million and $0.3 million, respectively, of government
compensation recognized resulting from the Act. Results for 2002 include a
$12.5 million charge in connection with write-off of all of the Companys
goodwill. (See Note 12 to the financial statements.) Financial and
statistical data for Alaska is shown following the financial statements. A
discussion of this data follows. Revenues Operating revenue increased 3.7% during 2002 as compared to 2001. Available
seat miles increased during each quarter of 2002 as compared to 2001 due to the
addition of service to five cities (Calgary, Boston, Denver, Newark and Miami)
and due to the negative impact of the terrorist attacks on 4th quarter 2001
capacity. For the full year 2002, capacity was up 8.0% while revenue passenger
miles increased at a slightly lower rate (7.6%), resulting in a 0.3 point
decrease in passenger load factor. In our largest market, Southern California,
capacity was slightly higher in 2002 compared to 2001, and traffic was slightly
lower, resulting in a decrease in load factor of 1.1 points. Capacity and
traffic gains experienced in the last two quarters in this market were offset
by decreases in the first two quarters. In our second largest market,
Anchorage/Fairbanks to the U.S. mainland, both capacity and traffic increased
when compared to 2001; traffic increased at a higher rate than capacity,
resulting in an increase in load factor of 1.8 points for the year. The
average load factor for our newest five cities was better than the system
average. Yield per passenger mile was down in each quarter of the year: 5.0% in the
first quarter, 2.5% in the second quarter, 3.9% in the third quarter and 3.0%
in the fourth quarter. The decrease in passenger yield was due to a
combination of fewer business passengers, a drop off in demand due to the
events of September 11, fare sales offered to stimulate demand, and the sagging
economy. 30




---



##### Table of Contents



For the full year 2002, yields were down 3.6%. The higher traffic
combined with the lower yield resulted in a 3.7% increase in
passenger revenue. Freight and mail revenues decreased 7.8%. After September 11, new security
measures had a negative impact on our freight and mail volumes, resulting in a
negative impact on revenues. Other-net revenues increased 20.7%, largely due to increased revenue from the
sale of miles in Alaskas frequent flyer program, and redemption of miles on
partner airlines. (Alaska recognizes revenue for the difference between the
funds received for the sale of miles to third parties and the cost of the award
redemptions on partner airlines.) Expenses Operating expenses grew by $76.1 million, or 4.1%, as a result of an 8.0%
increase in ASMs and a 3.6% decrease in cost per ASM. The cost per ASM
excluding fuel increased by 0.2% during the first nine months of 2002 when
compared to the same period in 2001, but decreased by 8.9% in the fourth
quarter, primarily due to the impact of the terrorist attacks in 2001.
Explanations of significant year-over-year changes in the components of
operating expenses are as follows:  
    
    Wages and benefits increased 9.7% due to a 9.5% increase in
average wages and benefits per employee and a 0.3% increase in the
number of employees. The 2002 results include a full year of a pilot
wage increase, which occurred in June 2001, step increases for union
employees, and annual merit raises for management employees.
Additionally, benefits expense significantly increased due to
increases in defined benefit plan costs and increases in health
insurance for all employees.
    
    Contracted services increased 6.2%, primarily due to higher rates
for ground handling services and a slightly higher volume of services
due to capacity growth. Increased airport security screening costs
subsequent to September 11, 2001 also contributed to the increase.
    
    Aircraft fuel expense decreased 3.4% due to a 8.7% decrease in
the cost per gallon of fuel, offset by a 5.8% increase in gallons
consumed. Fuel consumption rate per flight hour decreased slightly by
0.1%. The lower fuel prices saved $28.1 million.
    
    Aircraft maintenance expense increased 12.0% as a result of more
airframe checks in 2002. In addition, the 2001 results reflect a
reduced flight schedule as a result of the September 11 terrorist
attacks which resulted in the deferring of certain C checks and heavy
checks into 2002.
    
    Other selling expense and commissions consists of credit card
commissions, computer reservation systems fees, Mileage Plan award
costs for miles earned by flying on Alaska or Horizon, advertising
expenses and commission expense paid on the sale of tickets. The
decrease in 2002 was attributed to decreases in computerized
reservation system fees, advertising expense and Mileage Plan awards,
the elimination of travel agent base commissions and the continuing
shift to direct sales channels, offset by increases in credit card
commissions. In June 2002, we changed our travel agent commissions
program to 31




---



##### Table of Contents



eliminate base commissions and move to a 100% incentive-based program. In 2002, 55.9% of Air Group ticket sales
were made through travel agents, versus 59.9% in 2001. In 2002, 21.0%
of the ticket sales were made through Alaskas Internet web site
versus 16.3% in 2001.
    
    Depreciation and amortization increased 7.6% in 2002 as compared
to 2001, primarily due to the addition of eight owned aircraft during
the first and second quarters of 2001.
    
    Landing fees and other rentals increased 11.1%, exceeding the
3.1% increase in landings, due to higher landing fee and rental rates
at airports throughout the system. The higher rates reflect the
airports increased cost of operations due to new security directives
and expansion of their facilities.
    
    Other expense increased 3.4%, primarily due to higher
expenditures for insurance, flight crew hotels and utilities, partly
offset by lower property taxes, recruiting, passenger remuneration,
uninsured losses and legal costs. Subsequent to the events of
September 11, we experienced significant increases in hull, liability
and war risk insurance rates, and were also subject to surcharges for
war risk coverage. As a result of these increases, Alaska incurred
$37.4 million in aircraft insurance expense in 2002, compared to $13.1
million in 2001. Nonoperating Income (Expense) Net nonoperating loss was $9.7 million in 2002 compared to nonoperating income
of $55.2 million in 2001. The $64.9 million decrease was primarily due to U.S.
government compensation of $71.6 million recognized in 2001 compared to $0.3
million in 2002. In 2001, Alaska recognized $71.6 million of U.S. government compensation.
During the third quarter of 2002, the DOT completed its review procedures and
remitted final compensation to Alaska of $0.2 million. Interest expense, net
of capitalized interest, totaled $39.9 million in 2001 which compares to $44.2
million in 2002. For 2002, other-net includes $8.5 million in gains resulting from hedge
ineffectiveness on fuel hedging contracts. For 2001, amounts related to hedge
ineffectiveness were de minimis. Cumulative Effect of Accounting Change Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. Under this
statement, goodwill is no longer amortized, but instead is tested for
impairment on a minimum of an annual basis. During the second quarter of 2002,
we completed the first step of our impairment test related to our $12.5 million
of goodwill. In the fourth quarter of 2002, we completed the second step of
our impairment test and determined that all of our goodwill was impaired. As a
result, we recorded a one-time, non-cash charge, effective January 1, 2002, of
$12.5 million to write-off all of our goodwill. This charge is reflected as a
cumulative effect of accounting change in the Statement of Operations for 2002. Critical Accounting Policies 32




---



##### Table of Contents



The discussion and analysis of our financial position and results of operations
is based upon our financial statements, which have been prepared in accordance
with accounting principles generally accepted in the U.S. The preparation of
these financial statements requires us to make estimates and judgments that
affect our financial position and results of operations. See Note 1 to the
financial statements for a description of our significant accounting policies.
Critical accounting estimates are defined as those that are reflective of significant
judgment and uncertainties, and potentially result in materially different
results under different assumptions and conditions. We have identified the
following critical accounting estimates. We have discussed the development,
selection and disclosure of these policies with our audit committee. Mileage Plan We have a loyalty program that awards miles to passengers who fly on Alaska or
Horizon and our travel partners. Additionally, we sell miles to third parties,
such as our credit card partner, for cash. In either case, the outstanding
miles may be redeemed for travel on Alaska, Horizon, or any of our alliance
partners. We have an obligation to provide this future travel; therefore, for
awards earned by passengers who fly on Alaska, Horizon or our travel partners,
we recognize a liability and the corresponding expense for this future
obligation. For miles sold to third parties, a majority of the sales proceeds
are recorded as deferred revenue and recognized when the award transportation
is provided. The deferred proceeds are recognized as passenger revenue when
awards are issued on Alaska, and as other-net revenue for awards issued on
other airlines. At December 31, 2003, we had approximately 75 billion miles outstanding,
resulting in an aggregate liability of $336 million. The liability is computed
based on several assumptions that require significant management judgment to
estimate and formulate. There are uncertainties inherent in estimates;
therefore, an incorrect assumption impacts the amount and/or timing of revenue
recognition or Mileage Plan expenses. The most significant assumptions in
accounting for the Mileage Plan are described below.  1.
    
    The number of miles that will not be redeemed for travel:Members may not reach the mileage threshold necessary for a free ticket and
outstanding miles may not always be redeemed for travel. Therefore, based on
the number of Mileage Plan accounts and the miles in the accounts, we
estimate how many miles will never be used (breakage), and do not record a
liability for those miles. Our estimates of breakage consider activity in
our members accounts, account balances, and other factors. We believe our
breakage assumptions are reasonable. A hypothetical 1.0% change in our
estimate of breakage has approximately a $3.8 million affect on the
liability. However, actual breakage could differ significantly from our
estimates given the dynamic nature of the program and our inability to
predict our members future behavior.2.
    
    The number of miles used per award (i.e., free ticket):We estimate how many miles will be used per award. If actual miles used are
more or less than estimated, we may need to adjust the liability and
corresponding expense. Our estimates are based on the current requirements
in our Mileage Plan program and historical redemptions on Alaska, Horizon or
other airlines.3.
    
    The costs which will be incurred to carry the passenger: 33




---



##### Table of Contents



When the frequent flyer travels on his or her award ticket, incremental costs
such as food, fuel and insurance are incurred to carry that passenger. We
estimate what these costs (excluding any contribution to overhead and profit)
will be and accrue a liability. If the passenger travels on another airline
on an award ticket, we often must pay the other airline for carrying the
passenger. The other airline costs are based on negotiated agreements and
are often substantially higher than the costs we would incur to carry that
passenger. We estimate how much we will pay to other airlines for future travel awards based on
historical redemptions and settlements with other carriers and accrue a
liability accordingly. The costs actually incurred by us or paid to other
airlines may be higher or lower than the costs that were estimated and
accrued, we may need to adjust our liability and corresponding expense.4.
    
    Redemption on Alaska or Horizon versus other airlines:The cost for Alaska or Horizon to carry an award passenger is typically lower
than the cost we will pay to other airlines. We estimate the number of
awards which will be redeemed on Alaska or Horizon versus other airlines and
accrue the costs on this based on our estimate of historical redemption
patterns. If the number of awards redeemed on other airlines is higher or
lower than estimated, we may need to adjust our liability and corresponding
expense. We review all Mileage Plan estimates each quarter, and change our assumptions
if facts and circumstances indicate that a change is necessary. Any such
change in assumptions could have a significant effect on our financial position
and results of operations. Pension Plans We account for the defined benefit pension plans using SFAS No. 87, Employers
Accounting for Pensions. Under SFAS No. 87, pension expense is recognized on
an accrual basis over employees approximate service periods. Pension expense
calculated under SFAS No. 87 is generally independent of funding decisions or
requirements. We recognized expense for our defined benefit pension plans of
$20.0 million, $40.0 million and $73.5 million in 2001, 2002 and 2003,
respectively. The calculation of pension expense and the corresponding liability requires
the use of a number of important assumptions, including the expected long-term
rate of return on plan assets and the assumed discount rate. Changes in these
assumptions can result in different expense and liability amounts, and future
actual experience can differ from these assumptions. At December 31, 2003, the
fair value of our pension plan assets totaled $529.5 million. We anticipate
making a cash contribution of approximately $49.0 million during 2004. Pension expense increases as the expected rate of return on pension plan assets
decreases. At December 31, 2003, we estimate that the pension plan assets will
generate a long-term rate of return of 8.0%. This rate is equal to the assumed
rate of 8.0% used at December 31, 2002, and was developed by evaluating input
from consultants and economists as well as long-term inflation assumptions. We
regularly review the actual asset allocation and periodically rebalance
investments as considered appropriate. This expected long-term rate of return
on plan assets at December 31, 2003 is based on an allocation of U.S. equities
and U.S. fixed income securities. Decreasing the expected long-term rate of
return by 0.5% (from 8.0% to 7.5%) would increase our estimated 2004 pension
expense by approximately $2.7 million. 34




---



##### Table of Contents



Pension liability and future pension expense increase as the discount rate is
reduced. We discounted future pension obligations using a rate of 6.75% and
6.00% at December 31, 2002 and 2003, respectively. The discount rate is
determined based on the current rates earned on high quality long-term bonds.
Decreasing the discount rate by 0.5% (from 6.00% to 5.50%) would increase our
accumulated benefit obligation at December 31, 2003 by approximately $51.0
million and increase estimated 2004 pension expense by approximately $9.8
million. Future changes in plan asset returns, assumed discount rates and various other
factors related to the participants in our pension plans will impact our future
pension expense and liabilities. We cannot predict what these factors will be
in the future. Long-lived Assets As of December 31, 2003, we had approximately $1.8 billion of property and
equipment and related assets. In accounting for these long-lived assets, we
make estimates about the expected useful lives of the assets, the expected
residual values of the assets, and the potential for impairment based on the
fair value of the assets and the cash flows they generate. Factors indicating
potential impairment include, but are not limited to, significant decreases in
the market value of the long-lived assets, a significant change in the
long-lived assets condition, and operating cash flow losses associated with the
use of the long-lived asset. Due to the events of September 11 and the impact
on the airline industry, in 2001 we evaluated whether the book value of our
aircraft was impaired in accordance with SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.
We performed an impairment test, as required by SFAS No. 121, which was based
on the estimated future undiscounted cash flows to be generated by our
aircraft. Based on this test, we determined that no impairment write-down was
necessary for our fleet. In 2002 and 2003, due to volatile economic conditions and indications of
declining aircraft market values, we evaluated whether the book value of our
aircraft was impaired in accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. (This statement supercedes SFAS
No. 121.) No impairment was necessary based on the results of the evaluations. There is inherent risk in estimating the future cash flows used in the
impairment test. If cash flows do not materialize as estimated, there is a
risk the impairment charges recognized to date may be inaccurate, or further
impairment charges may be necessary in the future. Liquidity and Capital Resources The table below presents the major indicators of financial condition and
liquidity. December 31, 2002
    
    December 31, 2003
    
    Change(In millions, except debt-to-capital and per-share amounts)Cash and marketable securities
    
    $
    635.7
    
    
    $
    811.9
    
    
    $
    176.2Working capital
    
    
    226.3
    
    
    
    179.7
    
    
    
    (46.6
    )Long-term debt and
capital lease obligations
    
    
    856.7
    
    
    
    756.8
    
    
    
    (99.9
    )
 35




---



##### Table of Contents



December 31, 2002
    
    December 31, 2003
    
    Change(In millions, except debt-to-capital and per-share amounts)Shareholders equity
    
    
    569.7
    
    
    
    698.1
    
    
    
    128.4Long-term Debt-to-capital
    
    
    60%:40
    %
    
    
    52%:48
    %
    
    NALong-term Debt-to-capital assuming aircraft
operating leases are capitalized
at seven times annualized rent
    
    
    75%:25
    %
    
    
    70%:30
    %
    
    NA
 We plan to meet our capital and operating commitments through cash and
marketable securities on hand at December 31, 2003 of $811.9 million and
internally generated funds from operations. During 2003, we received $123.6
million in capital contributions from Air Group (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. During the year ended 2003, our cash and marketable securities increased $176.2
million to $811.9 million at December 31, 2003. This increase primarily
reflects cash provided by operating activities of $318.6 million and cash
provided by financing activities of $181.8 million, partially offset by cash
used for the purchase of property and equipment of $307.7 million and $15.2
million paid for restricted deposits and other. Cash Provided by Operating Activities Net cash provided by operating activities was $318.6 million in 2003, compared
to $119.6 million in 2002 and $282.9 million in 2001. Significant cash flows
in 2003 included the receipt of $52.8 million from the government under the
Emergency Wartime Supplemental Appropriations Act in May 2003 and our payment
of $40 million to fund our defined benefit plans. The increase in cash flows
from 2002 to 2003 also resulted from a reduction in our net loss from 2002.
Other contributing factors to our operating cash flow include year over year
increases in air traffic liabilities and other current liabilities. Cash flows
from operations in 2001 include the receipt of $71.6 million in U.S. government
cash compensation received under the Air Transportation and Safety and System
Stabilization Act. Cash Used in Investing Activities Cash used in investing activities was $576.8 million in 2003 compared to $355.6
million in 2002 and $213.0 million in 2001. In 2003, we had net purchases of
$253.9 million of marketable securities and $307.7 million for property and
equipment. Our aircraft related capital expenditures increased $150.3 million
over 2002, primarily reflecting additional aircraft added to our operating
fleet including six 737-700s and five 737-900s. Cash Provided by Financing Activities In 2003, cash provided by financing activities was $181.8 million, reflecting
capital contributions received from Air Group of $123.6 million and new debt
issuances of $129.5 million, offset by long-term debt and capital lease
payments of $71.3 million. Additionally, debt issuances of $129.5 million, $58.0 million and $234.5
million in 2003, 2002 and 2001, respectively, were secured by the related
flight equipment, including the purchase of four, one and eight new Boeing
aircraft in 2003, 2002 and 2001, respectively, and one used Boeing 737 aircraft
in 2001. The 2003 debt issuances have interest rates that vary with the London
Interbank Offered Rate (LIBOR) and payment terms ranging from 12 to 15 years. 36




---



##### Table of Contents



Contractual Obligations, Commitments and Off-Balance Sheet Arrangements At December 31, 2003, we had firm orders for three aircraft requiring aggregate
payments of approximately $110 million, as set forth below. In addition, we
have options to acquire 26 additional B737s. We expect to finance the new
aircraft 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 and payments
by year: Delivery Period - Firm OrdersBeyondAircraft
    
    2004
    
    2005
    
    2006
    
    TotalBoeing 737-900
    
    
    1
    
    
    
    2
    
    
    
    
    
    
    
    3Payments (Millions)
    
    $
    53
    
    
    $
    57
    
    
    $
    
    
    
    $
    110
 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 additional periodic pre-delivery deposits to the manufacturer for the
aircraft. Under certain specified events, including default by the Trust, we
may be required to pay the manufacturer the amounts to be 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 payments 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 December 31, 2003, our obligations relating to such advances
equaled approximately $11.6 million which will be paid in 2004. This amount is
included as an aircraft purchase commitment in the summary of contractual
obligations below. The following table provides a summary of our current and long-term debt
obligations, capital lease obligations, operating lease commitments and
aircraft purchase commitments as of December 31, 2003. This table excludes
other obligations that we may have, such as pension obligations (discussed in
Note 7 to Financial Statements) and routine purchase obligations entered into
in the normal course of business. Beyond(in millions)
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    2008
    
    TotalCurrent and long-term debt
    
    $
    198.6
    
    
    $
    45.9
    
    
    $
    49.1
    
    
    $
    51.9
    
    
    $
    54.9
    
    
    $
    554.7
    
    
    $
    955.1Capital lease obligations
    
    
    1.8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.8Operating lease commitments
    
    
    175.8
    
    
    
    170.9
    
    
    
    133.5
    
    
    
    102.5
    
    
    
    101.9
    
    
    
    579.2
    
    
    
    1,263.8Aircraft purchase commitments
    
    
    52.7
    
    
    
    57.1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    109.8Total
    
    $
    428.9
    
    
    $
    273.9
    
    
    $
    182.6
    
    
    $
    154.4
    
    
    $
    156.8
    
    
    $
    1,133.9
    
    
    $
    2,330.5
 As described in Note 6 to the Financial Statements, the 2004 capital lease
obligation recorded on our balance sheet primarily represents the end of lease
buyouts of two airplanes totaling $6.2 million. In January 2004, subsequent to
year end, these leases were renegotiated and will be 37




---



##### Table of Contents



reflected as operating leases in future periods. The table above excludes the
capital lease obligation recorded at December 31, 2003 related to the two
aircraft. Our $150 million credit facility expires and is due in December 2004.
Management is considering various alternatives including renewing or replacing
the credit facility although there can be no assurance that this can be
accomplished on acceptable terms to the Company. Management also intends to make funding payments to our defined benefit plans
during 2003 totaling $49 million. In 2003, Air Group completed the private placement of $150.0 million of
floating rate senior convertible notes due in 2023 pursuant to Rule 144A of the
Securities Act of 1933, as amended. Net proceeds from the offering were $144.9
million, of which $22.3 million was used to acquire U.S. government securities
to fund the first three years of interest payments. In 2003, Air Group made a
capital contribution of the remaining net proceeds from the sale of the notes
to Alaska. Alaska has used the remaining proceeds from the notes for working
capital requirements such as fuel, rent, maintenance or payroll costs as well
as other purposes, which may include the acquisition of
aircraft and other capital assets, repayment of debt, and maintenance of
desired cash balances. Although we have not yet determined how each payment of
principal or interest due will be funded in the future, we anticipate that
these payments will be funded either by dividends, distributions, loans,
advances or other payments from Air Group subsidiaries including
Alaska, or through new borrowings or
financings by Alaska Air Group. Any such payments could be subject to statutory or contractual restrictions. Currently, the only
contractual restrictions are contained in our $150 million credit
facility, which expires in December 2004 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 investments, lease
obligations, sales of assets, and additional indebtedness. Such provisions
limit the amount of funds we can distribute to Alaska Air Group. As of
December 31, 2003, $104.1 million was available to distribute to Alaska Air
Group via dividend without violating the covenants in Alaskas credit facility.
The notes do not restrict our ability to enter into
additional agreements limiting or prohibiting the distribution of earnings,
loans or other payments to Alaska Air Group. No dividends were paid to Alaska
Air Group during the years ended December 31, 2001, 2002 and 2003. At December
31, 2003, we were in compliance with all loan provisions. New Accounting Standards In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities.
FIN 46, as amended by FIN 46 (Revised) in December 2003, requires consolidation
of certain types of entities in which the Company absorbs a majority of the
entitys expected losses, receives a majority of the entitys expected returns,
or both, as a result of ownership, contractual or other financial interests in
the entity. These entities are called variable interest entities. The
principal characteristics of variable interest entities are (1) an insufficient
amount of equity to absorb the entitys expected losses, (2) equity owners as a
group are not able to make decisions about the entitys activities, and (3)
equity that does not absorb the entitys losses or receive the entitys
residual returns. Variable interests are contractual, ownership or other
monetary interests in an entity that change with fluctuations in 38




---



##### Table of Contents



the entitys net asset value. As a result, variable interest entities can
arise from items such as lease agreements, loan arrangements, guarantees or
service contracts. If an entity is determined to be a variable interest entity, the entity must be
consolidated by the primary beneficiary. The primary beneficiary is the
holder of the variable interests that absorbs a majority of the variable
interest entitys expected losses or receives a majority of the entitys
residual returns in the event no holder has a majority of the expected losses.
There is no primary beneficiary in cases where no single holder absorbs the
majority of the expected losses or receives a majority of the residual returns.
The determination of the primary beneficiary is based on qualitative aspects
of the arrangements involved or projected cash flows at the inception of the
transaction with the variable interests entity. FIN 46 is applicable to financial statements of companies that have interests
in special purpose entities, as defined, during the year ended 2003. We are the lessee in a series of operating leases covering our leased aircraft.
In many instances, the lessors are trusts established by a third party
specifically to purchase, finance and lease aircraft to us. These leasing
entities meet the criteria for variable interest entities. However, they do
not meet the consolidation requirements of FIN 46 because we are not the
primary beneficiary of the entitys expected gains or losses. Our conclusions
are based on the fact that the leasing arrangements involved contain terms
which are consistent with market terms at the inception of the lease and do not
include residual value guarantees made by us, fixed-price purchase obligations
or similar features that obligate us to absorb the majority of expected losses
of the variable interest entities. Our maximum exposure under these types of
lease arrangements is the remaining lease payments, which are reflected in
future lease commitments in Note 5 (plus the cost, if any, of bringing the
equipment into compliance with the physical condition required for return). 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. SFAS No. 148 allowed companies
adopting the fair value based method of SFAS No. 123 to utilize one of three
alternative transition methods as long as SFAS No. 123 was adopted in a fiscal
year beginning prior to December 16, 2003. To date, the Company has not
adopted SFAS No. 123 and would therefore be required to use on of two methods
proscribed by SFAS No. 148 if it adopted SFAS No. 123 in the future. The FASB
currently is working on a project to develop a new standard for accounting for
stock-based compensation and expects to issue a final standard in the second
half of 2004. In September 2003, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants released a Draft Statement of
Position entitled Accounting for Certain Costs and Activities Related to
Property, Plant, and Equipment (Draft SOP). The Draft SOP, which is expected
to be issued in its final form in first quarter 2004, would become effective
for the Company January 1, 2005. The primary areas of applicability of the
Draft SOP to the Company are in the areas of planned major maintenance
activities (airframe and engine overhauls) and component accounting. 39




---



##### Table of Contents



As discussed in Property, Equipment and Depreciation, the Company currently
capitalizes costs related to major airframe and engine overhauls and amortizes
those costs to maintenance expense over the shorter of the life of the overhaul
or the remaining lease term. In the Draft SOP, these costs would be considered
a planned major maintenance activities and, as such, would be expensed as
incurred. 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 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK We have interest rate risk in our floating rate debt obligations and our
available for sale marketable investment portfolio, and commodity price risk in
jet fuel required to operate our aircraft fleet. We purchase jet fuel at
prevailing market prices, and seek to manage market risk through execution of a
documented hedging strategy. We have market sensitive instruments in the form
of fixed rate debt instruments and financial derivative instruments used to
hedge our exposure to jet fuel price increases. We do not purchase or hold any
derivative financial instruments for trading purposes. Fuel Hedging We utilize our fuel hedges as a form of insurance against significant increases
in fuel prices. We believe there is significant risk in not hedging against the
possibility of such fuel price increases. At December 31, 2003, Air Group had
fuel hedge contracts in place to hedge 132.1 million gallons of its expected
jet fuel usage in 2004, 116.1 million gallons in 2005 and 10.2 million gallons
in 2006. This represents 33%, 28% and 2% of Air Groups anticipated fuel
consumption in 2004, 2005 and 2006, respectively. Prices of these agreements
range from $26 to $28 per barrel. A hypothetical 10% increase in jet fuel
prices would increase 2004 fuel expense by approximately $28.3 million. A
hypothetical 10% decrease in jet fuel prices would decrease 2004 fuel expense
for Alaska by approximately $28.9 million. This analysis includes the effect
of the fuel hedging contracts in place at December 31, 2003. Currently, a
one-cent change in the fuel price per gallon affects annual fuel costs for
Alaska by approximately $3.4 million. 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. All changes in fair value that are considered to be
effective hedges are recorded in accumulated other comprehensive income (loss)
until the underlying jet fuel is consumed. To the extent the change in the
value of the fuel hedge contracts does not perfectly offset the change in the
value of the aircraft fuel purchase being hedged, the change is recognized in
earnings as part of nonoperating income (expense) because we believe it better
portrays the results of our documented risk management strategy. That strategy
is to reduce, to the extent possible, volatility in West Coast Jet fuel prices
(our purchased commodity) through hedge contracts based on West Texas
Intermediate (WTI) crude (our purchased hedge commodity). We believe that market
fluctuations in the prices of West Coast jet that do not correlate with market
fluctuations in WTI crude are beyond our control and are thus classified in
nonoperating income (expense) in the statement of operations. As of December 31, 2002 and 2003, the fair values of our fuel hedge positions
were $14.0 million and $15.7 million, respectively. All of the 2002 fair value
amounts and $10.3 million of the 2003 40




---



##### Table of Contents



fair value amounts are included in prepaid expenses and other current assets in the balance
sheets. The remaining 2003 fair value amount of $5.4 million is reflected in
other assets in the balance sheets. During 2002 and 2003, we recognized $6.3 million and $19.6 million,
respectively, in realized hedging gains, which are reflected in aircraft fuel
in our Statements of Operations. Hedge ineffectiveness resulted in nonoperating expense of $5.9 million for
2001, nonoperating income of $8.5 million for 2002 and nonoperating income of
$6.8 million for 2003. These amounts are recorded as nonoperating income
(expense) in other-net in our Statements of Operations. In 2002 and 2003, we recorded a net gain of $8.0 million and a net loss of $0.6
million, net of tax, in other comprehensive income (loss). These amounts
include 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 2002 and 2003. Financial Market Risk We have exposure to market risk associated with changes in interest rates
related primarily to our debt obligations and short-term investment portfolio.
Our debt obligations include variable rates, which have exposure to changes in
interest rates. A hypothetical 10% change in the average interest rates
incurred on variable rate debt during 2003 would correspondingly change our net
earnings and cash flows associated with these items by approximately $2.6
million. During 2003, we issued $129.5 million ($65.0 million in the second quarter of
2003, $32.0 million in the third quarter of 2003, and $32.5 million in the
fourth quarter of 2003) of debt secured by flight equipment, having interest
rates that vary with LIBOR and payment terms ranging from 12 to 15 years. We also have investments in marketable securities, which are exposed to market
risk associated with changes in interest rates. If short-term interest rates
were to average 1% more than they did in 2003, interest income would increase
by 50 basis points. 41




---



##### Table of Contents



ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Item 15. Revision to Previously Filed Financial Statements and SEC Filings We previously recorded unrealized gains and losses related to the ineffective
portion of changes in fair value of our fuel hedge positions as nonoperating
income (expense) and then reclassified those gains and losses to fuel expense
as those hedges were settled. This practice was not consistent with our stated
policy, which was to record the ineffective portion in nonoperating income
(expense). We have revised our financial statements to adjust our historical
presentation of such items. Such revisions have resulted in reclassification
between operating income (loss) and nonoperating income (expense) in the
statements of operations. The revisions have no impact on previously reported
pretax income (loss), net income (loss), the balance sheets, the statement of
shareholders equity or the statements of cash flows for any prior periods.
They also have no impact on cost per ASM excluding fuel, a non-GAAP measure we
believe is important to some users of our financial statements. See Note 13 to
the financial statements for further discussion of this matter. The effects of the revisions for the quarterly periods in 2002 and 2003 is as
follows (in millions, except per share amounts): As Previously Reported: 1st Quarter
    
    2nd Quarter
    
    3rd Quarter
    
    4th Quarter2002 (a)
    
    2003
    
    2002
    
    2003 (b)
    
    2002
    
    2003
    
    2002
    
    2003 (c)Operating revenues
    
    $
    412.2
    
    
    $
    427.0
    
    
    $
    478.7
    
    
    $
    510.6
    
    
    $
    512.4
    
    
    $
    585.3
    
    
    $
    429.8
    
    
    $
    504.5Aircraft fuel
    
    
    55.2
    
    
    
    76.9
    
    
    
    64.2
    
    
    
    69.1
    
    
    
    70.7
    
    
    
    81.6
    
    
    
    67.2
    
    
    
    79.1Operating income (loss)
    
    
    (39.0
    )
    
    
    (61.6
    )
    
    
    (0.1
    )
    
    
    8.3
    
    
    
    18.8
    
    
    
    59.2
    
    
    
    (53.9
    )
    
    
    (19.9
    )Nonoperating income
(expense)
    
    
    (2.7
    )
    
    
    (9.0
    )
    
    
    0.1
    
    
    
    51.3
    
    
    
    (5.7
    )
    
    
    (9.1
    )
    
    
    (4.7
    )
    
    
    (7.4
    )Income (loss) before
accounting change
    
    
    (26.8
    )
    
    
    (45.1
    )
    
    
    (0.8
    )
    
    
    36.8
    
    
    
    8.9
    
    
    
    29.6
    
    
    
    (38.3
    )
    
    
    (18.3
    )Net income (loss)
    
    
    (39.3
    )
    
    
    (45.1
    )
    
    
    (0..8
    )
    
    
    36.8
    
    
    
    8.9
    
    
    
    29.6
    
    
    
    (38.3
    )
    
    
    (18.3
    )
  (a)
    
    Net loss for the three months ended March 31, 2002 includes $12.5 million
cumulative effect of the accounting change in connection with the
impairment of goodwill.(b)
    
    Net income for the three months ended June 30, 2003 includes $52.8
million (pretax) received related to assistance from the government under
the Emergency Wartime Supplemental Appropriations Act.(c)
    
    Operating loss for the three months ended December 31, 2003 includes
adjustments to increase operating expenses by $2.4 million (pretax)
related to prior years. Operating loss for the three months ended
December 31, 2003 also includes adjustments to increase operating expenses
by $1.8 million (pretax) and increase operating revenues by $6.3 million
(pretax), both related to previous quarters in 2003. These adjustments to
operating expenses represent corrections to maintenance expense ($3.6
million) and wages and benefits ($1.0 million) in the aggregate. The
adjustment to operating revenues resulted from a correction to deferred
revenue as a result of planned deletions of certain accounts with expired
miles. In addition, interest income for the 2003 year includes a
correction to investment premium amortization recorded in the first
quarter that reduced interest income by $2.8 million (pretax) related to
the previous year. Management does not believe that these amounts are
material to the periods affected. Revised: 1st Quarter
    
    2nd Quarter
    
    3rd Quarter
    
    4th Quarter2002 (a)
    
    2003
    
    2002 (d)
    
    2003 (b)(d)
    
    2002 (d)
    
    2003 (d)
    
    2002 (d)
    
    2003 (c)(d)Operating revenues
    
    $
    412.2
    
    
    $
    427.0
    
    
    $
    478.7
    
    
    $
    510.6
    
    
    $
    512.4
    
    
    $
    585.3
    
    
    $
    429.8
    
    
    $
    504.5
 42




---



##### Table of Contents



1st Quarter
    
    2nd Quarter
    
    3rd Quarter
    
    4th Quarter2002 (a)
    
    2003
    
    2002 (d)
    
    2003 (b)(d)
    
    2002 (d)
    
    2003 (d)
    
    2002 (d)
    
    2003 (c)(d)Aircraft fuel
    
    
    55.2
    
    
    
    76.9
    
    
    
    65.4
    
    
    
    72.0
    
    
    
    71.9
    
    
    
    83.3
    
    
    
    68.2
    
    
    
    79.9Operating income (loss)
    
    
    (39.0
    )
    
    
    (61.6
    )
    
    
    (1.3
    )
    
    
    5.4
    
    
    
    17.6
    
    
    
    57.5
    
    
    
    (54.9
    )
    
    
    (20.7
    )Nonoperating income
(expense)
    
    
    (2.7
    )
    
    
    (9.0
    )
    
    
    1.2
    
    
    
    54.2
    
    
    
    (4.5
    )
    
    
    (7.4
    )
    
    
    (3.7
    )
    
    
    (6.6
    )Income (loss) before
accounting change
    
    
    (26.8
    )
    
    
    (45.1
    )
    
    
    (0.8
    )
    
    
    36.8
    
    
    
    8.9
    
    
    
    29.6
    
    
    
    (38.3
    )
    
    
    (18.3
    )Net income (loss)
    
    
    (39.3
    )
    
    
    (45.1
    )
    
    
    (0.8
    )
    
    
    36.8
    
    
    
    8.9
    
    
    
    29.6
    
    
    
    (38.3
    )
    
    
    (18.3
    )
  (a)
    
    Net loss for the three months ended March 31, 2002 includes $12.5 million
cumulative effect of the accounting change in connection with the
impairment of goodwill.(b)
    
    Net income for the three months ended June 30, 2003 includes $52.8
million (pretax) received related to assistance from the government under
the Emergency Wartime Supplemental Appropriations Act.(c)
    
    Operating loss for the three months ended December 31, 2003 includes
adjustments to increase operating expenses by $2.4 million (pretax)
related to prior years. Operating loss for the three months ended
December 31, 2003 also includes adjustments to increase operating expenses
by $1.8 million (pretax) and increase operating revenues by $6.3 million
(pretax), both related to previous quarters in 2003. These adjustments to
operating expenses represent corrections to maintenance expense ($3.6
million) and wages and benefits ($1.0 million) in the aggregate. The
adjustment to operating revenues resulted from a correction to deferred
revenue as a result of planned deletions of certain accounts with expired
miles. In addition, interest income for the 2003 year includes a
correction to investment premium amortization recorded in the first
quarter that reduced interest income by $2.8 million (pretax) related to
the previous year. Management does not believe that these amounts are
material to the periods affected.(d)
    
    Aircraft fuel, operating income (loss) and nonoperating income (expense)
for the three months ended June 30, 2002 and 2003, September 20, 2002 and
2003 and December 31, 2002 and 2003 have been revised to reflect the
ineffective portion of changes in fair value of fuel hedge positions as a
component of nonoperating income (expense). 
 ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None 
 ITEM 9A.CONTROLS AND PROCEDURES As of December 31, 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, 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 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. As discussed in Air Groups Form 8-K filed with the Commission on February 27,
2004, subsequent to Air Groups January 28, 2004 press release summarizing Air
Groups fourth quarter and full year 2003 financial results, further review of
the Mileage Plan liability and related deferred revenue as of December 31, 2003
revealed that these amounts had not been fully adjusted to reflect planned
deletions of certain accounts with expired miles. The consequent adjustment to
reduce the total Mileage Plan liability and deferred revenue estimate from
$344.4 million to $336.0 million resulted in an $8.4 million (pretax) increase
in total revenues for the fourth quarter and full year which is reflected in
the consolidated financial statements included herein. This resulted from a
deficiency in the application of computer system change control procedures,
which did not identify a mileage plan coding error nor was the error discovered
in 43




---



##### Table of Contents



the normal account review process. Management believes that controls are now
in place to ensure that expired miles are deleted appropriately. We made no changes in our internal controls over financial reporting during the
fiscal quarter ended December 31, 2003, 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 these controls and procedures in the future. 
 PART IV 
 ITEM 15.EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Financial Statements: Page(s)Selected Quarterly Financial Information (Unaudited)
    
    
    42Balance Sheets as of December 31, 2002 and 2003
    
    
    46-47Statements of Operations for the years ended
December 31, 2001, 2002 and 2003 (as revised)
    
    
    48Statements of Shareholders Equity for the years ended
December 31, 2001, 2002 and 2003
    
    
    49Statements of Cash Flows for the years ended
December 31, 2001, 2002 and 2003
    
    
    50Notes to Financial Statements
    
    
    51-65Independent Auditors Report
    
    
    66Financial Statement Schedule II, Valuation and Qualifying Accounts,
for the years ended December 31, 2001, 2002 and 2003
    
    
    67
 See Exhibit Index on
page 68.  (b)
    
    During the fourth quarter of 2003, we filed or furnished the following
reports on Form 8-K: December 19, 2003:Item 5. Other Events and Item 7. Financial Statements
and Exhibits. No financial statements were filed with the report, which
included a press release announcing that the Alaska Airlines Pilots Negotiating
Team had decided to terminate the current round of early contract
negotiations with Alaska Airlines management. 44




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
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.By:
    
    /s/ William S. Ayer
    
    Date: May 20, 2004William S. Ayer, Chairman and Chief Executive Officer
 Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on May 20, 2004 on behalf
of the registrant and in the capacities indicated. /s/ William S. Ayer
    
    Chairman, President, Chief Executive Officer and DirectorWilliam S. Ayer/s/ Bradley D. Tilden
    
    Executive Vice President/Finance and Chief Financial Officer(Principal Financial Officer)Bradley D. Tilden/s/ Brandon S. Pedersen
    
    Staff Vice President/Finance and Controller(Principal Accounting Officer)Brandon S. Pedersen
 45




---



##### Table of Contents



BALANCE SHEETS
Alaska Airlines, Inc. ASSETS As of December 31 (In Millions)
    
    2002
    
    2003Current AssetsCash and cash equivalents
    
    $
    268.9
    
    
    $
    192.5Marketable securities
    
    
    366.8
    
    
    
    619.4Receivables from related companies
    
    
    126.7
    
    
    
    120.5Receivables  less allowance for doubtful accounts
(2002 - $1.9; 2003 - $1.6)
    
    
    81.8
    
    
    
    83.0Inventories and supplies  net
    
    
    24.6
    
    
    
    20.7Deferred income taxes
    
    
    60.2
    
    
    
    80.9Prepaid expenses and other assets
    
    
    47.5
    
    
    
    36.3Total Current Assets
    
    
    976.5
    
    
    
    1,153.3Property and EquipmentFlight equipment
    
    
    1,959.2
    
    
    
    2,188.2Other property and equipment
    
    
    359.3
    
    
    
    391.2Deposits for future flight equipment
    
    
    64.7
    
    
    
    32.82,383.2
    
    
    
    2,612.2Less accumulated depreciation & amortization
    
    
    709.4
    
    
    
    816.3Total Property and Equipment  Net
    
    
    1,673.8
    
    
    
    1,795.9Intangible Assets
    
    
    50.9
    
    
    
    45.6Other Assets
    
    
    49.9
    
    
    
    71.6Total Assets
    
    $
    2,751.1
    
    
    $
    3,066.4
 See accompanying notes to financial statements. 46




---



##### Table of Contents



BALANCE SHEETS
Alaska Airlines, Inc. LIABILITIES AND
SHAREHOLDERS EQUITY As of December 31 (In Millions Except Share Amounts)
    
    2002
    
    2003Current LiabilitiesAccounts payable
    
    $
    118.5
    
    
    $
    108.8Payables to related companies
    
    
    1.7
    
    
    
    2.7Accrued aircraft rent
    
    
    67.5
    
    
    
    67.8Accrued wages, vacation and payroll taxes
    
    
    76.3
    
    
    
    81.4Other accrued liabilities
    
    
    226.5
    
    
    
    269.1Air traffic liability
    
    
    211.1
    
    
    
    237.1Current portion of long-term debt and
capital lease obligations
    
    
    48.6
    
    
    
    206.7Total Current Liabilities
    
    
    750.2
    
    
    
    973.6Long-Term Debt & Capital Lease Obligations, Net of Current
    
    
    856.7
    
    
    
    756.8Other Liabilities and CreditsDeferred income taxes
    
    
    153.7
    
    
    
    181.4Deferred revenue
    
    
    224.5
    
    
    
    246.0Other liabilities
    
    
    196.3
    
    
    
    210.5574.5
    
    
    
    637.9Commitments and ContingenciesShareholders EquityCommon stock, $1 par valueAuthorized: 1,000 sharesIssued: 2002 and 2003 - 500 shares
    
    
    
    
    
    
    Capital in excess of par value
    
    
    324.8
    
    
    
    448.4Accumulated other comprehensive loss
    
    
    (82.0
    )
    
    
    (80.2
    )Retained earnings
    
    
    326.9
    
    
    
    329.9569.7
    
    
    
    698.1Total Liabilities and Shareholders Equity
    
    $
    2,751.1
    
    
    $
    3,066.4
 See accompanying notes to financial statements. 47




---



##### Table of Contents



STATEMENTS OF OPERATIONS
Alaska Airlines, Inc. Year Ended December 31(In Millions)
    
    2001
    
    2002
    
    2003Revised (See Note 13)
    
    Revised (See Note 13)Operating RevenuesPassenger
    
    $
    1,607.6
    
    
    $
    1,667.7
    
    
    $
    1,840.4Freight and mail
    
    
    78.2
    
    
    
    72.1
    
    
    
    77.3Other  net
    
    
    77.2
    
    
    
    93.3
    
    
    
    109.7Total Operating Revenues
    
    
    1,763.0
    
    
    
    1,833.1
    
    
    
    2,027.4Operating ExpensesWages and benefits
    
    
    642.9
    
    
    
    703.4
    
    
    
    778.6Employee profit sharing
    
    
    
    
    
    
    
    
    
    
    2.9Contracted services
    
    
    76.0
    
    
    
    80.1
    
    
    
    81.6Aircraft fuel
    
    
    269.8
    
    
    
    260.7
    
    
    
    312.1Aircraft maintenance
    
    
    129.7
    
    
    
    145.2
    
    
    
    153.4Aircraft rent
    
    
    137.6
    
    
    
    128.2
    
    
    
    123.9Food and beverage service
    
    
    55.5
    
    
    
    63.5
    
    
    
    58.7Other selling expenses and commissions
    
    
    166.8
    
    
    
    154.6
    
    
    
    148.0Depreciation and amortization
    
    
    106.1
    
    
    
    114.0
    
    
    
    119.5Loss on sale of assets
    
    
    5.0
    
    
    
    1.7
    
    
    
    3.4Landing fees and other rentals
    
    
    99.5
    
    
    
    110.5
    
    
    
    127.8Other
    
    
    145.7
    
    
    
    148.8
    
    
    
    136.9Total Operating Expenses
    
    
    1,834.6
    
    
    
    1,910.7
    
    
    
    2,046.8Operating Loss
    
    
    (71.6
    )
    
    
    (77.6
    )
    
    
    (19.4
    )Nonoperating Income (Expense)Interest income
    
    
    26.0
    
    
    
    23.2
    
    
    
    15.2Interest expense
    
    
    (47.4
    )
    
    
    (46.6
    )
    
    
    (45.2
    )Interest capitalized
    
    
    7.5
    
    
    
    2.1
    
    
    
    1.5U.S. government compensation
    
    
    71.6
    
    
    
    0.3
    
    
    
    52.8Other  net
    
    
    (2.5
    )
    
    
    11.3
    
    
    
    6.955.2
    
    
    
    (9.7
    )
    
    
    31.2Income (loss) before income tax and accounting change
    
    
    (16.4
    )
    
    
    (87.3
    )
    
    
    11.8Income tax expense (benefit)
    
    
    (4.6
    )
    
    
    (30.3
    )
    
    
    8.8Income (loss) before accounting change
    
    
    (11.8
    )
    
    
    (57.0
    )
    
    
    3.0Cumulative effect of accounting change
    
    
    
    
    
    
    (12.5
    )
    
    
    Net Income (Loss)
    
    $
    (11.8
    )
    
    $
    (69.5
    )
    
    $
    3.0
 See accompanying notes to financial statements. 48




---



##### Table of Contents



STATEMENTS OF SHAREHOLDERS EQUITY
Alaska Airlines, Inc. AccumulatedCapital in
    
    OtherCommon
    
    Excess of
    
    Comprehensive
    
    Retained(In Millions)
    
    Stock
    
    Par Value
    
    Income (Loss)
    
    Earnings
    
    TotalBalances at December 31, 2000
    
    
    
    
    
    $
    324.8
    
    
    $
    (0.4
    )
    
    $
    408.2
    
    
    $
    732.62001 net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11.8
    )
    
    
    (11.8
    )Other comprehensive income (loss):Officers supplemental retirement plan
net of $0.4 tax benefit
    
    
    
    
    
    
    
    
    
    
    (0.7
    )
    
    
    
    
    
    
    (0.7
    )Related to marketable securities:Change in fair value
    
    
    
    
    
    
    
    
    
    
    3.4Reclassification to earnings
    
    
    
    
    
    
    
    
    
    
    (3.5
    )Income tax effect
    
    
    
    
    
    
    
    
    
    
    (0.1
    )
    
    
    
    
    
    
    (0.1
    )Related to fuel hedges:Change in fair value
    
    
    
    
    
    
    
    
    
    
    (1.7
    )Income tax effect
    
    
    
    
    
    
    
    
    
    
    0.7(1.0
    )
    
    
    
    
    
    
    (1.0
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (13.6
    )Balances at December 31, 2001
    
    
    
    
    
    
    324.8
    
    
    
    (2.2
    )
    
    
    396.4
    
    
    
    719.02002 net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (69.5
    )
    
    
    (69.5
    )Other comprehensive income (loss):Officers supplemental retirement plan
net of $0.4 tax benefit
    
    
    
    
    
    
    
    
    
    
    (0.7
    )
    
    
    
    
    
    
    (0.7
    )Related to marketable securities:Change in fair value
    
    
    
    
    
    
    
    
    
    
    (0.4
    )Reclassification to earnings
    
    
    
    
    
    
    
    
    
    
    0.6Income tax effect
    
    
    
    
    
    
    
    
    
    
    (0.1
    )0.1
    
    
    
    
    
    
    
    0.1Related to fuel hedges:Change in fair value
    
    
    
    
    
    
    
    
    
    
    22.5Reclassification to earnings
    
    
    
    
    
    
    
    
    
    
    (9.7
    )Income tax effect
    
    
    
    
    
    
    
    
    
    
    (4.8
    )8.0
    
    
    
    
    
    
    
    8.0Minimum pension liability adjustment
net of $52.5 tax benefit
    
    
    
    
    
    
    
    
    
    
    (87.2
    )
    
    
    
    
    
    
    (87.2
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (149.3
    )Balances at December 31, 2002
    
    
    
    
    
    
    324.8
    
    
    
    (82.0
    )
    
    
    326.9
    
    
    
    569.72003 net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.0
    
    
    
    3.0Other comprehensive income (loss):Officers supplemental retirement plan
net of $1.0 tax benefit
    
    
    
    
    
    
    
    
    
    
    (2.0
    )
    
    
    
    
    
    
    (2.0
    )Related to marketable securities:Change in fair value
    
    
    
    
    
    
    
    
    
    
    (1.2
    )Reclassification to earnings
    
    
    
    
    
    
    
    
    
    
    (0.1
    )Income tax effect
    
    
    
    
    
    
    
    
    
    
    0.5(0.8
    )
    
    
    
    
    
    
    (0.8
    )Related to fuel hedges:Change in fair value
    
    
    
    
    
    
    
    
    
    
    24.0Reclassification to earnings
    
    
    
    
    
    
    
    
    
    
    (25.0
    )Income tax effect
    
    
    
    
    
    
    
    
    
    
    0.4(0.6
    )
    
    
    
    
    
    
    (0.6
    )Minimum pension liability adjustment
net of $3.3 tax expense
    
    
    
    
    
    
    
    
    
    
    5.2
    
    
    
    
    
    
    
    5.2Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4.8Capital contribution from Air Group
    
    
    
    
    
    
    123.6
    
    
    
    
    
    
    
    
    
    
    
    123.6Balances at December 31, 2003
    
    $
    
    
    
    $
    448.4
    
    
    $
    (80.2
    )
    
    $
    329.9
    
    
    $
    698.1
 See accompanying notes to financial statements. 49




---



##### Table of Contents



STATEMENTS OF CASH FLOWS
Alaska Airlines, Inc. Year Ended December 31 (In Millions)
    
    2001
    
    2002
    
    2003Cash flows from operating activities:Net income (loss)
    
    $
    (11.8
    )
    
    $
    (69.5
    )
    
    $
    3.0Adjustments to reconcile net loss to
net cash provided by operating activities:Cumulative effect of accounting change
    
    
    
    
    
    
    12.5
    
    
    
    Depreciation and amortization
    
    
    106.1
    
    
    
    114.2
    
    
    
    119.5Amortization of airframe and engine overhauls
    
    
    56.7
    
    
    
    59.8
    
    
    
    63.8Changes in derivatives fair values
    
    
    4.9
    
    
    
    (4.7
    )
    
    
    2.3Loss on sale of assets
    
    
    5.0
    
    
    
    1.7
    
    
    
    3.4Increase in deferred income tax liabilities
    
    
    31.4
    
    
    
    19.5
    
    
    
    5.7(Increase) decrease in accounts receivable  net
    
    
    14.3
    
    
    
    (70.0
    )
    
    
    5.0(Increase) decrease in other current assets
    
    
    (6.4
    )
    
    
    (15.9
    )
    
    
    4.0Increase (decrease) in air traffic liability
    
    
    7.7
    
    
    
    (5.3
    )
    
    
    26.0Increase in other current liabilities
    
    
    44.0
    
    
    
    20.9
    
    
    
    39.3Increase in deferred revenue and other-net
    
    
    31.0
    
    
    
    56.4
    
    
    
    46.6Net cash provided by operating activities
    
    
    282.9
    
    
    
    119.6
    
    
    
    318.6Cash flows from investing activities:Proceeds from disposition of assets
    
    
    1.2
    
    
    
    1.3
    
    
    
    0.5Purchases of marketable securities
    
    
    (258.5
    )
    
    
    (630.8
    )
    
    
    (942.9
    )Sales and maturities of marketable securities
    
    
    446.4
    
    
    
    433.9
    
    
    
    689.0Aircraft deposits returned
    
    
    9.0
    
    
    
    22.4
    
    
    
    1.2Property and equipment additions:Aircraft purchase deposits
    
    
    (37.9
    )
    
    
    (22.1
    )
    
    
    (7.6
    )Capitalized overhauls
    
    
    (45.5
    )
    
    
    (56.2
    )
    
    
    (62.0
    )Aircraft
    
    
    (257.5
    )
    
    
    (40.6
    )
    
    
    (196.5
    )Other flight equipment
    
    
    (31.8
    )
    
    
    (8.8
    )
    
    
    (11.9
    )Other property
    
    
    (37.3
    )
    
    
    (40.9
    )
    
    
    (31.4
    )Restricted deposits and other
    
    
    (1.1
    )
    
    
    (13.8
    )
    
    
    (15.2
    )Net cash used in investing activities
    
    
    (213.0
    )
    
    
    (355.6
    )
    
    
    (576.8
    )Cash flows from financing activities:Proceeds from issuance of long-term debt, net
    
    
    388.8
    
    
    
    58.0
    
    
    
    129.5Long-term debt and capital lease payments
    
    
    (69.2
    )
    
    
    (43.8
    )
    
    
    (71.3
    )Capital contribution from Air Group
    
    
    
    
    
    
    
    
    
    
    123.6Net cash provided by financing activities
    
    
    319.6
    
    
    
    14.2
    
    
    
    181.8Net change in cash and cash equivalents
    
    
    389.5
    
    
    
    (221.8
    )
    
    
    (76.4
    )Cash and cash equivalents at beginning of year
    
    
    101.2
    
    
    
    490.7
    
    
    
    268.9Cash and cash equivalents at end of year
    
    $
    490.7
    
    
    $
    268.9
    
    
    $
    192.5Supplemental disclosure of cash paid (refunded)
during the year for:Interest (net of amount capitalized)
    
    $
    49.9
    
    
    $
    45.2
    
    
    $
    43.3Income taxes
    
    
    (18.4
    )
    
    
    (22.8
    )
    
    
    (0.4
    )See accompanying notes to financial statements.
 50




---



##### Table of Contents



NOTES TO FINANCIAL STATEMENTS
Alaska Airlines, Inc.
December 31, 2003 Note 1. Summary of Significant Accounting Policies Organization and Basis of Presentation Alaska Airlines, Inc. (Alaska or the Company), an Alaska corporation, is a
wholly owned subsidiary of Alaska Air Group, Inc. (Air Group), a Delaware
corporation. Air Group is also the parent company of Alaska Air Group Leasing
(AAGL) 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 and their
preparation requires the use of managements estimates. Actual results could
differ from these estimates. Certain reclassifications have been made in prior
years financial statements to conform to the 2003 presentation. Nature of Operations Alaska is a major airline serving primarily Alaska; the U.S. West Coast; five
cities on the U.S. East Coast; Vancouver, Canada; and Mexico. It operates an
all jet fleet and its average passenger trip is 967 miles. Substantially all
of Alaskas sales occur in the United States. Cash and Cash Equivalents Cash equivalents consist of highly liquid investments with original maturities
of three months or less. They are carried at cost, which approximates market.
The Company reduces cash balances when checks are disbursed. Due to the time
delay in checks clearing the banks, the Company normally maintains a negative
cash balance, which is reported as a current liability. The amount of the
negative cash balance was $24.8 million and $22.6 million at December 31, 2002
and 2003, respectively, and is included in accounts payable. Receivables Receivables consist primarily of airline traffic (including credit card)
receivables, amounts from customers, mileage plan partners, government tax
authorities, and other miscellaneous amounts due to the Company, and are net of
an allowance for doubtful accounts of $1.9 million at December 31, 2002 and
$1.6 million at December 31, 2003. Management determines the allowance for
doubtful accounts based on known troubled accounts and historical experience
applied to an aging of accounts. Inventories and Supplies  net Inventory is comprised of expendable, repairable and rotable flight equipment.
Expendable aircraft parts, materials and supplies are stated at average cost
and are included in inventories and supplies-net. Repairable and Rotable
inventory are included in flight equipment. An obsolescence allowance for
flight equipment expendable parts is accrued based on estimated disposal dates
and salvage values. Surplus inventories are carried at their net realizable
value. The allowance for all non-surplus expendable inventories was $14.4
million at December 31, 2002, and $16.6 million at December 31, 2003. Property, Equipment and Depreciation Property and equipment are recorded at cost and depreciated using the
straight-line method over their estimated useful lives, which are as follows: Aircraft and related flight equipment:Boeing 737-200C
    
    10-14 yearsBoeing 737-400/700/900
    
    20 yearsBoeing MD-80
    
    20 yearsBuildings
    
    10-30 years
 51




---



##### Table of Contents



Capitalized leases and
leasehold improvements
    
    Term of leaseOther equipment
    
    3-15 years
 Flight equipment includes repairable inventory parts, net of an obsolescence
allowance. As of December 31, 2002 and 2003, this allowance totaled $13.0
million and $12.6 million, respectively. Routine maintenance and repairs are expensed when incurred. The costs of major
airframe and engine overhauls are capitalized and amortized to maintenance
expense over the shorter of the life of the overhaul or the remaining lease
term. Major modifications that extend the life or improve the usefulness of
aircraft are capitalized and depreciated over their estimated period of use.
Assets and related obligations for items financed under capital leases are
initially recorded at an amount equal to the present value of the future
minimum lease payments. The Company reviews for impairment long-lived assets to be held and used
whenever events or changes in circumstances indicate that the total carrying
amount of an asset (asset group) may not be recoverable. The Company groups
assets for purposes of such reviews at the lowest level for which identifiable
cash flows of the asset group are largely independent of the cash flows of
other groups of assets and liabilities. An impairment loss is recognized when
estimated future undiscounted cash flows expected to result from the use of the
asset (asset group) and its eventual disposition are less than its carrying
amount. If the asset (asset group) is not considered recoverable, an amount
equal to the excess of the carrying amount over the fair value will be charged
against the asset (asset group) with a corresponding expense reflected in the
statement of operations. Internally-Used Software Costs The Company capitalizes costs to develop internal-use software that are
incurred in the application development stage. Amortization commences when the
software is ready for its intended use and the amortization period is the
estimated useful life of the software, generally three to five years.
Capitalized costs primarily include contract labor and payroll costs of the
individuals dedicated to the development of internal use software. The Company
capitalized software development costs of $9.2 million, $6.9 million and $3.2
million during the years ended December 31, 2001, 2002, and 2003, respectively. Deferred Revenue Deferred revenue results primarily from the sale of mileage credits, the sale
and leaseback of aircraft, and the receipt of manufacturer or vendor credits.
This revenue is recognized when award transportation is provided or over the
term of the applicable agreements. Leased Aircraft Return Costs Cash payments associated with returning leased aircraft are accrued immediately
after the last heavy maintenance visit prior to the schedule aircraft return
date, based on the time remaining on the lease, planned aircraft usage and the
provisions included in the lease agreement, although the actual amount due to
any lessor upon return will not be known with certainty until the end of the
lease. As leased aircraft are returned, any payments are charged against the
established accrual. The accrual is part of other current and long-term
liabilities, and was $14.2 million as of December 31, 2002 and December 31,
2003. Revenue Recognition Passenger revenue is recognized when the passenger travels. Tickets sold but
not yet 52




---



##### Table of Contents



used are reported as air traffic liability. Freight and mail revenues
are recognized when service is provided. Other-net revenues are primarily
related to the Mileage Plan and they are recognized as described in the
Frequent Flyer Awards paragraph below. Frequent Flyer
Awards
Alaska operates a frequent flyer program (Mileage Plan) that provides travel
awards to members based on accumulated mileage. For miles earned by flying on
Alaska and through airline partners, the estimated incremental cost of
providing free travel awards is recognized as a selling expense and accrued as
a liability as miles are accumulated. Alaska also sells mileage credits to
non-airline partners such as hotels, car rental agencies, and a major bank that
offers Alaska Airlines affinity credit cards. The Company defers the portion of
the sales proceeds that represents the estimated fair value of the award
transportation and recognizes that amount as revenue when the award
transportation is provided. The deferred proceeds are recognized as passenger
revenue for awards redeemed on Alaska, and as other-net revenue for awards
redeemed on other airlines. Alaskas Mileage Plan liabilities are included
under the following balance sheet captions at December 31 (in millions): 2002
    
    2003Current Liabilities:Other accrued liabilities
    
    $
    87.0
    
    
    $
    112.9Other Liabilities and Credits:Deferred revenue
    
    
    183.9
    
    
    
    204.5Other liabilities
    
    
    32.1
    
    
    
    18.6Total
    
    $
    303.0
    
    
    $
    336.0
 Contracted Services Contracted services includes expenses for ground handling, security, navigation
fees, temporary employees, data processing fees, and other similar services. Other Selling Expenses and Commissions Other selling expenses and commissions include credit card commissions, global
distribution systems charges, Mileage Plan free travel awards, advertising,
promotional costs, commissions and incentives. Advertising production costs
are expensed the first time the advertising takes place. Advertising expense
was $15.2 million, $14.3 million, and $15.3 million, respectively, in 2001,
2002, and 2003. Capitalized Interest Interest is capitalized on flight equipment purchase deposits and ground
facility progress payments as a cost of the related asset. The interest cost
is based on the Companys weighted average borrowing rate and is depreciated
over the estimated useful life of the asset. The Company ceases capitalization
of interest on aircraft when delivery dates are deferred. Capitalization
continues when the deferral period is over. Income Taxes The Company uses the asset and liability approach for accounting and reporting
income taxes. Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, and for operating loss and tax credit carryforwards. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected
to be recovered or settled. The effect on deferred tax assets and liabilities
of a change in tax rates is recognized in the period that includes the
enactment date. Stock Options 53




---



##### Table of Contents



The Companys employees participate in three Air Group stock option plans that
provide for the purchase of Air Group common stock at stipulated prices on the
dates of the grant by certain officers and key employees of Air Group and its
subsidiaries. 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 had compensation cost for the Companys stock options been
determined in accordance with Statement of Financial Accounting Standards
(SFAS) No. 123. 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 with the following assumptions used for grants in 2001, 2002, and
2003, respectively: dividend yield of 0% for all years; volatility of 44%, 49%,
and 43%; risk-free interest rates of 4.26%, 3.82%, and 2.97%; and expected
lives of 5 years for all years. Using these assumptions, the weighted average
fair value of options granted was $12.70, $13.61, and $8.98 in 2001, 2002, and
2003, respectively. 2001
    
    2002
    
    2003Income (loss) before
accounting change (in millions):As reported
    
    $
    (11.8
    )
    
    $
    (57.0
    )
    
    $
    3.0Deduct: Total stock-based
compensation expense
determined under fair
value-based methods
for all awards, net of
related tax
    
    
    (3.7
    )
    
    
    (4.8
    )
    
    
    (4.8
    )Pro forma net loss before
accounting change
    
    $
    (15.5
    )
    
    $
    (61.8
    )
    
    $
    (1.8
    )Net income (loss)As reported
    
    $
    (11.8
    )
    
    $
    (69.5
    )
    
    $
    3.0Deduct: Total stock-based
compensation expense
determined under fair
value-based methods
for all awards, net of
related tax
    
    
    (3.7
    )
    
    
    (4.8
    )
    
    
    (4.8
    )Pro forma net loss
    
    $
    (15.5
    )
    
    $
    (74.3
    )
    
    $
    (1.8
    )
 In December 2002, the Financial Accounting Standards Board (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.
SFAS No. 148 allows companies adopting the fair value based method of SFAS No.
123 to utilize one of three alternative transition methods. To date, the
Company has not adopted SFAS No. 123. The FASB currently is working on a
project to develop a new standard for accounting for stock-based compensation
and expects to issue a final standard in the second half of 2004. Derivative Financial Instruments The Company records all derivative instruments 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. Operating results can be significantly impacted by changes in the price of
aircraft fuel. To manage the risks associated with changes in aircraft fuel
prices, the Company uses swap agreements and call options for crude oil and
other commodities. These contracts, referred to as fuel hedge contracts,
have a high correlation to changes in aircraft fuel prices, and therefore
qualify as cash flow hedges. Each period, the contracts are adjusted to fair
market value. The change in the value of the fuel hedge contracts that
perfectly offsets the change in the value of the aircraft fuel being hedged is
recorded as other comprehensive income or loss until the hedged contract is
settled and is then recognized in earnings as part of fuel 54




---



##### Table of Contents



expense. To the extent the change in the value of the fuel hedge contracts does not perfectly
offset the change in the value of the aircraft fuel purchase being hedged, the
change is recognized in earnings as part of nonoperating income (expense)
because the Company believes it better portrays the results of its documented
risk management strategy. That strategy is to reduce, to the extent possible,
volatility in West Coast Jet fuel prices (the Companys
purchased commodity)
through hedge contracts based on West Texas Intermediate (WTI) crude (the
Companys purchased hedge commodity). The Company believes that market fluctuations
in the prices of West Coast jet that do not correlate with market fluctuations
in WTI crude are beyond the Companys control and are thus classified in
nonoperating income (expense) in the consolidated statement of operations. At December 31, 2003, Air Group had fuel hedge contracts in place to hedge
132.1 million gallons of its expected jet fuel usage in 2004, 116.1 million
gallons in 2005 and 10.2 million gallons in 2006. This represents 33%, 28% and
2% of Air Groups anticipated fuel consumption in 2004, 2005 and 2006,
respectively. Of these contracts, approximately 85% of projected fuel usage
relates to the Company. The Company recognized $5.9 million in nonoperating expense in 2001, $8.5
million and $6.8 million in nonoperating income in 2002 and 2003, respectively,
related to the ineffectiveness on fuel hedge contracts. As of December 31, 2002 and 2003, the fair value of the Companys fuel hedge
positions were $14.0 million and $15.7 million, respectively. All of the 2002
fair value amounts and $5.4 million of the 2003 fair value amounts are included
in prepaid expenses and other current assets in the balance sheets. The
remaining 2003 fair value amount of $10.3 million is reflected in other assets
in the balance sheets. During 2002 and 2003, the Company recognized gains of $6.3 million and $19.6
million, respectively, from the cash settlement of hedging activities. In
2001, hedging gains resulting from cash settlements of hedging activities were
de minimis. These gains are reflected in aircraft fuel in the statements of
operations. The Company enters into foreign exchange forward contracts, generally with
maturities of less than one month, to manage the risk associated with net
foreign currency transactions. Resulting gains and losses are recognized
currently in other operating expense. The Company periodically enters into
interest rate swap agreements to hedge interest rate risk. At December 31,
2003, there were no foreign currency contracts or interest rate swap agreements
outstanding. New Accounting Standards In 2003, the Company adopted FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (FIN 45). FIN 45 requires a guarantor
to recognize, at the inception of a guarantee, a liability for the fair value
of the obligation undertaken in issuing the guarantee. This interpretation
applies to guarantees issued or modified after December 31, 2002. While the
Company has various guarantees included in contracts in the normal course of
business, primarily in the form of indemnities, these guarantees would only
result in immaterial increases in future costs, and do not represent
significant commitments or contingent liabilities of the indebtedness of
others. 55




---



##### Table of Contents



In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation
of Variable Interest Entities. FIN 46 requires consolidation of certain types
of entities in which the Company absorbs a majority of the entitys expected
losses, receives a majority of the entitys expected returns, or both, as a
result of ownership, contractual or other financial interests in the entity.
These entities are called variable interest entities. The principal
characteristics of variable interest entities are (1) an insufficient amount of
equity to absorb the entitys expected losses, (2) equity owners as a group are
not able to make decisions about the entitys activities, and (3) equity that
does not absorb the entitys losses or receive the entitys residual returns.
Variable interests are contractual, ownership or other monetary interests in an
entity that change with fluctuations in the entitys net asset value. As a
result, variable interest entities can arise from items such as lease
agreements, loan arrangements, guarantees or service contracts. If an entity is determined to be a variable interest entity, the entity must be
consolidated by the primary beneficiary. The primary beneficiary is the
holder of the variable interests that absorbs a majority of the variable
interest entitys expected losses or receives a majority of the entitys
residual returns in the event no holder has a majority of the expected losses.
There is no primary beneficiary in cases where no single holder absorbs the
majority of the expected losses or receives a majority of the residual returns.
The determination of the primary beneficiary is based on
qualitative aspects of the arrangements involved or projected cash flows at the
inception of the transaction with the variable interests entity. FIN 46 is applicable to financial statements of companies that have interests
in special purpose entities, as defined, during the year ended December 31,
2003. The Company is the lessee in a series of operating leases covering the
Companys leased aircraft. In many instances, the lessors are trusts
established by a third party specifically to purchase, finance and lease
aircraft to the Company. These leasing entities meet the criteria for variable
interest entities. However, because the Company is not the primary beneficiary
of the entitys expected gains or losses, the Company is not required to
consolidate these entities. The leasing arrangements involved contain terms
consistent with market terms at their inception and do not include residual
value guarantees made by us, fixed-price purchase obligations or similar
features that would obligate the Company to absorb the majority of expected
losses of the variable interest entities. The Companys maximum expected
exposure under these types of lease arrangements is the remaining lease
payments, which are reflected in future lease commitments in Note 6 (plus the
cost, if any, of bringing the equipment into compliance with the physical
condition required for return). Fourth Quarter Adjustments Operating loss for the three months and year ended December 31, 2003 includes
adjustments to increase operating expenses by $2.4 million (pretax) related to
prior years. Operating loss for the three months ended December 31, 2003 also
includes adjustments to increase operating expenses by $1.8 million (pretax)
and increase operating revenues by $6.3 million (pretax), both related to
previous quarters in 2003. In addition, interest income for the 2003 year
includes an adjustment recorded in the first quarter that reduced interest
income by $2.8 million (pretax) related to the previous year. These
adjustments to operating expenses 56




---



##### Table of Contents



represent corrections to maintenance expense ($3.6 million) and wages and benefits ($1.0 million) in the aggregate. The
adjustment to operating revenues resulted from a correction to deferred revenue
as a result of planned deletions of certain accounts with expired miles. In
addition, interest income for the 2003 year includes a correction to investment
premium amortization an adjustment recorded in the first quarter that reduced
interest income by $2.8 million (pretax) related to the previous year.
Management does not believe that these amounts are material to the periods
affected. Note 2. Marketable Securities At December 31, 2002 and 2003 all of the Companys marketable securities were
classified as available-for-sale. The securities are carried at fair value,
with the unrealized gains and losses reported in stockholders equity under the
caption Accumulated Other Comprehensive Income (Loss). Realized gains and
losses are included in other nonoperating income (expense) in the statements of
operations. The cost of securities sold is based on the specific
identification method. Interest and dividends on marketable securities are
included in interest income in the statements of operations. Marketable securities consisted of the following at December 31 (in millions): 2002
    
    2003Cost:U.S. government securities
    
    $
    156.1
    
    
    $
    184.9Asset backed obligations
    
    
    118.1
    
    
    
    161.0Other corporate obligations
    
    
    91.0
    
    
    
    273.1$
    365.2
    
    
    $
    619.0Fair value:U.S. government securities
    
    $
    158.2
    
    
    $
    184.5Asset backed obligations
    
    
    118.1
    
    
    
    161.6Other corporate obligations
    
    
    90.5
    
    
    
    273.3$
    366.8
    
    
    $
    619.4
 At December 31, 2002 and 2003, gross unrealized gains and losses were not
material to the financial statements. Of the marketable securities on hand at December 31, 2003, 78% mature in 2004,
10% in 2005, and 12% thereafter. 2001
    
    2002
    
    2003Proceeds from sales
and maturities
    
    $
    446.4
    
    
    $
    433.9
    
    
    $
    689.0Gross realized gains
    
    
    4.0
    
    
    
    1.3
    
    
    
    0.9Gross realized losses
    
    
    0.4
    
    
    
    1.7
    
    
    
    1.0
 Note 3. Other Assets Other assets consisted of the following at December 31 (in millions): 2002
    
    2003Prepaid pension cost
    
    $
    
    
    
    $
    53.2Restricted deposits
    
    
    40.6
    
    
    
    18.5Deferred costs and other
    
    
    9.3
    
    
    
    $
    49.9
    
    
    $
    71.7
 Note 4. Related Company Transactions During 2003, the Company received capital contributions of $123.6 million from
Air Group. This amount is reflected in capital in excess of par value in the
Companys December 31, 2003 balance sheet. During 2000, Alaska transferred a flight simulator to AAGL 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 57




---



##### Table of Contents



amounts from Horizon for its participation in the plan. 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 $3.1 million, $2.1 million, and $2.4 million during
2001, 2002, and 2003, respectively. At December 31, 2003, receivables from
related companies include $68.5 million from Horizon, $10.0 million from AAGL
and $42.0 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 fully-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 $19.0 million, $24.0
million, and $39.6 million in 2001, 2002, and 2003, respectively, which 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 $3.9 million, $4.4 million, and
$9.1 million in 2001, 2002, and 2003, respectively. In the normal course of business, Alaska and Horizon provide certain ground
handling services to the other company. Charges for ground services provided
by Alaska to Horizon totaled $0.7 million, $1.7 million, and $2.4 million
during 2001, 2002, and 2003, respectively. Charges for ground services
provided by Horizon to Alaska totaled $2.4 million, $2.6 million, and $4.1
million during 2001, 2002, and 2003, respectively. Note 5. Long-Term Debt and Capital Lease Obligations At December 31, long-term debt and capital lease obligations were as follows (in millions): 2002
    
    2003Fixed rate notes payable
due through 2015*
    
    $
    559.3
    
    
    $
    532.6Variable rate notes payable
due through 2018*
    
    
    334.2
    
    
    
    422.5Long-term debt
    
    
    893.5
    
    
    
    955.1Capital lease obligations
    
    
    11.8
    
    
    
    8.4Less current portion
    
    
    (48.6
    )
    
    
    (206.7
    )$
    856.7
    
    
    $
    756.8
 *The weighted average fixed interest rate was 7.4% during 2002 and 2003. The
weighted average variable interest rate was 2.5% during 2002 and 2003,
respectively. At December 31, 2003, borrowings of $955.1 million were secured by flight
equipment and real property. During 2003, Alaska issued $129.5 million of debt secured by flight equipment,
having interest rates that vary with LIBOR and payment terms of 12 to 15 years.
In September 2001, Alaska borrowed $150 million under its credit facility at
an interest rate that varies with LIBOR and is payable on or before December
31, 2004. 58




---



##### Table of Contents



In March 2003, the Company received $63.6 million under a note with Air Group.
From the date of issuance, interest was calculated at a variable rate of
3-month LIBOR plus 2.5%. In November 2003, Air Group forgave the note through the issuance of a capital
contribution, which is reflected in capital in excess of par in our December
31, 2003 balance sheet. At December 31, 2003, long-term debt principal payments for the next five
years were as follows (in millions): 2004
    
    $
    198.72005
    
    
    45.82006
    
    
    49.12007
    
    
    51.92008
    
    
    54.9Thereafter
    
    
    554.7Total principal payments
    
    $
    955.1
 Alaskas $150 million credit facility, which expires in December 2004,
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 investments, lease obligations, sales of assets, and additional
indebtedness. Such provisions limit the amount of funds Alaska can distribute
to Air Group. As of December 31, 2003, $104.1 million was available to
distribute to Air Group via dividend without violating the covenants in Alaska
Airlines credit facility. No dividends were paid to Alaska Air Group during
the years ended December 31, 2001, 2002 and 2003. The Company is considering
various alternatives including renewing or replacing the credit facility,
although there can be no assurance that this can be accomplished on acceptable
terms to the Company. At December 31, 2003, the Company was in compliance with all loan provisions. Note 6. Commitments Lease Commitments At December 31, 2003, the Company had lease contracts for 51 aircraft that have
remaining noncancelable lease terms of one to 14 years. The majority of
airport and terminal facilities are also leased. Total rent expense was $192.5
million, $197.8 million, and $199.8 million in 2001, 2002, and 2003,
respectively. Future minimum lease payments with noncancelable terms in excess of one year as
of December 31, 2003 are shown below (in millions): 59




---



##### Table of Contents



Operating Leases
    
    CapitalAircraft
    
    Facilities
    
    Leases2004
    
    $
    113.8
    
    
    $
    62.0
    
    
    $
    8.32005
    
    
    108.4
    
    
    
    62.4
    
    
    
    0.22006
    
    
    105.0
    
    
    
    28.5
    
    
    
    0.22007
    
    
    89.9
    
    
    
    12.7
    
    
    
    0.12008
    
    
    93.2
    
    
    
    8.7
    
    
    
    Thereafter
    
    
    483.8
    
    
    
    95.5
    
    
    
    Total lease payments
    
    $
    994.1
    
    
    $
    269.8
    
    
    
    8.8Less amount representing interest
    
    
    
    
    
    
    
    
    
    
    (0.4
    )Present value of capital lease payments
    
    
    
    
    
    
    
    
    
    $
    8.4
 Aircraft Commitments The Company has firm orders for three Boeing 737 series aircraft to be
delivered between 2004 and 2005. The firm orders require payments of
approximately $110 million between 2004 and 2005. As of December 31, 2003,
deposits of $29.6 million related to the firm orders had been made. In
addition to the ordered aircraft, the Company has purchase options on 26 Boeing
737s. The Company is party to a purchase agreement with an aircraft manufacturer.
Under the agreement, upon commitment to purchase the aircraft, the Company must
make deposits to the manufacturer of 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, the Company may be required to pay the manufacturer the amounts paid by
the Trust in order to retain the right to purchase the aircraft. The Company
makes monthly payments to the Trust related to the advances made by the Trust
to the manufacturer, which payments 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 December 31, 2003, the Companys obligations
related to such advances equaled approximately $11.6 million, which is
scheduled for payment during the first quarter of 2004. Note
7. Employee Benefit Plans
Four defined benefit and five defined contribution retirement plans cover
various employee groups of the Company. The defined benefit plans provide
benefits based on an employees term of service and average compensation for a
specified period of time before retirement. The Company also maintains
unfunded, noncontributory defined benefit plans for certain elected officers.
A summary of each plan follows: Pension Plans-Defined Benefit The Companys pension plans are funded as required by the Employee Retirement
Income Security Act of 1974 (ERISA). The defined benefit plan assets consist
primarily of marketable equity and fixed income securities. The Company uses a
December 31 measurement date for these plans. The following table sets forth
the status of the plans for 2002 and 2003 (in millions): 2002
    
    2003Projected benefit obligationBeginning of year
    
    $
    507.2
    
    
    $
    640.7Service cost
    
    
    37.2
    
    
    
    44.6Interest cost
    
    
    38.6
    
    
    
    43.1Amendments
    
    
    3.8
    
    
    
    Change in assumptions
    
    
    41.3
    
    
    
    85.9Actuarial loss
    
    
    25.7
    
    
    
    5.2Benefits paid
    
    
    (13.1
    )
    
    
    (14.5
    )End of year
    
    $
    640.7
    
    
    $
    805.0Plan assets at fair valueBeginning of year
    
    $
    454.5
    
    
    $
    418.1Actual return on plan assets
    
    
    (42.6
    )
    
    
    88.1Employer contributions
    
    
    19.3
    
    
    
    37.8Benefits paid
    
    
    (13.1
    )
    
    
    (14.5
    )End of year
    
    $
    418.1
    
    
    $
    529.5
 The accumulated benefit obligation for the defined benefit pension plan was
$530.3 million and $663.8 million at December 31, 2002 and 2003, respectively. Funded status
    
    
    (222.6
    )
    
    
    (275.6
    )Unrecognized loss
    
    
    250.1
    
    
    
    272.5Unrecognized prior service cost
    
    
    50.2
    
    
    
    45.0Net amount recognized
    
    $
    77.7
    
    
    $
    41.9
 60




---



##### Table of Contents



Amounts recognized in the balance sheet:Intangible asset
    
    
    50.2
    
    
    
    45.0Accrued benefit liability-current
    
    
    (38.0
    )
    
    
    (49.0
    )Accrued benefit liability-long term
    
    
    (74.2
    )
    
    
    (85.3
    )Accumulated other comprehensive income
    
    
    139.7
    
    
    
    131.2Net amount recognized
    
    $
    77.7
    
    
    $
    41.9
 Weighted average assumptions used to determine
Benefit obligations as of December 31 Discount rate
    
    
    6.75
    %
    
    
    6.00
    %Rate of compensation increase
    
    
    5.4
    %
    
    
    5.4
    %
 Weighted average assumptions used to determine
Net periodic benefit cost as of December 31 Discount rate
    
    
    7.25
    %
    
    
    6.75
    %Expected return on plan assets
    
    
    8.0
    %
    
    
    8.0
    %Rate of compensation increase
    
    
    5.4
    %
    
    
    5.4
    %
 In determining the expected return on plan assets, the Company assesses the
current level of expected returns on risk free investments (primarily
government bonds), the historical level of the risk premium associated with the
other asset classes in which the portfolio is invested and the expectations for
future returns of each asset class. The expected return for each asset class
is then weighted based on the target asset allocation to develop the expected
long-term rate of return on assets assumption for the portfolio. The asset allocation of the defined benefit plans, by asset category, is as
follows as of the end of 2002 and 2003: 2002
    
    2003Asset category:Equity securities
    
    
    58
    %
    
    
    65
    %Fixed income securities
    
    
    36
    
    
    
    34Other
    
    
    6
    
    
    
    1Plan assets
    
    
    100
    %
    
    
    100
    %
 The Companys investment policy focuses on achieving maximum returns at a
reasonable risk for pension assets over a full market cycle. The Company uses
a number of fund managers and invests in various asset classes to diversify
risk. Target allocations for the primary asset classes are approximately: Domestic equities:
    
    
    60
    %Fixed income:
    
    
    40
    %
 Pension assets are rebalanced periodically to maintain the above target asset
allocations. Up to 12% of the equity portfolio may be invested in a pooled
fund of small capitalization stocks. An individual equity investment will not
exceed 10% of the entire equity portfolio. Fixed income securities carry a
minimum A rating by Moodys and/or Standard and Poors and the average life
of the bond portfolio may not exceed 10 years. Net pension expense for the defined benefit plans included the following
components for 2001, 2002, and 2003 (in millions): 2001
    
    2002
    
    2003Service cost
    
    $
    29.0
    
    
    $
    37.2
    
    
    $
    44.6Interest cost
    
    
    32.3
    
    
    
    38.6
    
    
    
    43.1Expected return on assets
    
    
    (46.0
    )
    
    
    (46.4
    )
    
    
    (33.9
    )Amortization of
prior service cost
    
    
    4.6
    
    
    
    5.2
    
    
    
    5.2Recognized actuarial
loss
    
    
    0.1
    
    
    
    5.4
    
    
    
    14.5Net pension expense
    
    $
    20.0
    
    
    $
    40.0
    
    
    $
    73.5
 In 2002, the Company recorded an $87.2 million (net of taxes of $52.5 million)
non-cash charge to equity in connection with the defined benefit plans that the
Company sponsors for eligible employees. This charge resulted from an unfunded
accrued benefit obligation resulting from lower than expected returns on plan
assets and a reduction in discount rate. In 2003, the Company recorded a
reduction of this equity charge of $8.5 million ($5.2 million, net of taxes of
$3.3 million) primarily reflecting higher than expected return on assets. The Company expects to contribute $49.0 million to these defined benefit
pension plans during 2004. 61




---



##### Table of Contents



Pension Plans-Noncontributory The Company also maintains unfunded, noncontributory defined benefit plans for
certain elected officers. These plans use a December 31 measurement date. The
following table sets forth the status of the plans for 2002 and 2003 (in
millions): 2002
    
    2003Projected benefit obligationBeginning of year
    
    $
    28.3
    
    
    $
    30.9Service cost
    
    
    0.6
    
    
    
    0.8Interest cost
    
    
    2.0
    
    
    
    2.1Amendments
    
    
    0.5
    
    
    
    Change in assumptions
    
    
    
    
    
    
    2.9Actuarial gain
    
    
    1.0
    
    
    
    0.9Benefits paid
    
    
    (1.5
    )
    
    
    (1.8
    )End of year
    
    $
    30.9
    
    
    $
    35.8Plan assets at fair valueBeginning of year
    
    $
    
    
    
    $
    Actual return on plan assets
    
    
    
    
    
    
    Employer contributions
    
    
    1.5
    
    
    
    1.7Benefits paid
    
    
    (1.5
    )
    
    
    (1.7
    )End of year
    
    $
    
    
    
    $
    
 The accumulated benefit obligation for the noncontributory defined benefit plan
was $29.6 million and $34.3 million at December 31, 2002 and 2003,
respectively. Weighted average assumptions used to determine
Benefit obligations as of December 31 Discount rate
    
    
    6.75
    %
    
    
    6.00
    %Rate of compensation increase
    
    
    5.4
    %
    
    
    5.4
    %
 Weighted average assumptions used to determine
Net periodic benefit cost as of December 31 Discount rate
    
    
    7.25
    %
    
    
    6.75
    %Rate of compensation increase
    
    
    5.4
    %
    
    
    5.4
    %Funded status
    
    
    (30.9
    )
    
    
    (35.8
    )Unrecognized loss
    
    
    5.8
    
    
    
    9.2Unrecognized prior service cost
    
    
    0.7
    
    
    
    0.6Net amount recognized
    
    
    ($24.4
    )
    
    
    ($26.0
    )
 2002
    
    2003Amounts recognized in the balance sheet:Intangible assets
    
    $
    0.7
    
    
    $
    0.6Accrued benefit liability-current
    
    
    (1.5
    )
    
    
    (1.5
    )Accrued benefit liability-long term
    
    
    (28.2
    )
    
    
    (32.7
    )Accumulated other comprehensive income
    
    
    4.6
    
    
    
    7.6Net amount recognized
    
    $
    (24.4
    )
    
    $
    (26.0
    )
 Net pension expense for the noncontributory defined benefit plans included the
following components for 2001, 2002 and 2003 (in millions): 2001
    
    2002
    
    2003Service cost
    
    $
    0.8
    
    
    $
    0.6
    
    
    $
    0.8Interest cost
    
    
    1.8
    
    
    
    2.0
    
    
    
    2.1Amortization of
prior service cost
    
    
    
    
    
    
    0.1
    
    
    
    0.1Actuarial loss
    
    
    
    
    
    
    
    
    
    
    0.3Net pension expense
    
    $
    2.6
    
    
    $
    2.7
    
    
    $
    3.3
 Defined Contribution Plans The defined contribution plans are deferred compensation plans under section
401(k) of the Internal Revenue Code. All of these plans require Company
contributions. Total expense for the defined contribution plans was $10.2
million, $12.4 million, and $14.7 million, respectively, in 2001, 2002, and
2003. Profit Sharing Plans The Company has an employee profit sharing plan. There was no profit sharing
expense during 2001 or 2002. In 2003, the Company recorded profit sharing
expense of $2.9 million. Other Postretirement Benefits The Company allows retirees to continue their medical, dental, and vision
benefits by paying all or a portion of the active employee plan premium until
eligible for Medicare, currently age 65. This results in a subsidy to
retirees, because the premiums received by the Company are less than the actual
cost of the retirees claims. The accumulated 62




---



##### Table of Contents



postretirement benefit
obligation (APBO) for this subsidy is unfunded, and at December
31, 2002 and 2003 was $52.7 million and $77.3 million, respectively. The
accrued liability related to the subsidy is included with other liabilities on
the Balance Sheet, and totaled $31.3 million and $39.2 million at December 31,
2002 and 2003, respectively. Annual expense related to this subsidy was
approximately $4.6 million in 2001, $4.4 million in 2002, and $9.6 million in
2003. The Company uses a December 31 measurement date to assess obligations
associated with the subsidy. Net periodic benefit cost for the postretirement
medical plans included the following components for 2001, 2002, and 2003 (in
millions): 2001
    
    2002
    
    2003Service cost
    
    $
    1.5
    
    
    $
    2.3
    
    
    $
    3.5Interest cost
    
    
    2.1
    
    
    
    3.2
    
    
    
    4.3Expected return on assets
    
    
    
    
    
    
    
    
    
    
    Amortization of
prior service cost
    
    
    0.1
    
    
    
    (0.2
    )
    
    
    (0.2
    )Recognized actuarial
loss (gain)
    
    
    0.9
    
    
    
    (0.9
    )
    
    
    2.0Net periodic benefit cost
    
    $
    4.6
    
    
    $
    4.4
    
    
    $
    9.6
 A 1% higher or lower trend rate has the following effect on the Companys
postretirement medical plans during 2001, 2002, and 2003 (in millions): 2001
    
    2002
    
    2003Change in service and interest cost1% higher trend rate
    
    $
    0.6
    
    
    $
    1.0
    
    
    $
    1.31% lower trend rate
    
    
    (0.5
    )
    
    
    (0.6
    )
    
    
    (1.1
    )Change in year-end postretirement benefit obligation1% higher trend rate
    
    $
    5.0
    
    
    $
    7.0
    
    
    $
    10.51% lower trend rate
    
    
    (4.2
    )
    
    
    (6.0
    )
    
    
    (9.0
    )
 Note 8. Income Taxes Alaska files a consolidated tax return with Air Group and other Air Group
subsidiaries. Each member of the consolidated group, including Alaska,
calculates its tax provision and tax liability, if applicable, on a
separate-entity basis. Any differences between the consolidated amounts and
the total of the subsidiaries amounts are included in the tax provision of the
parent company. Deferred income taxes reflect the impact of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
such amounts for tax purposes. Deferred tax (assets) and liabilities comprise
the following at December 31 (in millions): 2002
    
    2003Excess of tax over book
depreciation
    
    $
    342.2
    
    
    $
    406.8Fuel hedges
    
    
    4.2
    
    
    
    3.8Other - net
    
    
    9.7
    
    
    
    3.7Gross deferred tax liabilities
    
    
    356.1
    
    
    
    414.3Frequent flyer program
    
    
    (112.4
    )
    
    
    (125.3
    )Alternative minimum tax
    
    
    (56.1
    )
    
    
    (51.9
    )Leased aircraft return provisions
    
    
    (5.9
    )
    
    
    (5.4
    )Inventory obsolescence
    
    
    (6.7
    )
    
    
    (11.8
    )Deferred revenue
    
    
    (12.4
    )
    
    
    (12.7
    )Employee benefits
    

    
    (53.1
    )
    
    
    (73.4
    )Loss carryforwards*
    
    
    (4.6
    )
    
    
    (22.0
    )Other - net
    
    
    (11.4
    )
    
    
    (11.3
    )Gross deferred tax assets
    
    
    (262.6
    )
    
    
    (313.8
    )Net deferred tax liabilities
    
    $
    93.5
    
    
    $
    100.5Current deferred tax asset
    
    $
    (60.2
    )
    
    $
    (80.9
    )Noncurrent deferred tax liability
    
    
    153.7
    
    
    
    181.4Net deferred tax liability
    
    $
    93.5
    
    
    $
    100.5
 * Federal loss carryforwards of $49.8 million ($17.4 million tax effected)
expire in 2023. State loss carryforwards of $101.9 million ($4.6 million tax
effected) expire beginning in 2005 and ending in 2023. The components of income tax expense (benefit) were as follows (in millions): 2001
    
    2002
    
    2003Current tax expense (benefit):Federal
    
    $
    (22.1
    )
    
    $
    (34.0
    )
    
    $
    2.5State
    
    
    (1.2
    )
    
    
    (2.0
    )
    
    
    0.6Total current
    
    
    (23.3
    )
    
    
    (36.0
    )
    
    
    3.1Deferred tax expense (benefit):Federal
    
    
    19.1
    
    
    
    5.1
    
    
    
    4.6State
    
    
    (0.4
    )
    
    
    0.6
    
    
    
    1.1Total deferred
    
    
    18.7
    
    
    
    5.7
    
    
    
    5.7Total tax expense (benefit)
    
    $
    (4.6
    )
    
    $
    (30.3
    )
    
    $
    8.8
 63




---



##### Table of Contents



Income tax benefit reconciles to the amount computed by applying the U.S.
federal rate of
35% to income before taxes and accounting change as follows (in millions): 2001
    
    2002
    
    2003Income (loss) before income tax
and accounting change
    
    $
    (16.4
    )
    
    $
    (87.3
    )
    
    $
    11.8Expected tax expense
(benefit)
    
    $
    (5.7
    )
    
    $
    (30.6
    )
    
    $
    4.1Nondeductible expenses
    
    
    2.2
    
    
    
    1.8
    
    
    
    2.1State income tax
    
    
    (1.1
    )
    
    
    (1.9
    )
    
    
    0.9Other - net
    
    
    
    
    
    
    0.4
    
    
    
    1.7Actual tax expense
(benefit)
    
    $
    (4.6
    )
    
    $
    (30.3
    )
    
    $
    8.8Effective tax rate
    
    
    28.0
    %
    
    
    34.7
    %
    
    
    74.6
    %
 At December 31, 2002 and 2003, the Company had tax receivables from affiliated
companies of $17.7 million and $14.7 million, respectively. Note 9. Financial Instruments The estimated fair values of the Companys financial instruments were as
follows (in millions): December 31, 2002Carrying
    
    FairAmount
    
    ValueAssets:Cash and cash equivalents
    
    $
    268.9
    
    
    $
    268.9Marketable securities
    
    
    366.8
    
    
    
    366.8Restricted deposits
    
    
    40.6
    
    
    
    40.6Fuel hedge contracts
    
    
    14.0
    
    
    
    14.0Liabilities:Long-term debt
    
    
    893.5
    
    
    
    926.7
 December 31, 2003Carrying
    
    FairAmount
    
    ValueAssets:Cash and cash equivalents
    
    $
    192.5
    
    
    $
    192.5Marketable securities
    
    
    619.4
    
    
    
    619.4Restricted deposits
    
    
    18.5
    
    
    
    18.5Fuel hedge contracts
    
    
    15.7
    
    
    
    15.7Liabilities:Long-term debt
    
    
    955.1
    
    
    
    978.1
 The fair value of cash equivalents approximates carrying value due to the
short maturity of these instruments. The fair value of marketable securities
is based on quoted market prices. The fair value of fuel hedge contracts is
based on commodity exchange prices. The fair value of restricted deposits
approximates the carrying amount. The fair value of long-term debt is based
on a discounted cash flow analysis using the Companys current borrowing rate. Note 10. U.S. Government Compensation In September 2001, the U.S. Government passed the Air Transportation Safety and
System Stabilization Act to provide $5 billion of cash compensation and $10
billion of loan guarantees to U.S. airlines. The purpose of this Act was to
compensate the airlines for direct and incremental losses for the period
September 11 through December 31, 2001 as a result of the September 11
terrorist attacks. In 2001, the Company recorded government compensation of $71.6 million. This
amount is reflected in nonoperating income (expense) in the statements of
operations. During the third quarter of 2002, the Department of Transportation
completed its review procedures and remitted final compensation payments to the
Company of $0.2 million. 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 were not imposed by the TSA and carrier fees were not
paid during the period June 1, 2003 through September 30, 2003. In May 2003,
the Company received its share of the one-time cash grant in the amount of
$52.8 million. 64




---



##### Table of Contents



In August 2003, the Company received $2.5 million from the Federal Aviation
Administration in reimbursement of flight deck reinforcement expenditures. The
reimbursement was recorded as an offset to capital costs. Note 11. Contingencies The Company is a party to routine 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. Note 12. Change in Accounting Principles In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets. Under this statement, goodwill is considered to have an indefinite
life and is no longer amortized but instead is subject to periodic impairment
testing. Effective January 1, 2002, the Company adopted SFAS No. 142.
Assuming the Company had adopted this standard as of January 1, 2001, the
Companys net loss for the year ended December 31, 2001 would have been reduced
by approximately $0.5 million for the impact of goodwill amortization. During the second quarter of 2002, the Company completed the first step of its
impairment test related to its $12.5 million of goodwill and determined that
the net book value exceeded its fair value. In the fourth quarter of 2002, the
Company completed the second step of its impairment test and determined that
all of the Companys goodwill was impaired. As a result, the Company recorded
a one-time, non-cash charge, effective January 1, 2002 of $12.5 million to
write-off all of its goodwill. This charge is reflected as a cumulative effect
of accounting change in the 2002 statement of operations. Note 13. Revision of Previously Issued Financial Statements The Company previously recorded unrealized gains and losses related to the
ineffective portion of changes in fair value of our fuel hedge positions as
non-operating income (expense) and then reclassified those gains and losses to
fuel expense as those hedges were settled. This practice was not consistent
with its policy, which was to record the ineffective portion in non-operating
income (expense). The Company has revised its financial statements to adjust
its historical presentation of such items. Such revisions have resulted in
reclassification between operating income (loss) and nonoperating income
(expense) in the statements of operations. The revisions have no impact on
previously reported pretax income (loss), net income (loss), the balance
sheets, the statements of shareholders equity or the statements of cash flows
for any prior periods. The
effect of the revisions for 2001, 2002, and 2003 is as follows (in
millions): 2001
    
    2002
    
    2003Total Aircraft Fuel:As Previously Reported
    
    $
    269.8
    
    
    $
    257.3
    
    
    $
    306.7As Revised
    
    $
    269.8
    
    
    $
    260.7
    
    
    $
    312.1Total Operating Expenses:As Previously Reported
    
    $
    1,834.6
    
    
    $
    1,907.3
    
    
    $
    2,041.4As Revised
    
    $
    1,834.6
    
    
    $
    1,910.7
    
    
    $
    2,046.8Total Operating Loss:As Previously Reported
    
    $
    (71.6
    )
    
    $
    (74.2
    )
    
    $
    (14.0
    )As Revised
    
    $
    (71.6
    )
    
    $
    (77.6
    )
    
    $
    (19.4
    )Nonoperating Income
(Expense):As Previously Reported
    
    $
    55.2
    
    
    $
    (13.1
    )
    
    $
    25.8As Revised
    
    $
    55.2
    
    
    $
    (9.7
    )
    
    $
    31.2
 65




---



##### Table of Contents



INDEPENDENT AUDITORS REPORT Board of Directors and Shareholder of Alaska Airlines, Inc.
Seattle, Washington We have audited the accompanying balance sheets of Alaska Airlines, Inc.
(an Alaska Corporation) (the Company), a wholly owned subsidiary of Alaska
Air Group, Inc., as of December 31, 2003 and 2002, and the related statements
of operations, shareholders equity, and cash flows for each of the three years
in the period ended December 31, 2003. Our audits also included the financial
statement schedule listed in the Index at Item 15(a). These financial
statements and financial statement schedule are the responsibility of the
Companys management. Our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 2003 and
2002, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2003, in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, such financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents
fairly in all material respects the information set forth therein. As discussed in Note 12 to the financial statements, the Company adopted
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets, effective January 1, 2002. The accompanying consolidated statements of operations for each of the
three years in the period ended December 31, 2003 have been revised to reflect
consistent application of the Companys policy to record the ineffective
portion of its fuel hedging positions in other income/expense as further
described in Note 13. /s/ DELOITTE & TOUCHE LLP Seattle, Washington
February 27, 2004
(May 20, 2004 as to Note 13) 66




---



##### Table of Contents



VALUATION AND QUALIFYING ACCOUNTS
Alaska Airlines, Inc.
    
    Schedule II
 AdditionsBeginning
    
    Charged
    
    (A)
    
    Ending(In Millions)
    
    Balance
    
    to Expense
    
    Deductions
    
    BalanceYear Ended December 31, 2001(a) Reserve deducted from asset
to which it applies:Allowance for doubtful accounts
    
    $
    1.7
    
    
    $
    2.5
    
    
    $
    (2.4
    )
    
    $
    1.8Obsolescence allowance for flight
equipment spare parts
    
    $
    20.2
    
    
    $
    4.1
    
    
    $
    0.0
    
    
    $
    24.3(b) Reserve recorded as other
long-term liabilities:Leased aircraft return provision
    
    $
    8.0
    
    
    $
    4.0
    
    
    $
    (0.4
    )
    
    $
    11.6Year Ended December 31, 2002(a) Reserve deducted from asset
to which it applies:Allowance for doubtful accounts
    
    $
    1.8
    
    
    $
    1.6
    
    
    $
    (1.5
    )
    
    $
    1.9Obsolescence allowance for flight
equipment spare parts
    
    $
    24.3
    
    
    $
    4.1
    
    
    $
    (1.0
    )
    
    $
    27.4(b) Reserve recorded as other
long-term liabilities:Leased aircraft return provision
    
    $
    11.6
    
    
    $
    2.8
    
    
    $
    (0.2
    )
    
    $
    14.2Year Ended December 31, 2003(a) Reserve deducted from asset
to which it applies:Allowance for doubtful accounts
    
    $
    1.9
    
    
    $
    0.9
    
    
    $
    (1.2
    )
    
    $
    1.6Obsolescence allowance for flight
equipment spare parts
    
    $
    27.4
    
    
    $
    3.4
    
    
    $
    (1.6
    )
    
    $
    29.2(b) Reserve recorded as other
long-term liabilities:Leased aircraft return provision
    
    $
    14.2
    
    
    $
    5.0
    
    
    $
    (5.0
    )
    
    $
    14.2
 (A) Deduction from reserve for purpose for which reserve was created. 67




---



##### Table of Contents



EXHIBIT INDEX Certain of the following exhibits have heretofore been filed with the
Commission and are incorporated herein by reference from the document
described in parenthesis. Certain others are filed herewith. *3.1
    
    Articles of Incorporation of Alaska Airlines,
Inc. as amended through March 7, 1991 (Exhibit
3.1 to Form 10-Q for the six months ended June
30, 2002)*3.2
    
    Bylaws of Alaska Airlines, Inc. as amended and
in effect November 4, 1997*4.1
    
    Trust Indentures and Security Agreement for
Alaska Airlines Equipment Trust Certificates,
Series A and B (Exhibit No. 4(a)(1) to Form S-3,
Amendment No. 1, Registration No. 33-46668)*4.2
    
    Trust Indentures and Security Agreement for
Alaska Airlines Equipment Trust Certificates,
Series C and D (Exhibit No. 4(a)(1) to Form S-3,
Amendment No. 2, Registration No. 33-46668)*4.3
    
    Participation Agreement for Alaska Airlines
Equipment Trust Certificates, Series A and B
(Exhibit No. 4(b)(1) to Form S-3, Amendment No.
1, Registration No. 33-46668)*4.4
    
    Participation Agreement for Alaska Airlines
Equipment Trust Certificates, Series C and D
(Exhibit No. 4(b)(1) to Form S-3, Amendment No.
2, Registration No. 33-46668)*4.5
    
    Lease Agreement for Alaska Airlines Equipment
Trust Certificates (Exhibit No. 4(b)(2) to Form
S-3, Registration No. 33-46668)*10.1
    
    Management Incentive Plan (Exhibit 10.1 to 2002
Alaska Air Group, Inc. Form 10-K)*10.2
    
    Loan Agreement dated as of December 1, 1984,
between Alaska Airlines, Inc. and the Industrial
Development Corporation of the Port of Seattle
(Exhibit 10-38 to 1984 10-K for Alaska Air
Group, Inc. SEC File No. 001-08957)
 68




---



##### Table of Contents



*#10.3
    
    Lease Agreement dated January 22, 1990 between
International Lease Finance Corporation and
Alaska Airlines, Inc. for the lease of a
B737-400 aircraft, summaries of 19 substantially
identical lease agreements and Letter Agreement
#1 dated January 22, 1990 (Exhibit 10-14 to 1990
Alaska Air Group, Inc. 10-K SEC File No.
001-08957)*#10.4(a)
    
    Agreement dated September 18, 1996 between
Alaska Airlines, Inc. and Boeing for the
purchase of 12 Boeing 737-400 aircraft (Exhibit
10.1 to Third Quarter 1996 Alaska Air Group,
Inc. 10-Q SEC File No. 001-08957)*#10.4(b)
    
    Supplemental Agreement 6 to Agreement dated
September 18, 1996 between Alaska Airlines, Inc.
and Boeing for the purchase of 12 Boeing 737-400
aircraft (Exhibit 10.5(b) to 2002 Alaska Air
Group, Inc. Form 10-K SEC File No. 001-08957)*10.5
    
    Alaska Air Group, Inc. 1981 Supplementary
Retirement Plan for Elected Officers, as amended
by First Amendment to the Alaska Airlines, Inc.
and Alaska Air Group, Inc. Supplementary
Retirement Plan for Officers****10.6
    
    Alaska Air Group, Inc. 1995 Supplementary
Retirement Plan for Elected Officers, as amended
by First Amendment to the Alaska Air Group, Inc.
1995 Elected Officers Supplementary Retirement
Plan and Second Amendment to the Alaska Air
Group, Inc. 1995 Elected Officers Supplementary
Retirement Plan*****12.1
    
    Calculation of Ratio of Earnings to Fixed Charges**23
    
    Consent of Deloitte & Touche LLP**31.1
    
    Section 302 Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350**31.2
    
    Section 302 Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350**32.1
    
    Section 906 Certification of
Chief Executive Officer Pursuant to 18 U.S.C. Section 1350**32.2
    
    Section 906 Certification of
Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
 69




---



##### Table of Contents



*
    
    Previously filed.**
    
    Filed herewith.***
    
    Indicates management contract or compensatory plan or arrangement.#
    
    Confidential treatment was requested as to a portion of this document.
 70