ALK Q3 2011 10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 
(Mark One)
T
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

 
OR
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


 For the transition period from                      to                                         
 
Commission File Number 1-8957
ALASKA AIR GROUP, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
91-1292054
(State or other jurisdiction of
incorporation or organization
 
(I.R.S. Employer
Identification No.)
 
19300 International Boulevard, Seattle, Washington 98188
(Address of principal executive offices)

Registrant's telephone number, including area code: (206) 392-5040
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes T  No £ 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes T No £
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer   T
Accelerated filer  £ 
Non-accelerated filer   £
Smaller reporting company   £
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes £ No T
 
The registrant has 35,514,972 common shares, par value $1.00, outstanding at October 31, 2011.
 

 

Table of Contents

ALASKA AIR GROUP, INC.
Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2011
 
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 



 


2

Table of Contents

As used in this Form 10-Q, the terms “Air Group,” “our,” “we” and the “Company” refer to Alaska Air Group, Inc. and its subsidiaries, unless the context indicates otherwise. Alaska Airlines, Inc. and Horizon Air Industries, Inc. are referred to as “Alaska” and “Horizon,” respectively, and together as our “airlines.”

Cautionary Note Regarding Forward-Looking Statements
In addition to historical information, this Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. You can generally identify forward-looking statements as statements containing the words "believe," "expect," "will," "anticipate," "intend," "estimate," "project," "assume" or other similar expressions, although not all forward-looking statements contain these identifying words. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from historical experience or the Company’s present expectations. Some of the things that could cause our actual results to differ from our expectations are:

changes in our operating costs, primarily fuel, which can be volatile;
general economic conditions, including the impact of those conditions on customer travel behavior;
the competitive environment in our industry;
our significant indebtedness;
our ability to meet our cost reduction goals;
an aircraft accident or incident;
labor disputes and our ability to attract and retain qualified personnel;
operational disruptions;
the concentration of our revenue from a few key markets;
actual or threatened terrorist attacks, global instability and potential U.S. military actions or activities;
our reliance on automated systems and the risks associated with changes made to those systems;
changes in laws and regulations.

You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Our forward-looking statements are based on the information currently available to us and speak only as of the date on which this report was filed with the SEC. We expressly disclaim any obligation to issue any updates or revisions to our forward-looking statements, even if subsequent events cause our expectations to change regarding the matters discussed in those statements. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such differences might be significant and materially adverse to our shareholders. For a discussion of these and other risk factors, see Item 1A "Risk Factors” of the Company’s annual report on Form 10-K for the year ended December 31, 2010. Please consider our forward-looking statements in light of those risks as you read this report.


3

Table of Contents

PART I.
FINANCIAL INFORMATION

ITEM 1.
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(in millions)
September 30, 2011

 
December 31, 2010

ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
67.5

 
$
89.5

Marketable securities
1,198.3

 
1,118.7

Total cash and marketable securities
1,265.8

 
1,208.2

Receivables – net
148.3

 
120.1

Inventories and supplies – net
44.3

 
45.1

Deferred income taxes
130.2

 
120.5

Fuel hedge contracts
31.0

 
61.4

Prepaid expenses and other current assets
106.7

 
106.7

Total Current Assets
1,726.3

 
1,662.0

 
 
 
 
Property and Equipment
 

 
 

Aircraft and other flight equipment
4,058.0

 
3,807.6

Other property and equipment
730.1

 
647.8

Deposits for future flight equipment
208.1

 
202.5

 
4,996.2

 
4,657.9

Less accumulated depreciation and amortization
1,646.1

 
1,509.5

Total Property and Equipment – Net
3,350.1

 
3,148.4

 
 
 
 
Fuel Hedge Contracts
47.2

 
69.9

 
 
 
 
Other Assets
136.6

 
136.3

 
 
 
 
Total Assets
$
5,260.2

 
$
5,016.6


See accompanying notes to condensed consolidated financial statements.


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Table of Contents

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

(in millions except share amounts)
September 30, 2011

 
December 31, 2010

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
88.0

 
$
60.2

Accrued aircraft rent
36.7

 
43.1

Accrued wages, vacation and payroll taxes
147.9

 
176.6

Other accrued liabilities
491.0

 
501.2

Air traffic liability
541.1

 
422.4

Current portion of long-term debt
213.6

 
221.2

Total Current Liabilities
1,518.3

 
1,424.7

 
 
 
 
Long-Term Debt, Net of Current Portion
1,178.8

 
1,313.0

Other Liabilities and Credits
 

 
 

Deferred income taxes
398.2

 
279.9

Deferred revenue
394.0

 
403.5

Obligation for pension and postretirement medical benefits
336.3

 
367.1

Other liabilities
170.3

 
123.0

 
1,298.8

 
1,173.5

Commitments and Contingencies


 


Shareholders' Equity
 

 
 

Preferred stock, $1 par value Authorized: 5,000,000 shares, none issued or outstanding

 

Common stock, $1 par value Authorized: 100,000,000 shares, Issued: 2011 – 37,758,719 shares; 2010 – 37,010,140 shares
37.8

 
37.0

Capital in excess of par value
843.3

 
815.5

Treasury stock (common), at cost: 2011 –2,113,247 shares; 2010 – 1,086,172 shares
(107.4
)
 
(46.0
)
Accumulated other comprehensive loss
(256.0
)
 
(267.2
)
Retained earnings
746.6

 
566.1

 
1,264.3

 
1,105.4

Total Liabilities and Shareholders' Equity
$
5,260.2

 
$
5,016.6


See accompanying notes to condensed consolidated financial statements.


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Table of Contents

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

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(in millions except per share amounts)
2011

 
2010

 
2011

 
2010

Operating Revenues
 
 
 
 
 
 
 
Passenger
 
 
 
 
 
 
 
Mainline
$
887.4

 
$
779.2

 
$
2,409.7

 
$
2,068.5

Regional
213.4

 
198.1

 
584.2

 
547.0

Total passenger revenue
1,100.8

 
977.3

 
2,993.9

 
2,615.5

Freight and mail
29.9

 
29.4

 
83.9

 
80.5

Other – net
67.4

 
61.3

 
195.7

 
177.8

Total Operating Revenues
1,198.1

 
1,068.0

 
3,273.5

 
2,873.8

 
 
 
 
 
 
 
 
Operating Expenses
 

 
 

 
 

 
 

Wages and benefits
245.1

 
240.2

 
737.2

 
719.1

Variable incentive pay
19.1

 
23.0

 
53.4

 
62.5

Aircraft fuel, including hedging gains and losses
420.1

 
220.9

 
1,012.1

 
683.2

Aircraft maintenance
49.9

 
55.3

 
152.3

 
166.1

Aircraft rent
28.8

 
33.9

 
88.3

 
106.3

Landing fees and other rentals
62.0

 
59.8

 
179.8

 
173.6

Contracted services
46.1

 
40.7

 
136.2

 
121.4

Selling expenses
47.4

 
44.3

 
133.0

 
116.1

Depreciation and amortization
62.2

 
57.8

 
184.2

 
172.0

Food and beverage service
17.6

 
15.6

 
49.8

 
42.2

Other
54.6

 
49.8

 
173.5

 
145.8

Fleet transition costs
2.0

 
9.8

 
38.9

 
13.2

Total Operating Expenses
1,054.9

 
851.1

 
2,938.7

 
2,521.5

Operating Income
143.2

 
216.9

 
334.8

 
352.3

 
 
 
 
 
 
 
 
Nonoperating Income (Expense)
 

 
 

 
 

 
 

Interest income
4.5

 
7.6

 
18.4

 
22.7

Interest expense
(25.7
)
 
(29.5
)
 
(69.1
)
 
(81.4
)
Interest capitalized
2.1

 
1.4

 
5.5

 
4.7

Other – net
1.2

 
1.8

 
3.4

 
4.1

 
(17.9
)
 
(18.7
)
 
(41.8
)
 
(49.9
)
Income before income tax
125.3

 
198.2

 
293.0

 
302.4

Income tax expense
47.8

 
75.8

 
112.5

 
116.1

Net Income
$
77.5

 
$
122.4

 
$
180.5

 
$
186.3

 
 
 
 
 
 
 
 
Basic Earnings Per Share:
$
2.15

 
$
3.41

 
$
5.02

 
$
5.21

Diluted Earnings Per Share:
$
2.12

 
$
3.32

 
$
4.91

 
$
5.08

Shares used for computation:
 
 
 
 
 
 
 
Basic
35.977

 
35.898

 
35.984

 
35.755

Diluted
36.619

 
36.830

 
36.725

 
36.706


See accompanying notes to condensed consolidated financial statements.

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Table of Contents

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (unaudited)
Alaska Air Group, Inc.

(in millions)
 
Common Shares Outstanding

 
Common Stock

 
Capital in Excess of Par Value

 
Treasury Stock, at Cost

 
Accumulated Other Comprehensive Loss

 
Retained Earnings

 
Total

Balances at December 31, 2010
 
35.924

 
$
37.0

 
$
815.5

 
$
(46.0
)
 
$
(267.2
)
 
$
566.1

 
$
1,105.4

Net income for the nine months ended September 30, 2011
 
 

 
 

 
 

 
 

 
 

 
180.5

 
180.5

Other comprehensive income (loss):
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Related to marketable securities:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Change in fair value
 
 

 
 

 
 

 
 

 
(0.1
)
 
 

 
 

Reclassification to earnings
 
 

 
 

 
 

 
 

 
(2.7
)
 
 

 
 

Income tax effect
 
 

 
 

 
 

 
 

 
1.0

 
 

 
 

 
 
 

 
 

 
 

 
 

 
(1.8
)
 
 

 
(1.8
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Related to employee benefit plans:
 
 

 
 

 
 

 
 

 
40.2

 
 

 
 

Income tax effect
 
 
 
 
 
 
 
 
 
(15.1
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
25.1

 
 
 
25.1

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Related to interest rate derivative instruments:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Change in fair value
 
 

 
 

 
 

 
 

 
(19.4
)
 
 

 
 

Income tax effect
 
 

 
 

 
 

 
 

 
7.3

 
 

 
 

 
 
 

 
 

 
 

 
 

 
(12.1
)
 
 

 
(12.1
)
Total comprehensive income
 
 

 
 

 
 

 
 

 
 

 
 

 
191.7

Purchase of treasury stock
 
(1.030
)
 

 

 
(61.6
)
 
 

 
 

 
(61.6
)
Stock-based compensation
 

 

 
9.5

 

 
 

 
 

 
9.5

Treasury stock issued under stock plans
 
0.003

 

 

 
0.2

 
 

 
 

 
0.2

Stock issued for employee stock purchase plan
 
0.063

 
0.1

 
2.7

 

 
 

 
 

 
2.8

Stock issued under stock plans
 
0.685

 
0.7

 
15.6

 

 
 

 
 

 
16.3

Balances at September 30, 2011
 
35.645

 
$
37.8

 
$
843.3

 
$
(107.4
)
 
$
(256.0
)
 
$
746.6

 
$
1,264.3


See accompanying notes to condensed consolidated financial statements.


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Table of Contents

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

 
Nine Months Ended September 30,
(in millions)
2011

 
2010

Cash flows from operating activities:
 
 
 
Net income
$
180.5

 
$
186.3

Adjustments to reconcile net income (loss) to net cash
 

 
 

Fleet transition costs
38.9

 
13.2

Depreciation and amortization
184.2

 
172.0

Stock-based compensation
9.5

 
10.6

Increase in air traffic liability
118.7

 
95.7

Increase in other assets and liabilities - net
77.0

 
28.6

Net cash provided by operating activities
608.8

 
506.4

 
 
 
 
Cash flows from investing activities:
 

 
 

Property and equipment additions:
 

 
 

Aircraft and aircraft purchase deposits
(260.3
)
 
(109.3
)
Other flight equipment
(18.4
)
 
(20.6
)
Other property and equipment
(15.8
)
 
(24.0
)
Total property and equipment additions
(294.5
)
 
(153.9
)
Proceeds from disposition of assets
19.9

 
4.7

Purchases of marketable securities
(781.7
)
 
(796.7
)
Sales and maturities of marketable securities
697.2

 
646.6

Construction of Terminal 6 at LAX
(80.4
)
 
(0.3
)
Restricted deposits and other
0.9

 
0.6

Net cash used in investing activities
(438.6
)
 
(299.0
)
 
 
 
 
Cash flows from financing activities:
 
 
 

Proceeds from issuance of long-term debt
106.5

 

Long-term debt payments
(248.3
)
 
(231.3
)
Purchase of treasury stock
(61.6
)
 
(31.2
)
Proceeds and tax benefit from issuance of common stock
16.7

 
29.1

Other financing activities
(5.5
)
 
(9.0
)
Net cash used in financing activities
(192.2
)
 
(242.4
)
 
 
 
 
Net change in cash and cash equivalents
(22.0
)
 
(35.0
)
Cash and cash equivalents at beginning of year
89.5

 
164.2

Cash and cash equivalents at the end of the period
$
67.5

 
$
129.2

 
 
 
 
Supplemental disclosure
 

 
 

Cash paid during the period for:
 
 
 
Interest (net of amount capitalized)
$
66.0

 
$
79.3

Income taxes
2.2

 
(4.9
)
Non-cash transactions:
 
 
 
Relocation credit and assets constructed on account related to Terminal 6 at LAX
$
10.5

 
$


See accompanying notes to condensed consolidated financial statements.

8

Table of Contents        


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Alaska Air Group, Inc.
September 30, 2011
 
NOTE 1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Organization and Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements of Alaska Air Group, Inc. (Air Group or the Company) include the accounts of the parent company, Alaska Air Group, Inc., and its principal subsidiaries, Alaska Airlines, Inc. (Alaska) and Horizon Air Industries, Inc. (Horizon), through which the Company conducts substantially all of its operations. These interim condensed consolidated financial statements are unaudited and should be read in conjunction with the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. In the opinion of management, all adjustments have been made that are necessary to present fairly the Company’s financial position as of September 30, 2011, as well as the results of operations for the three and nine months ended September 30, 2011 and 2010. The adjustments made were of a normal recurring nature. 

The Company’s interim condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). In preparing these statements, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities, as well as the reported amounts of revenues and expenses. Significant estimates made include assumptions used to record expenses and revenues associated with the Company’s Mileage Plan; assumptions used in the calculations of pension expense in the Company’s defined-benefit plans; and the amounts of certain accrued liabilities. Actual results may differ from the Company’s estimates.
 
Reclassifications
 
Certain reclassifications have been made to conform the prior year’s data to the current format.
 
New and Prospective Accounting Pronouncements

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

In September 2009, the FASB issued ASU 2009-13, Multiple Deliverable Revenue Arrangements - A Consensus of the FASB Emerging Issues Task Force. This update provides application guidance on whether multiple deliverables exist, how the deliverables should be separated and how the consideration should be allocated to one or more units of accounting. This guidance also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. This accounting standard was effective for the Company for revenue arrangements entered into or materially modified in fiscal years beginning on January 1, 2011. It primarily impacts the accounting for recognition of revenue associated with frequent flyer credits. There was no immediate significant impact of this new standard on the Company's consolidated financial statements and there will be no impact until the Company materially modifies or enters into new contracts associated with its frequent flyer program.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The standard revises guidance for fair value measurement and expands the disclosure requirements. It is effective for fiscal years beginning after December 15, 2011. The Company is currently evaluating the impact that the adoption of this standard will have on the Company's consolidated financial statements.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income - Presentation of Comprehensive Income. The standard revises guidance for the presentation and prominence of the items reported in other comprehensive income. It is effective for fiscal years beginning after December 15, 2011. The Company is currently evaluating the impact that the adoption of this standard will have on the presentation of the Company's consolidated financial statements.


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Table of Contents        


The FASB has issued a number of proposed ASUs. Those proposed ASUs are as follows:

Proposed ASU - Revenue Recognition - was issued in June 2010 and continues to evolve. We believe that a new revenue recognition standard could significantly impact the Company's accounting for the Company's Mileage Plan frequent flyer credits earned by passengers who fly on us or our partners, or miles sold to third parties.

Proposed ASU - Leases - was issued in August 2010 and continues to evolve. This proposed standard overhauls accounting for leases and would apply a “right-of-use” model in accounting for nearly all leases. For lessees, this would result in recognizing an asset representing the lessee's right to use the leased asset for the lease term and a liability to make lease payments. This proposed standard eliminates the operating lease concept from an accounting perspective, thereby eliminating rent expense from the income statement. This proposed standard, if adopted, would significantly impact the Company's consolidated financial statements.

These proposed ASUs are subject to change and no effective dates have been assigned.

NOTE 2. FAIR VALUE OF FINANCIAL INSTRUMENTS
 
Fair Value Measurements

Accounting standards define fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The standards also establish a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:
 
Level 1 - Quoted prices in active markets for identical assets or liabilities.
 
Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

No significant transfers between Level 1 and Level 2 occurred during the nine months ended September 30, 2011.

Cash, Cash Equivalents and Marketable Securities

The Company uses the “market approach” in determining the fair value of its cash, cash equivalents and marketable securities. The securities held by the Company are valued based on observable prices in active markets.

Amounts measured at fair value as of September 30, 2011 are as follows (in millions):
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash and cash equivalents
$
33.6

 
$
33.9

 
$

 
$
67.5

Marketable securities
160.0

 
1,038.3

 

 
1,198.3

Total
$
193.6

 
$
1,072.2

 
$

 
$
1,265.8


All of the Company’s marketable securities are classified as available-for-sale. The securities are carried at fair value, with unrealized gains and losses reported in shareholders’ equity under the caption “accumulated other comprehensive loss” (AOCL). Realized gains and losses are included in other nonoperating income (expense) in the condensed consolidated statements of operations.
 
The cost of securities sold is based on the specific identification method. Interest and dividends on marketable securities are included in interest income in the condensed consolidated statements of operations.
 

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Table of Contents        


The Company’s overall investment strategy has a primary goal of maintaining and securing its investment principal. The Company’s investment portfolio is managed by well-known financial institutions and continually reviewed to ensure that the investments are aligned with the Company’s documented strategy.
 
Marketable securities consisted of the following (in millions):  
 
September 30, 2011

 
December 31, 2010

Amortized Cost:
 
 
 
U.S. government securities
$
393.1

 
$
514.8

Asset-backed obligations
219.2

 
176.8

Other corporate obligations
575.9

 
414.2

 
$
1,188.2

 
$
1,105.8

Fair value:
 

 
 

U.S. government securities
$
397.7

 
$
518.5

Asset-backed obligations
219.7

 
176.7

Other corporate obligations
580.9

 
423.5

 
$
1,198.3

 
$
1,118.7


Of the marketable securities on hand at September 30, 2011, 5% mature in 2011, 28% in 2012, and 67% thereafter. Gross gains and losses for the nine months ended September 30, 2011 and 2010 were not material to the condensed consolidated financial statements.

Some of the Company’s asset-backed securities held at September 30, 2011 had credit losses, as defined in the accounting standards. Credit losses of $1.5 million were recorded through earnings in the third quarter of 2011. Credit losses of $2.2 million were recorded through earnings in 2009. Credit losses represent the difference between the present value of future cash flows at the time and the amortized cost basis of the affected securities.

Management does not believe the securities associated with the remaining $3.3 million net unrealized losses recorded in AOCL are “other-than-temporarily” impaired, as defined in the accounting standards, based on the current facts and circumstances. Management currently does not intend to sell these securities prior to their recovery nor does it believe that it will be more-likely-than-not that the Company would need to sell these securities for liquidity or other reasons.

Gross unrealized gains and losses at September 30, 2011 are presented in the table below (in millions): 
 
 
 
Unrealized Losses
 
 
 
 
 
Unrealized Gains in AOCL
 
Less than 12 months
 
Greater than 12 months
 
Total Unrealized Losses
 
Less: Credit Loss Previously Recorded in Earnings
 
Net Unrealized Losses in AOCL
 
Net Unrealized Gains/(Losses) in AOCL
 
Fair Value of Securities with Unrealized Losses
U.S. Government Securities
$
4.8

 
$
(0.2
)
 
$

 
$
(0.2
)
 
$

 
$
(0.2
)
 
$
4.6

 
$
63.1

Asset-backed obligations
1.3

 
(0.5
)
 
(4.0
)
 
(4.5
)
 
(3.7
)
 
(0.8
)
 
0.5

 
89.5

Other corporate obligations
7.3

 
(2.3
)
 

 
(2.3
)
 

 
(2.3
)
 
5.0

 
197.8

Total
$
13.4

 
$
(3.0
)
 
$
(4.0
)
 
$
(7.0
)
 
$
(3.7
)
 
$
(3.3
)
 
$
10.1

 
$
350.4


Fair Value of Financial Instruments

The majority of the Company’s financial instruments are carried at fair value. Those include cash, cash equivalents and marketable securities (Note 2), fuel hedge contracts (Note 3), interest rate swap agreements (Note 3), and restricted deposits (Note 7). The Company’s long-term fixed-rate debt is not carried at fair value.

The estimated fair value of the Company’s long-term debt was as follows (in millions):
 
Carrying Amount
 
Fair Value
Long-term debt at September 30, 2011
$
1,392.4

 
$
1,426.6

Long-term debt at December 31, 2010
$
1,534.2

 
$
1,531.0


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The fair value of long-term debt is based on a discounted cash flow analysis using the Company’s current borrowing rate. The fair value of fuel hedge contracts is based on commodity exchange prices. The fair value of interest rate swap agreements is based on quoted market swap rates. The fair value of restricted deposits approximates the carrying amount.

NOTE 3. DERIVATIVE INSTRUMENTS

Fuel Hedge Contracts

The Company’s operations are inherently dependent upon the price and availability of aircraft fuel. To manage economic risks associated with fluctuations in aircraft fuel prices, the Company periodically enters into call options for crude oil and swap agreements for jet fuel refining margins, among other initiatives. The Company records these instruments on the balance sheet at their fair value. Changes in the fair value of these fuel hedge contracts are recorded each period in aircraft fuel expense.

The following table summarizes the components of aircraft fuel expense for the three and nine months ended September 30, 2011 and 2010 (in millions):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2011
 
2010
 
2011
 
2010
Raw or “into-plane” fuel cost
$
337.4

 
$
233.8

 
$
969.5

 
$
651.9

(Gains) or losses in value and settlements of fuel hedge contracts
82.7

 
(12.9
)
 
42.6

 
31.3

Aircraft fuel expense
$
420.1

 
$
220.9

 
$
1,012.1

 
$
683.2

 
Cash received, net of premiums expensed, for hedges that settled during the three months ended September 30, 2011 was $1.6 million, compared to the net cost from hedges that settled during the same period of 2010 of $3.8 million. Cash received, net of premiums expensed, for hedges that settled during the nine month periods ended September 30, 2011 and 2010 was $30.6 million and $2.1 million, respectively.

The Company uses the “market approach” in determining the fair value of its hedge portfolio. The Company’s fuel hedging contracts consist of over-the-counter contracts, which are not traded on an exchange. The fair value of these contracts is determined based on observable inputs that are readily available in active markets or can be derived from information available in active, quoted markets. Therefore, the Company has categorized these contracts as Level 2 in the fair value hierarchy described in Note 2.

Outstanding fuel hedge positions as of November 3, 2011 are as follows:
 
Approximate % of
Expected Fuel
Requirements
Gallons Hedged
(in millions)
Approximate Crude Oil
Price per Barrel
Approximate Premium Price per Barrel
Fourth Quarter 2011
50
%
48.6

$86
$11
Remainder of 2011
50
%
48.6

$86
$11
First Quarter 2012
50
%
49.6

$88
$12
Second Quarter 2012
50
%
52.9

$92
$13
Third Quarter 2012
50
%
54.5

$94
$13
Fourth Quarter 2012
50
%
52.1

$92
$13
Full Year 2012
50
%
209.1

$92
$13
First Quarter 2013
38
%
38.4

$93
$14
Second Quarter 2013
32
%
34.7

$92
$15
Third Quarter 2013
27
%
30.1

$93
$15
Fourth Quarter 2013
21
%
22.9

$95
$15
Full Year 2013
29
%
126.1

$93
$14
First Quarter 2014
16
%
17.2

$96
$15
Second Quarter 2014
11
%
12.1

$94
$15
Third Quarter 2014
5
%
6.2

$86
$16
Full Year 2014
8
%
35.5

$94
$15

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

The Company also has financial swap agreements in place to fix the refining margin component for approximately 50% of fourth quarter 2011 estimated jet fuel purchases at an average price of 93 cents per gallon and approximately 30% of first quarter 2012 estimated jet fuel purchases at an average price of 92 cents per gallon.

As of September 30, 2011 and December 31, 2010, the net fair values of the Company's fuel hedge positions were as follows (in millions):
 
September 30, 2011

 
December 31, 2010

Crude oil call options or “caps”
$
75.2

 
$
129.3

Refining margin swap contracts
3.0

 
2.0

   Total
$
78.2

 
$
131.3


The balance sheet amounts include capitalized premiums paid to enter into the contracts of $128.7 million and $108.6 million at September 30, 2011 and December 31, 2010, respectively.

Interest Rate Swap Agreements

The Company has interest rate swap agreements with a third party designed to hedge the volatility of the underlying variable interest rate in the Company's aircraft lease agreements for six B737-800 aircraft. The agreements stipulate that the Company pay a fixed interest rate over the term of the contract and receive a floating interest rate. All significant terms of the swap agreement match the terms of the lease agreements, including interest-rate index, rate reset dates, termination dates and underlying notional values. The agreements expire from September 2020 through March 2021 to coincide with the lease termination dates.

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

At September 30, 2011, the Company had a liability of $28.2 million associated with these contracts, $6.2 million of which is expected to be reclassified into earnings within the next twelve months. The fair value of these contracts is determined based on the difference between the fixed interest rate in the agreements and the observable LIBOR-based interest forward rates at period end, multiplied by the total notional value. As such, the Company places these contracts in Level 2 of the fair value hierarchy.

NOTE 4. LONG-TERM DEBT
 
Long-term debt obligations were as follows (in millions):
 
September 30, 2011
 
December 31, 2010
Fixed-rate notes payable due through 2024
$
1,063.0

 
$
1,233.6

Variable-rate notes payable due through 2024
329.4

 
300.6

Long-term debt
1,392.4

 
1,534.2

Less current portion
213.6

 
221.2

 
$
1,178.8

 
$
1,313.0

 
During the first nine months of 2011, the Company made scheduled debt payments of $111.0 million. In addition, the Company prepaid the full debt balance on seven outstanding aircraft debt agreements totaling $137.3 million. In the third quarter of 2011, the Company borrowed approximately $106.5 million for six of the Q400 aircraft delivered in the first six months of 2011. The Company expects to prepay another $12.5 million in the fourth quarter.


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Table of Contents        


Bank Lines of Credit
 
The Company has two $100 million credit facilities. Both facilities have variable interest rates based on LIBOR plus a specified margin. Borrowings on one of the $100 million facilities, which expires in March 2013, are secured by aircraft. Borrowings on the other $100 million facility are secured by certain accounts receivable, spare engines, spare parts and ground service equipment. During the third quarter of 2011, we modified the second facility by extending the term from March 2014 to March 2016 and reduced the commitment fee. The Company has no immediate plans to borrow using either of these facilities. These facilities have a requirement to maintain a minimum unrestricted cash and marketable securities balance of $500 million. The Company is in compliance with this covenant at September 30, 2011.

NOTE 5. COMMON STOCK REPURCHASE

In the three months ended September 30, 2011, the Company repurchased 518,500 shares of its common stock for $30.4 million under the $50.0 million repurchase plan authorized by the Board of Directors in June 2011. For the nine months ended September 30, 2011, the Company repurchased 1,030,300 shares for $61.6 million under this plan and the $50.0 million repurchase plan authorized by the Board of Directors in June 2010. Since 2007, the Company has repurchased 8.1 million shares of its common stock under such programs for $242 million for an average price of approximately $30 per share.

NOTE 6. EMPLOYEE BENEFIT PLANS
 
Pension Plans - Qualified Defined Benefit

Net pension expense for the three and nine months ended September 30, 2011 and 2010 included the following components (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2011
 
2010
 
2011
 
2010
Service cost
$
8.7

 
$
8.1

 
$
26.7

 
$
24.3

Interest cost
18.1

 
16.9

 
54.7

 
50.7

Expected return on assets
(22.0
)
 
(17.7
)
 
(66.2
)
 
(53.1
)
Amortization of prior service cost
(0.3
)
 
(0.2
)
 
(0.7
)
 
(0.6
)
Actuarial loss
5.5

 
5.5

 
17.7

 
16.5

Net pension expense
$
10.0

 
$
12.6

 
$
32.2

 
$
37.8


The Company contributed $11.1 million and $33.4 million to its qualified defined-benefit plans during the three and nine months ended September 30, 2011, compared to contributions of $15.2 million and $45.6 million to its qualified defined-benefit pension plans during the three and nine months ended September 30, 2010, respectively.

On June 20, 2011, the Board of Directors authorized the Company to amend its defined-benefit pension plans for salaried employees such that participants' benefits will freeze effective January 1, 2014. Active participants in the defined-benefit plan will receive a higher Company contribution to the defined-contribution plan beginning on the same date. The Company remeasured the projected benefit obligation and recorded an immaterial curtailment loss from the amendments.

Pension Plans - Nonqualified Defined Benefit

Net pension expense for the unfunded, noncontributory defined-benefit plans was $1.1 million and $0.8 million for the three months ended September 30, 2011 and 2010, and was $3.0 million and $2.3 million for the nine months ended September 30, 2011 and 2010. Similar to the qualified plan, the Board of Directors amended the nonqualified defined-benefit plan such that participants' benefits will be frozen effective January 1, 2014.

Post-retirement Medical Benefits

Net periodic benefit cost for the post-retirement medical plans for the three months ended September 30, 2011 and 2010 was $3.6 million and $3.1 million, respectively. The net periodic benefit cost for the nine months ended September 30, 2011 and 2010 was $11.0 million and $9.3 million, respectively.



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NOTE 7. OTHER ASSETS

Other assets consisted of the following (in millions):
 
 
September 30, 2011
 
December 31, 2010
Restricted deposits (primarily restricted investments)
$
82.8

 
$
83.6

Deferred costs and other(a)
53.8

 
52.7

 
$
136.6

 
$
136.3

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

At September 30, 2011, the Company's restricted deposits were primarily restricted investments used to guarantee various letters of credit and workers' compensation self-insurance programs. The restricted investments consist of highly liquid securities with original maturities of three months or less. They are carried at cost, which approximates fair value.

NOTE 8. MILEAGE PLAN

Alaska's Mileage Plan deferrals and liabilities are included under the following balance sheet captions (in millions):
 
 
September 30, 2011
 
December 31, 2010
Current Liabilities:
 
 
 
Other accrued liabilities
$
274.7

 
$
278.0

Other Liabilities and Credits:
 

 
 

Deferred revenue
375.2

 
382.1

Other liabilities
14.8

 
13.8

Total
$
664.7

 
$
673.9

 
Alaska's Mileage Plan revenue is included under the following condensed consolidated statement of operations captions for the three and nine months ended September 30, 2011 and 2010 (in millions):

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2011
 
2010
 
2011
 
2010
Passenger revenues
$
51.7

 
$
49.9

 
$
156.2

 
$
142.0

Other-net revenues
51.0

 
47.5

 
148.2

 
138.1

Total Mileage Plan revenues
$
102.7

 
$
97.4

 
$
304.4

 
$
280.1


NOTE 9. STOCK-BASED COMPENSATION PLANS
The Company has stock awards outstanding under a number of long-term incentive equity plans, one of which actively provides for the grant of stock awards to directors, officers and employees of the Company and its subsidiaries. Compensation expense is recorded over the shorter of the vesting period or the period between the grant date and the date the employee becomes retirement-eligible as defined in the applicable plan. All stock-based compensation expense is recorded in wages and benefits in the condensed consolidated statements of operations.

Stock Options
 
During the nine months ended September 30, 2011, the Company granted 72,740 options with a weighted-average grant-date fair value of $32.99 per share. During the same period in the prior year, the Company granted 129,970 options with a weighted-average grant-date fair value of $18.05 per share.

The Company recorded stock-based compensation expense related to stock options of $0.5 million and $0.7 million for the three months ended September 30, 2011 and 2010 respectively. The Company recorded expense of $2.5 million and $3.5 million for the nine months ended September 30, 2011 and 2010, respectively. As of September 30, 2011, $2.3 million of compensation cost associated with unvested stock option awards attributable to future service had not yet been recognized. This amount will be recognized as expense over a weighted-average period of 1.9 years.


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Table of Contents        


As of September 30, 2011, options to purchase 743,725 shares of common stock were outstanding with a weighted-average exercise price of $33.58. Of that total, 266,977 were exercisable at a weighted-average exercise price of $33.94.

Restricted Stock Awards

During the nine months ended September 30, 2011, the Company awarded 79,216 restricted stock units (RSUs) to certain employees, with a weighted-average grant date fair value of $61.15. This amount reflects the value of the total RSU awards at the grant date based on the closing price of the Company's common stock.

The Company recorded stock-based compensation expense related to RSUs of $1.0 million and $0.7 million for the three month period ended September 30, 2011 and 2010, respectively, and $4.8 million and $4.5 million for the nine months ended September 30, 2011 and 2010, respectively.

As of September 30, 2011 $4.9 million of compensation cost associated with unvested RSUs attributable to future service had not yet been recognized. This amount will be recognized as expense over a weighted-average period of 1.8 years.

Performance Stock Awards

From time to time, the Company issues performance stock unit awards (PSUs) to certain executives. PSUs vest based on performance or market performance measures.

Currently outstanding PSUs were issued in 2010 and 2011. There are several tranches of PSUs that vest based on differing performance conditions including a market condition tied to the Company's total shareholder return relative to an airline peer group, and based on certain performance goals established by the Compensation Committee of the Board of Directors. The total grant-date fair value of PSUs issued during the nine months ended September 30, 2011 was $2.3 million.

The Company recorded $0.5 million and $0.4 million of compensation expense related to PSUs in the three months ended September 30, 2011 and 2010, respectively, and $1.5 million and $2.1 million for the nine months ended September 30, 2011 and 2010, respectively.

As of September 30, 2011 $3.1 million of compensation cost associated with unvested PSUs attributable to future performance had not yet been recognized. This amount will be recognized as expense over a weighted-average period of 1.8 years.

Deferred Stock Awards

In the second quarter of 2011, the Company awarded 4,208 Deferred Stock Unit awards (DSUs) to members of its Board of Directors as a portion of their retainers. The underlying common shares are issued upon retirement from the Board, but require no future service period. As a result, the entire intrinsic value of the awards on the date of grant was expensed in the quarter granted. The total amount of compensation expense recorded in the first nine months of 2011 was $0.3 million.

The Company awarded 6,328 DSUs and recorded compensation expense of $0.3 million in the first nine months of 2010.

Employee Stock Purchase Plan

Compensation expense recognized under the Employee Stock Purchase Plan was $0.2 million and $0.1 million for the three months ended September 30, 2011 and 2010, respectively, and was $0.4 million and $0.2 million for the nine months ended September 30, 2011 and 2010, respectively.


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Table of Contents        


Summary of Stock-Based Compensation

The table below summarizes the components of total stock-based compensation for the three and nine months ended September 30, 2011 (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2011
 
2010
 
2011
 
2010
Stock options
$
0.5

 
$
0.7

 
$
2.5

 
$
3.5

Restricted stock units
1.0

 
0.7

 
4.8

 
4.5

Performance share units
0.5

 
0.4

 
1.5

 
2.1

Deferred stock awards

 

 
0.3

 
0.3

Employee stock purchase plan
0.2

 
0.1

 
0.4

 
0.2

Total stock-based compensation
$
2.2

 
$
1.9

 
$
9.5

 
$
10.6

 
NOTE 10. FLEET TRANSITION
  
Horizon Fleet Transition to All-Q400 Fleet

During the second quarter of 2011, Horizon completed its transition to an all-Q400 fleet and removed all residual CRJ-700 inventory in the third quarter, resulting in a gain of $2.6 million. During the first nine months of 2011 and 2010, the Company recorded net charges of $28.3 million and $10.3 million, respectively, associated with removing these aircraft from operations.

On July 21, 2011, Horizon entered into a letter of intent to sell 16 Q200 aircraft, and received acceptance of the agreement on September 13, 2011, indicating that the sale of the aircraft was probable. This resulted in the Company recording a loss of $4.6 million in the third quarter associated with the termination of the underlying lease and subsequent sale of the aircraft. The total loss during the first nine months of 2011 was $10.6 million.

Subsequent to period end, in accordance with the letter of intent, the Company completed the disposition of 13 aircraft and expects to complete the remaining transactions in the fourth quarter.

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Table of Contents        


NOTE 11. OPERATING SEGMENT INFORMATION
 
Effective January 1, 2011, Horizon's business model changed such that 100% of its capacity is sold to Alaska under a capacity purchase agreement (CPA). As is typical for similar arrangements, certain costs such as landing fees and aircraft rents, selling and distribution costs, and fuel costs directly related to regional flights operated by Horizon are now recorded by Alaska. Also, based on the terms of the new agreement, Horizon's revenues and Alaska's regional revenues have changed significantly on a year over year basis. All inter-company revenues and expenses are eliminated in consolidation, and these changes have no impact on the consolidated results.
Operating segment information for Alaska and Horizon for the three and nine months ended September 30 were as follows (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2011
 
2010
 
2011
 
2010
Operating revenues:
 
 
 
 
 
 
 
Alaska—mainline passenger(a)
$
887.4

 
$
779.2

 
$
2,409.7

 
$
2,068.5

Alaska—regional passenger(a)
213.4

 
88.9

 
584.2

 
247.6

Total Alaska passenger revenues
$
1,100.8

 
$
868.1

 
$
2,993.9

 
$
2,316.1

Alaska—other revenues
95.3

 
88.0

 
273.3

 
250.1

Total Alaska operating revenues
$
1,196.1

 
$
956.1

 
$
3,267.2

 
$
2,566.2

Horizon—brand flying(b)

 
109.2

 

 
299.4

Horizon—CPA
91.2

 
69.0

 
279.3

 
202.8

Horizon—other revenues
2.0

 
2.7

 
6.3

 
8.2

Total Horizon operating revenues
$
93.2

 
$
180.9

 
$
285.6

 
$
510.4

Elimination of inter-company revenues
(91.2
)
 
(69.0
)
 
(279.3
)
 
(202.8
)
Consolidated operating revenues
$
1,198.1

 
$
1,068.0

 
$
3,273.5

 
$
2,873.8

 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Alaska—mainline, excluding fuel
$
504.1

 
$
491.8

 
$
1,500.2

 
$
1,433.5

Alaska—mainline fuel
376.7

 
188.1

 
889.2

 
574.3

Alaska—regional
179.9

 
74.7

 
530.9

 
221.5

Total Alaska operating expenses
$
1,060.7

 
$
754.6

 
$
2,920.3

 
$
2,229.3

Horizon(c)
84.9

 
165.1

 
295.8

 
492.6

Other(d)
0.5

 
0.4

 
1.9

 
2.4

Elimination of inter-company expenses
(91.2
)
 
(69.0
)
 
(279.3
)
 
(202.8
)
Consolidated operating expenses
$
1,054.9

 
$
851.1

 
$
2,938.7

 
$
2,521.5

 
 
 
 
 
 
 
 
Nonoperating expenses:
 

 
 

 
 

 
 

Alaska
$
(13.8
)
 
$
(14.5
)
 
$
(29.4
)
 
$
(36.2
)
Horizon
(3.9
)
 
(4.1
)
 
(12.1
)
 
(13.5
)
Other(d)
(0.2
)
 
(0.1
)
 
(0.3
)
 
(0.2
)
Consolidated nonoperating expenses
$
(17.9
)
 
$
(18.7
)
 
$
(41.8
)
 
$
(49.9
)
 
 
 
 
 
 
 
 
Income (loss) before income tax:
 

 
 

 
 

 
 

Alaska—mainline
$
87.0

 
$
172.4

 
$
260.9

 
$
273.3

Alaska—regional
34.6

 
14.6

 
56.6

 
27.4

Total Alaska
$
121.6

 
$
187.0

 
$
317.5

 
$
300.7

Horizon(c)
4.4

 
11.7

 
(22.3
)
 
4.3

Other(d)
(0.7
)
 
(0.5
)
 
(2.2
)
 
(2.6
)
Consolidated income before income tax
$
125.3

 
$
198.2

 
$
293.0

 
$
302.4



18

Table of Contents        


 
September 30, 2011
 
December 31, 2010
Total assets at end of period:
 
 
 
Alaska
$
4,845.2

 
$
4,610.2

Horizon
794.1

 
747.2

Other(d)
1,595.2

 
1,375.6

Elimination of inter-company accounts
(1,974.3
)
 
(1,716.4
)
Consolidated
$
5,260.2

 
$
5,016.6


(a) 
Alaska mainline passenger revenue represents revenue from passengers aboard Alaska jets. Alaska regional passenger revenue represents revenue earned by Alaska on capacity provided by Horizon, SkyWest Airlines and another small third-party carrier in the state of Alaska under capacity purchase arrangements.
(b) 
As 100% of Horizon's capacity is sold to Alaska under the CPA, Horizon no longer has brand flying revenue.
(c) 
Includes special charges of $2.0 million and $38.9 million for the three and nine months ended September 30, 2011 related to fleet transition charges at Horizon.
(d) 
Includes parent company results and its investments in Alaska and Horizon, which are eliminated in consolidation.

NOTE 12. CONTINGENCIES

The Company is a party to routine litigation matters incidental to its business and with respect to which no material liability is expected. Management believes the ultimate disposition of the matters is not likely to materially affect the Company's financial position or results of operations. This forward-looking statement is based on management's current understanding of the relevant law and facts, and it is subject to various contingencies, including the potential costs and risks associated with litigation and the actions of arbitrators, judges and juries.

NOTE 13. CONTRUCTION OF TERMINAL 6 AT LAX

In 2009, the Company announced plans to move from Terminal 3 to Terminal 6 at Los Angeles International Airport (LAX). As part of this move, the Company agreed to manage and fund up to $175 million of the project during the design and construction phase. The total project is estimated to cost approximately $250 million and is expected to be completed in the spring of 2012.

On April 19, 2011, the Company signed a funding agreement with the City of Los Angeles and Los Angeles World Airports, which would reimburse the Company for the majority of the construction costs either during the course of, or upon the completion of, construction. The Company anticipates that its proprietary non-reimbursable share of the total cost of the project will be approximately $25 million.

As of September 30, 2011, the Company recorded $107.0 million associated with this project in Other property and equipment. In addition, the Company recorded $11.4 million related to reimbursements and credits from the City of Los Angeles in Other long-term liabilities.


19

Table of Contents        


ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
OVERVIEW
 
The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand our Company, our operations and our present business environment. MD&A is provided as a supplement to - and should be read in conjunction with - our condensed consolidated financial statements and the accompanying notes. All statements in the following discussion that are not statements of historical information or descriptions of current accounting policy are forward-looking statements. Please consider our forward-looking statements in light of the risks referred to in this report's introductory cautionary note and the risks mentioned in the Company's filings with the Securities and Exchange Commission, including those listed in Item 1A "Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010. This overview summarizes MD&A, which includes the following sections:

·
Third Quarter in Review - highlights from the third quarter of 2011 outlining some of the major events that happened during the period and how they affected our financial performance.

·
Results of Operations - an in-depth analysis of the results of operations for the three and nine months ended September 30, 2011. We believe this analysis will help the reader better understand our condensed consolidated statements of operations. This section also includes forward-looking statements regarding our view of the remainder of 2011.

·
Critical Accounting Estimates - a discussion of our accounting estimates that involve significant judgment and uncertainties.

·
Liquidity and Capital Resources - an analysis of cash flows, sources and uses of cash, contractual obligations, and commitments, and an overview of financial position.

Our filings with the Securities and Exchange Commission, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are accessible free of charge at www.alaskaair.com. The information contained on our website is not a part of this quarterly report on Form 10-Q.

THIRD QUARTER IN REVIEW

Our consolidated pretax income was $125.3 million during the third quarter of 2011 compared to $198.2 million in the third quarter of 2010. The decline in our pretax earnings was directly due to the $199.2 million increase in aircraft fuel with minor increases in other operating costs, partially offset by a $130.1 million increase in operating revenues.

Economic fuel averaged $3.24 per gallon in the third quarter of 2011, compared to $2.37 per gallon in 2010, resulting in a $98.2 million increase in our economic fuel expense. In addition, we recognized mark-to-market losses associated with our fuel hedge positions of $84.3 million, compared to gains of $16.7 million in the same period of 2010.

Consolidated unit revenues increased 7.1% compared to the third quarter of 2010, from increases in both the ticket yield and load factor.  More detail regarding these increases can be found in the "Comparison of the Three Months Ended September 30, 2011 to the Three Months Ended September 30, 2010" section below.

Excluding the mark-to-market fuel adjustment and fleet transition charges, we reported record third quarter net income of $131.1 million for the three months ended September 30, 2011 compared to $118.1 million for the same period in 2010. Please refer to our reconciliation of these non-GAAP measures to the most directly comparable GAAP measure of our pretax income in the "Comparison of the Three Months Ended September 30, 2011 to the Three Months Ended September 30, 2010" section below.

Other significant developments during the third quarter of 2011 and through the filing of this Form 10-Q are described below.

Operational Performance

Alaska's operational results continue to be among the best in the industry. Alaska Airlines held the No. 1 spot on the U.S. Department of Transportation on-time performance among the 10 largest U.S. airlines based on capacity for the last twelve

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months ending in July. Horizon has also seen significant improvements in on-time arrival performance, increasing from 82.9% for the three months ended September 2010 to 91.1% for the same period of the current year.

New Markets
 
We recently announced daily non-stop seasonal service between Palm Springs and San Jose beginning February 2012, daily non-stop service between Seattle and Kansas City beginning March 2012, daily non-stop service between San Jose and Honolulu and between Oakland and Honolulu beginning April 2012.

Stock Repurchase
 
In the three months ended September 30, 2011, we repurchased 518,500 shares of common stock for $30.4 million under the $50.0 million repurchase plan authorized by our Board of Directors in June 2011. In the nine months ended September 30, 2011, we repurchased 1,030,300 shares for $61.6 million under this plan and the $50.0 million repurchase plan authorized by the Board of Directors in June 2010. Since 2007, we have repurchased 8.1 million shares of common stock under such programs for $242 million for an average price of approximately $30 per share.

Outlook
 
Our primary focus every year is to run safe, compliant and reliable operations at our airlines. In addition to our primary objective, our key initiative in 2011 has been and continues to be a focus on optimizing revenue through our network planning and, to a lesser extent, the way we merchandise fares and ancillary products and services on our website and through mobile applications.  

As we look to the remainder of 2011, there are some concerns that the economy is softening and the ability of the airlines to raise ticket prices will not be enough to cover higher fuel costs. We will be monitoring passenger demand and advance bookings closely and will be diligent in our efforts to continue to match capacity with demand. As of the date of this report, however, our advance bookings for the fourth quarter are strong. Our advance bookings currently suggest that load factors will be up about 2.5 points in November and half a point in December compared to the prior-year periods on a 3% expected increase in capacity for the fourth quarter.

RESULTS OF OPERATIONS
 
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2011 TO THREE MONTHS ENDED SEPTEMBER 30, 2010
Our consolidated net income for the third quarter of 2011 was $77.5 million, or $2.12 per diluted share, compared to net income of $122.4 million, or $3.32 per diluted share, in the third quarter of 2010. Significant items impacting the comparability between the periods are as follows:

Both periods include adjustments to reflect the timing of net unrealized mark-to-market gains or losses related to our fuel hedge positions. In the third quarter of 2011 we recognized net mark-to-market losses of $84.3 million ($52.4 million after tax, or $1.43 per share) compared to gains of $16.7 million ($10.4 million after tax, or $0.28 per share) in the third quarter of 2010.

The third quarter of 2011 includes Horizon fleet transition costs of $2.0 million ($1.2 million after tax, of $0.03 per share) compared to $9.8 million ($6.1 million, or $0.17 per share) in third quarter of 2010.
We believe disclosure of the impact of these individual charges is useful information to investors and other readers because:

Along with our GAAP results, we also present this information in our quarterly earnings press releases and discuss this information in our quarterly earnings conference call;
We believe it is the basis by which we are evaluated by industry analysts;
Our results excluding these items are most often used in internal management and board reporting and decision-making;  
Our results excluding these adjustments serve as the basis for our various employee incentive plans, and thus the information allows investors to better understand the changes in variable incentive pay expense in our condensed consolidated statements of operations;  and
It is useful to monitor performance without these items as it improves a reader's ability to compare our results to those of other airlines.

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

Excluding the mark-to-market adjustments and fleet transition costs, our adjusted consolidated net income for the third quarter of 2011 was $131.1 million, or $3.58 per diluted share, compared to an adjusted consolidated net income of $118.1 million, or $3.21 per share, in the third quarter of 2010.
 
 
Three Months Ended September 30,
 
 
2011
 
2010
(in millions except per share amounts)
 
Dollars
 
Diluted EPS
 
Dollars
 
Diluted EPS
Net income and diluted EPS, excluding noted items
 
$
131.1

 
$
3.58

 
$
118.1

 
$
3.21

Fleet transition costs, net of tax
 
(1.2
)
 
(0.03
)
 
(6.1
)
 
(0.17
)
Adjustments to reflect the timing of gain or loss recognition resulting from mark-to-market fuel-hedge accounting, net of tax
 
(52.4
)
 
(1.43
)
 
10.4

 
0.28

Net income and diluted EPS as reported
 
$
77.5

 
$
2.12

 
$
122.4

 
$
3.32



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OPERATING STATISTICS SUMMARY (unaudited)
 
 
 
 
 
 
 
 
 
 
Alaska Air Group, Inc.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2011
 
2010
 
Change
 
 
2011
 
2010
 
Change
 
Consolidated:(a)
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
6,709

 
6,389

 
5.0
 %
 
 
18,707

 
17,489

 
7.0
 %
 
Revenue passenger miles (RPM) (000,000)
6,703

 
6,259

 
7.1
 %
 
 
18,849

 
17,013

 
10.8
 %
 
Available seat miles (ASM) (000,000)
7,748

 
7,394

 
4.8
 %
 
 
22,329

 
20,709

 
7.8
 %
 
Revenue passenger load factor
86.5
%
 
84.6
%
 
1.9

pts 
 
84.4
%
 
82.2
%
 
2.2

pts 
Operating revenue per ASM (RASM)

15.46
¢
 

14.44
¢
 
7.1
 %
 
 

14.66
¢
 

13.88
¢
 
5.6
 %
 
Passenger revenue per ASM (PRASM)

14.21
¢
 

13.22
¢
 
7.5
 %
 
 

13.41
¢
 

12.63
¢
 
6.2
 %
 
Operating expense per ASM (CASM), excluding fuel and CRJ-700 fleet transition costs(b)

8.17
¢
 

8.39
¢
 
(2.6
)%
 
 

8.45
¢
 

8.81
¢
 
(4.1
)%
 
Economic fuel cost per gallon(b)
$
3.24

 
$
2.37

 
36.7
 %
 
 
$
3.13

 
$
2.31

 
35.5
 %
 
Fuel gallons (000,000)
103.8

 
100.3

 
3.5
 %
 
 
299.8

 
281.1

 
6.7
 %
 
Average number of full-time equivalent employees
11,859

 
11,722

 
1.2
 %
 
 
11,850

 
11,712

 
1.2
 %
 
Operating fleet at period-end
165

 
168

 
(3
)
a/c
 
165

 
168

 
(3
)
a/c
 
 

 
 

 
 

 
 
 
 
 
 
 

 
Mainline Jet Operating Statistics:
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenue passengers (000)
4,839

 
4,562

 
6.1
 %
 
 
13,479

 
12,373

 
8.9
 %
 
RPM (000,000)
6,035

 
5,580

 
8.2
 %
 
 
17,011

 
15,124

 
12.5
 %
 
ASM (000,000)
6,936

 
6,544

 
6.0
 %
 
 
19,991

 
18,197

 
9.9
 %
 
Revenue passenger load factor
87.0
%
 
85.3
%
 
1.7

pts 
 
85.1
%
 
83.1
%
 
2.0

pts 
Yield per passenger mile

14.70
¢
 

13.96
¢
 
5.3
 %
 
 

14.17
¢
 

13.68
¢
 
3.6
 %
 
PRASM

12.79
¢
 

11.91
¢
 
7.4
 %
 
 

12.05
¢
 

11.37
¢
 
6.0
 %
 
CASM, excluding fuel(b)

7.27
¢
 

7.52
¢
 
(3.3
)%
 
 

7.50
¢
 

7.88
¢
 
(4.8
)%
 
Economic fuel cost per gallon(b)
$
3.23

 
$
2.37

 
36.3
 %
 
 
$
3.13

 
$
2.30

 
36.1
 %
 
Fuel gallons (000,000)
90.6

 
85.5

 
6.0
 %
 
 
260.8

 
237.4

 
9.9
 %
 
Average number of full-time equivalent employees
8,960

 
8,737

 
2.6
 %
 
 
8,914

 
8,631

 
3.3
 %
 
Aircraft utilization (blk hrs/day)
10.7

 
10.4

 
2.9
 %
 
 
10.5

 
9.9