Alaska Airlines - 10-Q quarterly report FY

Horizon Air
Revenues
Capacity decreased by 0.2%.  Traffic increased by 1.4% due to longer average passenger trip lengths, and passenger load factor increased 1.0 percentage points  Passenger revenues decreased 3.3%, as passenger yields decreased 4.6%.  A reduction in business passengers has caused the lower yields.  The lower yield trends are expected to continue during 2001.

Other-net revenues increased $5.4 million, primarily due to manufacturer support received as compensation for delays in delivery of CRJ 700 aircraft.  Additional support is expected during the third and fourth quarters of 2001.

Expenses
Operating expenses grew by 5.6% as a result of a 5.8% increase in cost per ASM.  Horizon’s expenses have been significantly impacted by delivery of the CRJ 700 aircraft, which has been delayed by the manufacturer from January 2001 to July 2001.  The Company hired and trained pilots, flight attendants and mechanics, and purchased spare parts in anticipation of the new fleet.  These preparations have increased costs, but the expected benefits of the new and more efficient aircraft have not yet occurred.  Explanations of significant year-over-year changes in the components of operating expenses are as follows:

Consolidated Nonoperating Income (Expense)  Net nonoperating items were $3.1 million expense in 2001 compared to $1.7 million income in 2000.  The $4.8 million change was primarily due to higher interest expense resulting from new debt incurred during the past twelve months.  Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended.  SFAS 133 requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value.  Consequently, a $0.8 million charge was recorded in the second quarter of 2001 to recognize the reduction in fair value of fuel hedging contracts in accordance with the new standard.

Six Months 2001 Compared with Six Months 2000
The consolidated net loss for the six months ended June 30, 2001 was $28.4 million, or $(1.07) per share compared with an income before accounting change (and excluding a special charge in 2000) of $14.4 million, or $0.54 per share (diluted) in 2000.  The consolidated operating loss for the first six months of 2001 was $38.2 million compared with an operating income (excluding a special charge) of $20.5 million for 2000.  A discussion of operating results for the two airlines follows.

Alaska Airlines  Operating income (excluding a special charge in 2000) decreased $38.6 million to a $21.4 million operating loss in 2001.  Changes in operating revenues and operating expenses are generally due to the same reasons stated above in the second quarter comparison.

Horizon Air  Operating income decreased $19.9 million to a $15.8 million operating loss in 2001.  Except for maintenance expense, changes in operating revenues and operating expenses are generally due to the same reasons stated above in the second quarter comparison.  Maintenance expense is up 18.5% due to expenses related to the accelerated timeframe for phasing out the Fokker F-28 jet aircraft.

Consolidated Nonoperating Income (Expense)  Net nonoperating items were $4.9 million expense in 2001 compared to $2.9 million income in 2000.  The $7.8 million change was primarily due to higher interest expense and a $2.5 million reduction in fair value of fuel hedging contracts.

Consolidated Income Tax Credit  Accounting standards require the Company to provide for income taxes each quarter based on its estimate of the effective tax rate for the full year.  The volatility of air fares and fuel prices and the seasonality of the Company's business make it difficult to accurately forecast full-year pretax results.  In addition, a relatively small change in pretax results can cause a significant change in the effective tax rate due to the magnitude of nondeductible expenses, such as goodwill amortization and employee per diem costs.  In estimating the 34.1% tax rate for the first half of 2001, the Company considered a variety of factors, including the U.S. federal rate of 35%, estimates of nondeductible expenses and state income taxes, and the 39.1% and 39.2% tax rates used for full years 1998 and 1999.  This rate is evaluated each quarter and adjustments are made if necessary.

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

The Company's cash and marketable securities portfolio decreased by $91.1 million during the first six months of 2001.  Operating activities provided $123.7 million of cash during this period.  Additional cash was provided by the issuance of $136.5 million of new debt and the return of $50.6 million of flight equipment deposits.  Cash was used for $284.6 million of capital expenditures, including the purchase of seven new Boeing 737 aircraft, flight equipment deposits, spare parts and airframe and engine overhauls, and for $117.8 million of debt repayment.

Shareholders' equity decreased $27.8 million, primarily due to the net loss of $28.4 million.

Commitments  At June 30, 2001, the Company had firm orders for 48 aircraft requiring aggregate payments of approximately $1.1 billion, as set forth below.  In addition, Alaska has options to acquire 26 more B737s, and Horizon has options to acquire 15 Dash 8-400s and 25 CRJ 700s.  Alaska and Horizon expect to finance the new planes with leases, long-term debt or internally generated cash.

* With manufacturer approval, some of  these firm orders may be converted to other Next Generation Boeing 737 aircraft.

New Accounting Standards  In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" (effective July 1, 2001) and SFAS No. 142, "Goodwill and Other Intangible Assets" (effective for the Company on January 1, 2002).  SFAS 141 prohibits pooling-of-interests accounting for acquisitions.  SFAS 142 specifies that goodwill and some intangible assets will no longer be amortized but instead will be subject to periodic impairment testing.  The Company is in the process of evaluating the financial statement impact of adoption of SFAS 142.  However, the Compamy expects that the adoption of SFAS 142 will not have a material impact on the financial statements.

PART II.  OTHER INFORMATION
ITEM 1.  Legal Proceedings
Oakland Maintenance Investigation
In December 1998 the U.S. attorney for the Northern District of California initiated a grand jury investigation concerning certain 1998 maintenance activities at Alaska’s Oakland maintenance base.  The investigation has also included the aircraft involved in the loss of Flight 261 in January 2000.  Alaska is cooperating with this investigation.  To the Company’s knowledge, no charges have been filed.  The FAA has separately proposed a civil penalty of $44,000 in connection with this matter.  The parties are in settlement discussions over this penalty.  These proceedings are described in more detail in the Alaska Air Group, Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 2000.

Flight 261 Litigation
Alaska is a defendant in a number of lawsuits relating to the loss of Flight 261 on January 31, 2000.  Lawsuits on behalf of all 88 passengers and crew on board have been filed against Alaska, The Boeing Company and others.  The suits seek unspecified compensatory and punitive damages.  In May 2001 the judge presiding over the majority of the cases ruled that punitive damages are not available against Alaska.  Consistent with industry standards, the Company maintains insurance against aircraft accidents.  This litigation is described in more detail in the Alaska Air Group, Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 2000.

FAA Audit
In April 2000, the FAA performed an audit of Alaska's maintenance and flight operations departments to ensure adherence to mandated procedures. The FAA proposed civil penalties of approximately $1 million in connection with this inspection, which the parties have settled for a negotiated amount.  The Company expects no further material activity in this matter. This audit and the actions taken by the FAA and Alaska as a result are described in more detail in the Alaska Air Group, Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 2000.