SEC Filing | Alaska Air Group Inc

Employer

Beginning Date

Ending Date

Alaska Airlines, Inc.

January 1, 1998

Horizon Air Industries, Inc.

January 1, 1998

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Form 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-K

(Mark One)

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 *[NO FEE REQUIRED]*

For the fiscal year ended December 31, 2007

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 *[NO FEE REQUIRED]*

For the transition period from to

Commission File Number 1-8957

ALASKA AIR GROUP, INC.

A Delaware Corporation

91-1292054

19300 International Boulevard, Seattle, Washington 98188

Telephone: (206) 392-5040

(I.R.S. Employer Identification No.)

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class		Name of Each Exchange on Which Registered
Common Stock, $1.00 Par Value		New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x

As of December 31, 2007, shares of common stock outstanding totaled 38,050,680. The aggregate market value of the shares of common stock of Alaska Air Group, Inc. held by nonaffiliates on June 29, 2007, was approximately $1.12 billion (based on the closing price of $27.86 per share on the New York Stock Exchange on that date).

DOCUMENTS INCORPORATED BY REFERENCE


Title of Document		Part Hereof Into Which Document is to be Incorporated
Definitive Proxy Statement Relating to 2008 Annual Meeting of Shareholders		Part III

ALASKA AIR GROUP, INC.

ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2007

TABLE OF CONTENTS


PART I		5
ITEM 1.	OUR BUSINESS	5
	WHERE YOU CAN FIND MORE INFORMATION	5
	OUR AIRLINES	5
	ALASKA	5
	HORIZON	6
	INDUSTRY CONDITIONS	6
	FUEL	7
	MARKETING AND COMPETITION	8
	ALLIANCES WITH OTHER AIRLINES	8
	COMPETITION	8
	TICKET DISTRIBUTION	9
	EMPLOYEES	9
	EXECUTIVE OFFICERS OF THE REGISTRANT	11
	REGULATION	12
	GENERAL	12
	AIRLINE FARES	13
	ENVIRONMENTAL MATTERS	13
	CUSTOMER SERVICE	14
	MILEAGE PLAN PROGRAM	14
	OTHER INFORMATION	15
	SEASONALITY AND OTHER FACTORS	15
	INSURANCE	15
	OTHER GOVERNMENT MATTERS	15
ITEM 1A.	RISK FACTORS	16
ITEM 1B.	UNRESOLVED STAFF COMMENTS	21
ITEM 2.	PROPERTIES	22
	AIRCRAFT	22
	GROUND FACILITIES AND SERVICES	23
ITEM 3.	LEGAL PROCEEDINGS	23
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	23
PART II		24
ITEM 5.	MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES	24
	SALES OF NON-REGISTERED SECURITIES	24
	PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS	24
	PERFORMANCE GRAPH	25
ITEM 6.	SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA	26
ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	28
	OVERVIEW	28
	YEAR IN REVIEW	28
	RESULTS OF OPERATIONS	32
	2007 COMPARED WITH 2006	32
	Alaska Airlines	36
	Horizon Air	43


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	Consolidated Nonoperating Income (Expense)	46
	Consolidated Income Tax Expense (Benefit)	47
	2006 COMPARED WITH 2005	47
	Alaska Airlines	47
	Horizon Air	50
	Consolidated Nonoperating Income (Expense)	52
	Consolidated Income Tax Expense (Benefit)	52
	CHANGE IN ACCOUNTING POLICY	52
	CRITICAL ACCOUNTING ESTIMATES	53
	NEW ACCOUNTING STANDARDS	56
	LIQUIDITY AND CAPITAL RESOURCES	57
	ANALYSIS OF OUR CASH FLOWS	57
	CONTRACTUAL OBLIGATIONS, COMMITMENTS AND OFF-BALANCE SHEET ARRANGEMENTS	58
	EFFECT OF INFLATION AND PRICE CHANGES	59
	OTHER	59
ITEM 7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK	60
	MARKET RISK – AIRCRAFT FUEL	60
	FINANCIAL MARKET RISK	60
ITEM 8.	CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	61
	SELECTED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION	61
	REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	62
	CONSOLIDATED BALANCE SHEETS	64
	CONSOLIDATED STATEMENTS OF OPERATIONS	66
	CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY	67
	CONSOLIDATED STATEMENTS OF CASH FLOWS	69
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS	70
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	98
ITEM 9A.	CONTROLS AND PROCEDURES	98
	EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES	98
	CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING	98
	MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING	98
	REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	99
ITEM 9B.	OTHER INFORMATION	100
PART III		101
ITEM 10.	DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE	101
ITEM 11.	EXECUTIVE COMPENSATION	101
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT, AND RELATED STOCKHOLDER MATTERS	101
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE	101
ITEM 14.	PRINCIPAL ACCOUNTANT FEES AND SERVICES	101
PART IV		102
ITEM 15.	EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES	102
SIGNATURES		103

As used in this Form 10-K, 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.”


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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

In addition to historical information, this Form 10-K 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:

•

the competitive environment in our industry;

•

changes in our operating costs, including fuel, which can be volatile;

•

labor disputes and our ability to attract and retain qualified personnel;

•

the amounts of potential lease termination payments with lessors for our remaining MD-80 and Q200 leased aircraft and related sublease payments from sublessees, if applicable;

•

our significant indebtedness;

•

compliance with our financial covenants;

•

potential downgrades of our credit ratings and the availability of financing;

•

our ability to meet our cost reduction goals;

•

operational disruptions;

•

general economic conditions, as well as economic conditions in the geographic regions we serve;

•

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;

•

insurance costs;

•

our inability to achieve or maintain profitability;

•

fluctuations in our quarterly results;

•

an aircraft accident or incident;

•

liability and other claims asserted against us;

•

our reliance on automated systems and the risks associated with changes made to those systems;

•

our reliance on third-party vendors and partners;

•

changes in laws and regulations; and

•

increases in government fees and taxes.

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 in this Form 10-K, see “Item 1A: Risk Factors.” Please consider our forward-looking statements in light of those risks as you read this report.


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PART I

ITEM 1. OUR BUSINESS

We are a Delaware corporation incorporated in 1985 and we have two principal subsidiaries: Alaska Airlines, Inc. (Alaska) and Horizon Air Industries, Inc. (Horizon). Through these subsidiaries, we provide passenger air service to approximately 25 million passengers per year to nearly 100 destinations. We also provide freight and mail services, primarily to and within the state of Alaska and on the West Coast. Although Alaska and Horizon both operate as airlines, their business plans, competition, and economic risks differ substantially. Alaska is a major airline that operates an all-jet fleet with an average passenger trip length of 1,051 miles. Horizon is a regional airline, operates turboprop and jet aircraft, and its average passenger trip is 386 miles. Individual financial information about Alaska and Horizon is in Note 15 to the consolidated financial statements and throughout this section, specifically in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Both of our airlines endeavor to distinguish themselves from competitors by providing a higher level of customer service and differentiating amenities. Our outstanding employees and excellent service in the form of advance seat assignments, expedited check-in, attention to customer needs, a generous frequent flyer program, well-maintained aircraft, a first-class section aboard Alaska aircraft, and other amenities are regularly recognized by independent studies, awards, and surveys of air travelers. For example, Horizon was named the “2007 Regional Airline of the Year” by Air Transport World, a leading industry publication, and Alaska was named in the top five U.S. carriers for premium service in a recent Zagat survey. We are very proud of these awards and we continue to strive to have the best customer service in the industry.

WHERE YOU CAN FIND MORE INFORMATION

We maintain an Internet website at www.alaskaair.com. 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 filed or furnished pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available on our website at www.alaskaair.com, free of charge, as soon as reasonably practicable after the electronic filing of these reports with the Securities and Exchange Commission. The information contained on our website is not a part of this annual report on Form 10-K.

OUR AIRLINES

ALASKA

Alaska Airlines is an Alaska corporation that was organized in 1932 and incorporated in 1937. We offer extensive north/south service within the western U.S., Canada and Mexico, and passenger and dedicated cargo services to and within the state of Alaska. We also provide long-haul east/west service to eight cities in the continental U.S., primarily from Seattle, where we have our largest concentration of departures; although we do offer long-haul departures from Anchorage, Los Angeles, and Portland, Oregon. During 2007, we also initiated service to Hawaii, with non-stops from Seattle to Honolulu and Lihue and from Anchorage to Honolulu.

In 2007, we carried 17.6 million revenue passengers in our mainline operations, and in each year since 1973, we have carried more passengers between Alaska and the U.S. mainland than any other airline. Based on the


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number of passengers, Alaska’s leading airports are Seattle, Los Angeles, Anchorage and Portland. Based on 2007 revenues, the leading nonstop routes are Seattle-Anchorage, Seattle-Los Angeles, and Seattle-San Diego. At December 31, 2007, Alaska’s operating fleet consisted of 115 jet aircraft, compared to 114 aircraft as of December 31, 2006.

Alaska’s passenger traffic by market is presented below:


	2007		2006
West Coast	46	%	45	%
Within Alaska and between Alaska and the U.S. mainland	21	%	20	%
Mexico	11	%	11	%
Canada	4	%	4	%
Other, including transcontinental and Hawaii	18	%	20	%

Total	100	%	100	%

HORIZON

Horizon Air Industries, a Washington corporation that first began service and was incorporated in 1981, and was acquired by Air Group in 1986. It is the largest regional airline in the Pacific Northwest, and serves a number of cities in six states and six cities in Canada under the Horizon brand. In 2008, Horizon began service to Loreto, Mexico, from Los Angeles and will serve its seventh city in Canada when it begins service to Prince George, British Columbia, in May 2008. In addition to operating under its own brand, Horizon operated regional jet service as Frontier JetExpress through the end of November 2007 under an agreement with Frontier Airlines. Horizon terminated this agreement with Frontier at that time and has redeployed the nine CRJ-700s back into the Air Group route structure.

In 2007, Horizon carried 7.6 million revenue passengers. Approximately 92% of Horizon’s revenue passenger miles in 2007 were flown domestically, primarily in the states of Washington, Oregon and Idaho, compared to 91% in 2006. The Canada markets accounted for 8% of revenue passenger miles in 2007, compared to 9% in 2006. Based on passenger enplanements, Horizon’s leading airports are Seattle, Portland, Boise, and Spokane. Based on revenues in 2007, the leading nonstop routes are Portland-Seattle, Spokane-Seattle, and Ontario-Portland. At December 31, 2007, Horizon’s operating fleet consisted of 21 jets and 49 turboprop aircraft. Except for those flights that were operated as Frontier JetExpress, Horizon flights are listed under the Alaska Airlines designator code in airline reservation systems.

Alaska and Horizon integrate their flight schedules to provide convenient, competitive connections between most points served by their systems. In 2007 and 2006, approximately 22% and 24%, respectively, of Horizon’s passengers connected to flights operated by Alaska.

INDUSTRY CONDITIONS

Our industry is highly competitive and is characterized by low profit margins and high fixed costs, primarily for wages, aircraft fuel, aircraft ownership costs and facilities rents. Because expenses of a 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. In other words, a minor shortfall in expected revenue levels could cause a disproportionately negative impact on our results of operations. Passenger demand and ticket prices are, to a large measure, influenced by the general state of the economy in some parts of the United States, current events and available capacity.

In 2007, the airline industry posted its second year of net profits since 2000. However, with the dramatic increase in fuel prices and a softening economy, industry profits were lower than originally predicted by industry experts and analysts. In 2005 and 2006, load factors and unit revenues climbed higher in the wake of strong demand and a healthy economy. That strong demand and a reduction in total capacity in some regions, as other major carriers shifted capacity to international routes, allowed domestic carriers to raise ticket prices. However, there was some softening in demand for air


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travel early in 2007, and unit revenues declined on a year-over-year basis during the first half of the year. Unit revenues rebounded later in the year, principally in response to higher passenger load factors and actions taken to help offset increases in jet fuel prices.

Several traditional or “legacy” carriers have reorganized through bankruptcy proceedings over the past several years. These carriers have gained a competitive advantage by significantly reducing their costs almost immediately. In addition, so called “low-cost carriers” (LCCs) have grown significantly since 2001 and currently carry more than 30% of total U.S. domestic passenger traffic. However, the line between the LCCs and legacy carriers is becoming more blurred as the legacy carriers make further reductions in unit costs and the LCCs face cost pressures, and as the legacy carriers reduce service offerings. Because of their unit cost advantage, the LCCs and recently reorganized airlines have and continue to exert downward pressure on ticket prices compared to historical levels. Because of the relatively low barriers to entry and financial success of LCCs, we expect the expansion of low-cost and low-fare carriers to continue. We compete with many of these carriers directly now, and expect to compete with new entrants in the future. For example, Virgin America, a new LCC, has announced plans to offer non-stop service between Seattle and Los Angeles and between Seattle and San Francisco in the spring of 2008.

FUEL

Our business and financial results are highly affected by the price and, potentially, the availability of jet fuel. Fuel prices have increased dramatically over the past few years and these increases have hurt our financial results. We refer to the price we pay at the airport or “into- plane” price, including applicable taxes, as our “raw” fuel price. Raw fuel prices are impacted by world oil prices and refining costs, which can vary by region in the U.S. Generally, West Coast jet fuel prices are somewhat higher and substantially more volatile than prices in the Gulf Coast or on the East Coast, putting both Alaska and Horizon at a competitive disadvantage. Historically, fuel costs have generally represented 10% to 15% of an airline’s operating costs. However, in recent years, fuel costs have risen sharply to represent 20% to 30% of total operating costs for airlines. Both the crude oil and refining cost components of jet fuel are volatile and outside of our control, and they can have a significant and immediate impact on our operating results. Our average raw fuel cost per gallon increased 8%, 17%, and 34%, in 2007, 2006, and 2005, respectively.

LOGO

We almost exclusively use crude oil call options as hedges to decrease our exposure to the volatility of jet fuel prices. Call options effectively cap our pricing on the crude oil component of fuel prices, limiting our exposure to increasing fuel prices on a percentage of our planned fuel consumption. With these call option contracts, we still benefit from the decline in crude oil prices, as there is no downward exposure other than the premiums we pay to enter into the contracts. We also use collar structures in limited instances for fuel hedging purposes. Additionally, we enter into fuel purchase contracts that fix the refining margin we pay on a certain percentage of our fuel consumption.

Fuel costs, including gains and losses stemming from changes in the value of our hedge portfolio, were approximately 27% of our total operating expenses in 2007, 26% in 2006, and 20% in 2005. Currently, a one-cent change in our hedged fuel price per gallon affects annual fuel costs by approximately $4.0 million. In addition


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to our hedging program, we believe that operating fuel-efficient aircraft helps to mitigate the effect of high fuel prices.

Due to the competitive nature of the airline industry, airlines often have been unable to immediately pass on increased fuel prices to customers by increasing fares. Conversely, any potential benefit of lower fuel prices could be offset by increased fare competition and lower revenues.

Although we do not currently anticipate a significant reduction in jet 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 resulting in price increases, which could adversely affect our business. If there were major reductions in the availability of jet fuel, our business would be adversely affected.

MARKETING AND COMPETITION

ALLIANCES WITH OTHER AIRLINES

We have marketing alliances with several other airlines that provide reciprocal frequent flyer mileage credit and redemption privileges as well as code sharing on certain flights as shown in the table below. Alliances enhance our revenues by:

•

offering our customers more travel destinations and better mileage credit/redemption opportunities;

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giving us access to more connecting traffic from other airlines; and

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providing members of our alliance partners’ frequent flyer programs an opportunity to travel on Alaska and Horizon while earning mileage credit in our partners’ programs.

Most of our codeshare relationships are free-sell codeshares, where the marketing carrier sells seats on the operating carrier’s flights from the operating carrier’s inventory, but takes no inventory risk. Our marketing agreements have various termination dates, and at any time, one or more may be in the process of renegotiation.

Our marketing alliances with other airlines as of December 31, 2007 are as follows:


	Frequent Flyer Agreement		Codeshare— Alaska Flight # on Flights Operated by Other Airline	Codeshare— Other Airline Flight # On Flights Operated by Alaska/ Horizon
Major U.S. or International Airlines
American Airlines/American Eagle	Yes		Yes	Yes
Air France	Yes		No	Yes
British Airways	Yes		No	No
Cathay Pacific Airways	Yes		No	No
Continental Airlines	Yes		Yes	Yes
Delta/Delta Connection**	Yes		Yes	Yes
KLM	Yes		No	Yes
Lan S.A.	Yes		No	Yes
Northwest Airlines	Yes		Yes	Yes
Qantas	Yes		No	Yes
Regional Airlines
Era Aviation	Yes	*	Yes	No
PenAir	Yes	*	Yes	No
Big Sky Airlines	No		Yes	No

*	This airline does not have its own frequent flyer program. However, Alaska’s Mileage Plan members can earn and redeem miles on this airline’s route system.

**	Alaska has codeshare agreements with the Delta Connection carriers Skywest and ASA as part of its agreement with Delta Air Lines.

COMPETITION

Competition in the airline industry is intense. We believe the principal competitive factors in the industry that are important to customers are:

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safety record and reputation,

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flight schedules,

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fares,

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customer service,

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routes served,

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frequent flyer programs,

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on-time arrivals,

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baggage handling,

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on-board amenities,

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type of aircraft, and

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code-sharing relationships.


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Together, Alaska and Horizon carry approximately 3.2% of all U.S. domestic passenger traffic. We compete with one or more domestic or foreign airlines on most of our routes, including Southwest Airlines, United Airlines, Northwest Airlines, Continental Airlines, American Airlines, Delta Air Lines, US Airways, and regional affiliates associated with some of these carriers. Most of these airlines are larger and have greater financial resources and name recognition or lower operating costs than our companies. In addition, competitors that have successfully reorganized out of bankruptcy have lower operating costs derived from renegotiated labor, supply and financing agreements. Some of these competitors have chosen to add service, reduce their fares, or both in our markets. Continuing growth of LCCs, including Southwest Airlines, AirTran Airways, Frontier Airlines, jetBlue Airways, and Virgin America, places significant competitive pressures on us and other network carriers because the LCCs have the ability to charge a lower fare for travel between similar cities. As such, we may be unable to compete effectively against other airlines that introduce service or discounted fares in the markets that we serve. Due to its short-haul markets, Horizon also competes with ground transportation in many markets, including train, bus and automobile transportation.

TICKET DISTRIBUTION

Airline tickets are distributed through three primary channels:

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Airline websites such as alaskaair.com or horizonair.com. It is less expensive for us to sell through these direct channels and, as a result, we continue to take steps to drive more business to our websites. In addition, we believe this channel is preferable from a branding and customer-relationship standpoint in that we can establish ongoing communication with the customer and tailor offers accordingly. In October 2007, we passed a significant milestone by processing over 50% of our monthly sales through our website – a sign of progress toward our goal of transitioning more of our customers to this direct sales channel.

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Traditional and online travel agents. Consumer reliance on traditional travel agencies is shrinking, giving way to online travel agencies. Both traditional and online travel agencies typically use Global Distribution Systems (GDS), such as Sabre, to obtain their fare and inventory data from airlines. Bookings made through these agencies result in a fee that is charged to the airline. Many of our large corporate customers require that we use these agencies. Some of our competitors do not use this distribution channel and, as a result, have lower ticket distribution costs.

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Reservation call centers. These call centers are located in Phoenix, Arizona; Kent, Washington; and Boise, Idaho. We generally charge a $10 fee for booking reservations through these call centers.

Our sales by channel are presented below:


	2007		2006
Alaskaair.com/horizonair.com	43	%	39	%
Traditional and online travel agencies	43	%	47	%
Reservations call center	12	%	12	%
All other channels	2	%	2	%

Total	100	%	100	%

EMPLOYEES

Labor costs have historically made up 30% to 40% of an airline’s total operating costs. Most major airlines, including ours, have employee groups that are covered by collective bargaining agreements. Often, airlines with unionized work forces have higher labor costs than carriers without unionized work forces, and they may not have the ability to adjust labor costs downward quickly enough to respond to new competition. New entrants into the U.S. airline industry generally do not have unionized work forces, which can be a competitive advantage for those airlines. Alaska has been able to reduce wages and benefits costs from 2004 levels through a number of initiatives, but we have experienced recent increases in wage and benefit costs because of normal scale and step increases,


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market wage increases, and higher healthcare costs. Horizon faces similar pressures on wages and benefits. We expect to see continued upward pressure on wages and benefits in the future. We recognize the need to continue to improve employee productivity in order to mitigate this cost pressure and to reduce our wages and benefits on an available-seat-mile basis. We have initiatives underway to increase productivity and efficiency.

We had 14,710 (Alaska and Horizon had 10,526 and 4,184, respectively) active full-time and part-time employees at December 31, 2007, compared to 14,485 (10,454 at Alaska and 4,031 at Horizon) as of December 31, 2006. Wages, salaries and benefits (including variable incentive pay) represented approximately 30% and 28% of our total operating expenses in 2007 and 2006, respectively.

At December 31, 2007, labor unions represented 84% of Alaska’s and 48% of Horizon’s employees. Our relations with our labor organizations are governed by the Railway Labor Act (RLA). Under this act, collective bargaining agreements 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 prescribed by the RLA and/or 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 that an impasse exists, at which point the National Mediation Board offers binding arbitration to the parties. Either party may decline to submit to arbitration. If either party rejects arbitration, 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, if invoked, lasts for 30 days and is followed by another “cooling-off” period of 30 days. At the end of the applicable “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 on the collective bargaining agreements and/or the hiring of workers to replace strikers.

Alaska’s union contracts at December 31, 2007 were as follows:


Union	Employee Group	Number of Employees	Contract Status
Air Line Pilots Association International (ALPA)	Pilots	1,483	In Negotiations

Association of Flight Attendants (AFA)	Flight attendants	2,720	Amendable 4/27/10

International Association of Machinists and	Ramp service and stock clerks; and Clerical, office and passenger service	664	Amendable 7/17/10
Aerospace Workers (IAM/RSSA)		3,121	Amendable 7/17/10

Aircraft Mechanics Fraternal Association (AMFA)	Technicians, inspectors and cleaners	678	Amendable 10/01/09

Mexico Workers Association of Air Transport	Station personnel in Mexico	111	Amendable 9/29/09

Transport Workers Union of America (TWU)	Dispatchers	35	Amendable 7/01/10*

*	Collective bargaining agreement contains interest arbitration provision.


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Horizon’s union contracts at December 31, 2007 were as follows:


Union	Employee Group	Number of Employees	Contract Status
International Brotherhood of Teamsters (IBT)	Pilots	722	In Negotiations

AFA	Flight attendants	672	In Negotiations

AMFA	Technicians and related classifications	507	Amendable 11/30/08

TWU	Dispatchers	21	Amendable 10/6/08

National Automobile, Aerospace, Transportation and General Workers	Station personnel in Vancouver and Victoria, BC, Canada	85	Expires 2/14/10

EXECUTIVE OFFICERS OF THE REGISTRANT

The executive officers of Alaska Air Group, Inc. (including its subsidiaries Alaska and Horizon), their positions and their respective ages (as of February 1, 2008) are as follows:


Name	Position	Age	Air Group or Subsidiary Officer Since
William S. Ayer	Chairman, President and Chief Executive Officer of Alaska Air Group, Inc. and Alaska Airlines, Inc.	53	1985

Bradley D. Tilden	Executive Vice President/Finance and Planning and Chief Financial Officer of Alaska Air Group, Inc. and Alaska Airlines, Inc.	47	1994

Keith Loveless	Vice President/Legal and Corporate Affairs, General Counsel and Corporate Secretary of Alaska Air Group, Inc. and Alaska Airlines, Inc.	51	1996

Gregg Saretsky	Executive Vice President/Flight and Marketing of Alaska Airlines, Inc.	48	1998

Glenn S. Johnson	Executive Vice President/Airports, Maintenance and Engineering of Alaska Airlines, Inc.	49	1991

Jeffrey D. Pinneo	President and Chief Executive Officer of Horizon Air Industries, Inc.	51	1990

Brandon S. Pedersen	Vice President/Finance and Controller of Alaska Air Group, Inc. and Alaska Airlines, Inc. (Principal Accounting Officer)	41	2003

Mr. Ayer has been President since February 2003 and became Chairman and Chief Executive Officer in May 2003. Mr. Ayer is also Chairman, President and Chief Executive Officer of Alaska Airlines. He has served as Alaska Airlines’ Chairman since February 2003, as Chief Executive Officer since January 2002 and as President since November 1997. Prior to that, he was Sr. Vice President/Customer Service, Marketing and Planning of Alaska Airlines from January 1997, and Vice President/Marketing and Planning from August 1995. Prior thereto, he served as Sr. Vice President/Operations of Horizon Air from January 1995. Mr. Ayer serves on the boards of Alaska Airlines, Puget Energy, Inc., the Alaska Airlines Foundation, Angel Flight West, Inc., and the Museum of Flight. He also serves on the University of Washington Business School Advisory Board, and was recently appointed a director of the Seattle branch of the Federal Reserve Board.

Mr. Tilden joined Alaska Airlines in 1991, became controller of Alaska Airlines and Alaska Air Group in 1994, CFO in February 2000, Executive Vice President/Finance in January 2002, and Executive Vice President/Finance and Planning in 2007.


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Mr. Loveless became Corporate Secretary and Assistant General Counsel of Alaska Air Group and Alaska Airlines in 1996. In 1999, he was named Vice President/Legal and Corporate Affairs, General Counsel and Corporate Secretary of Alaska Air Group and Alaska Airlines.

Mr. Saretsky joined Alaska Airlines in March 1998 as Vice President/Marketing and Planning. In 2000, he became Senior Vice President/Marketing and Planning. He was elected Executive Vice President/Marketing and Planning of Alaska Airlines in 2002, and in 2007 he was elected Executive Vice President/ Flight and Marketing.

Mr. Johnson became Vice President/Controller and Treasurer of Horizon Air Industries in 1991 and Vice President/Customer Services in 2002. He moved to Alaska Airlines in 2003 where he has served in several roles, including Vice President/Finance and Controller and Vice President/Finance and Treasurer. Most recently, he has served as Senior Vice President/Customer Service – Airports from January 2006 through April 2007. In April 2007, he was elected Executive Vice President/Airports and Maintenance and Engineering.

Mr. Pinneo became Vice President/Passenger Service of Horizon Air Industries in 1990 following nine years at Alaska Airlines in various marketing roles. In January 2002, he was named President and CEO of Horizon Air.

Mr. Pedersen joined Alaska Airlines in 2003 as Staff Vice President/Finance and Controller of Alaska Air Group and Alaska Airlines and was elected Vice President/Finance and Controller for both entities in 2006.

REGULATION

GENERAL

The Department of Transportation (DOT) and the Federal Aviation Administration (FAA) exercise significant regulatory authority over air carriers.

•

DOT: 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 DOT. 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. Certificates do not expire, but may be revoked for failure to comply with federal aviation statutes, regulations, orders or the terms of the certificates. In addition, the DOT has jurisdiction over the approval of international codeshare agreements, alliance agreements between domestic major airlines, international route authorities and certain consumer protection matters, such as advertising, denied boarding compensation and baggage liability. International treaties may also contain restrictions or requirements for flying outside of the U.S.

•

FAA: The FAA, through Federal Aviation Regulations (FARs), generally regulates all aspects of airline operations, 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, both our operations specifications and a maintenance program for each type of aircraft we operate. The maintenance program provides for the ongoing maintenance of such aircraft, ranging from frequent routine inspections to major overhauls. From time to time the FAA issues airworthiness directives (ADs) that must be incorporated into our aircraft maintenance program and operations. All airlines are subject to enforcement actions that are brought by the FAA from time to time for alleged violations of FARs or ADs. At this time, we are not aware of any enforcement proceedings that could either materially affect our financial position or impact our authority to operate.

The Aviation and Transportation Security Act (the Security Act) generally provides for enhanced aviation security measures. Pursuant to the


12

Security Act, the Transportation Security Administration (TSA) is responsible for aviation security. The Security Act mandates that the TSA shall provide for the screening of 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 most of these functions with its own federal employees. The TSA also provides for increased security on flight decks of aircraft and requires federal air marshals to be present on certain flights. The Security Act imposes 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. In addition, carriers are required to pay an additional amount to the TSA to cover the cost of providing security measures equal to the amount the air carriers paid for screening passengers and property in 2000. We paid $12.6 million to the TSA for this security charge in 2007, 2006 and 2005.

The Department of Justice has jurisdiction over airline antitrust matters. The U.S. Postal Service 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 fly to foreign countries and pursue alliances with international carriers, we may be subject to certain regulations of foreign agencies.

AIRLINE FARES

Airlines are permitted to establish their own domestic fares without governmental regulation, and the industry is characterized by vigorous price competition. The DOT 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. Although air carriers are required to file and adhere to international fare and rate tariffs, substantial commissions, overrides and discounts given to travel agents, brokers and wholesalers characterize many international markets.

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 effect 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 (OSHA) concerning employee safety and health matters. The U.S. Environmental Protection Agency, or EPA, OSHA, and other federal agencies have been authorized to create and enforce regulations that have an impact on our operations. In addition to these federal activities, various states have been delegated certain authorities under these 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 Airport 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 established aircraft noise reduction programs, including the imposition of nighttime curfews. The Airport Noise and Capacity Act generally requires FAA approval of local noise restrictions on aircraft. We believe we have sufficient scheduling flexibility to accommodate local noise restrictions.

At December 31, 2007, all of our aircraft met the Stage 3 noise requirements under the Airport

Noise and Capacity Act of 1990. However,


		13

special noise ordinances restrict the timing of flights operated by Alaska, Horizon and other airlines at Burbank, Long Beach, Orange County, San Diego, San Jose, and Sun Valley. In addition, due to capacity restrictions, Orange County, Reagan National, Long Beach, Chicago O’Hare, Newark, and Vancouver, B.C. airports restrict the type of aircraft, number of flights, or the time of day that airlines can operate.

Although we do not currently anticipate that these regulatory matters, individually or collectively, will have a material effect on our financial condition, results of operations or cash flows, new regulations or compliance issues that we do not currently anticipate could have the potential to harm our financial condition, results of operations or cash flows in future periods.

CUSTOMER SERVICE

Along with other domestic airlines, we have implemented a customer service commitment plan to address a number of service goals, including, but not limited to, goals relating to lowest fare availability, delays, cancellations and diversions, baggage delivery and liability, guaranteed fares and ticket refunds.

MILEAGE PLAN 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, a grocery store chain, a telephone company, hotels, car rental agencies, and other businesses. 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 or to terminate the program.

Mileage can be redeemed for free or discounted travel and for various other 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 capacity-controlled seating. Mileage Plan accounts are generally deleted after three years of inactivity in a member’s account. However, we have announced plans to reduce this to two years beginning in April 2008. As of December 31, 2007 and 2006, Alaska estimated that approximately 3.7 million and 3.2 million, respectively, round-trip flight awards were eligible for redemption by Mileage Plan members. Of those eligible awards, Alaska estimated that approximately 88% would ultimately be redeemed. For the year 2007, approximately 870,000 round-trip and 270,000 one-way flight awards were redeemed and flown on Alaska and Horizon. One-way awards were introduced in February 2007. For the years 2006 and 2005, approximately 850,000 and 750,000 round-trip flight awards, respectively, were redeemed and flown on Alaska and Horizon. Those awards represent approximately 9.7%, 8.6%, and 7.9% for 2007, 2006, and 2005, respectively, of the total passenger miles flown on Alaska and Horizon. For the years 2007, 2006, and 2005, approximately 243,200, 252,600, and 239,900, respectively, round-trip flight awards were redeemed and flown on airline partners.

For miles earned through travel on Alaska or Horizon and their airline partners, the estimated incremental cost of providing free travel awards in the future is recognized as a selling expense and accrued as a liability as miles are accumulated. The incremental cost of providing award travel on Alaska or Horizon does not include a contribution to overhead, aircraft ownership cost, or profit. Alaska also sells mileage credits to its non-airline partners. Alaska defers a majority of the sales proceeds and recognizes revenue when award transportation is provided on Alaska, Horizon or another partner airline. At December 31, 2007 and 2006, the deferred revenue and the total liability for providing free travel on Alaska and Horizon and for estimated payments to partner airlines was $648.5 million and $545.6 million, respectively, the majority of which is deferred revenue from the sale of mileage credits. Revenue attributable to the Mileage Plan was $227.6 million, $194.2 million, and $180.2 million in 2007, 2006 and 2005, respectively.


14

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 our business is subject to seasonal fluctuations. Our operating income is generally lowest (or if it be the case, our loss the greatest) during the first and fourth quarters due principally to lower traffic, generally increases in the second quarter and typically reaches its highest level during the third quarter as a result of vacation travel, including increased activity in the state of Alaska.

In addition to passenger loads, factors that could cause our quarterly operating results to vary include:

•

pricing initiatives by us and our competitors,

•

changes in fuel costs,

•

the timing and amount of maintenance expenditures (both planned and unplanned),

•

increases or decreases in passenger and volume-driven variable costs, and

•

labor actions.

In addition to those factors listed above, seasonal variations in traffic, the timing of various expenditures such as maintenance events and adverse weather conditions may affect our operating results from quarter to quarter. Many of the markets we serve 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 (particularly in the state of Alaska and the Pacific Northwest) than some of our competitors, who may be better able to spread weather-related risks over larger route systems.

No material part of our business or that of our subsidiaries is dependent upon a single customer, or upon a few high-volume customers. Consequently, the loss of one or more of even our largest customers would likely not have a material adverse effect upon our financial condition, results of operations or cash flows.

INSURANCE

We carry insurance for passenger liability and property and aircraft damage in amounts and of the type generally consistent with industry practice.

After September 11, 2001, aviation insurers significantly reduced the amount of insurance coverage for third-party liability for claims resulting from acts of terrorism, war or similar events. At the same time, the insurers significantly increased the premiums for such coverage as well as for aviation insurance in general. Since then, however, our insurance rates have been declining. During 2006 and 2007, our insurance rates fell below 2001 levels. We attribute this decline to general rate reductions as well as the extensive safety programs maintained by both of our airlines.

Pursuant to authority granted in the Air Transportation Safety and System Stabilization Act, the Homeland Security Act of 2002, as amended by the Consolidated Appropriations Act 2008, the U.S. government has offered, and we have accepted, war risk insurance to replace commercial war risk insurance through August 31, 2008.

OTHER GOVERNMENT MATTERS

We have elected to participate in the Civil Reserve Air Fleet program, whereby we have agreed to 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. Participation in the program is a prerequisite for bidding on various governmental travel contracts.


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ITEM 1A. RISK FACTORS

If any of the following occurs, our business, financial condition and results of operations could suffer. In such case, the trading price of our common stock could also decline. These risk factors may not be exhaustive. We operate in a continually changing business environment and new risk factors emerge from time to time. Management cannot predict such developments, nor can it assess the impact, if any, on our business of such new risk factors or of events described in any forward-looking statements.

The airline industry is highly competitive and subject to rapid 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 nature 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. Over the past few years, airlines have reduced domestic routes and the number of planes available, which has resulted in reduced domestic industry capacity and a trend towards increased fares. Although capacity has declined based on a nationwide average, capacity on the West Coast has actually increased. If airlines decide to increase their capacity further in the future, this could cause fares to decline, which may adversely affect our business and results of operations. Many of our competitors are larger than our airlines and therefore, may have significantly greater financial resources and name recognition or lower operating costs than we do. In addition, competitors who have successfully reorganized out of bankruptcy have lowered their operating costs as a result of renegotiated labor, supply and financing agreements. From time to time in the past, some of these competitors have chosen to add service, reduce their fares, or take other such competitive steps in our key markets. We may be unable to compete effectively against such other airlines that introduce service or discounted fares in the markets that we serve.

The airline industry, and particularly regional airlines like Horizon, also faces competition from ground transportation alternatives, such as buses, trains or automobiles.

The U.S. and Mexico recently amended their bilateral agreement relating to commercial air service. The amendments expand authorized service levels to cities we serve in Mexico. Other airlines have added service to many of the city pairs we currently serve, which has increased competition and has negatively affected our results of operations. Further increases in competition in these markets may result in additional negative pressure on our results of operations.

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, accounting for 27% and 26% of total operating expenses for the years ended December 31, 2007 and 2006, respectively. Significant increases in fuel costs during the past several years have negatively affected our results of operations. Further increases will harm our financial condition and results of operations, unless we are able to increase fares.

Historically, fuel costs and availability have been unpredictable and subject to wide price fluctuations based on geopolitical issues and supply and demand. We have not generally been able to increase fares to offset increases in the price of fuel until recently and we may not be able to do so in the future.

We utilize fuel hedges as a form of insurance against the volatility of fuel prices. To manage the risk of fuel price increases, we purchase call options that are designed to cap a portion of our fuel costs at designated per-barrel oil prices. Even with hedges, we are substantially and increasingly exposed to increases in jet fuel costs as the price at which we are hedged increases.


16

A significant increase in labor costs or change in key personnel could adversely affect our business and results of operations.

We compete against the major U.S. airlines and other businesses 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. In such case, 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.

Labor costs are a significant component of our total expenses, accounting for approximately 30% and 28% of our total operating expenses in 2007 and 2006, respectively. As of December 31, 2007, labor unions represented approximately 84% of Alaska’s and 48% of Horizon’s employees. Each of our represented employee groups has a separate collective bargaining agreement, and could make demands that would increase our operating expenses and adversely affect our financial performance. Uncertainty around open contracts could be a distraction to many employees, reduce employee engagement in our business and divert management’s attention from other projects. Disengaged employees could prevent us from achieving the operational improvements in completion rate and on-time performance that we seek.

In 2005, Alaska and the Air Line Pilots Association (ALPA) were unable to reach a new agreement, and therefore, pursuant to the terms of the collective bargaining agreement that existed at the time, the parties submitted the agreement to binding arbitration. That arbitration decision, which was effective May 1, 2005, resulted in an average pilot wage reduction of 26%. That contract became amendable on May 1, 2007, and Alaska is currently in negotiations with ALPA. Horizon is also in negotiations with the International Brotherhood of Teamsters on a new pilot agreement. The Horizon pilot contract became amendable in September 2006. Factoring in pay rates, productivity measures, and pension and postretirement medical benefits, we believe our pilot unit costs at both Alaska and Horizon are among the highest in the industry for the size of aircraft operated.

Our continuing obligation to fund our traditional defined-benefit pension plans could negatively affect our ability to compete in the marketplace. This is because some of our competitors either have eliminated such obligations through bankruptcy or have never had traditional pension plans in place. Currently, all of our defined-benefit pension plans are closed to new entrants, with the exception of the plan covering Alaska’s pilots.

Finally, to the extent we are unable to maintain the outsourcing or subcontracting of certain services for our business, we would incur substantial costs, including costs associated with hiring new employees, in order to perform these services in-house.

Our failure to successfully reduce unit costs at both Alaska and Horizon could harm our business.

We continue to strive toward aggressive cost-reduction goals that are an important part of our business strategy of offering the best value to passengers through competitive fares while achieving acceptable profit margins and return on capital. We believe having a lower cost structure better positions us to be able to fund growth and take advantage of market opportunities. If we are unable to further reduce our non-fuel unit costs and achieve targeted profitability, we will likely not be able to grow our business and therefore our financial results may suffer.

Our indebtedness and other fixed obligations 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 debt. 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, 2007 and 2006, we had approximately $1.3 billion and $1.2 billion of long-term debt outstanding, respectively, approximately $1.3 billion and $1.1 billion of which was secured by flight equipment and real property. In addition to long-term debt, we have

significant other fixed obligations under operating


		17

leases related to our aircraft, airport terminal space, other airport facilities and office space. As of December 31, 2007, future minimum lease payments under noncancelable operating leases with initial or remaining terms in excess of one year were approximately $1.1 billion for 2008 through 2012 and an aggregate of $526.2 million for the years thereafter.

At December 31, 2007, we had firm orders to purchase 46 aircraft requiring future aggregate payments of approximately $1.0 billion through 2011. Although we have secured financing for a number of these commitments, there is no guarantee that additional financing will be available when required. Our inability to secure the financing could have a material adverse effect on our cash balances or result in delays in or our inability to take delivery of aircraft, which would impair our growth or fleet-simplification plans.

Our outstanding long-term debt and other fixed obligations could have important consequences. For example, they could:

•

limit our ability to obtain additional financing to fund 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 lease payments and 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.

We cannot ensure that we will be able to generate sufficient cash flow from our operations to pay our debt and other fixed obligations as they become due. If we fail to do so, our business could be harmed.

Alaska is required to comply with specific financial covenants in certain agreements. We cannot be certain now that Alaska will be able to comply with these covenants or provisions or that these requirements will not limit our ability to finance our future operations or capital needs.

Our operations are often affected by factors beyond our control, including changing economic and other conditions, which could harm our financial condition and results of operations.

Like other airlines, our operations often are affected by changes in economic and other conditions caused by factors largely beyond our control, including:

•

economic recession, interest rate increases, inflation, international or domestic conflicts, terrorist activity, or other changes in economic or business conditions;

•

air traffic congestion at airports or other air traffic control problems;

•

adverse weather conditions; and

•

increased security measures or breaches in security.

Delays and cancellations frustrate passengers, reduce aircraft utilization and increase costs, all of which affect our profitability. Due to our geographic area of operations, we believe a significant portion of our operation is more susceptible to adverse weather conditions than that of many of our competitors. Any general reduction in airline passenger traffic as a result of any of the above-mentioned factors could harm our business, financial condition and results of operations.

We depend on a few key markets to be successful.

Our strategy is to focus on serving a few key markets, including Seattle, Portland, Los Angeles and Anchorage. A significant portion of our flights occurs to and from our Seattle hub. In 2007, traffic to and from Seattle accounted for 62% of our total traffic.

We believe that concentrating our service offerings in this way allows us to maximize our investment in personnel, aircraft, and ground facilities, as well as to gain greater advantage


18

from sales and marketing efforts in those regions. As a result, we remain highly dependent on our key markets. Our business would be harmed by any circumstances causing a reduction in demand for air transportation in our key markets. An increase in competition in our key markets could also cause us to reduce fares or take other competitive measures that could harm our business, financial condition and results of operations.

The airline industry continues to face potential security concerns and related costs.

The terrorist attacks of September 11, 2001 and their aftermath have negatively affected the airline industry, including our company. More recently, the foiled terror plot in the United Kingdom in August 2006 resulted in new security measures that also impacted our company. Additional terrorist attacks, the fear of such attacks or other hostilities involving the U.S. could have a further significant negative effect on the airline industry, including us, and could:

•

significantly reduce passenger traffic and yields due to a potentially dramatic drop in demand for air travel;

•

significantly increase security and insurance costs;

•

make war risk or other insurance unavailable or extremely expensive;

•

increase fuel costs and the volatility of fuel prices;

•

increase costs from airport shutdowns, flight cancellations and delays resulting from security breaches and perceived safety threats; and

•

result in a grounding of commercial air traffic by the FAA.

The occurrence of any of these events would harm our business, financial condition and results of operations.

Increases in insurance costs or reductions in insurance coverage would harm our business, financial condition and results of operations.

Immediately following the September 11, 2001 terrorist attacks, aviation insurers dramatically increased airline insurance premiums and significantly reduced the insurance coverage 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 System Stabilization Act and the Homeland Security Act of 2002, as most recently amended by the Consolidated Appropriations Act of 2008, the U.S. government continues to offer 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 war and allied perils coverage for hull and comprehensive insurance and twice the limits of third-party liability insurance carried by the airline on September 11, 2001.

Although our insurance costs have declined to pre-2001 levels, aviation insurers could increase their premiums again 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 currently mandated through August 31, 2008. Although the government may extend the deadline for providing such coverage, we cannot be certain that any extension will occur, or if it does, for 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 and the coverage will be much more limited, including smaller aggregate limits and shorter cancellation periods. Significant increases in insurance premiums would adversely affect our business, financial condition and results of operations.

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 could involve a significant loss of life and


		19

result in a loss of 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. Although we strive to maintain the highest standards of safety and reliability and believe that should an accident or

incident nevertheless occur, we also currently

maintain liability insurance in amounts and of the type generally consistent with industry practice. However, 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.

We rely heavily on automated systems to operate our business, and a failure of these systems or by their operators could harm our business.

We depend on automated systems to operate our business, including our computerized airline reservation system, our telecommunication systems, our website, our maintenance systems, and other systems. Substantially all of our tickets are issued 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, maintain secure information, 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. In addition, we rely on other automated systems for crew scheduling, flight dispatch, and other operational needs. Disruption in, changes to, or a breach of these systems could result in the loss of important data, increase our expenses and possibly cause us to temporarily cease our operations.

We rely on partner airlines for codeshare and frequent flyer marketing arrangements.

Alaska and Horizon are parties to marketing agreements with a number of domestic and international air carriers, or “partners,” including but not limited to American Airlines, Continental Airlines, Delta Air Lines and Northwest Airlines. These agreements provide that certain flight segments operated by us are held out as partner “codeshare” flights and that certain partner flights are held out for sale as Alaska codeshare flights. In addition, the agreements generally provide that members of Alaska’s Mileage Plan program can earn miles on or redeem miles for partner flights and vice versa. We receive a significant amount of revenue from flights sold under codeshare arrangements. In addition, we believe that the frequent flyer arrangements are an important part of our Mileage Plan program. The loss of a significant partner or certain partner flights could have a negative effect on our revenues or the attractiveness of our Mileage Plan, which we believe is a source of competitive advantage.

We rely on third-party vendors for certain critical activities.

We have historically relied on outside vendors for a variety of services and functions critical to our business, including airframe and engine maintenance, ground handling, fueling, computer reservation system hosting and software maintenance. As part of our cost-reduction efforts, our reliance on outside vendors has increased and may continue to do so in the future. In recent years, Alaska has subcontracted its heavy aircraft maintenance, fleet service, facilities maintenance, and ground handling services at certain airports, including Seattle-Tacoma International Airport, to outside vendors.

Our use of outside vendors increases our exposure to several risks. In the event that one or more

vendors goes into bankruptcy, ceases operation or fails to perform as promised, replacement services may not be readily available at competitive rates, or at all. Although we believe that our vendor oversight and quality control is among the best in the industry, if one of our vendors fails to perform adequately we may experience increased costs, delays, maintenance issues, safety issues or negative public perception of our airline. Vendor


20

bankruptcies, unionization, regulatory compliance issues or significant changes in the competitive marketplace among suppliers could adversely affect vendor services or force Alaska to renegotiate

existing agreements on less favorable terms. These events could result in disruptions in Alaska’s operations or increases in its cost structure.

We are dependent on a limited number of suppliers for aircraft and parts.

Alaska is dependent on Boeing as its sole supplier for aircraft and many aircraft parts. Horizon is similarly dependent on Bombardier. As a result, we are more vulnerable to any problems associated with the supply of those aircraft and parts, including design defects, mechanical problems, contractual performance by the manufacturers, or adverse perception by the public that would result in customer avoidance or in actions by the FAA resulting in an inability to operate our aircraft. Carriers that operate a more diversified fleet are better positioned than we are to manage such events.

Changes in government regulation imposing additional requirements and restrictions on our operations or on the airports at which we operate 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 U.S. Department of Transportation, the Transportation Security Administration and the Federal Aviation Administration (the “FAA”) have issued regulations that have required significant expenditures relating to the maintenance and operation of airlines. For example, the FAA has issued regulations covering, among other things, security measures, collision avoidance systems, noise abatement, environmental restrictions, safety procedures and maintenance regulations. Similarly, many aspects of an airline’s operations are subject to increasingly stringent federal, state and local laws protecting the environment.

Because of significantly higher security and other costs incurred by airports since September 11, 2001, many airports have increased their rates and charges to air carriers. 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. Although lawmakers may impose these additional fees and view them as “pass-through” costs, we believe that a higher total ticket price will influence consumer purchase and travel decisions and may result in an overall decline in passenger traffic, which would harm our business.

Recently, there has been some discussion of an “airline passenger’s bill of rights” at both the national and state levels. Bills have recently been proposed in several states that will regulate airlines when operating in those specific states. If these bills were to become law, they could impose additional economic and resource constraints on our airlines and could negatively impact our financial performance.

The market price of our common stock may be volatile.

The market price of our stock can be influenced by many factors, a number of which are outside of our control, including those discussed above. Some of the primary factors in the volatility of our stock price are:

•

our actual or anticipated financial performance;

•

the overall financial performance of the industry;

•

other industry factors, such as discussion of consolidation;

•

the price of crude oil; and

•

other macro or geopolitical factors.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None


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ITEM 2. PROPERTIES

AIRCRAFT

The following tables describe the aircraft we operate and their average age at December 31, 2007:


Aircraft Type	Passenger Capacity	Owned	Leased	Total	Average Age in Years
Alaska Airlines
Boeing 737-400	144	3	31	34	12.4
Boeing 737-400C	72	5	—	5	15.3
Boeing 737-400F	—	1	—	1	8.8
Boeing 737-700	124	17	3	20	7.0
Boeing 737-800	157	26	3	29	1.1
Boeing 737-900	172	12	—	12	5.4
Boeing MD-80	140	—	14	14	15.1

		64	51	115	8.3

Horizon Air
Bombardier Q200	37	—	16	16	10.2
Bombardier Q400	74–76	18	15	33	4.0
Bombardier CRJ-700	70	2	19	21	5.5

		20	50	70	5.9

Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” discusses future orders and options for additional aircraft.

As of December 31, 2007, 47 of the 64 aircraft owned by Alaska and five of the 20 aircraft owned by Horizon are subject to liens securing long-term debt, and the majority of the other owned Alaska aircraft serve as collateral for our $185 million line-of-credit facility. Alaska’s leased 737-400, 737-700, 737-800 and MD-80 aircraft have lease expiration dates between 2008 and 2016, between 2009 and 2010, between 2015 and 2018, and between 2008 and 2012, respectively. Horizon’s leased Q200, Q400 and CRJ-700 aircraft have expiration dates between 2012 and 2014, in 2018, and between 2008 and 2020, respectively. Alaska and Horizon have 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.

In 2006, Alaska announced a plan to transition to an all-Boeing 737 fleet by the end of 2008, which includes the accelerated retirement of our MD-80 fleet. In 2007, Horizon announced its plan to transition out of the Q200 aircraft by the end of 2009 and replace them with larger Q400 aircraft. Giving consideration to these fleet transition plans, the following table displays the currently anticipated fleet counts for Alaska and Horizon as of the end of each quarter in 2008:


	31-Mar-08	30-Jun-08	30-Sep-08	31-Dec-08
Alaska Airlines
MD80	9	7	4	—
737-400	34	34	34	32
737-400F**	1	1	1	1
737-400C**	5	5	5	5
737-700	20	20	20	20
737-800*	33	36	41	46
737-900	12	12	12	12

Totals	114	115	117	116

Horizon Air
Q200	13	12	12	10
Q400	33	33	33	36
CRJ-700	20	20	20	20

Totals	66	65	65	66

*	The total includes one additional leased aircraft in 2008.

**	F=Freighter; C=Combination freighter/passenger

Although the number of aircraft in our operating fleet at the end of each period presented remains relatively consistent, it is important to note that the larger B737-800s and the Q400s are replacing the smaller-gauge MD-80s and Q200s. Therefore, our total capacity, as measured by available seat miles, will increase even though the number of aircraft remains consistent.


22

GROUND FACILITIES AND SERVICES

Alaska and Horizon lease ticket counters, gates, cargo and baggage space, office space, and other support areas at the majority of the airports they serve. Alaska also owns 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. These include a five-bay hangar and shops complex (used primarily for line maintenance), a flight operations and training center, an air cargo facility, an information technology office and mainframe computer facility, two office buildings, and corporate headquarters complex. Alaska also leases a stores warehouse, and office spaces for a reservation facility and for various administrative functions in Kent, Washington. Alaska’s major facilities outside of Seattle include a regional headquarters building, an air cargo facility and a hangar/office facility in Anchorage, as well as leased reservations facilities in Phoenix, Arizona and Boise, Idaho. Alaska uses its own employees for ground handling services at most of our airports in the state of Alaska. At other airports throughout our system, those services are contracted to various third-party vendors.

Horizon owns its Seattle corporate headquarters building. It leases an operations, training, and aircraft maintenance facility in Portland; line maintenance stations in Boise, Pasco and Seattle; and temporary hangar facility in Spokane for Q400 modification work.

ITEM 3. LEGAL PROCEEDINGS

Grievance with International Association of Machinists

In June 2005, the International Association of Machinists (IAM) filed a grievance under its Collective Bargaining Agreement (CBA) with Alaska alleging that Alaska violated the CBA by, among other things, subcontracting the ramp service operation in Seattle. The dispute was referred to an arbitrator and hearings on the grievance commenced in January 2007, with a final hearing date in August 2007. We expect a decision from the arbitrator in the first half of 2008.

Other items

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 discussed above 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 judges and juries.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS

None


		23

PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

As of December 31, 2007, there were 38,050,680 shares of common stock of Alaska Air Group, Inc. issued and outstanding and 3,609 shareholders of record. We also held 4,771,306 treasury shares at a cost of $112.5 million. We have not paid dividends on the common stock since 1992. Our common stock is listed on the New York Stock Exchange (symbol: ALK).

The following table shows the trading range of Alaska Air Group, Inc. common stock on the New York Stock Exchange.


	2007				2006
	High		Low		High		Low
First Quarter	$	44.52	$	36.56	$	36.19	$	29.44
Second Quarter		38.99		25.90		40.54		33.86
Third Quarter		29.09		21.50		41.09		33.60
Fourth Quarter		28.00		21.15		45.85		37.50

SALES OF NON-REGISTERED SECURITIES

None

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

In September 2007, the Board of Directors authorized the Company to repurchase up to $100 million of its common stock over a period of twelve months. As of December 31, 2007, the Company had repurchased 2,593,282 shares of common stock for a total of $62.8 million under this authorization as noted in the following table. The repurchased shares have been recorded as treasury shares in the accompanying consolidated balance sheet.


	Total Number of Shares Purchased	Average Price Paid per Share		Maximum remaining dollar value of shares that can be purchased under the plan
September 18, 2007 through September 30, 2007	210,000	$	24.03
October 1, 2007 – October 31, 2007	590,000	$	24.81
November 1, 2007 – November 30, 2007	1,189,482	$	23.36
December 1, 2007 – December 31, 2007	603,800	$	25.42

Total	2,593,282	$	24.22	$	37,190,231

All of the shares purchased in the period were under the plan noted above.


24

PERFORMANCE GRAPH

The following graph compares our cumulative total stockholder return since December 31, 2002 with the S&P 500 Index and the Dow Jones U.S. Airlines Index. The graph assumes that the value of the investment in our common stock and each index (including reinvestment of dividends) was $100 on December 31, 2002.

LOGO


		25

ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND
OPERATING DATA


	2007			2006			2005			2004			2003
Consolidated Operating Results
Year Ended December 31 (in millions, except per share amounts):
Operating Revenues	$	3,506.0		$	3,334.4		$	2,975.3		$	2,723.8		$	2,444.8
Operating Expenses		3,294.0			3,421.7			2,808.8			2,718.1			2,455.9
Operating Income (Loss)		212.0			(87.3	)		166.5			5.7			(17.5	)
Nonoperating income (expense), net of interest capitalized (a)		(10.4	)		(0.5	)		(29.3	)		(26.3	)		46.5
Income (loss) before income tax and accounting change		201.6			(87.8	)		137.2			(20.6	)		29.0
Income (loss) before accounting change		125.0			(52.6	)		84.5			(15.3	)		13.5
Net Income (Loss)	$	125.0		$	(52.6	)	$	(5.9	)	$	(15.3	)	$	13.5
Average basic shares outstanding		40.125			37.939			27.609			26.859			26.648
Average diluted shares outstanding		40.424			37.939			33.917			26.859			26.730
Basic earnings (loss) per share before accounting change	$	3.12		$	(1.39	)	$	3.06		$	(0.57	)	$	0.51
Basic earnings (loss) per share		3.12			(1.39	)		(0.21	)		(0.57	)		0.51
Diluted earnings (loss) per share before accounting change		3.09			(1.39	)		2.65			(0.57	)		0.51
Diluted earnings (loss) per share		3.09			(1.39	)		(0.01	)		(0.57	)		0.51
Consolidated Financial Position
At End of Period (in millions, except ratio):
Total assets	$	4,490.9		$	4,077.1		$	3,792.0		$	3,335.0		$	3,259.2
Long-term debt and capital lease obligations, net of current portion		1,124.6			1,031.7			969.1			989.6			906.9
Shareholders’ equity		1,024.0			885.5			827.6			664.8			674.2
Ratio of earnings to fixed charges (b)		1.52			0.42			1.78			0.89			1.22
Statistics
Alaska Airlines Mainline Operating Data:
Revenue passengers (000)		17,558			17,165			16,759			16,295			15,047
Revenue passenger miles (RPM) (000,000)		18,451			17,822			16,915			16,231			14,554
Available seat miles (ASM) (000,000)		24,208			23,278			22,292			22,276			20,804
Revenue passenger load factor		76.2	%		76.6	%		75.9	%		72.9	%		70.0	%
Yield per passenger mile		13.81	¢		13.76	¢		12.91	¢		12.47	¢		12.65	¢
Operating revenues per ASM		11.52	¢		11.50	¢		10.76	¢		10.02	¢		9.74	¢
Operating expenses per ASM		10.54	¢		11.92	¢		10.14	¢		10.07	¢		9.81	¢
Average number of full-time equivalent employees		9,679			9,322			9,065			9,968			10,040
Operating fleet at period-end		115			114			110			108			109
Horizon Air Combined Operating Data (c):
Revenue passengers (000)		7,552			6,860			6,481			5,930			4,934
Revenue passenger miles (RPM) (000,000)		2,918			2,691			2,475			2,155			1,640
Available seat miles (ASM) (000,000)		3,978			3,632			3,400			3,107			2,569
Revenue passenger load factor		73.4	%		74.1	%		72.8	%		69.3	%		63.9	%
Yield per passenger mile		24.30	¢		23.53	¢		21.98	¢		22.61	¢		26.96	¢
Operating revenues per ASM		18.06	¢		17.73	¢		16.36	¢		16.20	¢		18.06	¢
Operating expenses per ASM		18.07	¢		17.40	¢		15.50	¢		15.57	¢		17.79	¢
Average number of full-time equivalent employees		3,806			3,611			3,456			3,423			3,361
Operating fleet at period-end		70			69			65			65			62

(a)	Includes capitalized interest of $27.8 million, $24.7 million, $8.9 million, $1.7 million, $2.3 million, $2.7 million, $10.6 million, $17.7 million, $12.6 million, $7.0 million, and $5.3 million for 2007, 2006, 2005, 2004, 2003, 2002, 2001, 2000, 1999, 1998, and 1997, respectively.

(b)	For 2006, 2004, 2002, 2001, and 2000 earnings are inadequate to cover fixed charges by $107.6 million, $17.4 million, $99.5 million, $69.1 million, and $44.6 million, respectively. See Exhibit 12.1 to this Form 10-K.

(c)	Includes Horizon services operated as Frontier JetExpress in 2004 through 2007 and flights operated under the Capacity Purchase Agreement with Alaska in 2007.


26

ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND
OPERATING DATA—(Continued)


	2002			2001			2000			1999			1998			1997
Consolidated Operating Results
Year Ended December 31 (in millions, except per share amounts):
Operating Revenues	$	2,224.1		$	2,152.8		$	2,194.0		$	2,091.5		$	1,912.0		$	1,747.4
Operating Expenses		2,317.3			2,279.1			2,227.1			1,901.7			1,700.1			1,606.2
Operating Income (Loss)		(93.2	)		(126.3	)		(33.1	)		189.8			211.9			141.2
Nonoperating income (expense), net of interest capitalized (a)		(8.6	)		62.8			6.2			23.2			(6.2	)		(15.5	)
Income (loss) before income tax and accounting change		(101.8	)		(63.5	)		(26.9	)		213.0			205.7			125.7
Income (loss) before accounting change		(67.2	)		(43.4	)		(20.4	)		129.4			125.3			73.8
Net Income (Loss)	$	(118.6	)	$	(43.4	)	$	(67.2	)	$	129.4		$	125.3		$	73.8
Average basic shares outstanding		26.546			26.499			26.440			26.372			23.388			14.785
Average diluted shares outstanding		26.546			26.499			26.440			26.507			26.367			22.689
Basic earnings (loss) per share before accounting change	$	(2.53	)	$	(1.64	)	$	(0.77	)	$	4.91		$	5.36		$	4.99
Basic earnings (loss) per share		(4.47	)		(1.64	)		(2.54	)		4.91			5.36			4.99
Diluted earnings (loss) per share before accounting change		(2.53	)		(1.64	)		(0.77	)		4.88			4.75			3.25
Diluted earnings (loss) per share		(4.47	)		(1.64	)		(2.54	)		4.88			4.75			3.25
Consolidated Financial Position
At End of Period (in millions, except ratio):
Total assets	$	2,880.7		$	2,950.5		$	2,528.1		$	2,196.0		$	1,742.6		$	1,533.3
Long-term debt and capital lease obligations, net of current portion		856.7			852.2			509.2			337.0			171.5			401.4
Shareholders’ equity		655.7			851.3			895.1			959.2			822.1			509.4
Ratio of earnings to fixed charges (b)		0.28			0.48			0.66			3.07			2.94			2.12
STATISTICS
Alaska Airlines Mainline Operating Data:
Revenue passengers (000)		14,154			13,668			13,525			13,620			13,056			12,284
Revenue passenger miles (RPM) (000,000)		13,186			12,249			11,986			11,777			11,283			10,386
Available seat miles (ASM) (000,000)		19,360			17,919			17,315			17,341			16,807			15,436
Revenue passenger load factor		68.1	%		68.4	%		69.2	%		67.9	%		67.1	%		67.3	%
Yield per passenger mile		12.65	¢		13.12	¢		13.56	¢		12.86	¢		12.51	¢		12.49	¢
Operating revenues per ASM		9.47	¢		9.84	¢		10.20	¢		9.75	¢		9.41	¢		9.43	¢
Operating expenses per ASM		9.87	¢		10.24	¢		10.35	¢		9.81	¢		8.25	¢		8.54	¢
Average number of full-time equivalent employees		10,142			10,115			9,611			9,183			8,704			8,236
Operating fleet at period-end		102			101			95			89			84			78
Horizon Air Combined Operating Data (c):
Revenue passengers (000)		4,815			4,668			5,044			4,984			4,389			3,686
Revenue passenger miles (RPM) (000,000)		1,514			1,350			1,428			1,379			1,143			889
Available seat miles (ASM) (000,000)		2,428			2,148			2,299			2,194			1,815			1,446
Revenue passenger load factor		62.4	%		62.8	%		62.1	%		62.9	%		63.0	%		61.5	%
Yield per passenger mile		26.02	¢		28.15	¢		29.82	¢		28.77	¢		29.02	¢		32.56	¢
Operating revenues per ASM		17.29	¢		19.02	¢		19.27	¢		18.96	¢		19.16	¢		21.00	¢
Operating expenses per ASM		17.87	¢		21.02	¢		19.53	¢		17.74	¢		18.16	¢		20.64	¢
Average number of full-time equivalent employees		3,476			3,764			3,795			3,603			3,019			2,756
Operating fleet at period-end		63			60			62			62			60			62


		27

ITEM 7. 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 the Company, our operations and our present business environment. MD&A is provided as a supplement to – and should be read in conjunction with – our consolidated financial statements and the accompanying notes. All statements in the following discussion that are not reports of historical information or descriptions of current accounting policy are forward-looking statements. Please consider our forward-looking statements in light of the risks referred to in this report’s introductory cautionary note and the risks mentioned in the Company’s filings with the Securities and Exchange Commission. This overview summarizes the MD&A, which includes the following sections:

•

Year in Review—highlights from 2007 outlining some of the major events that happened during the year and how they affected our financial performance.

•

Results of Operations—an in-depth analysis of the results of operations of Alaska and Horizon for the three years presented in our consolidated financial statements. We believe this analysis will help the reader better understand our consolidated statements of operations. Financial and statistical data for Alaska and Horizon are also included here. This section includes forward-looking statements regarding our view of 2008.

•

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, commitments and off-balance sheet arrangements, an overview of financial position and the impact of inflation and changing prices.

YEAR IN REVIEW

In 2007, we reported consolidated net income of $125.0 million compared to a net loss of $52.6 million in 2006. The 2006 results included the following items that impact the comparability between the periods:

•

We recorded $189.5 million ($118.5 million after tax) of fleet transition costs related to our MD-80 fleet.

•

We also recorded a $24.8 million ($15.5 million after tax) restructuring charge associated with the voluntary severance package offered to certain of our employees represented by the International Association of Machinists and to our flight attendants as part of new four-year collective bargaining agreements.

Both periods include adjustments to reflect the timing of gain or loss recognition resulting from mark-to-market fuel hedge accounting – we recorded a $52.2 million gain in 2007 compared to an $89.9 million loss in 2006.

The revenue environment in 2007 was characterized by increased competition in our primary markets and a softer demand environment in our West Coast market. However, yield at Alaska (which represents approximately 88% of consolidated revenues) improved slightly as we and other carriers attempted to raise fares to cover higher fuel costs. Both Alaska and Horizon posted higher passenger traffic. These factors resulted in an increase in total consolidated revenues of $171.6 million.

Our total operating expenses declined by $127.7 million during 2007 compared to 2006. This decrease is primarily due to the 2006 fleet transition and restructuring charges mentioned above and mark-to-market gains associated with an increase in the value of our fuel hedge portfolio, offset by increases in other operating expenses in 2007. See “Results of Operations” below for further discussion of changes in revenues and operating expenses for both Alaska and Horizon.


28

Accomplishments

Accomplishments from 2007 include:

•

Alaska marked its 75^th anniversary with several celebration events and the unveiling of the “Starliner 75,” a new Boeing 737-800 aircraft painted in a vintage DC-3 livery.

•

Horizon was named “2007 Regional Airline of the Year” by Air Transport World. The publication cited, among other positive items, an exemplary safety record, superior commitment to customer service, and positive financial results during challenging industry times.

•

In October 2007, we reached another website milestone by processing over 50% of our monthly sales through alaskaair.com for the first time.

•

Alaska initiated service to the Hawaiian Islands in October 2007– something our customers and employees had been looking forward to for many years. Horizon also began non-stop service between Portland, Oregon and Santa Rosa, California. Alaska and Horizon have also initiated or announced additional service in certain existing markets or connected cities already served with new non-stop service.

Common Stock Repurchase

In September 2007, our Board of Directors authorized the Company to repurchase up to $100 million of our common stock over a period of twelve months. At December 31, 2007, we had repurchased 2.6 million shares of common stock for a total of $62.8 million. We believe this repurchase program enhances shareholder value and demonstrates our commitment to providing investors a return on capital employed in our business. The repurchased shares have been recorded as treasury shares in our consolidated balance sheet.

Airport of the Future

On October 16, 2007, we unveiled the first phase of our patented “Airport of the Future” at Seattle Tacoma International Airport. Once the project is complete, additional facilities are coming online in the first half of 2008, the “Airport of the Future” will allow both Alaska and Horizon customers to check in for their flights and drop bags more quickly, improve our agents’ productivity, and allow us to handle more customers without increasing our airport space. We debuted this concept at the Ted Stevens International Airport in Anchorage in 2004 and since that time, customer wait times have been reduced significantly.

Row 44

In September 2007, Alaska announced its plan to launch in-flight wireless Internet service in 2008 based on Row 44, Inc.’s satellite-based broadband connectivity solution. We plan to test the system on Alaska’s aircraft in the first half of 2008. If the test is successful, we plan to equip all of our aircraft at Alaska with this equipment. This technology will provide customers with a unique entertainment and business network in the air. Passengers with Wi-Fi-enabled devices – such as laptop computers, PDAs, smart phones and portable gaming systems – will have high-speed access to the Internet, e-mail, virtual private networks and stored in-flight entertainment content.

Hawaiian Vacations

During the third quarter of 2007, Alaska announced the acquisition of certain assets of Hawaiian Vacations Inc., an Anchorage-based company that charters aircraft and markets package tours to the Hawaiian Islands. The acquisition of these assets will help accelerate our entrance into the Anchorage-Honolulu market, which began December 9, 2007 with one daily round trip.

Q400 Landing Gear Inspections

On September 12, 2007, Horizon temporarily grounded 19 of its 33 Bombardier Q400 turboprops as a precautionary measure following an all-operator message from Bombardier Aerospace of Canada. On September 13, in response to a Transport Canada airworthiness directive (AD), Horizon grounded its entire Q400


		29

fleet to begin the required landing gear inspections. The AD was produced in the wake of two landing gear failure incidents involving Scandinavian Airlines (SAS) in Europe. Horizon, which has operated the Canadian-manufactured Q400 since 2001, has never experienced any issues like those encountered by SAS in these incidents. The inspections were completed over a 13-day period and the aircraft were put back into service after that time.

Labor Costs and Negotiations

We are pleased with the long-term contracts that have been reached with the majority of our labor groups. We are now in the process of negotiating new contracts with pilots at both Alaska and Horizon and with flight attendants at Horizon. The contract with Alaska’s pilots became amendable May 1, 2007, and the contract with Horizon’s pilots became amendable September 12, 2006. We hope to reach negotiated agreements with each of these groups that recognize the important contributions that they make to both of our airlines, without harming either company’s competitive position. Factoring in pay rates, productivity measures, pension, and post-retirement medical benefits, we believe our pilot unit costs are among the highest in the industry for the size of aircraft operated.

We do not know what the final outcome of these negotiations will be or when agreements will be reached. However, uncertainty around open contracts could be a distraction to some employees, reduce employee engagement in our business, and hinder us from achieving the operational goals (such as on-time and completion-rate targets) that we have set.

Alaska Fleet Transition

During the first quarter of 2006, we announced our plan to retire our entire MD-80 fleet by the end of 2008 as part of Alaska’s move to an all-Boeing 737 fleet. We believe this transition, when completed, will provide more than $130 million in annual operating savings by way of lower fuel, maintenance, and training costs.

During 2007, we sold all 20 of our owned operating MD-80s. The majority of these aircraft are now leased from the buyer under short-term lease arrangements, which will allow us to maintain our current MD-80 retirement schedule through December 2008. We ceased operation of seven of these leased MD-80s in 2007, including one at the end of December that was earlier than anticipated. The charge associated with the early retirement in December 2007 was not material.

We currently have long-term lease arrangements on four MD-80 aircraft that we plan to cease operating before the end of the lease term. We anticipate that once these aircraft have been removed from operation, we will dispose of them through a lease buy-out or a sublease arrangement, or we will store them at a long-term storage facility. It is likely that we will record a charge in our statement of operations if either of these events occurs. Aggregate minimum lease payments for these four aircraft through the end of their lease terms total approximately $68.5 million as of December 31, 2007.

Horizon Fleet Transition

In 2006, Horizon entered into an agreement to sublease 16 of its Bombardier Q200 aircraft to a third party. During 2007, 11 aircraft were transferred, resulting in a loss on the sublease arrangement of $14.1 million that is reflected as “Fleet transition costs – Horizon” in the consolidated statements of operations. We expect the average loss per aircraft to be approximately $1.4 million, which will be recorded as each aircraft leaves the fleet.

In April 2007, Horizon announced an order for 15 additional Q400 aircraft, with options for 20 more. These aircraft will be delivered in 2008 and 2009. With this order, we plan to phase out the remaining leased Q200 aircraft by the end of 2009, and we are in the process of negotiating transactions that would allow for their exit from the fleet. We believe the market has improved since the earlier Q200 sublease transaction, but the amount or timing of any potential loss or gain cannot be reasonably estimated at this time.


30

In 2007, Horizon posted a pretax loss of $10.6 million. We have a number of initiatives underway to improve Horizon’s operating results, including evaluating whether further fleet simplification of Horizon’s fleet away from regional jets to an all-Q400 fleet would be beneficial. However, no decisions have been made at this time.

Capacity Purchase Agreements

Alaska and Horizon entered into a Capacity Purchase Agreement (CPA) effective January 1, 2007, whereby Alaska purchases capacity on certain routes (“capacity purchase markets”) from Horizon as specified by the agreement. This agreement has resulted in a new presentation in Alaska’s statement of operations. The actual passenger revenue from the capacity purchase markets is identified as “Passenger revenue – purchased capacity” and the associated costs are identified as “Purchased capacity costs.”

Alaska also has a similar arrangement in place with a third-party carrier for flying between Anchorage and Dutch Harbor, Alaska. Historically, the revenue from this arrangement was presented in “Other revenue – net” and the associated costs were in “Contracted services” in Alaska’s statement of operations. Now, all of these revenues and costs are presented with the Horizon purchased capacity revenues and costs, and the prior period has been reclassified to conform to the current presentation.

Alaska and Horizon entered into the CPA in order to improve the visibility of both the revenues and the costs of flying in the capacity purchase markets. Under the CPA, Alaska pays Horizon a contractual amount for the purchased capacity in the incentive markets regardless of the revenue collected on those flights. The amount paid to Horizon is generally based on Horizon’s operating costs plus a margin. Alaska bears the inventory and revenue risk in those markets. Accordingly, Alaska records the related passenger revenue. Alaska records payments to Horizon in “Purchased capacity costs.” Horizon records the payment from Alaska as “Passenger revenue.”

The Air Group planning department works to strategically deploy certain Horizon aircraft by optimizing the balance of local and “flow” traffic connections with Alaska in order to maximize total returns to the Company and to allow Alaska to deploy its larger jets to other routes. Prior to 2007, there was a revenue-sharing arrangement in place whereby Alaska made a payment to Horizon if certain covered markets created losses for Horizon. Alternatively, Horizon made a payment to Alaska if those markets were profitable.

Under both the revenue-sharing arrangement that was previously in place and the new CPA, the payments made from Alaska to Horizon are eliminated in consolidation and do not impact Air Group’s consolidated results.

Frontier JetExpress

In November 2007, Horizon discontinued its contract flying with Frontier Airlines as Frontier JetExpress. We had nine CRJ-700 aircraft dedicated to this program, all of which have returned to Horizon’s operating fleet. Two of these aircraft were returned in the first quarter, one in the third quarter and the remaining six in the fourth quarter of 2007. We have used these aircraft for productive and strategic redeployments throughout Horizon’s network and in capacity purchase markets with Alaska. However, the influx of new capacity has depressed yields in some of our markets.

Line of Credit Modification

In April 2007, we announced the Second Amendment of the March 25, 2005, $160 million variable-rate credit facility with a syndicate of financial institutions. The terms of the Second Amendment provide that any borrowings will be secured by either aircraft or cash collateral. The Second Amendment: (i) increased the size of the facility to $185 million; (ii) improved the collateral advance rates for certain aircraft; (iii) extended the agreement by two years with a maturity date of March 31, 2010; and (iv) repriced the credit facility to reflect current market rates. We currently have no immediate plans to borrow using this credit facility. In July 2007, we executed the Third Amendment to the credit facility, which amended a covenant restriction to allow borrowings between Alaska Airlines and its affiliates of up to $500 million, from $300 million previously.


		31

Outlook

We currently expect to increase Alaska mainline capacity by 3% and reduce Horizon total system capacity by 4% in 2008 compared to 2007. The expected capacity increase at Alaska is due primarily to the anticipated delivery of 17 new B737-800 aircraft in 2008 and the annualization of capacity additions that resulted from 14 B737-800 aircraft delivered in 2007, offset by the retirement of 15 MD-80 aircraft and, to a lesser extent, scheduled retirement of other aircraft.

We will continue to monitor our flight schedules to see if there are further opportunities to reduce unprofitable flying and perhaps retire some of our MD-80s sooner than currently planned. We recently announced that we will be eliminating our Oakland – Orange County route and Alaska will shift to Horizon its daily flights from Seattle to Reno and Boise in an effort to reduce costs and increase profitability.

On a net basis, we expect that Alaska’s fleet size will grow by one aircraft in 2008 (from 115 to 116), although the B737-800 aircraft are larger than the MD-80s, allowing for the capacity growth mentioned above. Horizon’s expected capacity decrease is due largely to the anticipated reduction of several Q200 aircraft and the retirement of one CRJ700, offset by the delivery of four new Q400 aircraft in 2008 and the annualization of 13 new Q400 aircraft delivered in 2007. Additionally, there has been an increase in the number of seats on a portion of the fleet of Q400s from 74 seats to 76 seats (all Q400 aircraft will have 76 seats by the end of 2008). The aircraft deliveries in 2008 at both Alaska and Horizon are planned to replace outgoing aircraft, increase frequency in our existing markets and, to a lesser degree, serve new markets.

For much of the past three years, Alaska’s operational performance has fallen short of our goals and our customers’ expectations. We currently have several initiatives underway to help improve our on-time performance, completion rates, baggage handling, and other important customer-driven operational measures. Delivering on these core operational promises is one of our highest-priority internal goals for 2008.

RESULTS OF OPERATIONS

2007 COMPARED WITH 2006

Our consolidated net income for 2007 was $125.0 million, or $3.09 per diluted share, compared to a net loss of $52.6 million, or $1.39 per diluted share, in 2006. Several items, as noted below, affect the comparability between the two periods:

•

During 2006, we recorded fleet transition costs of $189.5 million ($118.5 million after tax, or $3.12 per share) associated with our fleet transition plan. See Note 2 to the consolidated financial statements.

•

In 2006, we recognized restructuring charges of $24.8 million ($15.5 million after tax, or $0.41 per share) associated with an offer of voluntary severance to certain of Alaska’s employees represented by the IAM and the AFA.

•

Both periods include adjustments to reflect the timing of gain or loss recognition resulting from mark-to-market fuel hedge accounting. In 2007, we recognized mark-to-market gains of $52.2 million ($32.7 million after tax, or $0.81 per diluted share), compared to a loss of $89.9 million ($56.3 million after tax, or $1.48 per share) in 2006.

We believe disclosure of the impact of these individual charges is useful information to investors and other readers because:

•

it is useful to monitor performance without these items as it improves a reader’s ability to compare our results to other airlines;


32

•

our results excluding these special items is the basis for our various employee incentive plans, thus allowing investors to better understand the changes in variable incentive pay expense in our consolidated statements of operations;

•

our results excluding these items is most often used in internal management and board reporting and decision-making; and

•

we believe it is the basis by which we are evaluated by industry analysts.

Our consolidated results are primarily driven by the results of our two operating carriers. Alaska reported pretax income of $216.0 million in 2007, while Horizon reported a pretax loss of $10.6 million in 2007. Financial and statistical data for Alaska and Horizon are shown on pages 34 and 35, respectively. An in-depth discussion of the results of Alaska and Horizon begins on page 36.


		33

ALASKA AIRLINES FINANCIAL AND STATISTICAL DATA


	Quarter Ended December 31								Year Ended December 31
	2007			2006			% Change		2007			2006			% Change		2005			% Change
Financial Data (in millions):
Operating Revenues:
Passenger	$	612.8		$	570.6		7.4		$	2,547.2		$	2,453.1		3.8		$	2,183.0		12.4
Freight and mail		21.3			21.6		(1.4	)		94.2			93.4		0.9			90.3		3.4
Other—net		41.3			36.6		12.8			147.1			129.6		13.5			125.9		2.9

Total mainline operating revenues		675.4			628.8		7.4			2,788.5			2,676.1					2,399.2		11.5
Passenger—purchased capacity		71.9			3.4		NM			281.4			16.4		NM			16.9		(3.0	)

Total Operating Revenues		747.3			632.2		18.2			3,069.9			2,692.5		14.0			2,416.1		11.4

Operating Expenses:
Wages and benefits		191.0			190.4		0.3			752.9			743.3		1.3			722.1		2.9
Variable incentive pay		2.3			10.4		(77.9	)		13.5			27.7		(51.3	)		15.3		81.0
Aircraft fuel, including hedging gains and losses		182.2			189.8		(4.0	)		737.5			757.0		(2.6	)		476.0		59.0
Aircraft maintenance		42.0			38.2		9.9			149.8			156.8		(4.5	)		185.2		(15.3	)
Aircraft rent		29.5			26.3		12.2			112.8			110.9		1.7			116.8		(5.1	)
Landing fees and other rentals		42.8			40.3		6.2			170.1			158.2		7.5			156.2		1.3
Contracted services		32.9			30.2		8.9			124.1			117.5		5.6			104.9		12.0
Selling expenses		30.0			31.5		(4.8	)		129.3			141.5		(8.6	)		132.6		6.7
Depreciation and amortization		36.2			38.2		(5.2	)		142.3			137.8		3.3			125.4		9.9
Food and beverage service		12.1			12.2		(0.8	)		46.9			48.3		(2.9	)		48.8		(1.0	)
Other		48.1			42.7		12.6			173.1			161.1		7.4			157.6		2.2
Fleet transition costs		—			—		NM			—			189.5		NM			—		NM
Restructuring charges and adjustments		—			(7.6	)	NM			—			24.8		NM			20.4		NM

Total mainline operating expenses		649.1			642.6		1.0			2,552.3			2,774.4		(8.0	)		2,261.3		22.7
Purchased capacity costs		80.7			3.2		NM			302.8			14.3		NM			15.0		(4.7	)

Total Operating Expenses		729.8			645.8		13.0			2,855.1			2,788.7		2.4			2,276.3		22.5

Operating Income (Loss)		17.5			(13.6	)	NM			214.8			(96.2	)	NM			139.8		NM

Interest income		15.1			15.1					64.8			56.3					32.5
Interest expense		(21.3	)		(19.8	)				(86.2	)		(73.3	)				(51.2	)
Interest capitalized		6.6			6.0					25.7			21.5					8.1
Other—net		(2.7	)		0.2					(3.1	)		(0.5	)				(5.0	)

		(2.3	)		1.5					1.2			4.0					(15.6	)

Income (Loss) Before Income Tax and Accounting Change	$	15.2		$	(12.1	)	NM		$	216.0		$	(92.2	)	NM		$	124.2		NM

Mainline Operating Statistics:
Revenue passengers (000)		4,191			4,107		2.0			17,558			17,165		2.3			16,759		2.4
RPMs (000,000) “traffic”		4,498			4,243		6.0			18,451			17,822		3.5			16,915		5.4
ASMs (000,000) “capacity”		6,020			5,755		4.6			24,208			23,278		4.0			22,292		4.4
Passenger load factor		74.7	%		73.7	%	1.0	pts		76.2	%		76.6	%	(0.4	)pts		75.9	%	0.7	pts
Yield per passenger mile		13.62	¢		13.45	¢	1.3			13.81	¢		13.76	¢	0.3			12.91	¢	6.7
Operating revenues per ASM		11.22	¢		10.93	¢	2.7			11.52	¢		11.50	¢	0.2			10.76	¢	6.8
Passenger revenue per ASM		10.18	¢		9.91	¢	2.7			10.52	¢		10.54	¢	(0.2	)		9.79	¢	7.6
Operating expenses per ASM		10.78	¢		11.17	¢	(3.5	)		10.54	¢		11.92	¢	(11.6	)		10.14	¢	17.6
Aircraft fuel cost per ASM		3.02	¢		3.30	¢	(8.3	)		3.04	¢		3.25	¢	(6.4	)		2.13	¢	53.0
Fleet transition costs per ASM		—			—		NM			—			0.81	¢	NM			0.00	¢	NM
Restructuring charges per ASM		—			-0.13	¢	NM			—			0.11	¢	NM			0.09	¢	NM
Navigation fee refund per ASM		—			—		—			—			—		—			0.02	¢	NM
Aircraft fuel cost per gallon	$	2.09		$	2.18		(4.1	)	$	2.08		$	2.14		(2.8	)	$	1.37		56.2
Economic fuel cost per gallon	$	2.48		$	1.98		25.2		$	2.20		$	1.92		14.6		$	1.53		25.5
Fuel gallons (000,000)		87.2			87.1		0.1			354.3			354.3		0.0			346.4		2.3
Average number of full-time equivalent employees		9,672			9,485		2.0			9,679			9,322		3.8			9,065		2.8
Aircraft utilization (blk hrs/day)		10.7			10.6		0.9			10.9			11.0		(0.9	)		10.8		1.9
Average aircraft stage length (miles)		946			914		3.5			926			919		0.8			898		2.3
Operating fleet at period-end		115			114		1	a/c		115			114		1	a/c		110		4	a/c
Purchased Capacity Operating Statistics:
RPMs (000,000)		287			9		NM			1,099			41		NM			42		NM
ASMs (000,000)		386			15		NM			1,453			67		NM			71		NM

NM	= Not Meaningful


34

HORIZON AIR FINANCIAL AND STATISTICAL DATA


	Quarter Ended December 31								Year Ended December 31
	2007			2006			% Change		2007			2006			% Change		2005			% Change
Financial Data (in millions):
Operating Revenues:
Passenger	$	179.6		$	155.0		15.9		$	709.2		$	633.1		12.0		$	544.0		16.4
Freight and mail		0.5			0.9		(44.4	)		2.3			3.9		(41.0	)		3.8		2.6
Other—net		1.8			2.9		(37.9	)		6.9			7.0		(1.4	)		8.6		(18.6	)

Total Operating Revenues		181.9			158.8		14.5			718.4			644.0		11.6			556.4		15.7

Operating Expenses:
Wages and benefits		51.1			49.0		4.3			201.2			189.3		6.3			173.7		9.0
Variable incentive pay		1.3			2.3		(43.5	)		7.3			9.1		(19.8	)		4.7		93.6
Aircraft fuel, including hedging gains and losses		38.3			30.0		27.7			138.8			116.5		19.1			72.9		59.8
Aircraft maintenance		23.1			23.9		(3.3	)		92.0			73.9		24.5			43.3		70.7
Aircraft rent		15.7			17.3		(9.2	)		65.6			69.3		(5.3	)		70.2		(1.3	)
Landing fees and other rentals		14.1			11.6		21.6			56.9			46.9		21.3			47.7		(1.7	)
Contracted services		7.2			6.9		4.3			27.1			27.0		0.4			23.8		13.4
Selling expenses		7.7			6.3		22.2			31.2			31.5		(1.0	)		29.1		8.2
Depreciation and amortization		8.6			4.9		75.5			33.9			18.5		83.2			16.8		10.1
Food and beverage service		0.7			0.7		0.0			2.8			2.9		(3.4	)		2.5		16.0
Other		12.3			9.9		24.2			48.0			46.9		2.3			42.2		11.1
Fleet transition costs		3.5			—		NM			14.1			—		NM			—		NM

Total Operating Expenses		183.6			162.8		12.8			718.9			631.8		13.8			526.9		19.9

Operating Income (Loss)		(1.7	)		(4.0	)	NM			(0.5	)		12.2		NM			29.5		NM

Interest income		1.1			1.0					4.5			3.7					1.6
Interest expense		(4.5	)		(1.6	)				(16.6	)		(7.4	)				(5.5	)
Interest capitalized		0.3			1.1					2.1			3.2					0.8
Other—net		—			—					(0.1	)		—					—

		(3.1	)		0.5					(10.1	)		(0.5	)				(3.1	)

Income (Loss) Before Income Tax and Accounting Change	$	(4.8	)	$	(3.5	)	NM		$	(10.6	)	$	11.7		NM		$	26.4		NM

Combined Operating Statistics: (a)
Revenue passengers (000)		1,930			1,689		14.3			7,552			6,860		10.1			6,481		5.8
RPMs (000,000) “traffic”		723			659		9.7			2,918			2,691		8.4			2,475		8.7
ASMs (000,000) “capacity”		996			903		10.3			3,978			3,632		9.5			3,400		6.8
Passenger load factor		72.6	%		73.0	%	(0.4	)pts		73.4	%		74.1	%	(0.7	)pts		72.8	%	1.3	pts
Yield per passenger mile		24.84	¢		23.52	¢	5.6			24.30	¢		23.53	¢	3.3			21.98	¢	7.0
Operating revenues per ASM		18.26	¢		17.59	¢	3.9			18.06	¢		17.73	¢	1.9			16.36	¢	8.4
Operating expenses per ASM		18.43	¢		18.03	¢	2.2			18.07	¢		17.40	¢	3.9			15.50	¢	12.2
Aircraft fuel cost per ASM		3.85	¢		3.32	¢	16.0			3.49	¢		3.21	¢	8.7			2.14	¢	50.0
Fleet transition costs per ASM		0.35	¢		—		NM			0.35	¢		—		NM			—		NM
Aircraft fuel cost per gallon (a)	$	2.18		$	2.19		(0.5	)	$	2.14		$	2.14		0.0		$	1.41		51.8
Economic fuel cost per gallon (a)	$	2.54		$	1.98		28.3		$	2.28		$	1.93		18.1		$	1.58		22.2
Fuel gallons (000,000)		17.6			13.7		28.5			64.8			54.3		19.3			51.3		5.8
Average number of full-time equivalent employees		3,887			3,670		5.9			3,806			3,611		5.4			3,456		4.5
Aircraft utilization (blk hrs/day)		8.4			8.6		(2.3	)		8.6			8.8		(2.3	)		8.7		1.1
Operating fleet at period-end		70			69		1	a/c		70			69		1	a/c		65		4	a/c

NM	= Not Meaningful

(a)	Represents combined information for all Horizon flights, including those operated under Capacity Purchase Agreements with Alaska and as Frontier JetExpress. See page 43 for additional line of business information.


		35

ALASKA AIRLINES

Alaska reported income before income taxes of $216.0 million during 2007 compared to a loss before income taxes of $92.2 million in 2006. The $308.2 million difference between the periods is primarily the result of the fleet transition and restructuring charges recognized in 2006 totaling $214.3 million, combined with a reduction in fuel expense following mark-to-market fuel-hedging losses recorded in 2006 as compared to mark-to-market fuel- hedging gains in the current year. These mark-to-market adjustments are a result of changes in the value of our fuel hedge portfolio driven by changes in the price of crude oil.

The year’s most important trend was the dramatic increase in raw and economic fuel costs and the commensurate increase in passenger revenue as we (and many of our competitors) attempted to pass along the increased fuel costs. See page 39 for a discussion of raw and economic fuel costs.

ALASKA REVENUES

Total operating revenues increased $377.4 million, or 14.0%, in 2007 as compared to 2006. The new Capacity Purchase Agreement with Horizon described above made up $265.0 million of the increase, with mainline revenues (defined as passenger revenues from those flights operating on Alaska Airlines jets plus freight, mail and other revenues) contributing $112.4 million of the increase. The components of Alaska’s revenue are summarized in the following table:


	Years Ended December 31
(in millions)	2007		2006		% Change
Passenger Revenue— mainline	$	2,547.2	$	2,453.1	3.8
Freight and mail		94.2		93.4	0.9
Other—net		147.1		129.6	13.5

Total Mainline Revenues	$	2,788.5	$	2,676.1	4.2

Passenger Revenue—purchased capacity		281.4		16.4	NM

Total Operating Revenues	$	3,069.9	$	2,692.5	14.0

NM	= Not Meaningful


36

Operating Revenue—Mainline

Mainline passenger revenue increased 3.8% on a 4.0% increase in available seat miles offset by a modest decline in mainline passenger revenue per available seat mile (PRASM). The slight decline in PRASM was the result of a 0.3% increase in yields, offset by a 0.4-point decline in load factor compared to 2006.

Although the load factor for the full year was down from 2006, load factors outpaced 2006 in the second half of the year after lagging 2006 in the first half of the year. These load factor improvements contributed to the increase in unit passenger revenue (PRASM) seen in the third and fourth quarters. We believe the full-year load factor decline is due to capacity growth in connection with the replacement of older aircraft with larger B737-800 aircraft without a commensurate increase in the number of passengers. Our advance bookings currently suggest that load factors will be up 2 to 3 points in the first quarter of 2008 compared to the same period in 2007.

Freight and mail revenue was flat compared to 2006. This is primarily due to a decline in freight and mail volumes resulting from lower capacity that stemmed from the delay in the conversion of four of our B737-400 passenger aircraft to combi aircraft, offset by an increase in cargo yields, including those coming through fuel surcharges. We currently anticipate an increase in freight and mail revenues in 2008 as we expect to deploy our full capacity for the entire year.

Other—net revenues increased $17.5 million, or 13.5%, primarily as a result of higher commission revenue associated with the sale of mileage credits to our bank partner. When we sell mileage credits, we defer the majority of the proceeds and recognize that revenue when award travel takes place. Commission revenue represents the difference between the proceeds from the sale of miles and the amount we defer.

Passenger Revenue—Purchased Capacity

Passenger revenue—purchased capacity increased by $265.0 million to $281.4 million because of the CPA with Horizon.

Although the markets subject to the CPA have changed slightly compared to those included under the prior revenue-sharing arrangement, we believe it is useful to evaluate year-over-year revenue information to gauge actual trends in those markets. This factors out the impact of the intercompany capacity purchase agreement and, as a result, gives readers information about the aggregate impact to Air Group revenues. In 2006, Horizon recorded $221.5 million in revenues for markets covered by the prior revenue- sharing arrangement. Yields in those markets declined 3.3% and load factor increased 1.5 points on a 29.7% increase in capacity.


		37

During 2007, purchased capacity costs exceeded passenger revenue—purchased capacity by $21.4 million. However, the reported results of purchased capacity flying do not reflect the total contribution of these flights to our mainline operation as many of the flights feed traffic from smaller cities.

ALASKA EXPENSES

For the year, total operating expenses increased $66.4 million compared to 2006 as a result of new purchased capacity costs recorded under the CPA with Horizon, offset by a decline in mainline operating costs. The components of Alaska’s operating expenses are summarized in the following table:


	Years Ended December 31
Operating Expenses (in millions)	2007		2006		% Change
Mainline operating expenses	$	2,552.3	$	2,774.4	(8.0	)
Purchased capacity costs		302.8		14.3	NM

Total Operating Expenses	$	2,855.1	$	2,788.7	2.4

NM	= Not meaningful

Mainline Operating Expenses

Total mainline operating costs for 2007 declined by $222.1 million or 8.0% compared to 2006. The absence of the fleet transition costs and restructuring charges in 2007, and lower aircraft fuel expense resulting from mark-to-market gains associated with the value of our fuel hedge portfolio were the primary causes of the decline.

Along with our financial and statistical data on page 34, we are presenting here our line-item expenses on a per-ASM basis (in cents). We believe this information is useful to investors because it highlights areas in which costs have increased or decreased either more or less than capacity:


	Years Ended December 31,			CASM Change
	2007	2006	2005	2007 vs. 2006		2006 vs. 2005
Wages and benefits	3.11	3.19	3.24	(0.08	)	(0.05	)
Variable incentive pay	0.06	0.12	0.07	(0.06	)	0.05
Aircraft fuel, including hedging gains and losses	3.04	3.25	2.13	(0.21	)	1.12
Aircraft maintenance	0.62	0.67	0.83	(0.05	)	(0.16	)
Aircraft rent	0.47	0.48	0.52	(0.01	)	(0.04	)
Landing fees and other rentals	0.70	0.68	0.70	0.02		(0.02	)
Contracted services	0.51	0.51	0.47	—		0.04
Selling expenses	0.53	0.61	0.59	(0.08	)	0.02
Depreciation and amortization	0.59	0.59	0.56	—		0.03
Food and beverage service	0.19	0.21	0.22	(0.02	)	(0.01	)
Other	0.72	0.69	0.72	0.03		(0.03	)
Fleet transition costs	—	0.81	—	(0.81	)	0.81
Restructuring charges and adjustments	—	0.11	0.09	(0.11	)	0.02

Total Mainline Operating Expenses per ASM	10.54	11.92	10.14	(1.37	)	1.78

Additional line item information is provided below.

Wages and Benefits

Wages and benefits were relatively flat in 2007, primarily as a result of the following:

•

a 3.8% increase in full-time equivalents. The number of full-time equivalent employees increased largely as a result of our initiative to improve our on-time performance and other operational goals;


38

•

an increase in the number of flight attendants as we transition to B737-800s, which have four flight attendants, compared to three in the MD-80 aircraft that are being replaced; and

•

normal step, scale and market-based wage increases.

These increases were offset by the following:

•

2006 included a $2.7 million contract-signing bonus paid to our flight attendants and a $1.9 million contract-signing bonus paid to our clerical, office and passenger service employees and our ramp service and stores agents; and

•

a reduction of $15.6 million in expenses associated with our defined-benefit plans as more of our employees transition over to an enhanced defined-contribution plan, offset by a $1.2 million increase in defined-contribution plan expense.

We currently expect wages and benefits to increase slightly in 2008 but decline on a per-ASM basis. This expectation is exclusive of any potential change in pilot wages that may result from our current contract negotiations.

Variable Incentive Pay

Variable incentive pay for 2007 decreased $14.2 million or 51.3%, compared to 2006. The decrease results from lower annual expense under the various Air Group profit-based incentive plans as our profitability was lower than originally expected, offset by higher expenses associated with our Operational Performance Rewards plan. For purposes of our incentive pay plans, profit is generally defined as results excluding fleet transition costs, restructuring charges, and other amounts specified in the various incentive plan documents and with fuel stated on an economic basis. Air Group maintains several incentive plans that collectively cover all of our employees and create alignment for employees, customers and shareholders. These plans include both operational and financial performance metrics that, to a large extent, are based on certain annual financial targets.

Aircraft Fuel

Aircraft fuel expense includes both raw fuel expense (as defined below) plus the effect of mark-to-market adjustments to our fuel hedge portfolio that we include in our income statement as the value of the portfolio increases and decreases. By definition, our aircraft fuel expense is very volatile, even between quarters, because it includes these gains or losses when the underlying instrument increases or decreases in value as crude oil prices increase or decrease. Raw fuel expense is defined as the price that we generally pay at the airport, or the “into-plane” price, including taxes. Raw fuel prices are impacted by world oil prices and refining costs, which can vary by region in the U.S. Raw fuel expense approximates cash paid to suppliers.

Aircraft fuel expense decreased $19.5 million, or 2.6%, compared to 2006. The elements of the change are illustrated in the following table:


	Years Ended December 31
(in millions, except per-gallon amounts)	2007			2006			% Change
Fuel gallons consumed		354.3			354.3		0.0
Raw price per gallon	$	2.33		$	2.16		7.9

Total raw fuel expense	$	825.7		$	765.6		7.9

Impact on fuel expense from changes in value of the fuel hedge portfolio (gain)		(88.2	)		(8.6	)	NM

Aircraft fuel expense	$	737.5		$	757.0		(2.6	)

NM	= Not meaningful

Fuel gallons consumed were flat on a 4.0% increase in capacity because of the improved fuel efficiency of our fleet as we transition out of the less-efficient MD-80 aircraft to newer, more-efficient B737-800 aircraft.

The raw fuel price per gallon increased by 7.9% as a result of higher West Coast jet fuel prices driven by higher crude oil costs.


		39

December 31, 2006 were lower than they were a year earlier. Our hedge portfolio consists primarily of call options that are based on the prices of crude oil.

We also evaluate economic fuel expense, which we define as raw fuel expense less the cash we receive from hedge counterparties for hedges that settle during the period, offset by the premium expense that we recognize. A key difference between aircraft fuel expense and economic fuel expense is the timing of gain or loss recognition. When we refer to economic fuel expense, we include gains only when they are realized through a cash receipt from our hedge contract counterparties. We believe this is the best measure of the effect that fuel prices are currently having on our business because it most closely approximates the net cash outflow associated with purchasing fuel for our operation. Accordingly, many industry analysts evaluate our results using this measure, and it is the basis for most internal management reporting and incentive pay plans.

Our economic fuel expense is calculated as follows:


	Years Ended December 31
(in millions, except per-gallon amounts)	2007			2006			% Change
Raw fuel expense	$	825.7		$	765.6		7.9
Less: cash received from settled hedges		(44.9	)		(87.0	)	NM

Economic fuel expense	$	780.8		$	678.6		15.1

Fuel gallons consumed		354.3			354.3		0.0

Economic fuel cost per gallon	$	2.20		$	1.92		14.6

NM	= Not meaningful

In 2005 and 2006, we realized significant benefits from in-the-money fuel hedge contracts. However, our fuel hedge protection declined substantially in 2007 as the strike price of our hedges was closer to current oil prices compared to those in place during the previous two years. The total cash benefit from hedges that settled during the period declined to $44.9 million in 2007 down from $87.0 million in 2006 and $108.8 million in 2005.

We currently expect economic fuel expense to be higher in 2008 than in 2007 because of high crude oil prices. For example, if oil were to average $87 per barrel in 2008, we would expect our raw fuel expense to be approximately $2.67 per gallon and the cash benefit of settled hedges to be approximately $55 million, resulting in an economic fuel price per gallon of approximately $2.52.

Aircraft Maintenance

Aircraft maintenance declined by $7.0 million, or 4.5%, compared to the prior year largely as a result of the benefits of our fleet transition as we replace our aging MD-80s and B737-200C aircraft with newer B737-800 and converted B737-400 aircraft, respectively. We currently expect maintenance expense to increase slightly in 2008 because of the timing of certain required maintenance events, offset by additional benefits to be realized from the fleet transition.

Aircraft Rent

Aircraft rent increased by $1.9 million, or 1.7%, because of the sale and short-term leaseback of substantially all of our owned MD-80 aircraft during the second quarter of 2007 and the addition of two new leased B737-800 aircraft in the fourth quarter of 2006, partially offset by the buyout of five leased MD-80 aircraft in the third quarter of 2006. We expect a year-over-year increase in aircraft rent in 2008 as we lease an additional B737-800, offset by the retirement of the MD-80s.

Landing Fees and Other Rentals

Landing fees and other rentals increased by $11.9 million, or 7.5%, compared to 2006 as a result of higher costs at Seattle-Tacoma International and other airports. We expect year-over-year increases in 2008 as a result of fees in our new Hawaii stations and for the continuing transition to 737-800 aircraft that are larger than the outgoing MD-80 aircraft.

Selling Expenses

Selling expenses declined by $12.2 million, or 8.6%, compared to 2006 as a result of lower


40

ticket distribution costs and credit card fees that resulted from new contracts that were put into place in the fourth quarter of 2006. The 2006 amount also included $3.7 million paid to Horizon under the revenue-sharing arrangement in certain designated markets that existed in 2006, compared to zero in the current year because of the new CPA. These declines were partially offset by higher advertising costs. We currently expect that selling expenses will decline slightly in 2008 as we continue to focus our efforts on shifting sales to our web sites, which reduces the commission we pay to outside providers.

Depreciation and Amortization

Depreciation and amortization increased $4.5 million, or 3.3%, compared to 2006. This is primarily the result of 10 new B737-800 aircraft delivered in 2006 and 14 in 2007, partially offset by the sale and leaseback of 20 MD-80s in 2007. We expect depreciation and amortization to increase by about 14% in 2008 as we acquire more new B737-800 aircraft.

Other Operating Expenses

Other operating expenses increased because of higher passenger remuneration costs, crew costs, professional fees, software license and maintenance costs, higher property taxes, and other costs, offset by lower liability insurance expense because of better rates negotiated in December 2006.

Mainline Operating Costs per Available Seat Mile (CASM)

Operating costs per ASM (CASM) is an important metric in the industry, and we use it to gauge the effectiveness of our cost-reduction efforts. Our effort to reduce unit costs focuses not only on controlling the actual dollars we spend, but also on increasing our capacity without adding a commensurate amount of cost.

Our mainline operating costs per mainline ASM are summarized below:


	Years Ended December 31
	2007		2006		%Change
Total mainline operating expenses per ASM (CASM)	10.54	¢	11.92	¢	(11.6	)
CASM includes the following components:
Fuel costs per ASM	3.04	¢	3.25	¢	(6.4	)
Fleet transition costs per ASM	—		0.81	¢	NM
Restructuring charges per ASM	—		0.11	¢	NM

NM	= Not meaningful

We have separately listed in the above table our fuels costs per ASM, fleet transition costs per ASM and restructuring charges per ASM. These amounts are included in CASM, but for internal purposes we consistently use unit cost metrics that exclude these items to measure our cost-reduction progress. We do so, and believe that such analysis may be important to investors and other readers of these financial statements for the following reasons:

•

Mainline cost per ASM excluding fuel is one of the most important measures used by managements of both Alaska and Horizon and the Air Group Board of Directors in assessing quarterly and annual cost performance. For Alaska Airlines, these decision-makers evaluate operating results of the “mainline” operation, which includes the operation of the B737 and MD-80 aircraft fleets branded in Alaska Airlines livery. The revenues and expenses associated with purchased capacity are evaluated separately.

•

Mainline cost per ASM excluding fuel (and other items as specified in our governing documents) is an important metric for the employee incentive plan that covers company management and executives.

•

By eliminating fuel expense from our unit cost metrics, we believe that we have better visibility into the results of our


		41

non-fuel cost-reduction initiatives. Our industry is highly competitive and is characterized by high fixed costs, so even a small reduction in non-fuel operating costs can result in a significant improvement in operating results. In addition, we believe that all domestic carriers are similarly impacted by changes in jet fuel costs over the long run, so it is important for management (and thus investors) to understand the impact of (and trends in) company-specific cost drivers such as labor rates and productivity, airport costs, maintenance costs, etc., which are more controllable by management.

•

Mainline cost per ASM excluding fuel is a measure commonly used by industry analysts, and we believe it is the basis by which they compare our airlines to others in the industry. The measure is also the subject of frequent questions from holders of our common stock.

•

Disclosure of the individual impact of certain noted items provides investors the ability to measure and monitor performance both with and without these special items. We believe that disclosing the impact of items such as the fleet transition costs and restructuring charges is important because it provides information on significant items that are not necessarily indicative of future performance. Industry analysts and investors consistently measure the Company’s performance without these items for better comparability between periods and among other airlines.

•

Although we disclose our “mainline” passenger unit revenues for Alaska, we do not (nor are we able to) evaluate mainline unit revenues excluding the impact that rising fuel costs have had on ticket prices. Fuel represents nearly 30% of our total mainline operating expenses, and fluctuations in our fuel prices often drive changes in unit revenues in the mid-to-long term. Although we believe it is useful to evaluate non-fuel unit costs for the reasons noted above, we would caution readers of these financial statements not to place undue reliance on unit costs excluding fuel as a measure or predictor of future profitability because of the significant impact of fuel costs on our business.

Our mainline unit costs excluding fuel and other special items for the first quarter and full year 2008 are expected to remain flat from similar measures in 2007. Our primary goal in 2008 is to improve our operational reliability, including our on-time performance, completion of scheduled flights, and baggage delivery metrics, with a special focus on our Seattle operations.

Purchased Capacity Costs

Purchased capacity costs increased $288.5 million, from $14.3 million in 2006 to $302.8 million in 2007. Of the total, $283.4 million was paid to Horizon under the new CPA for 1.4 billion ASMs. The balance includes amounts paid to a third party for the Dutch Harbor flying (which approximates the amount paid in 2006) and certain administrative and information technology costs borne by Alaska that are allocated to purchased capacity flying costs.

In the aggregate, costs of purchased capacity exceeded revenues in these markets by $21.4 million. The markets covered by the CPA with Horizon are both “flow” markets that provide connecting traffic to Alaska and “local” markets where Horizon’s regional jets are used to maximize returns (or minimize losses) to Air Group and allow Alaska to deploy its larger jets to other routes. Generally speaking, revenues in the flow markets exceed costs. However, revenue in most of the local markets falls short of costs. With high fuel prices and relatively high non-fuel costs, some of these routes operated by Horizon are unprofitable with CRJ-700s and are too small to support 737 service. We are evaluating alternatives to improve the results of these routes. Alternatives include reducing the size of the CRJ-700 fleet, moving some of the flying to the Q400, and having a portion of the capacity in these markets performed by a third party with larger, more efficient aircraft.


42

HORIZON AIR

Horizon reported a loss before income taxes of $10.6 million during 2007 compared to income before income taxes of $11.7 million in 2006. The $22.3 million decrease is primarily due to higher operating costs, including higher fuel costs and fleet transition costs of $14.1 million, partially offset by higher operating revenues.

There were several significant events in 2007 that impacted Horizon’s financial results, including charges associated with the transition of the Q200 fleet, a significant increase in maintenance costs related to scheduled engine overhauls, and the integration of the nine regional jets from Frontier JetExpress into the Horizon network. The extra capacity from the Frontier JetExpress operations proved harder to integrate than was originally planned because of a softer revenue environment and unexpected competition in some of our markets. Despite the dramatic increase in capacity, load factor declined only 0.7 points. However, the stable load factor came at the expense of yield on flying done under Horizon’s own brand, which declined 5.9%. In addition to assimilating the capacity from the Frontier JetExpress flying, Horizon also absorbed the operating costs for the returning jets, including fuel costs, which were previously the responsibility of Frontier.

HORIZON REVENUES

In 2007, operating revenues increased $74.4 million, or 11.6%, compared to 2006. Horizon’s passenger revenues are summarized in the table below:


Revenues (in millions) and % of ASMs	Years Ended December 31
	2007				2006
	Revenues		%ASMs		Revenues		%ASMs
Passenger revenue from Horizon “brand” flying	$	391.3	52		$	359.1	48
Revenue from CPA with Alaska		283.4	35			n/a	n/a
Passenger revenue—Alaska revenue share markets		n/a	n/a			221.5	29
Revenue from CPA with Frontier JetExpress		34.5	13			52.5	23

Total Passenger Revenue and % of ASMs	$	709.2	100	%	$	633.1	100	%

Horizon’s system-wide operating revenues per ASM increased by 1.9% from 2006. The increase was largely due to the shift in capacity out of Frontier JetExpress flying (which produced relatively low RASM because of the terms of the contract and the longer-haul nature of the flying) to higher RASM brand and Alaska CPA flying. As mentioned earlier, the Frontier JetExpress operation ceased in November 2007.

Line-of-business information is presented in the table below. In both CPA arrangements, Horizon is insulated from market revenue factors and is guaranteed contractual revenue amounts based on operational capacity. As a result, yield and load factor information for the CPA arrangements are not presented.

Year Ended December 31, 2007

Capacity and Mix

Load Factor

Yield

RASM

Actual
(000,000)

%
Change
Yr-over-Yr

Current
% Total

Point
Change
Yr-over-Yr

Actual

Point
Change
Yr-over-Yr

Actual

%
Change
Yr-over-Yr

Actual

%
Change
Yr-over-Yr

Brand Flying

2,086

19.6

pts

71.8

(2.4)

pts

26.14

(5.9)

19.20

(8.8)

Alaska CPA

1,383

29.7

pts

20.49

(2.7)

Frontier CPA

509

(38.1)

(10)

pts

6.77

6.0

System Total

3,978

9.5

100

—

73.4

(0.7)

pts

24.30

3.3

18.06

1.9

NM	= Not meaningful


		43

Horizon brand flying includes routes in the Horizon system not covered by the Alaska CPA. Horizon has the inventory and revenue risk in these markets. Passenger revenue from Horizon brand flying increased $32.2 million, or 9.0%, on a 19.6% increase in brand capacity offset by an 8.8% decline in unit revenues. The decline in unit revenues was due to a 2.4-point reduction in load factor, along with a 5.9% decline in yields, resulting from increased competition in many of these brand markets and from intentional pricing actions taken in certain markets to fill the additional capacity.

Revenue from the CPA with Alaska totaled $283.4 million during 2007. Under the CPA, the fee paid by Alaska is based on Horizon’s actual operating costs plus a specified margin. Under the prior revenue-sharing arrangement, Alaska made a payment to Horizon equal to Horizon’s loss in those markets, if any, and a quarterly bonus that was based on Alaska’s overall operating margin. Alternatively, Horizon made a payment to Alaska if those markets were profitable.

Revenue from the Frontier JetExpress flying declined 34.3% from $52.5 million in 2006 to $34.5 million in 2007 on a 38.1% decline in ASMs. The ASM decline is consistent with the wind-down of the JetExpress arrangement that occurred throughout 2007.

HORIZON EXPENSES

Total operating expenses increased $87.1 million, or 13.8%, as compared to 2006. Along with our financial and statistical data on page 35, we are presenting here our line item expenses on a per-ASM basis (in cents):


	Years Ended December 31,			CASM Change
	2007	2006	2005	2007 vs. 2006		2006 vs. 2005
Wages and benefits	5.06	5.21	5.11	(0.15	)	0.10
Variable incentive pay	0.18	0.25	0.14	(0.07	)	0.11
Aircraft fuel, including hedging gains and losses	3.49	3.21	2.14	0.28		1.07
Aircraft maintenance	2.31	2.03	1.27	0.28		0.76
Aircraft rent	1.65	1.91	2.07	(0.26	)	(0.16	)
Landing fees and other rentals	1.43	1.29	1.40	0.14		(0.11	)
Contracted services	0.68	0.74	0.70	(0.06	)	0.04
Selling expenses	0.79	0.87	0.86	(0.08	)	0.01
Depreciation and amortization	0.85	0.51	0.49	0.34		0.02
Food and beverage service	0.07	0.08	0.07	(0.01	)	0.01
Other	1.21	1.30	1.24	(0.09	)	0.06
Fleet transition costs	0.35	—	—	0.35		—

Total Operating Expenses per ASM	18.07	17.40	15.49	0.67		1.91


44

Significant period-over-period changes in the components of operating expenses are as follows:

Wages and Benefits

Wages and benefits increased $11.9 million, or 6.3%, as a result of a slight increase in full-time equivalent employees, higher wages due to market and step increases, and an increase in our group medical costs. We expect that wages and benefits will be flat in 2008 compared to 2007.

Aircraft Fuel

Aircraft fuel expense increased $22.3 million, or 19.1%, compared to 2006. The elements of the change are illustrated in the following table:


	Years Ended December 31
(in millions, except per-gallon amounts)	2007			2006			% Change
Fuel gallons consumed		64.8			54.3		19.3
Raw price per gallon	$	2.41		$	2.19		10.0

Total raw fuel expense	$	156.2		$	119.1		31.2

Impact on fuel expense from changes in value of the fuel hedge portfolio (gain)		(17.4	)		(2.6	)	NM

Aircraft fuel expense	$	138.8		$	116.5		19.1

NM	= Not meaningful

The 19.3% increase in consumption was driven by the return of all nine CRJ-700s from Frontier JetExpress and the introduction of several new Q400s into the fleet, replacing smaller Q200s. Under the Frontier JetExpress arrangement, fuel was purchased by Frontier. We expect to see a year-over-year increase in the number of gallons consumed in 2008 as we see the full effect of the fleet changes. Offsetting these increases in fuel consumption is the improved fuel efficiency of our fleet resulting from new Q400 aircraft deliveries. These more fuel-efficient aircraft have helped to improve the overall fuel-burn rate per ASM by approximately 3% from 2006.

The raw fuel price per gallon increased by 10% as a result of higher West Coast jet fuel prices driven by higher crude oil costs.

During 2007, we recorded mark-to-market gains reflecting an increase in the value of our fuel hedge portfolio between December 31, 2006 and December 31, 2007. In 2006, we recorded a mark-to-market loss, as oil prices on December 31, 2006 were lower than they were a year earlier. Our hedge portfolio consists primarily of call options that are based on the price of crude oil.

We realized gains of $8.5 million from settled hedge contracts in 2007, compared to $14.1 million in 2006. Our economic fuel expense is calculated as follows:


	Years Ended December 31
(in millions, except per-gallon amounts)	2007			2006			% Change
Raw fuel expense	$	156.2		$	119.1		31.2
Less: cash received from settled hedges		(8.5	)		(14.1	)	NM
Economic fuel expense	$	147.7		$	105.0		40.7

Fuel gallons consumed		64.8			54.3		19.3

Economic fuel cost per gallon	$	2.28		$	1.93		18.1

NM	= Not meaningful

Like Alaska, our fuel hedge protection declined substantially in 2007 as the strike price of our hedges was closer to current oil prices compared to those in place during the previous two years. The total cash benefit from hedges that settled during the period declined to $8.5 million in 2007 from $14.1 million in 2006 and $16.2 million in 2005.

We currently expect economic fuel expense to be higher in 2008 than in 2007 because of high crude oil prices. For example, if oil were to average $87 per barrel in 2008, we would expect our raw fuel expense to be approximately $2.72 per gallon and the cash benefit of settled hedges to be approximately $10 million, resulting in an economic fuel price per gallon of approximately $2.59.


		45

Aircraft Maintenance

Aircraft maintenance expense increased $18.1 million, or 24.5%, primarily as a result of a higher number of engine events, including scheduled events on our CRJ-700 engines. We expect maintenance expense in 2008 to be approximately $15 million lower than in 2007, primarily because of fewer CRJ-700 engine events. However, actual results could differ materially if the maintenance schedule is modified or we are forced to perform unforeseen maintenance activities.

Aircraft Rent

Aircraft rent declined by $3.7 million, or 5.3%, primarily as a result of the reduction in the number of leased Q200 aircraft in our operating fleet. These leased aircraft were replaced with new, owned Q400s during the year.

Depreciation and Amortization

Depreciation and amortization increased $15.4 million, or 83.2%, as a result of the 13 new Q400s that were delivered in 2007. We own all of these new aircraft. Additionally, we recorded higher depreciation expense on Q200 rotable and repairable parts since we now intend to phase out those aircraft by the end of 2009. We anticipate that depreciation and amortization expense will continue to increase in 2008 as we take more Q400 deliveries throughout the year.

Fleet Transition Costs

Fleet transition costs associated with the sublease of Q200 aircraft were $14.1 million in 2007 as a result of the 11 Q200 aircraft that were delivered to a third party. We expect total fleet transition costs to be approximately $8 million during 2008 as five additional Q200s leave the fleet and we record losses arising from the subleases.

Operating Costs per Available Seat Mile (CASM)

As discussed above, operating costs per ASM (CASM) is an important metric in the industry and we use it to gauge the effectiveness of our cost- reduction efforts. Like Alaska’s, Horizon’s efforts to reduce unit costs over the long term focus not only on controlling the actual dollars we spend, but also on increasing available seat miles without adding a commensurate amount of cost. We intend to increase capacity in the future primarily through larger-gauge aircraft as we replace our Q200 aircraft with larger Q400 aircraft. However, we expect a reduction of capacity in 2008 as noted previously, which puts upward pressure on our unit costs.

Our operating costs per ASM are summarized below:


	Years Ended December 31
	2007		2006		% Change
Total operating expenses per ASM (CASM)	18.07	¢	17.40	¢	3.9
CASM includes the following components:
Fuel costs per ASM	3.49	¢	3.21	¢	8.8
Fleet transition costs per ASM	0.35	¢	—		NM

NM	= Not meaningful

We currently forecast our costs per ASM excluding fuel and the fleet transition costs for the first quarter and full year of 2008 to be up about 1% and flat, respectively, compared to 2007.

CONSOLIDATED NONOPERATING INCOME (EXPENSE)

Net nonoperating expense was $10.4 million in 2007 compared to $0.5 million in 2006. Interest income declined by $0.4 million compared to 2006, primarily as a result of a lower average cash and marketable securities balance, partially offset by higher average portfolio returns. Interest expense increased $10.0 million because of new debt arrangements in 2006 and 2007 and increases in the average interest rate on our variable-rate debt. This increase was offset by the conversion to equity of our $150 million senior convertible notes in April 2006, which eliminated further interest expense on those notes. Other-net increased $2.6 million, and includes a $3.75 million expense associated with our investment in Row 44 given their early


46

stage nature. Capitalized interest increased $3.1 million from 2006, resulting from an increase in pre-delivery deposits in connection with our orders for B737-800 and Bombardier Q400 aircraft.

CONSOLIDATED INCOME TAX EXPENSE (BENEFIT)

Our consolidated effective income tax rate on income (loss) before income taxes for 2007 was 38.0% compared to an effective income tax rate of 40.1% in 2006. The effective rate for 2007 was positively impacted by $2.1 million in credits resulting from a favorable outcome of the state income tax matters referred to in Note 13. Excluding this benefit, our effective tax rate would have been 39.0%, which is different from our marginal 2007 tax rate of 37.4%. The difference is primarily due to the magnitude of nondeductible expenses, such as employee per-diem costs and stock-based compensation expense recorded for certain stock awards. The 2006 year includes $5.5 million of tax benefits associated with the reduction of certain tax contingency accruals for periods for which the statute of limitations expired in 2006. Excluding this benefit, our effective tax benefit rate for 2006 would have been 33.8%.

2006 COMPARED WITH 2005

Our consolidated net loss for 2006 was $52.6 million, or $1.39 per share, compared to a net loss of $5.9 million, or $0.01 per diluted share, in 2005.

Both the 2006 and 2005 results include certain significant items that affect the comparability of the years:

•

Our 2006 consolidated net loss includes charges of $189.5 million ($118.5 million after tax) associated with our fleet transition plan (See Note 2 to the consolidated financial statements);

•

We recorded restructuring charges of $24.8 million ($15.5 million after tax) in 2006 associated with the severance packages offered to eligible employees affected by new contracts this year compared to $20.4 million ($12.7 million after tax) in 2005 related to severance costs resulting from the subcontracting of the ramp services operation in Seattle and costs associated with the termination of the lease at our Oakland heavy maintenance base;

•

Adjustments to reflect the timing of gain or loss recognition resulting from mark-to-market fuel hedge accounting totaling $89.9 million ($56.3 million after tax) of losses and $61.7 million ($38.6 million after tax) of gains in 2006 and 2005, respectively;

•

Our 2005 consolidated net loss includes a $144.7 million pretax ($90.4 million after tax) charge resulting from the change in the method of accounting for major airframe and engine overhauls as discussed in Note 17 to the consolidated financial statements; and

•

Our 2005 results also include a $5.7 million ($3.6 million after tax) refund, including $1.0 million of related interest income, for navigation fees paid in Mexico.

We believe disclosure of the impact of these individual charges is useful information to investors and other readers because of the reasons provided above in the “2007 Compared With 2006” section.

Alaska reported a 2006 loss before income taxes of $92.2 million, while Horizon reported income before income taxes of $11.7 million. Financial and statistical data for Alaska and Horizon are shown on pages 34 and 35, respectively.

ALASKA AIRLINES

Alaska reported a loss before income taxes of $92.2 million during 2006 compared to income before income taxes and accounting change of $124.2 million in 2005. The $216.4 million difference between the years is primarily the result of the fleet transition and restructuring charges recognized in 2006 totaling $218.4 million, combined with a significant increase in fuel expenses, offset by an 11.4% increase in operating revenues and a reduction in maintenance costs and aircraft rent.


		47

As purchased capacity activity was not significant in 2006 and 2005, the ensuing discussion will be focused on mainline operations only.

ALASKA MAINLINE REVENUES

Mainline operating revenues increased $276.9 million, or 11.5%, during 2006 primarily as a result of a 6.8% increase in operating revenue per available seat mile (RASM) and a 4.4% increase in capacity. The increase in mainline RASM was driven almost entirely by a 6.7% increase in ticket yields resulting largely from higher ticket prices. The increase in capacity is primarily the result of having a larger aircraft fleet and a longer average stage length in 2006.

Load factor increased slightly by 0.7 percentage points to 76.6% during 2006.

Freight and mail revenues increased $3.1 million, or 3.4%, compared to 2005 primarily resulting from higher mail and freight yields and fuel surcharges that we added to our freight services beginning in the third quarter of 2005, offset by lower freight volumes. Revenues from our cargo operations were lower than expected for 2006 due to the delay in the delivery of our modified 737-400 cargo aircraft. Three of the four were originally scheduled for delivery in 2006, but none was actually delivered until 2007. These delays kept the cargo operations from increasing capacity and thereby the volume of cargo shipped.

Other-net revenues increased only slightly by $3.7 million, or 2.9%. Mileage Plan revenues were slightly lower than in 2006, primarily as a result of lower commissions recognized for sold miles. As yields increased in 2006, the rate at which we defer the revenue related to sold miles increased, resulting in a smaller percentage of cash receipts recorded as commission revenue during the period. The decline in commission revenue associated with sold miles was partially offset by higher net revenues from award redemption on our partner airlines.

ALASKA AIRLINES MAINLINE EXPENSES

Total mainline operating expenses increased $513.1 million, or 22.7%, as compared to 2005. This increase is largely due to fleet transition costs in 2006, a significant increase in aircraft fuel (including hedging gains and losses as we adjust the value of our hedges that will benefit future periods), and increases in wages and benefits, variable incentive pay, contracted services, selling expenses, depreciation and amortization, and restructuring charges, offset by a decline in aircraft maintenance and aircraft rent. Additional line item information is provided below.

Wages and Benefits

Wages and benefits increased by $21.2 million, or 2.9%, during 2006 compared to 2005 primarily as a result of the following:

•

a $2.7 million signing bonus and an increase in wages resulting from the new four-year contract with our flight attendants that was ratified during the second quarter of 2006;

•

a $1.9 million signing bonus and an increase in wages resulting from the new four-year contract with our clerical, office and passenger service employees and our ramp service and stores agents that was ratified during the third quarter of 2006;

•

market-based pay adjustments for our non-union personnel in the spring of 2006 and an increase in stock-based compensation expense following the adoption of SFAS 123R;

•

an increase in mechanics wages resulting from the contract ratified in the fourth quarter of 2005; and

•

increased postretirement medical and pension costs.

The increase from the prior year was partially offset by the following:

•

the reduction in pilot wages resulting from the pilot contract that took effect in May 2005; and

•

the subcontracting of our ramp services operation in Seattle in the second quarter of 2005.


48

Variable Incentive Pay

Variable incentive pay increased $12.4 million, or 81.0%, over 2005, primarily as a result of a significant improvement in Air Group’s 2006 profit, as defined in the incentive agreements.

Aircraft Fuel

Aircraft fuel increased $281.0 million, or 59.0%, in 2006 compared to 2005. The elements of the change are illustrated in the following table:


	Year Ended December 31
(in millions, except per-gallon amounts)	2006			2005			% Change
Fuel gallons consumed		354.3			346.4		2.3
Raw price per gallon	$	2.16		$	1.84		17.4

Total raw fuel expense	$	765.6		$	637.9		20.0

Impact on fuel expense from value changes in the fuel hedge portfolio (gain)		(8.6	)		(161.9	)	NM

Aircraft fuel expense	$	757.0		$	476.0		59.0

NM	= Not meaningful

Fuel gallons consumed increased by 2.3% primarily as a result of the increased capacity and the addition of new aircraft. Raw fuel cost per gallon increased by 17.4% as a result of higher West Coast jet fuel prices driven by the sharp increase in average world oil prices.

During 2006, we recorded a $78.4 million mark-to-market loss, reflecting a decline in the value of our fuel hedge portfolio between December 31, 2005 and December 31, 2006. In 2005, we recorded a $53.1 million mark-to-market gain, reflecting an increase in the value of the portfolio from the previous year. These mark-to-market adjustments are largely driven by the closing price of crude oil on the last date of the reporting period and can fluctuate significantly from period to period.

The total cash benefit from hedges that settled during the period declined from $108.8 million in 2005 to $87.0 million in 2006. Our economic fuel expense is calculated as follows:


	Year Ended December 31
(in millions, except per-gallon amounts)	2006			2005			% Change
Raw fuel expense	$	765.6		$	637.9		20.0
Less: cash received from settled hedges		(87.0	)		(108.8	)	NM

Economic fuel expense	$	678.6		$	529.1		28.3

Fuel gallons consumed		354.3			346.4		2.3

Economic fuel cost per gallon	$	1.92		$	1.53		25.5

NM	= Not meaningful

Aircraft Maintenance

Aircraft maintenance decreased by $28.4 million, or 15.3%, mostly as a result of fewer high-dollar engine maintenance events, a decline in the number and change in the mix of airframe events, lower per-event costs due to renegotiated contracts with our outside vendors, and savings from process improvement initiatives.

Aircraft Rent

Aircraft rent decreased by $5.9 million, or 5.1%, primarily as a result of the buyout of five MD-80 aircraft from leases during the third quarter of 2006, offset by two new B737-800 operating leases entered into in the fourth quarter of 2006.

Landing Fees and Other Rentals

Landing fees and other rentals increased slightly by $2.0 million, or 1.3%, as a result of slightly higher airport and security costs, specifically at Los Angeles International Airport (LAX) where a retroactive increase to the beginning of 2006 was imposed on certain carriers late in the year.


		49

The increase for Alaska was approximately $1.5 million. A large portion of this rate increase and retroactive charge was reversed and returned in 2007.

Contracted Services

Contracted services increased $12.6 million, or 12.0%, primarily resulting from the subcontracting of the Company’s Seattle ramp operations in May 2005. Additionally, a $4.7 million navigation fee refund was received in 2005, which reduced our 2005 expenses.

Selling Expenses

Selling expenses increased $8.9 million, or 6.7%, primarily as a result of an increase in revenue-related expenses such as credit card and codeshare commissions in connection with the rise in revenues over the prior period and an increase in incentive payments to Horizon for certain flying under the former revenue-sharing arrangement.

Depreciation and Amortization

Depreciation and amortization increased $12.4 million, or 9.9%, compared to 2005. This increase is primarily due to the delivery of two new owned B737-800 aircraft in 2005 and ten new, owned B737-800 aircraft in 2006, the purchase of five MD-80 aircraft from lessors during the third quarter of 2006, and the acceleration of depreciation on our owned MD-80 fleet to reduce the carrying value to estimated realizable value as they come out of the fleet, offset by the lower depreciable base on the MD-80 fleet following the impairment charge taken in the first quarter of 2006.

Operating Costs per Available Seat Mile (CASM)

As discussed above, operating costs per ASM (CASM) is an important metric in the industry and we use it to gauge the effectiveness of our cost- reduction efforts. Our mainline operating costs per mainline ASM are summarized below:


	Years Ended December 31
	2006		2005		% Change
Total mainline operating expenses per ASM (CASM)	11.92	¢	10.14	¢	17.6
CASM includes the following components:
Fuel costs per ASM	3.25	¢	2.13	¢	52.6
Fleet transition costs per ASM	0.81	¢	—		NM
Restructuring charges per ASM	0.11	¢	0.09	¢	NM
Navigation fee refund per ASM	—		(0.02	)¢

NM	= Not meaningful

HORIZON AIR

Horizon reported pretax income of $11.7 million during 2006 compared to income before income taxes and accounting change of $26.4 million in 2005. The $14.7 million decrease is primarily due to a 19.9% increase in operating costs, driven primarily by increased fuel and maintenance costs, offset by a 15.7% increase in operating revenues.

HORIZON AIR REVENUES

Operating revenues increased $87.6 million, or 15.7%, in 2006 compared to 2005. This increase reflects an 8.4% increase in per unit revenues (RASM) and a 6.8% increase in capacity.

Horizon’s passenger revenues are summarized in the table below:


Revenues (in millions) and % of ASMs	Year Ended December 31
	2006			2005
	Revenues		% ASMs	Revenues		% ASMs
Passenger revenue from Horizon “brand” flying	$	359.1	48	$	270.2	44
Passenger revenue—Alaska revenue share markets		221.5	29		223.4	33
Revenue from CPA with Frontier JetExpress		52.5	23		50.4	23

Total Passenger Revenue and % of ASMs	$	633.1	100	$	544.0	100


50

The capacity increase is primarily due to the addition of one CRJ-700 in January 2006, two Q400s that began operating in June and August 2006, increased capacity from adding four more seats to our Q400s in the third quarter of 2005, and increased flying for Frontier. Revenue and capacity from the Frontier contract flying represented approximately 8% of passenger revenues and 23% of capacity in 2006, similar to 2005.

The RASM increase from the prior-year period resulted from a 9.1% RASM increase in our native network flying (including “brand” flying and Alaska revenue share markets), offset by a 1.4% decline in RASM from the Frontier contract flying. The Frontier decline is a function of a 5.7% increase in capacity coupled with a fee arrangement based on certain measures that did not correspond to capacity. As such, the per-unit revenues were diluted as more capacity was added. Passenger load factor increased 1.3 percentage points to 74.1% as a result of an increase in demand. Passenger yield increased 7.0% to 23.53 cents, largely benefiting from industry-wide fare increases.

HORIZON EXPENSES

Operating expenses for 2006 increased $104.9 million, or 19.9%, compared to 2005, primarily due to increases in aircraft fuel, wages and benefits, and aircraft maintenance.

Explanations of significant year-over-year changes in the components of operating expenses in dollar terms are as follows:

Wages and Benefits

Wages and benefits increased $15.6 million, or 9.0%, over 2005, reflecting a 4.5% increase in the average number of full-time equivalent employees and an increase in wages per employee resulting from market and contract step increases.

Variable Incentive Pay

Variable incentive pay increased $4.4 million, or 93.6%, over 2005, as a result of the same reasons noted above in the Alaska discussion.

Aircraft Fuel

Aircraft fuel increased $43.6 million, or 59.8%, in 2006 compared to 2005. The elements of the change are illustrated in the following table:


(in millions, except per-gallon amounts)	Year Ended December 31
(in millions, except per-gallon amounts)	2006			2005			% Change
Fuel gallons consumed		54.3			51.3		5.8
Raw price per gallon	$	2.19		$	1.90		15.3

Total raw fuel expense	$	119.1		$	97.7		21.9

Impact on fuel expense from value changes in the fuel hedge portfolio (gain)		(2.6	)		(24.8	)	NM

Aircraft fuel expense	$	116.5		$	72.9		59.8

NM	= Not meaningful

Fuel gallons consumed increased by 5.8% primarily as a result of an increase in capacity and block hours. Raw fuel cost per gallon increased by 15.3% as a result of higher West Coast jet fuel prices driven by the sharp increase in average world oil prices.

During 2006, we recorded an $11.5 million mark-to-market loss reflecting a decline in the value of our fuel hedge portfolio between December 31, 2005 and December 31, 2006. In 2005, we recorded an $8.6 million mark-to-market gain reflecting an increase in the value of the portfolio from the previous year. These mark-to-market adjustments are largely driven by the closing price of crude oil on the last date of the reporting period and can fluctuate significantly from period to period.

The total cash benefit from hedges that settled during the period declined from $16.2 million in 2005 to $14.1 million in 2006. Our economic fuel expense is calculated as follows:


(in millions, except per-gallon amounts)	Year Ended December 31
(in millions, except per-gallon amounts)	2006			2005			% Change
Raw fuel expense	$	119.1		$	97.7		21.9
Less: cash received from settled hedges		(14.1	)		(16.2	)	NM

Economic fuel expense	$	105.0		$	81.5		28.8

Fuel gallons consumed		54.3			51.3		5.8

Economic fuel cost per gallon	$	1.93		$	1.58		22.2

NM	= Not meaningful


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Aircraft Maintenance

Aircraft maintenance expense increased $30.6 million, or 70.7%, primarily as a result of more scheduled heavy checks and engine overhauls for the Q200 and Q400 fleets with fewer aircraft covered under warranty.

Aircraft Rent

Aircraft rent declined slightly by $0.9 million, or 1.3%, in 2006 primarily resulting from the annualization of lower rates on extended leases and fewer leased engines.

Other Operating Expenses

Other operating expenses increased by $4.7 million, or 11.1%, largely as a result of higher crew expenses and passenger remuneration costs.

Operating Costs per Available Seat Mile (CASM)

As discussed above, operating costs per ASM (CASM) is an important metric in the industry and we use it to gauge the effectiveness of our cost-reduction efforts. Like Alaska, Horizon’s efforts to reduce unit costs focus not only on controlling the actual dollars we spend, but also on increasing available seat miles without adding a commensurate amount of cost.

Our operating costs per ASM are summarized below:


	Years Ended December 31
	2006		2005		% Change
Total operating expenses per ASM (CASM)	17.40	¢	15.50	¢	12.2
CASM includes the following components:
Fuel costs per ASM	3.21	¢	2.14	¢	50.0

CONSOLIDATED NONOPERATING INCOME (EXPENSE)

Net nonoperating expense was $0.5 million in 2006 compared to $29.3 million in 2005. Interest income increased $23.4 million compared to 2005, primarily as a result of higher average portfolio returns and a higher average

cash and marketable securities balance. Interest expense increased $15.0 million primarily resulting from interest rate increases on our variable-rate debt, new debt arrangements in 2006, and the changes to some of our variable-rate debt arrangements to slightly higher fixed rates. This increase was offset by the conversion of our $150 million senior convertible notes to equity in April 2006, which eliminated further interest expense on those notes. Capitalized interest increased $15.8 million from $8.9 million in 2005 to $24.7 million during 2006. This is due to the significant increase in pre-delivery deposits in connection with our orders for B737-800 and Bombardier Q400 aircraft.

CONSOLIDATED INCOME TAX EXPENSE (BENEFIT)

Our consolidated effective income tax rate on pretax income before the cumulative effect of the accounting change for 2006 was 40.1% compared to an effective income tax rate of 38.4% in 2005. The 2006 year also includes $5.5 million of tax benefits associated with the reduction of certain tax contingency accruals for periods for which the statute of limitations expired in 2006. Excluding this benefit, our effective tax benefit rate for 2006 would have been 33.8%, which is different from our marginal 2006 tax rate of 37.4%. The difference is primarily due to the magnitude of nondeductible expenses, such as employee per-diem costs and stock-based compensation expense recorded for certain stock awards. We applied our 2005 marginal rate of 37.5% to the cumulative effect of the accounting change.

CHANGE IN ACCOUNTING POLICY

Effective January 1, 2005, we changed our method of accounting for major airframe and engine overhauls from the capitalize and amortize method to the direct expense method. Under the former method, these costs were capitalized and amortized to maintenance expense over the shorter of the life of the overhaul or the remaining lease term. Under the direct expense method, overhaul costs are expensed as incurred. We believe that the direct expense method is preferable because it


52

eliminates the judgment and estimation needed to determine overhaul versus repair allocations in maintenance activities. Additionally, our approved maintenance program for the majority of our airframes now focuses more on shorter, but more frequent, maintenance visits. We also believe that the direct expense method is the predominant method used in the airline industry. Accordingly, effective January 1, 2005, we wrote off the net book value of our previously capitalized airframe and engine overhauls for all aircraft resulting in a charge of $144.7 million pretax ($90.4 million after tax). We do not believe disclosing the effect of adopting the direct expense method on net income for 2005 provides meaningful information because of

changes in our maintenance program, including the execution of a “power-by-the-hour” engine maintenance agreement with a third party in late 2004.

CRITICAL ACCOUNTING ESTIMATES

The discussion and analysis of our financial position and results of operations in this MD&A is based upon our consolidated financial statements. 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 consolidated 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 that potentially may result in materially different results under varying assumptions and conditions. Management has identified the following critical accounting estimates and has discussed the development, selection and disclosure of these policies with our audit committee.

MILEAGE PLAN

Our Mileage Plan loyalty program awards miles to member passengers who fly on Alaska or Horizon and our many travel partners. Additionally, we sell miles to third parties, such as our bank partner, for cash. In either case, the outstanding miles may be redeemed for travel on Alaska, Horizon or any of our alliance partners. As long

as the Mileage Plan is in existence, we have an obligation to provide this future travel. For awards earned by passengers who fly on Alaska, Horizon or our travel partners, we recognize a liability and the corresponding selling expense for this future obligation. For miles sold to third parties, the majority of the sales proceeds are recorded as deferred revenue and recognized when the award transportation is provided. The commission component of these sales proceeds (defined as the proceeds we receive from the sale of mileage credits minus the amount we defer) is recorded as other-net revenue when the cash is received. The deferred revenue is recognized as passenger revenue when awards are issued and flown on Alaska or Horizon, and as other-net revenue for awards issued and flown on partner airlines.

At December 31, 2007, we had approximately 114 billion miles outstanding, resulting in an aggregate liability and deferred revenue balance of $648.5 million. Both the liability and the deferred revenue are determined based on several assumptions that require significant management judgment to estimate and formulate. There are uncertainties inherent in estimates; therefore, an incorrect assumption could greatly affect 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 rate at which we defer sales proceeds from sold miles:

We defer an amount that represents our estimate of the fair value of a free travel award by looking to the sales prices of comparable paid travel. As fare levels change, our deferral rate changes, which may result in the recognition of a higher or lower portion of the cash proceeds from the sale of miles as commission revenue in any given quarter. For example, due to the year-over-year increases in average ticket prices, our deferral rate increased in 2007, resulting in lower commission revenue and an increase in the amount of revenue deferred for miles sold. Holding all other assumptions constant, an additional 1% increase in the deferral rate would have


		53

reduced our 2007 commission revenue by approximately $2.4 million.

2. The number of miles that will not be redeemed for travel (breakage):

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 in light of historical experience and future expectations. A hypothetical 1.0% change in our estimate of breakage (currently 12% in the aggregate) has approximately a $7.2 million effect on the liability. Actual breakage could differ significantly from our estimates.

3. The number of miles used per award (i.e., free ticket):

We estimate how many miles will be used per award. For example, our members may redeem credit for free travel to various locations or choose between a highly restricted award and an unrestricted 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.

4. The number of awards redeemed for travel 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 that will be redeemed on Alaska or Horizon versus on other airlines and accrue the estimated costs based on 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.

5. The costs that will be incurred to provide award travel:

When a frequent flyer travels on his or her award ticket on Alaska or Horizon, incremental costs such as food, fuel and insurance are incurred to carry that passenger. We estimate what these costs will be (excluding any contribution to overhead and profit) 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, and therefore we may need to adjust our liability and recognize a corresponding expense.

We review significant Mileage Plan assumptions 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. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R) (SFAS 158). SFAS 158 requires recognition of the overfunded or underfunded status of an entity’s defined-benefit pension and other postretirement plan as an asset or liability in the financial statements and requires recognition of the funded status in other comprehensive income.


54

Under SFAS No. 158, pension expense is recognized on an accrual basis over employees’ approximate service periods and is generally independent of funding decisions or requirements. We recognized expense for our qualified defined-benefit pension plans of $62.6 million, $78.3 million, and $71.7 million in 2007, 2006, and 2005, 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.

Pension expense increases as the expected rate of return on pension plan assets decreases. As of December 31, 2007, we estimate that the pension plan assets will generate a long-term rate of return of 7.75%. This rate was developed

using historical data as well as long-term inflation assumptions. We regularly review the actual asset allocation and periodically rebalance investments as appropriate. This expected long-term rate of return on plan assets at December 31, 2007 is based on an allocation of U.S. and non-U.S. equities and U.S. fixed income securities. Decreasing the expected long-term rate of return by 0.5% (from 7.75% to 7.25%) would increase our estimated 2008 pension expense by approximately $4.5 million.

Pension liability and future pension expense increase as the discount rate is reduced. We discounted future pension obligations using a rate of 6.00% and 5.75% at December 31, 2007 and 2006, 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 projected benefit obligation at December 31, 2007 by approximately $79.1 million and increase estimated 2008 pension expense by approximately $9.4 million.

With the exception of the plan covering Alaska’s pilots, all of our defined-benefit pension plans are closed to new entrants.

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, 2007, we had approximately $3.0 billion of property and equipment and related assets, net of accumulated depreciation. In accounting for these long-lived assets, we make estimates about the expected useful lives of the assets, changes in fleet plans, 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, management decisions regarding the future use of the assets, a significant change in the long-lived assets condition, and operating cash flow losses associated with the use of the long-lived asset.

In March 2006, our Board approved a plan to accelerate the retirement of our MD-80 fleet (15 owned and 11 leased aircraft at the time) and remove those aircraft from service by the end of 2008, which is earlier than the original retirement schedule. As a result of this decision, we evaluated impairment as required by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, and concluded that the carrying value of the MD-80 fleet was no longer recoverable when compared to the estimated remaining future cash flows. Accordingly, during the first quarter of 2006, the Company recorded an impairment charge totaling $131.1 million to write down the fleet to its estimated fair market value. Additionally, during the third quarter of 2006, we bought five MD-80 aircraft from lessors and terminated the leases for those five aircraft. The total purchase price for the five aircraft was $80.9 million, including assumed debt of $11.6 million. Immediately upon purchase of the aircraft, we evaluated impairment and concluded that the carrying value was not recoverable. As a result, we recorded an


		55

additional $58.4 million charge in the third quarter for the impairment. See Note 2 in the consolidated financial statements for further discussion about the impairment of the MD-80s.

In 2007, Horizon announced plans to phase out its remaining leased Q200 aircraft by the end of 2009 and is in the process of evaluating potential arrangements to dispose of those leased aircraft. All of these aircraft are leased under operating lease agreements. However, as a result of this decision, we reassessed the depreciable lives and salvage values of the related rotable and repairable Q200 parts and, as such, we have increased the periodic depreciation expense.

We are early in the process of evaluating whether further fleet simplification of Horizon’s fleet would be beneficial. Such simplification could involve a move away from the CRJ-700 aircraft to an all-Q400 fleet. No decisions have been made at this time. However, should we decide to exit the CRJ-700 fleet prior to the end of the lease expiration for those aircraft, we would likely revise the useful lives of the related rotable and repairable parts, which would result in higher depreciation expense.

There is inherent risk in estimating the fair value of our aircraft and related parts and their salvage values at the time of impairment. Actual proceeds upon disposition of the aircraft or related parts could be materially less than expected, resulting in additional loss. Our estimate of salvage value at the time of disposal could also change, requiring us to increase the depreciation expense on the affected aircraft.

WORKERS’ COMPENSATION AND EMPLOYEE HEALTH-CARE ACCRUALS

We use a combination of insurance and self-insurance mechanisms to provide for workers’ compensation claims and employee health-care benefits. Liabilities associated with these risks are not discounted and are estimated, in part, by considering historical claims experience, severity factors and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and

historical trends. Our workers’ compensation and employee health care accruals totaled $42.9 million at December 31, 2007, compared to $42.7 million at December 31, 2006.

NEW ACCOUNTING STANDARDS

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes a framework for measuring fair value and expands disclosure about fair-value measurements required under other accounting pronouncements. SFAS 157 does not change existing guidance as to whether or not an instrument is carried at fair value. The statement is effective for financial and nonfinancial assets and liabilities for fiscal years beginning after November 15, 2007 and 2008, respectively. We are currently evaluating the impact of adopting SFAS 157 but do not expect the statement to have a significant impact on our results from operations or financial position.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which allows entities the option to measure eligible financial instruments at fair value as of specified dates. Such election, which may be applied on an instrument-by-instrument basis, is typically irrevocable once elected. This statement is effective for fiscal years beginning after November 15, 2007, and early adoption is allowed under certain circumstances. We do not expect this statement to have a significant impact on our financial position, results of operations or cash flows.

In December 2007, the FASB issued SFAS No. 141R, Business Combinations, and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements. These standards were issued jointly and will require most identifiable assets, liabilities, noncontrolling interests, and goodwill acquired in a business combination to be recorded at full fair value and will require noncontrolling interests (previously referred to as minority interests) to be reported as a component of equity, which changes the accounting for transactions with noncontrolling interest holders. Both statements


56

are effective for fiscal years beginning on or after December 15, 2008. SFAS No. 141R will be applied only to acquisitions subsequent to the effective date and SFAS No. 160 will be applied prospectively to all noncontrolling interests, including any that arose before the effective date. We do not expect these statements to have a significant impact on our financial position, results of operations, or cash flows.

LIQUIDITY AND CAPITAL RESOURCES

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


(In millions, except per-share and debt-to-capital amounts)	December 31, 2007			December 31, 2006			Change
Cash and marketable securities	$	822.8		$	1,013.9		$	(191.1	)
Long-term debt, net of current portion		1,124.6			1,031.7			92.9
Shareholders’ equity		1,024.0			885.5			138.5
Book value per common share outstanding	$	26.91		$	21.97		$	4.94
Long-term debt-to-capital		52%:48	%		54%:46	%		(2)	pts
Long-term debt-to-capital assuming aircraft operating leases are capitalized at seven times annualized rent		70%:30	%		72%:28	%		(2)	pts

During the year ended December 31, 2007, our cash and marketable securities declined $191.1 million to $822.8 million. The following discussion summarizes the primary drivers of the decrease and our expectation of future cash requirements.

ANALYSIS OF OUR CASH FLOWS

Cash Provided by Operating Activities

During 2007, net cash provided by operating activities was $482.0 million, compared to $449.8 million during 2006. The increase resulted from higher revenues and lower cash contributions to our defined-benefit pension plans in 2007, offset by the $47.7 million reduction in cash received from settled hedges, and higher raw fuel costs and other non-fuel operating expenses. We contributed $52.5 million to our defined-benefit pension plans in 2007 compared to $121.9 million in 2006. We typically generate positive cash flows from operations, but anticipate consuming substantially all of that cash for capital expenditures and debt payments in 2008 and 2009.

Cash Used in Investing Activities

Our investing activities are primarily made up of capital expenditures associated with our fleet transition programs and, to a lesser extent, purchases and sales of marketable securities. Cash used in investing activities was $601.8 million during 2007, compared to $533.0 million in 2006. Our capital expenditures grew by $152.3 million as a result of the purchase of 14 B737-800s and 13 Q400s, versus the purchase of ten B737-800s, five leased MD-80s, two Q400s and one CRJ-700 in 2006. This was partially offset by proceeds of approximately $50 million from the sale of our MD-80s, which were subsequently leased back. We currently expect capital expenditures to be approximately $570 million (of which $490 million is expected to be aircraft-related) during 2008 as we take delivery of 16 new B737-800s and three new Q400s. Capital expenditures are expected to decrease significantly in 2009 and 2010 as we near the end of our committed firm aircraft deliveries. We do have a number of options for both B737-800 and Q400 aircraft available should we decide to convert those into firm commitments. However, a decision to exercise those options is highly dependent on our ability to deploy those new aircraft profitably and generate returns that exceed our cost of capital.

Cash Provided by Financing Activities

We finance a large portion of our capital spending with debt financing. Net cash provided by financing activities was $93.4 million during


		57

2007 compared to $240.3 million during 2006. We obtained debt financing of $196.1 million for six new B737-800 aircraft and received $6.1 million of cash upon the issuance of common stock through stock option exercises and our employee stock purchase plan. Additionally, we borrowed $85.8 million using our pre-delivery payment facility. Offsetting these cash inflows were normal long-term debt payments of $132.2 million and the $62.8 million repurchase of 2.6 million shares of our common stock.

We plan to meet our significant capital and operating commitments through internally generated funds from operations and cash and marketable securities on hand, additional debt financing, and availability of credit under our pre-delivery payment facility. We have financing already in place for deliveries of B737-800s through 2009 and, subsequent to December 31, 2007, we closed financing on 13 of our Q400s, resulting in cash proceeds of $193 million.

Bank Line-of-Credit Facility

Alaska has a $185 million variable-rate credit facility that expires in March 2010. As of December 31, 2007, there are no outstanding borrowings on this credit facility and the Company has no immediate plans to borrow using this credit facility. See Note 5 in the consolidated financial statements for further discussion.

Pre-delivery Payment Facility

Alaska’s $172 million variable-rate revolving loan facility is available to provide a portion of the pre-delivery funding requirements of Alaska’s purchase of new Boeing 737-800 aircraft under the current aircraft purchase agreement. The maximum available amount is reduced to $152 million beginning in August 2009. The facility expires on August 31, 2011. The interest rate is

based on one-month LIBOR plus a specified margin. Any borrowings will be secured by Alaska’s rights under the Boeing purchase agreement. The principal amounts outstanding on the facility relate to specified aircraft and will be repaid at the time that Alaska takes delivery of the aircraft, if not sooner. As of December 31, 2007, $85.8 million was outstanding.

CONTRACTUAL OBLIGATIONS, COMMITMENTS AND OFF-BALANCE SHEET ARRANGEMENTS

Aircraft Purchase Commitments

At December 31, 2007, we had firm orders to purchase 46 aircraft requiring future aggregate payments of approximately $1.0 billion, as set forth below. Alaska also has committed to delivery of one new B737-800 aircraft in 2008 under an operating lease arrangement. Alaska has options to acquire 45 additional B737s and Horizon has options to acquire 20 Q400s. Alaska and Horizon expect to finance the firm orders and, to the extent exercised, the option aircraft with leases, long-term debt or internally generated cash.

During 2007, Alaska took delivery of 14 B737-800s, all of which were paid for with cash on hand. Six were subsequently financed with fixed and variable-rate debt arrangements. Horizon took delivery of 13 Q400s, all of which were paid for with cash on hand. During 2007, Alaska sold and leased back 20 MD-80 aircraft.

The following table summarizes aircraft purchase commitments and payments by year, as of December 31, 2007:


	Delivery Period - Firm Orders
Aircraft	2008		2009		2010		2011		Total
Boeing 737-800		16		6		6		3		31
Bombardier Q400		3		12		—		—		15

Total		19		18		6		3		46

Payments (Millions)	$	491.6	$	355.3	$	157.9	$	44.9	$	1,049.7


58

Two of the B737-800 aircraft were delivered subsequent to December 31, 2007, but before the filing of this Form 10-K. The two B737-800 were paid for with cash on hand. The remaining B737-800 aircraft scheduled for delivery in 2008 are generally evenly spread throughout the rest of the year, although weighted more toward the last six months of the year. In addition to the 16 purchased aircraft above, Alaska has committed to an operating lease arrangement with a third party for one B737-800 to be delivered in March 2008. The three Q400s will be delivered in the fourth quarter of 2008. Financing for ten of the 2008 B737-800 deliveries has already been arranged. We expect to pay for the remaining deliveries with cash on hand. In January 2008, we obtained financing for 13 of the recently delivered Q400 aircraft, resulting in net proceeds from borrowings of $193 million.

Our agreements with Boeing and Bombardier provide us with flexibility to adjust aircraft deliveries in the future should we wish to accelerate or slow our growth.

Contractual Obligations

The following table provides a summary of our principal payments under current and long-term debt obligations, capital lease obligations, operating lease commitments, aircraft purchase commitments and other obligations as of December 31, 2007. This table excludes contributions to our various pension plans, which we expect to be approximately $50 million to $75 million per year through 2012.


											Beyond
(in millions)	2008		2009		2010		2011		2012		2012		Total
Current and long-term debt obligations (excluding the pre-delivery payment facility)	$	90.1	$	94.8	$	100.3	$	133.3	$	175.5	$	620.7	$	1,214.7
Current and long-term portions of the pre-delivery payment facility		85.8		—		—		—		—		—		85.8
Operating lease commitments (1)		256.2		231.5		216.6		177.5		178.2		526.2		1,586.2
Aircraft purchase commitments		491.6		355.3		157.9		44.9		—		—		1,049.7
Interest obligations (2)		80.6		69.2		62.9		56.3		47.3		130.1		446.4
Other obligations (3)		29.7		30.0		30.3		30.6		30.9		62.7		214.2

Total	$	1,034.0	$	780.8	$	568.0	$	442.6	$	431.9	$	1,339.7	$	4,597.0

(1)

Operating lease commitments generally include aircraft operating leases, airport property and hangar leases, office space, and other equipment leases. The aircraft operating leases include lease obligations for four leased MD-80 aircraft, all of which we intend to retire earlier than expected in connection with our fleet transition plan.

(2)	For variable-rate debt, future obligations are shown above using interest rates in effect as of December 31, 2007.

(3)	Includes minimum obligations under our long-term power-by-the-hour maintenance agreement, but excludes $27.9 million of unrecognized tax benefits for which we cannot make a reasonably reliable estimate of the amount and period of payment. See Note 13 to the consolidated financial statements.

EFFECT OF INFLATION AND PRICE CHANGES

Inflation and price changes other than for aircraft fuel do not have a significant effect on our operating revenues, operating expenses and operating income.

OTHER

We strive to provide a return to our investors that exceeds the cost of the capital employed in our business. Our targeted return on invested capital (ROIC) is 10%. We have not historically reached this threshold, nor did we in 2007. However, our strategic plan is built on the premise of providing an appropriate return to all capital providers.


		59

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK

We have interest-rate risk on 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 the majority of our jet fuel at prevailing market prices and seek to manage market risk through execution of a documented hedging strategy and other means. 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.

Market Risk – Aircraft Fuel

Currently, our fuel-hedging portfolio consists almost exclusively of crude oil call options. We utilize the contracts in our portfolio as hedges to decrease our exposure to the volatility of jet fuel prices. Call options are designed to effectively cap our cost of the crude oil component of fuel prices, allowing us to limit our exposure to increasing fuel prices. With these call option contracts, we still benefit from the decline in crude oil prices, as there is no downward exposure other than the premiums that we pay to enter into the contracts. Although to a lesser extent, we also use collar structures for fuel hedging purposes. We believe there is risk in not hedging against the possibility of fuel price increases. We estimate that a 10% increase or decrease in crude oil prices as of December 31, 2007 would increase or decrease the fair value of our hedge portfolio by approximately $35.4 million and $33.4 million, respectively.

Additionally, we have entered into fuel purchase contracts that fix the refining margin we pay for approximately 50% of our fuel consumption in the first quarter of 2008.

Our portfolio of fuel hedge contracts was worth $112.5 million at December 31, 2007, including $30.9 million of capitalized premiums paid to counterparties, compared to a portfolio value of $68.6 million at December 31, 2006.

We continue to believe that our fuel hedge program is an important part of our strategy to reduce our exposure to volatile fuel prices. We expect to continue to enter into these types of contracts prospectively, although significant changes in market conditions could affect our decisions. For more discussion, see Note 3 to our consolidated financial statements.

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- rate instruments, which have exposure to changes in interest rates. This exposure is somewhat mitigated through our variable-rate investment portfolio. A hypothetical 10% change in the average interest rates incurred on variable-rate debt during 2007 would correspondingly change our net earnings and cash flows associated with these items by approximately $2.8 million. In order to help mitigate the risk of interest rate fluctuations, we fixed the interest rates on certain existing variable-rate debt agreements in 2005 and 2006. Additionally, several of our new debt arrangements in 2006 and 2007 were fixed-rate arrangements and we converted our variable-rate $150 million senior notes to equity in 2006. We continue to enter into both variable-rate and fixed-rate arrangements in order to diversify our loan portfolio, so that we mitigate risk of severe market fluctuations. Our variable-rate debt is approximately 40% of our total long-term debt at December 31, 2007 compared to 37% at December 31, 2006. Subsequent to December 31, 2007 and through February 15, 2007, we have converted approximately $30 million of our variable-rate debt arrangements into fixed-rate arrangements and we intend to convert more in the future.

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 2007, interest income would increase by approximately $9.2 million.


60

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

SELECTED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (unaudited)


	1st Quarter						2nd Quarter				3rd Quarter					4th Quarter
(in millions, except per share)	2007			2006			2007		2006		2007**		2006			2007		2006
Operating revenues	$	759.4		$	735.4		$	904.4	$	873.0	$	988.8	$	935.7		$	853.4	$	790.3
Operating income (loss)		(18.1	)		(125.2	)		77.7		80.1		137.0		(24.0	)		15.4		(18.2	)
Net income (loss)		(10.3	)		(79.1	)		46.1		55.5		81.8		(17.4	)		7.4		(11.6	)
Basic earnings (loss) per share:
Net income (loss)*		(0.26	)		(2.36	)		1.14		1.46		2.02		(0.44	)		0.19		(0.29	)
Diluted earnings (loss) per share:
Net income (loss)*		(0.26	)		(2.36	)		1.13		1.38		2.01		(0.44	)		0.19		(0.29	)

*	For earnings per share, the sum of the quarters will not equal the total for the full year.

Third quarter results have been adjusted for an error in our calculation of deferred Mileage Plan revenues. The error resulted in an overstatement of passenger revenue of $6.3 million ($4.0 million, net of tax, or $0.10 per diluted share). We have concluded that this item is not material, and in accordance with SEC Staff Accounting Bulletin No. 108, we will make appropriate adjustments to our previously filed financial statements when they are presented in future Exchange Act reports.


		61

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders

Alaska Air Group, Inc.:

We have audited the accompanying consolidated balance sheets of Alaska Air Group, Inc. and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2007. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedule II. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Alaska Air Group, Inc. and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As discussed in the notes to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123(R), Share-Based Payment, SEC Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, and SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R), effective January 1, 2006.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Alaska Air Group, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 19, 2008, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ KPMG LLP

Seattle, Washington

February 19, 2008


62

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ALASKA AIR GROUP, INC.

CONSOLIDATED BALANCE SHEETS


As of December 31 (In millions)	2007		2006
ASSETS
Current Assets
Cash and cash equivalents	$	204.3	$	230.7
Marketable securities (including securities loaned of $109.8 and $108.4)		618.5		783.2

Total cash and marketable securities		822.8		1,013.9
Securities lending collateral		111.9		111.3
Receivables—less allowance for doubtful accounts of $1.6 and $2.9		138.0		134.2
Inventories and supplies—net		46.6		44.7
Deferred income taxes		84.9		134.2
Fuel hedge contracts		100.7		45.9
Prepaid expenses and other current assets		85.4		88.1

Total Current Assets		1,390.3		1,572.3

Property and Equipment
Aircraft and other flight equipment		2,981.2		2,296.6
Other property and equipment		574.5		530.7
Deposits for future flight equipment		430.0		437.8

		3,985.7		3,265.1
Less accumulated depreciation and amortization		1,023.4		906.1

Total Property and Equipment—Net		2,962.3		2,359.0

Fuel Hedge Contracts		11.8		22.7

Other Assets		126.5		123.1

Total Assets	$	4,490.9	$	4,077.1

See accompanying notes to consolidated financial statements.


64

ALASKA AIR GROUP, INC.

CONSOLIDATED BALANCE SHEETS


As of December 31 (In millions except share amounts)	2007			2006
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Accounts payable	$	101.5		$	90.0
Accrued aircraft rent		73.4			56.8
Accrued wages, vacation and payroll taxes		112.3			144.0
Other accrued liabilities		448.5			404.3
Air traffic liability		364.5			311.2
Securities lending obligation		111.9			111.3
Current portion of long-term debt		175.9			119.1

Total Current Liabilities		1,388.0			1,236.7

Long-Term Debt, Net of Current Portion		1,124.6			1,031.7

Other Liabilities and Credits
Deferred income taxes		132.6			114.6
Deferred revenue		413.6			333.0
Other liabilities		408.1			475.6

		954.3			923.2

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: 2007—42,821,986 shares
2006—42,501,163 shares		42.8			42.5
Capital in excess of par value		895.1			877.9
Treasury stock (common), at cost: 2007—4,771,306 shares
2006—2,207,474 shares		(112.5	)		(50.4	)
Accumulated other comprehensive loss		(133.3	)		(191.4	)
Retained earnings		331.9			206.9

		1,024.0			885.5

Total Liabilities and Shareholders’ Equity	$	4,490.9		$	4,077.1

See accompanying notes to consolidated financial statements.


		65

ALASKA AIR GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS


Year Ended December 31 (In millions except per share amounts)	2007			2006			2005
Operating Revenues
Passenger	$	3,236.5		$	3,083.0		$	2,728.7
Freight and mail		97.8			97.3			94.1
Other—net		171.7			154.1			152.5

Total Operating Revenues		3,506.0			3,334.4			2,975.3

Operating Expenses
Wages and benefits		957.9			937.0			903.6
Variable incentive pay		20.8			36.8			20.0
Aircraft fuel, including hedging gains and losses		876.3			873.5			548.9
Aircraft maintenance		241.8			230.7			228.5
Aircraft rent		178.4			180.2			187.0
Landing fees and other rentals		226.0			204.0			202.7
Contracted services		160.6			153.2			132.4
Selling expenses		160.5			169.3			163.4
Depreciation and amortization		177.4			157.5			143.4
Food and beverage service		49.7			51.2			51.3
Other		230.5			214.0			207.2
Fleet transition costs—Alaska		—			189.5			—
Fleet transition costs—Horizon		14.1			—			—
Restructuring charges and adjustments		—			24.8			20.4

Total Operating Expenses		3,294.0			3,421.7			2,808.8

Operating Income (Loss)		212.0			(87.3	)		166.5

Nonoperating Income (Expense)
Interest income		53.9			54.3			30.9
Interest expense		(88.0	)		(78.0	)		(63.0	)
Interest capitalized		27.8			24.7			8.9
Other—net		(4.1	)		(1.5	)		(6.1	)

		(10.4	)		(0.5	)		(29.3	)

Income (loss) before income tax and accounting change		201.6			(87.8	)		137.2
Income tax expense (benefit)		76.6			(35.2	)		52.7

Income (loss) before accounting change		125.0			(52.6	)		84.5
Cumulative effect of accounting change, net of tax		—			—			(90.4	)

Net Income (Loss)	$	125.0		$	(52.6	)	$	(5.9	)

Basic Earnings (Loss) Per Share:
Income (loss) before accounting change	$	3.12		$	(1.39	)	$	3.06
Cumulative effect of accounting change		NA			NA			(3.27	)

Net Income (Loss) Per Share	$	3.12		$	(1.39	)	$	(0.21	)

Diluted Earnings (Loss) Per Share:
Income (loss) before accounting change	$	3.09		$	(1.39	)	$	2.65
Cumulative effect of accounting change		NA			NA			(2.66	)

Net Income (Loss) Per Share	$	3.09		$	(1.39	)	$	(0.01	)

Shares used for computation:
Basic		40.125			37.939			27.609
Diluted		40.424			37.939			33.917

See accompanying notes to consolidated financial statements.


66

ALASKA AIR GROUP, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY


(In millions)	Common Shares Outstanding	Common Stock		Capital in Excess of Par Value		Treasury Stock, at Cost			Deferred Stock-Based Compensation			Accumulated Other Comprehensive Loss			Retained Earnings			Total
Balances at December 31, 2004	27.126	$	29.8	$	496.5	$	(60.5	)	$	(3.4	)	$	(81.6	)	$	284.0		$	664.8

2005 net loss																(5.9	)		(5.9	)
Other comprehensive income (loss):
Officers supplemental retirement plan net of $0.7 tax benefit													(1.1	)					(1.1	)

Related to marketable securities:
Change in fair value													(3.5	)
Reclassification to earnings													3.5
Income tax effect													0.0

													0.0						0.0

Related to fuel hedges:
Reclassification to earnings													(12.8	)
Income tax effect													4.7

													(8.1	)					(8.1	)

Minimum pension liability adjustment, net of $24.4 tax benefit													(41.2	)					(41.2	)

Total comprehensive loss																			(56.3	)
Deferred stock-based compensation					6.8					(6.8	)								0.0
Amortization of deferred stock-based compensation					—					2.1									2.1
Treasury stock sales	0.172		—		—		3.9												3.9
Stock issued for employee stock purchase plan	0.114		0.1		2.3		—												2.4
Stock issued under stock plans, including $1.8 tax benefit	0.342		0.3		10.4		—												10.7
Stock issued in equity offering, net of $0.4 fees	5.700		5.7		194.3														200.0

Balances at December 31, 2005	33.454	$	35.9	$	710.3	$	(56.6	)	$	(8.1	)	$	(132.0	)	$	278.1		$	827.6

Cumulative effect of adoption of SAB 108, net of $11.1 tax effect	—		—		—		—			—			—			(18.6	)		(18.6	)

Adjusted balances at December 31, 2005	33.454	$	35.9	$	710.3	$	(56.6	)	$	(8.1	)	$	(132.0	)	$	259.5		$	809.0
2006 net loss																(52.6	)		(52.6	)
Other comprehensive income (loss):
Pension liability adjustment, net of $25.2 tax benefit													(43.1	)					(43.1	)

Postretirement medical liability adjustment, net of $11.1 tax benefit													(18.7	)					(18.7	)

Officers supplemental retirement plan net of $0.2 tax effect													0.4						0.4

Related to marketable securities:
Change in fair value													4.0
Reclassification to earnings													(0.4	)
Income tax effect													(1.3	)

													2.3						2.3

Related to fuel hedges:
Reclassification to earnings													(0.6	)
Income tax effect													0.3

													(0.3	)					(0.3	)

Total comprehensive loss																			(112.0	)

See accompanying notes to consolidated financial statements.


		67

ALASKA AIR GROUP, INC.

CONSOLIDATED STATEMENT OF

SHAREHOLDERS’ EQUITY—(Continued)


(In millions)	Common Shares Outstanding		Common Stock		Capital in Excess of Par Value			Treasury Stock, at Cost			Deferred Stock-Based Compensation		Accumulated Other Comprehensive Loss			Retained Earnings		Total
Implementation of SFAS 123R						(8.1	)					8.1							0.0
Stock-based compensation						8.2													8.2
Treasury stock issued under stock plans	0.272			—		—			6.2										6.2
Stock issued for employee stock purchase plan	0.093			0.1		2.4			—										2.5
Stock issued under stock plans, including $4.1 tax benefit	0.706			0.7		25.3			—										26.0
Stock issued upon conversion of senior convertible notes, net of $4.4 million of unamortized issuance costs	5.769			5.8		139.8													145.6

Balances at December 31, 2006	40.294		$	42.5	$	877.9		$	(50.4	)	$	0.0	$	(191.4	)	$	206.9	$	885.5

2007 net income																	125.0		125.0
Other comprehensive income (loss):
Related to marketable securities:
Change in fair value														3.2
Reclassification to earnings														2.0
Income tax effect														(1.9	)

														3.3					3.3

Related to employee benefit plans:
Pension liability adjustment, net of $29.6 tax effect														49.8					49.8

Postretirement medical liability adjustment, net of $2.5 tax effect														4.1					4.1

Officers supplemental retirement plan, net of $0.5 tax effect														0.9					0.9

Total comprehensive income																			183.1
Purchase of treasury stock	(2.593	)							(62.8	)									(62.8	)
Stock-based compensation						11.2													11.2
Treasury stock issued under stock plans	0.029			—		—			0.7										0.7
Stock issued for employee stock purchase plan	0.127			0.1		2.9													3.0
Stock issued under stock plans, including $0.4 tax benefit	0.194			0.2		3.1													3.3

Balances at December 31, 2007	38.051		$	42.8	$	895.1		$	(112.5	)			$	(133.3	)	$	331.9	$	1,024.0

See accompanying notes to consolidated financial statements.


68

ALASKA AIR GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS


Year Ended December 31 (In millions)	2007			2006			2005
Cash flows from operating activities:
Net income (loss)	$	125.0		$	(52.6	)	$	(5.9	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Cumulative effect of accounting change, net of tax		—			—			90.4
Fleet transition costs		14.1			189.5			—
Restructuring charges and adjustments		—			24.8			20.4
Depreciation and amortization		177.4			157.5			143.4
Stock-based compensation		11.2			8.2			2.1
Changes in fair values of open fuel hedge contracts		(43.9	)		84.1			(70.1	)
Loss (gain) on sale of assets		(4.6	)		(0.4	)		1.6
Changes in deferred income taxes		61.1			(34.0	)		51.6
Tax benefit from stock option exercises		(0.4	)		(4.1	)		(1.8	)
(Increase) decrease in receivables—net		(3.8	)		(10.0	)		(24.8	)
Increase in prepaid expenses and other current assets		(4.6	)		(11.3	)		(13.4	)
Increase in air traffic liability		52.4			19.4			41.6
Increase (decrease) in other current liabilities		26.0			34.7			(11.5	)
Increase in deferred revenue and other-net		72.1			44.0			46.5

Net cash provided by operating activities		482.0			449.8			270.1

Cash flows from investing activities:
Proceeds from disposition of assets		63.4			3.6			6.5
Purchases of marketable securities		(1,149.3	)		(806.5	)		(1,184.5	)
Sales and maturities of marketable securities		1,321.1			935.9			1,121.4
Property and equipment additions:
Aircraft and aircraft purchase deposits		(737.6	)		(591.8	)		(345.0	)
Other flight equipment		(46.0	)		(37.8	)		(46.6	)
Other property and equipment		(50.8	)		(52.5	)		(32.9	)
Aircraft deposits returned		—			—			7.6
Restricted deposits and other		(2.6	)		16.1			(7.6	)

Net cash used in investing activities		(601.8	)		(533.0	)		(481.1	)

Cash flows from financing activities:
Proceeds from issuance of long-term debt, net		281.9			408.4			93.8
Long-term debt and capital lease payments		(132.2	)		(202.6	)		(54.2	)
Purchase of treasury stock		(62.8	)		—			—
Proceeds from issuance of common stock, net of related fees		6.1			30.4			215.2
Tax benefit from stock option exercises		0.4			4.1			1.8

Net cash provided by financing activities		93.4			240.3			256.6

Net change in cash and cash equivalents		(26.4	)		157.1			45.6
Cash and cash equivalents at beginning of year		230.7			73.6			28.0

Cash and cash equivalents at end of year	$	204.3		$	230.7		$	73.6

Supplemental disclosure of cash paid (refunded) during the year for:
Interest (net of amount capitalized)	$	58.6		$	48.2		$	51.7
Income taxes		3.5			9.5			1.5
Noncash investing and financing activities:
Conversion of senior convertible notes to equity	$	—		$	150.0		$	—
Debt assumed in purchase of MD-80 aircraft		—			11.6			—
Credit received for flight deposits deferred in other liabilities		—			—			9.7

See accompanying notes to consolidated financial statements.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Alaska Air Group, Inc.

December 31, 2007

NOTE 1. GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Basis of Presentation

The consolidated financial statements include the accounts of Alaska Air Group, Inc. (Air Group or the Company) and its subsidiaries, Alaska Airlines, Inc. (Alaska) and Horizon Air Industries, Inc. (Horizon), through which the Company conducts substantially all of its operations. All significant intercompany balances and transactions have been eliminated. 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 may differ from these estimates.

Nature of Operations

Both Alaska and Horizon operate as airlines. However, their business plans, competition, and economic risks differ substantially. Alaska is a major airline and principally serves destinations in the state of Alaska and provides north/south service between cities in the western U.S., Canada and Mexico. Alaska also provides east/west service to eight cities, primarily from Seattle and to a lesser extent, from Portland. In 2007, Alaska also initiated service to Hawaii from Seattle and Anchorage. It operates an all-jet fleet and its average passenger trip in 2007 was 1,051 miles. Horizon is a regional airline serving primarily the Pacific Northwest, northern California, and western Canada. Horizon serves its own native markets and provides certain contract flying for Alaska. Horizon operates both jet and turboprop aircraft, and its average passenger trip in 2007 was 386 miles.

West Coast passenger traffic accounted for 46% of Alaska’s 2007 revenue passenger miles, passenger traffic within Alaska and between Alaska and the U.S. mainland accounted for 21%, the Mexico markets accounted for 11%, the Canada markets accounted for 4%, and other markets accounted for 18%. Based on passenger enplanements, Alaska’s leading airports are Seattle, Los Angeles, Anchorage, and Portland. Based on 2007 revenues, its leading nonstop routes are Anchorage-Seattle, Los Angeles-Seattle, and San Diego-Seattle.

Approximately 92% of Horizon’s network revenue passenger miles (excluding flying as Frontier JetExpress) were flown domestically, primarily in the states of Washington, Oregon, Idaho, and California. The Canada markets accounted for 8% of revenue passenger miles in 2007. Based on passenger enplanements, Horizon’s leading airports are Seattle, Portland, Boise, and Spokane. Based on revenues in 2007, its leading nonstop routes are Portland-Seattle, Spokane-Seattle, and Ontario-Portland.

On January 1, 2004, Horizon began operating regional jet service branded as Frontier JetExpress under a 12-year agreement with Frontier Airlines. Horizon operated nine regional jet aircraft under the Frontier JetExpress brand in 2005 and 2006. In the third quarter of 2006, Horizon announced that it would discontinue the Frontier JetExpress program beginning in the first quarter of 2007, and had fully exited from the program by the end of November 2007. Flying under this agreement represented 13% of Horizon’s capacity and 5% of passenger revenues in 2007 and 23% of capacity and 8% of passenger revenues in 2006. These aircraft have been redeployed throughout the Air Group network.

The Company’s operations and financial results are subject to various uncertainties, such as industry instability, which has lead to bankruptcy filings by some of the major carriers, general economic conditions, intense competition, volatile fuel prices, a largely unionized work force, the need to finance large capital expenditures, government regulation, and potential aircraft incidents.

Approximately 84% and 48% of Alaska and Horizon employees, respectively, are covered by


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collective bargaining agreements. Approximately 14% and 46% of Alaska and Horizon employees, respectively, are covered under agreements that are currently in negotiations or become amendable prior to December 31, 2008.

The airline industry is characterized by high fixed costs. Small fluctuations in load factors and yield (a measure of ticket prices) can have a significant impact on operating results. The Company has been and continues working to reduce unit costs to better compete with carriers that have lower cost structures.

Substantially all of Alaska’s and Horizon’s sales occur in the United States. See Note 15 for operating segment information and geographic concentrations.

Reclassifications

Certain reclassifications have been made to conform the prior year’s data to the current format.

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 balance in its cash disbursement accounts, which is reported as a current liability. The amount of the negative cash balance was $22.3 million and $29.7 million at December 31, 2007 and 2006, respectively, and is included in accounts payable.

Securities Lending

From time to time, the Company lends certain marketable securities to third parties for a period of less than one year to enhance investment income. During the time period in which these securities are loaned to the third parties, the Company requires cash collateral for 102% of the daily market value of the loaned securities. This cash collateral is restricted and is deposited with a lending agent and invested by that agent in accordance with the Company’s guidelines. The Company maintains full ownership rights to the securities loaned and continues to earn interest and appreciation on them. As of December 31, 2007 and 2006, the Company had $109.8 million and $108.4 million of securities on loan under the program. These affected securities are included as marketable securities in the consolidated balance sheets.

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. 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

Expendable aircraft parts, materials and supplies are stated at average cost and are included in inventories and supplies-net. An obsolescence allowance for expendable parts is accrued based on estimated lives of the corresponding fleet type and salvage values. Surplus inventories are carried at their net realizable value. The allowance for all non-surplus expendable inventories was $24.6 million and $20.5 million at December 31, 2007 and 2006, respectively. Inventory and supplies-net also includes fuel inventory of $6.6 million and $7.2 million at December 31, 2007 and 2006, respectively. Repairable and rotable aircraft parts inventory are included in flight equipment.


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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 737-400/700/800/900		20 years
Bombardier Q400 and CRJ-700		15 years
Bombardier Q400 and CRJ-700 rotable spares		10 years
Buildings		25-30 years
Minor building and land improvements		10 years
Capitalized leases and leasehold improvements		Shorter of lease term or estimated useful life
Computer hardware and software		3-5 years
Other furniture and equipment		5-10 years

As a result of the expected early retirement of the MD-80 fleet, all aircraft and related flight equipment are being depreciated through 2008, depending on the scheduled retirement dates. All Q200 related parts are being depreciated through 2009, as that is the expected date that Horizon will no longer be operating the Q200 fleet.

“Related flight equipment” includes rotable and repairable spare inventory, which are depreciated over the associated fleet life unless otherwise noted.

Maintenance and repairs are expensed when incurred. Major modifications that extend the life or improve the usefulness of aircraft are capitalized and depreciated over their estimated period of use.

The Company evaluates long-lived assets to be held and used for impairment whenever events or changes in circumstances indicate that the total carrying amount of an asset or 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 or asset group and its eventual disposition are less than its carrying amount. If the asset or asset group is not considered recoverable, a write- down equal to the excess of the carrying amount over the fair value will be recorded.

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 $3.0 million, $2.4 million, and $2.3 million during the years ended December 31, 2007, 2006, and 2005, respectively.

Workers Compensation and Employee Health-Care Accruals

The Company uses a combination of self-insurance and insurance mechanisms to provide for workers compensation claims and employee health care benefits. Liabilities associated with the risks that are retained by the Company are not discounted and are estimated, in part, by considering historical claims experience, severity factors and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends.


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Deferred Revenue

Deferred revenue results primarily from the sale of mileage credits. This revenue is recognized when award transportation is provided or over the term of the applicable agreements.

Operating Leases

The Company leases aircraft, airport and terminal facilities, office space, and other equipment under operating leases. Some of these lease agreements contain rent escalation clauses or rent holidays. For scheduled rent escalation clauses during the lease terms or for rental payments commencing at a date other than the date of initial occupancy, the Company records minimum rental expenses on a straight-line basis over the terms of the leases in the consolidated statements of operations.

Leased Aircraft Return Costs

Cash payments associated with returning leased aircraft are accrued beginning immediately after the last heavy maintenance visit prior to the scheduled aircraft return date. This accrual is 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 lease termination.

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 $6.9 million and $9.2 million as of December 31, 2007 and December 31, 2006, respectively. There have been no material changes in our estimate of leased aircraft return costs during 2007

Revenue Recognition

Passenger revenue is recognized when the passenger travels. Tickets sold but not yet used are reported as air traffic liability. Passenger traffic commissions and related fees are expensed when the related revenue is recognized. Passenger traffic commissions and related fees not yet recognized are included as a prepaid expense. Due to complex pricing structures, refund and exchange policies, and interline agreements with other airlines, certain amounts are recognized as revenue using estimates regarding both the timing of the revenue recognition and the amount of revenue to be recognized. These estimates are generally based on the Company’s historical data.

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 “Mileage Plan” paragraph below.

Mileage Plan

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, Horizon and other airline partners, the estimated cost of providing free travel awards is recognized as a selling expense and accrued as a liability as miles are earned and accumulated. Alaska also sells mileage credits to non-airline partners such as hotels, car rental agencies, a grocery store chain, 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 and flown on Alaska or Horizon, and as other-net revenue for awards redeemed and flown on other airlines. The portion of the sales proceeds not deferred is recognized as commission income and included in other revenue-net in the consolidated statements of operations. Alaska’s Mileage Plan deferred revenue and liabilities are included under the following consolidated balance sheet captions at December 31 (in millions):


Balance Sheet Captions	2007		2006
Current Liabilities:
Other accrued liabilities	$	239.7	$	196.6
Other Liabilities and Credits:
Deferred revenue		387.8		328.3
Other liabilities		21.0		20.7

Total	$	648.5	$	545.6


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The amounts recorded in other accrued liabilities relate primarily to deferred revenue expected to be realized within one year, including $37.1 million and $32.7 million at December 31, 2007 and 2006, respectively, associated with Mileage Plan awards issued but not yet flown.

Alaska’s Mileage Plan revenue is included under the following consolidated statements of operations captions for the years ended December 31 (in millions):


	2007		2006		2005
Passenger revenues	$	115.6	$	95.5	$	81.3
Other-net revenues		112.0		98.7		98.9

Total Mileage Plan revenues	$	227.6	$	194.2	$	180.2

Aircraft Fuel

Aircraft fuel includes raw jet fuel and associated “into-plane” costs, fuel taxes, oil, and all of the gains and losses associated with fuel hedge contracts.

Contracted Services

Contracted services includes expenses for ground handling, security, navigation fees, temporary employees, data processing fees, and other similar services.

Selling Expenses

Selling expenses include credit card fees, global distribution systems charges, the estimated cost of 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 $13.7 million, $14.2 million, and $14.0 million during the years ended December 31, 2007, 2006, and 2005, respectively.

Capitalized Interest

Interest is capitalized on flight equipment purchase deposits as a cost of the related asset, and is depreciated over the estimated useful life of the asset. The capitalized interest is based on the Company’s weighted-average borrowing rate.

Derivative Financial Instruments

The Company accounts for financial derivative instruments utilizing Statement of Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities, as amended. See Note 3 for further discussion.

Income Taxes

The Company uses the asset and liability approach for accounting and reporting income taxes. Deferred tax assets and liabilities are recognized for 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. A valuation allowance would be established, if necessary, for the amount of any tax benefits that, based on available evidence, are not expected to be realized. The Company accounts for unrecognized tax benefits in accordance with Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48). See Note 13 for further discussion.

Taxes Collected from Passengers

Taxes collected from passengers, which include sales taxes, airport and security fees and other fees, are recorded on a net basis within passenger revenue in the consolidated statements of operations.


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Stock-Based Compensation

The Company adopted Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment: An Amendment of SFAS Nos. 123 and 95, as of January 1, 2006. This standard requires companies to recognize as expense the fair value of stock options and other equity-based compensation issued to employees as of the grant date. The standard applies to stock options, restricted stock units, and performance stock units that the Company grants to employees as well as the Company’s Employee Stock Purchase Plan (ESPP), which features a look-back provision and allows employees to purchase stock at a 15% discount. The Company used the “modified prospective method” to adopt SFAS 123R, which is explained below.

The adoption of SFAS 123R changed the accounting for stock options under the Company’s long-term incentive equity plans and for the Company’s ESPP. Accounting for the Company’s restricted stock awards did not change with the adoption of the standard. All stock-based compensation expense is recorded in wages and benefits in the consolidated statements of operations.

For stock options granted prior to January 1, 2006, for which the vesting period is not complete, the “modified prospective method” for transition permitted by SFAS 123R was used. Under this method, the Company accounts for the unvested portion of these awards on a prospective basis, with expense recognized in the consolidated statements of operations beginning January 1, 2006 using the grant-date fair values previously calculated for pro-forma disclosures. The Company selected this method due to the relatively limited use of stock-based awards and the immaterial impact on the comparability between periods. The standard also requires that tax benefits realized from stock award exercise gains in excess of stock-based compensation expense recognized for financial statement purposes be reported as cash flows from financing activities rather than as operating cash flows.

Previously, the Company applied 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. As such, no compensation cost was recognized for option grants or ESPP awards in periods prior to 2006. Had compensation cost for the Company’s stock options been determined using the fair-value method in 2005, the Company would have reported a net loss of $9.4 million, or $0.11 per diluted share, compared to the $5.9 million net loss, or $0.01 per diluted share, as reported.

Variable Interest Entities

The Company is 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 the Company. These leasing entities meet the criteria for variable interest entities. However, they do not meet the consolidation requirements of Financial Accounting Standards Board (FASB) issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46), because the Company is not the primary beneficiary of the entity’s expected gains or losses. The Company’s 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 the Company, fixed-price purchase obligations or similar features that obligate the Company to absorb the majority of expected losses of the variable interest entities. The Company’s maximum 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, which is accrued as leased aircraft return costs).

New Accounting Standards

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 expresses SEC staff views regarding the process by which misstatements in financial statements are


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evaluated for purposes of determining whether those misstatements are material to the Company’s financial statements. SAB 108 was effective for fiscal years ending after November 15, 2006. The Company adopted SAB 108 in the fourth quarter of 2006 with an effective date of January 1, 2006. See Note 16 for further discussion.

FIN 48 was adopted by the Company and became effective January 1, 2007. See Note 13 for a discussion of the impact of this interpretation on the Company’s financial position.

Fourth Quarter Adjustments

There were no significant adjustments in the fourth quarters of 2007 or 2005. Fourth quarter 2006 adjustments included a favorable $7.6 million adjustment to restructuring charges to adjust for the number of employees that withdrew their participation in the severance program. See Note 10 for further discussion.

NOTE 2. FLEET TRANSITION AND IMPAIRMENT

Alaska Transition to All-Boeing 737 Fleet

In March 2006, the Company’s Board approved a plan to accelerate the retirement of its MD-80 fleet (15 owned and 11 leased aircraft at the time) and remove those aircraft from service by the end of 2008. As a result of this decision, the Company evaluated impairment as required by SFAS No. 144 and concluded that the carrying value of the MD-80 fleet was no longer recoverable when compared to the estimated remaining future cash flows. Accordingly, during the first quarter of 2006, the Company recorded an impairment charge totaling $131.1 million (pretax) to write down the fleet to its estimated fair market value.

During the third quarter of 2006, the Company purchased five MD-80 aircraft from lessors and, in conjunction with the purchases, terminated the leases for those five aircraft, resulting in a pretax charge of $58.4 million.

During the second quarter of 2007, the Company sold 19 of its 20 owned MD-80s, and sold the 20^th aircraft subsequent to the end of the third quarter. The majority of these aircraft are being leased from the buyer under short-term lease arrangements that will allow the Company to maintain the current MD-80 retirement schedule through December 2008.

Alaska currently has four MD-80 aircraft under long-term lease arrangements that it plans to cease operating before the end of the lease term. Management anticipates that once these aircraft have been removed from operation, the Company will dispose of these aircraft through a lease buy-out, a sublease arrangement, or store them at a long-term storage facility. It is likely that the Company will record a charge in its statement of operations if any of these options occurs.

Horizon Fleet Transition

During the third quarter of 2006, Horizon signed a letter of intent with another carrier to sublease up to 16 of its Bombardier Q200 aircraft. Each sublease will result in a loss for Horizon approximating the difference between the lease payments and the sublease receipts. The loss on each aircraft will be recorded when the specific aircraft leave Horizon’s fleet and the sublease arrangement begins. In 2007, 11 of the aircraft were delivered to the other carrier, resulting in a sublease loss of $14.1 million. The Company expects the loss of the remaining five aircraft to average approximately $1.3 million per aircraft. These aircraft are expected to leave the fleet in the first half of 2008.

On April 23, 2007, Horizon announced an order for 15 additional Q400 aircraft, with options to purchase 20 more. These aircraft will be delivered in 2008 and 2009. With this order, Horizon plans to phase out the remaining Q200 aircraft by the end of 2009 and is in the process of negotiating transactions that would allow it to dispose of these aircraft. Since all of Horizon’s Q200 aircraft are leased, the Company may have a loss on the phase-out of the remaining Q200s, depending on market conditions at that time.


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However, the nature, timing or amount of any potential loss cannot be reasonably estimated at this point for the aircraft that are not part of the sublease agreement described above.

NOTE 3. 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, collar structures, and swap agreements for crude oil, among other initiatives.

The Company records derivative instruments, all of which are currently fuel hedge contracts, 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 years ended December 31, 2007, 2006 and 2005 (in millions):


	2007			2006			2005
Raw or “into-plane” fuel cost	$	981.9		$	884.7		$	735.6
Changes in value and settlements of fuel hedge contracts		(105.6	)		(11.2	)		(186.7	)

Aircraft fuel expense	$	876.3		$	873.5		$	548.9

The Company realized gains of $53.4 million, $101.1 million, and $125.0 million in 2007, 2006, and 2005, respectively, on fuel hedge contracts that settled during the period.

Outstanding fuel hedge positions as of December 31, 2007 are as follows:


	Approximate % of Expected Fuel Requirements		Gallons Hedged (in millions)	Approximate Crude Oil Price per Barrel
First Quarter 2008	50	%	49.7	$	66.88
Second Quarter 2008	38	%	39.7	$	66.71
Third Quarter 2008	33	%	37.7	$	68.62
Fourth Quarter 2008	34	%	35.3	$	68.21

Full Year 2008	39	%	162.4	$	67.53

First Quarter 2009	5	%	5.6	$	67.68
Second Quarter 2009	5	%	5.8	$	67.50
Third Quarter 2009	6	%	6.3	$	68.25
Fourth Quarter 2009	5	%	5.3	$	67.20

Full Year 2009	5	%	23.0	$	67.68

As of December 31, 2007 and 2006, the fair values of the Company’s fuel hedge positions were $112.5 million and $68.6 million, respectively, including capitalized premiums paid of $30.9 million and $39.3 million, respectively, and are presented as both current and non-current assets in the in the consolidated balance sheets.

NOTE 4. MARKETABLE SECURITIES

At December 31, 2007 and 2006 all of the Company’s marketable securities, including securities pledged under the securities lending program, were classified as available-for-sale. The securities are carried at fair value, with the unrealized gains and losses reported in shareholders’ equity under the caption “Accumulated Other Comprehensive Loss.” Realized gains and losses are included in other nonoperating income (expense) in the 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 consolidated statements of operations.


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Marketable securities consisted of the following at December 31 (in millions):


	2007		2006
Cost:
U.S. government securities	$	171.1	$	317.7
Asset-backed obligations		241.9		65.7
Other corporate obligations		200.5		400.1

	$	613.5	$	783.5

Fair value:
U.S. government securities	$	174.2	$	317.5
Asset-backed obligations		242.9		65.6
Other corporate obligations		201.4		400.1

	$	618.5	$	783.2

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 reputable financial institutions and continually reviewed to ensure that the investments are aligned with the Company’s documented strategy.

At December 31, 2007, available-for-sale investments in the Company’s marketable securities portfolio had net unrealized gains totaling $3.1 million, net of taxes, which are recorded in accumulated other comprehensive loss. Management does not believe that the securities with unrealized losses as of December 31, 2007 meet the criteria for recognition under existing other-than-temporary loss guidance. At December 31, 2007 and 2006, gross unrealized gains and losses were not material.

Of the marketable securities on hand at December 31, 2007, 13% mature in 2008, 33% in 2009, and 54% thereafter.

Activity for marketable securities for the years ended December 31, 2007, 2006 and 2005 is as follows:


	2007		2006		2005
Proceeds from sales and maturities	$	1,321.1	$	935.9	$	1,121.4
Gross realized gains		4.8		2.1		0.4

Gross realized losses		2.9		1.6		4.0

NOTE 5. LONG-TERM DEBT

At December 31, 2007 and 2006, long-term debt obligations were as follows (in millions):


	2007			2006
Fixed-rate notes payable due through 2020*	$	783.9		$	721.0
Variable-rate notes payable due through 2021*		430.8			390.6
Pre-delivery payment facility expiring in 2011*		85.8			39.2

Long-term debt		1,300.5			1,150.8
Less current portion		(175.9	)		(119.1	)

	$	1,124.6		$	1,031.7

*	The weighted-average fixed-interest rate was 6.9% as of December 31, 2007 and 2006. The weighted-average variable-interest rate, including the interest rate on the pre-delivery payment facility, was 6.5% and 6.8% as of December 31, 2007 and 2006, respectively.

At December 31, 2007, substantially all of the Company’s borrowings were secured by flight equipment, future delivery positions, and real property.

Alaska has a $172 million variable-rate revolving pre-delivery payment (PDP) facility with a syndicate of lenders to provide a portion of the pre-delivery funding requirements for the purchase of new Boeing 737-800 aircraft under the current aircraft purchase agreement. The interest rate is based on the one-month LIBOR plus a specified margin. Borrowings are secured by the Company’s rights under the Boeing purchase agreement. The principal amounts outstanding on the PDP facility relate to specified aircraft and will be repaid at the time the Company takes delivery of the aircraft, if not before, likely using cash on hand or proceeds from long-term debt financing on those aircraft. The Company executed an amendment to the facility in 2007 that extended the expiration date from August 2009 to August 2011. The amendment also reduced the maximum available amount from $172 million to $152 million beginning in August 2009.


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At December 31, 2007, long-term debt principal payments for the next five years are as follows (in millions):


	PDP Facility		Other		Total
2008	$	85.8	$	90.1	$	175.9
2009		—		94.8		94.8
2010		—		100.3		100.3
2011		—		133.3		133.3
2012		—		175.5		175.5
Thereafter		—		620.7		620.7

Total principal payments	$	85.8	$	1,214.7	$	1,300.5

During 2007, Alaska borrowed $196.1 million using fixed-rate and variable-rate debt secured by flight equipment and had gross borrowings on its pre-delivery payment facility of $85.8 million. The increase in debt from borrowings was offset by normal debt payments of $93.0 million and $39.2 million of payments on the pre-delivery payment facility.

Bank Line of Credit

The Company has a $185 million credit facility with a syndicate of financial institutions. The interest rate on the credit facility varies depending on certain financial ratios specified in the agreement with a minimum interest rate of LIBOR plus 2%. The agreement provides that any borrowings will be secured by either aircraft or cash collateral. This credit facility contains contractual restrictions and requires maintenance of specific levels of net worth, maintenance of certain debt and leases to net worth, leverage and fixed-charge coverage ratios, and limits on liens, asset dispositions, dividends, and certain other expenditures. Such provisions restrict Alaska Airlines from distributing any funds to Alaska Air Group in the form of dividends and limit the amount of funds Alaska Airlines can loan to its affiliates. In April 2007, the Company entered into the Second Amendment of the facility. The Second Amendment: (i) increased the size of the facility from $160 million to $185 million; (ii) improved the collateral advance rates for certain aircraft; (iii) extended the agreement by two years with a maturity date of March 31, 2010; and (iv) repriced the credit facility to reflect current market rates. The Company currently has no immediate plans to borrow using this credit facility. In July 2007, the Company executed the Third Amendment to the credit facility, which increased the amount of allowed borrowings between Alaska Airlines and its affiliates from $300 million to $500 million. As of December 31, 2007, there were no outstanding borrowings on this credit facility.

Certain Alaska loan agreements contain provisions that require maintenance of specified financial covenants. At December 31, 2007, the Company was in compliance with all financial covenants.

Subsequent Event

In January 2008, Horizon executed a fixed-rate debt arrangement to finance 13 of its recently delivered Q400 aircraft. Total proceeds from the debt were $193 million.

NOTE 6. COMMITMENTS

Lease Commitments

At December 31, 2007, the Company had lease contracts for 101 aircraft that have remaining noncancelable lease terms of less than one year to 12 years. The majority of airport and terminal facilities are also leased. Total rent expense was $333.5 million, $320.6 million, and $324.8 million, in 2007, 2006, and 2005, respectively.

Future minimum lease payments with noncancelable terms in excess of one year as of December 31, 2007 are shown below (in millions):


	Operating Leases
	Aircraft		Facilities
2008	$	193.4	$	62.8
2009		171.8		59.7
2010		169.7		46.9
2011		145.5		32.0
2012		149.5		28.7
Thereafter		412.1		114.1

Total lease payments	$	1,242.0	$	344.2


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Aircraft Commitments

In June 2005, Alaska entered into an aircraft purchase agreement to acquire B737-800 aircraft with deliveries beginning in January 2006 and continuing through April 2011. The purchase agreement also includes options rights to purchase additional aircraft under similar terms. As of December 31, 2007, Alaska was committed to purchasing 31 B737-800 aircraft, 16 of which will be delivered in 2008. Alaska has also entered into operating lease arrangements for two B737-800 aircraft and has committed to an operating lease for an additional B737-800 aircraft to be delivered in the first quarter of 2008.

Horizon entered into an aircraft purchase agreement in 2007 to acquire 15 Q400 aircraft with deliveries beginning in June 2008 and continuing through August 2009. The purchase agreement also includes options to purchase an additional 20 Q400 aircraft.

At December 31, 2007, the Company had firm purchase commitments for 46 total aircraft requiring remaining aggregate payments of approximately $1.0 billion.

Alaska and Horizon expect to finance the firm orders and, to the extent exercised, the option aircraft with leases, long-term debt, and internally generated cash.

NOTE 7. COMMON STOCK REPURCHASE PROGRAM

In September 2007, the Board of Directors authorized the Company to repurchase up to $100 million of its common stock over a period of twelve months. As of December 31, 2007, the Company had repurchased 2,593,282 shares of common stock for a total of $62.8 million under this authorization, and an additional 1,283,700 shares through February 19, 2008, bringing the total to 3,876,982 shares. The repurchased shares have been recorded as treasury stock in the accompanying consolidated balance sheet.

NOTE 8. EMPLOYEE BENEFIT PLANS

Four defined-benefit and five defined-contribution retirement plans cover various employee groups of Alaska and Horizon. 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. Alaska also maintains an unfunded, noncontributory defined-benefit plan for certain elected officers and an unfunded, non-contributory defined-contribution plan for other elected officers.

In 2006, the Company adopted SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R) (SFAS 158). SFAS 158 requires recognition of the overfunded or underfunded status of an entity’s defined-benefit pension and other postretirement plan as an asset or liability in the financial statements and requires recognition of the funded status in other comprehensive income.

Qualified Defined-Benefit Pension Plans

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.


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WEIGHTED AVERAGE ASSUMPTIONS USED TO DETERMINE BENEFIT OBLIGATIONS AS OF DECEMBER 31:

Discount rates of 6.00% and 5.75% were used as of December 31, 2007 and 2006, respectively. For both 2007 and 2006, the rate of compensation increase used varied from 3.52% to 4.53%, depending on the plan and the related workgroup.

WEIGHTED AVERAGE ASSUMPTIONS USED TO DETERMINE NET PERIODIC BENEFIT COST FOR THE YEARS ENDED DECEMBER 31:

Discount rates of 5.75% and 5.50% were used for the years ended December 31, 2007 and 2006, respectively. For 2007 and 2006, the expected return on plan assets used was 7.75%, and the rate of compensation increase used varied from 3.52% to 4.53%, depending on the plan and the related workgroup.

In determining the discount rate used, the Company’s policy is to use the rates on high-quality long-term bonds near the end of the year and round to the nearest 25 basis points. 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 qualified defined-benefit plans, by asset category, is as follows as of the end of 2007 and 2006:


	2007		2006
Asset category:
Domestic equity securities	54	%	53	%
Non-U.S. equity securities	15		15
Fixed income securities	31		29
Other	—		3

Plan 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:	55	%
Non-U.S. equities:	15	%
Fixed income:	30	%

Pension assets are rebalanced periodically to maintain these target asset allocations. 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 ten years. The Company does not currently intend to invest plan assets in the Company’s common stock.

Nonqualified Defined-Benefit Pension Plan

Alaska also maintains an unfunded, noncontributory defined-benefit plan for certain elected officers. This plan uses a December 31 measurement date.

WEIGHTED AVERAGE ASSUMPTIONS USED TO DETERMINE BENEFIT OBLIGATIONS AS OF DECEMBER 31:

Discount rates of 6.00% and 5.75% were used as of December 31, 2007 and 2006, respectively. The rate of compensation increase used was 5.00% as of December 31, 2007 and 2006.

WEIGHTED AVERAGE ASSUMPTIONS USED TO DETERMINE NET PERIODIC BENEFIT COST FOR THE YEARS ENDED DECEMBER 31:

Discount rates of 5.75% and 5.50% were used for the years ended December 31, 2007 and 2006, respectively. The rate of compensation increase used was 5.00% for the years ended December 31, 2007 and 2006.


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Combined Disclosures for Defined-Benefit Pension Plans

The following table sets forth the status of the plans for 2007 and 2006 (in millions):


	Qualified						Nonqualified
	2007			2006			2007			2006
Projected benefit obligation (PBO)
Beginning of year	$	1,051.3		$	989.1		$	34.6		$	37.7
Service cost		49.7			52.3			1.1			1.1
Interest cost		60.9			56.1			1.9			2.0
Plan amendments		(1.3	)		—			—			—
Curtailment gain		—			(2.9	)		—			—
Change in assumptions		—			—			—			(1.1	)
Actuarial (gain) loss		(51.1	)		9.2			(1.1	)		(1.1	)
Benefits paid		(52.6	)		(52.5	)		(1.6	)		(4.0	)

End of year	$	1,056.9		$	1,051.3		$	34.9		$	34.6

Plan assets at fair value
Beginning of year	$	835.9		$	680.9		$	—		$	—
Actual return on plan assets		74.8			85.6			—			—
Employer contributions		52.5			121.9			1.6			4.0
Benefits paid		(52.6	)		(52.5	)		(1.6	)		(4.0	)

End of year	$	910.6		$	835.9		$	—		$	—

Funded status (unfunded)	$	(146.3	)	$	(215.4	)	$	(34.9	)	$	(34.6	)

Percent funded		86.2	%		79.5	%		—			—

The accumulated benefit obligation for the qualified defined-benefit pension plans was $939.0 million and $964.8 million at December 31, 2007 and 2006, respectively. The accumulated benefit obligation for the nonqualified defined-benefit plan was $34.6 million and $33.4 million at December 31, 2007 and 2006, respectively.

As of December 31, 2007 and 2006, the amounts recognized in the consolidated balance sheets were as follows (in millions):


	2007				2006
	Qualified		Nonqualified		Qualified		Nonqualified
Accrued benefit liability-current	$	—	$	2.0	$	—	$	2.0
Accrued benefit liability-long term		146.3		32.9		215.4		32.6

Total liability recognized	$	146.3	$	34.9	$	215.4	$	34.6

AMOUNTS NOT YET REFLECTED IN NET PERIODIC BENEFIT COST AND INCLUDED IN ACCUMULATED OTHER COMPREHENSIVE INCOME OR LOSS (AOCI):


	2007				2006
	Qualified		Nonqualified		Qualified		Nonqualified
Prior service cost	$	21.7	$	0.3	$	28.0	$	0.3
Net loss		167.5		4.6		240.7		6.0

Amount recognized in AOCI (pretax)	$	189.2	$	4.9	$	268.7	$	6.3


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The estimated amortization of prior service cost and net loss from AOCI in 2008 is $4.5 million and $5.2 million, respectively, for the qualified defined-benefit pension plans. For the nonqualified defined-benefit pension plans, the estimated amortization of prior service cost and net loss from AOCI in 2008 is $0.1 million and $0.2 million, respectively.

Net pension expense for the defined-benefit plans included the following components for 2007, 2006, and 2005 (in millions):


	Qualified									Nonqualified
	2007			2006			2005			2007		2006		2005
Service cost	$	49.7		$	52.4		$	50.4		$	1.1	$	1.1	$	1.3
Interest cost		60.9			56.1			50.9			1.9		2.0		1.9
Expected return on assets		(66.3	)		(55.0	)		(49.9	)		—		—		—
Amortization of prior service cost		4.9			5.0			4.9			0.1		0.1		0.1
Curtailment loss		—			0.2			—			—		—		—
Recognized actuarial loss		13.4			19.6			15.4			0.3		0.4		0.3

Net pension expense	$	62.6		$	78.3		$	71.7		$	3.4	$	3.6	$	3.6

With the adoption of SFAS 158 in 2006, the Company now records all of the unrecognized prior service cost and net loss into AOCI in order to fully recognize the funded status of the plans. In 2005, the Company recorded $41.2 million (net of taxes of $24.4 million) in non-cash charges to equity in connection with the defined-benefit plans that the Company sponsors for eligible employees. The charge in 2005 can be partially attributed to the reduction of the discount rate and a change from the GAM83 mortality tables to the RP2000 tables.

The Company expects to contribute approximately $50 million and $2 million to the qualified and nonqualified defined-benefit pension plans, respectively, during 2008.

Future benefits expected to be paid over the next ten years under the defined-benefit pension plans from the assets of those plans as of December 31, 2007 are as follows (in millions):


	Qualified		Nonqualified
2008	$	28.1	$	2.0
2009		38.4		2.2
2010		50.1		2.2
2011		52.5		2.2
2012		57.5		2.4
2013 – 2017	$	391.6	$	14.2

Postretirement Medical 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 postretirement benefit obligation (APBO) for this subsidy is unfunded, and at December 31, 2007 and 2006 was $101.7 million and $97.5 million, respectively. This liability was determined using an assumed discount rate of 6.00% and 5.75% at December 31, 2007 and 2006, respectively.


	2007			2006
Accumulated postretirement benefit obligation
Beginning of year	$	97.5		$	82.1
Service cost		4.6			4.3
Interest cost		6.3			4.9
Amendments		—			8.7
Actuarial (gain) loss		(4.4	)		(0.3	)
Benefits paid		(2.3	)		(2.2	)

End of year	$	101.7		$	97.5


	2007			2006
Plan assets at fair value
Beginning of year	$	—		$	—
Employer contributions		2.3			2.2
Benefits paid		(2.3	)		(2.2	)
End of year	$	—		$	—

Funded status (unfunded)	$	(101.7	)	$	(97.5	)


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As of December 31, 2007 and 2006, the amounts recognized in the consolidated balance sheets were as follows (in millions):


	2007		2006
Accrued benefit liability-current	$	4.7	$	3.9
Accrued benefit liability-long term		97.0		93.6

Total liability recognized	$	101.7	$	97.5

AMOUNTS NOT YET REFLECTED IN NET PERIODIC BENEFIT COST AND INCLUDED IN AOCI:


	2007		2006
Prior service cost	$	1.0	$	0.7
Net loss		22.2		29.1

Amount recognized in AOCI (pretax)	$	23.2	$	29.8

The estimated amortization of prior service cost (credit) and net loss from AOCI in 2008 is $(0.4) million and $0.9 million, respectively.

The Company uses a December 31 measurement date to assess obligations associated with the subsidy of retiree medical costs. Net periodic benefit cost for the postretirement medical plans included the following components for 2007, 2006 and 2005 (in millions):


	2007			2006		2005
Service cost	$	4.6		$	4.3	$	3.4
Interest cost		6.3			4.9		4.1
Expected return on assets		—			—		—
Amortization of prior service cost		(0.3	)		4.4		(0.6	)
Recognized actuarial loss		2.4			1.9		1.6

Net periodic benefit cost	$	13.0		$	15.5	$	8.5

As this is a non-funded plan, the Company expects to contribute approximately $4.7 million to the postretirement medical benefits plan in 2008, which is equal to the expected benefit payments.

Future benefits expected to be paid over the next ten years under the postretirement medical benefits plan as of December 31, 2007 are as follows (in millions):


2008	$	4.7
2009		5.3
2010		6.0
2011		6.7
2012		7.0
2013 - 2017		42.6

Total payments	$	72.3

A 1% higher or lower trend rate in health care costs has the following effect on the Company’s postretirement medical plans during 2007, 2006 and 2005 (in millions):


	2007			2006			2005
Change in service and interest cost
1% higher trend rate	$	1.6		$	1.4		$	1.2
1% lower trend rate		(1.4	)		(1.2	)		(1.0	)
Change in year-end postretirement benefit obligation
1% higher trend rate	$	12.2		$	12.3		$	11.4
1% lower trend rate		(10.6	)		(10.6	)		(9.7	)

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 $26.4 million, $24.4 million, and $22.9 million in 2007, 2006, and 2005, respectively.

In 2006, the Company established a noncontributory, unfunded defined-contribution plan for certain elected officers of the Company who were ineligible for the nonqualified defined-benefit pension plan. Amounts recorded as liabilities under the plan are not material to the consolidated balance sheet at December 31, 2007.

Employee Incentive-Pay Plans

Alaska and Horizon have four separate plans that pay employees based on certain financial and operational metrics. The aggregate expense


84

under these plans in 2007, 2006 and 2005 was $20.8 million, $36.8 million, $20.0 million, respectively. The plans are summarized below:

•

The Profit Sharing Plan is based on Air Group profitability. Alaska’s pilots, ramp service and clerical, office and passenger service employees, and certain Horizon employees participate in this plan.

•

The Variable Pay Plans pay Alaska’s mechanics and Alaska’s flight attendants a percentage of their earnings as certain pretax margin levels are achieved.

•

Performance-Based Pay is a program that rewards non-union employees and Alaska dispatchers, represented by TWU, based on four separate metrics related to: (1) Air Group profitability, (2) safety, (3) achievement of unit-cost goals, and (4) employee engagement.

•

The Operational Performance Rewards Program entitles all Air Group employees to quarterly payouts of up to $300 per person if certain operational and customer service objectives are met.

NOTE 9. EARNINGS (LOSS) PER SHARE (EPS)

SFAS No. 128, Earnings Per Share, requires that companies use income from continuing operations before extraordinary items and the cumulative effect of an accounting change as the “control number” in determining whether potential common shares are dilutive or antidilutive. As the Company reported income before the accounting change in 2005, the potential common shares from the Company’s common stock options and senior convertible notes are included in the calculation for diluted earnings (loss) per share (EPS). Diluted EPS is calculated by dividing net income (loss) by the average common shares outstanding plus additional common shares that would have been outstanding assuming the conversion of contingently convertible securities as of the beginning of the year and the exercise of in-the-money stock options, using the treasury-stock method. For the years in which the convertible securities are dilutive, the associated interest expense, net of tax, must be added back to the net income or loss. For the year ended December 31, 2005, the dilutive impact of common stock options and 5.8 million common shares that would have been outstanding upon conversion of the senior convertible notes were included in the calculations. In 2007, 2006, and 2005, 1.7 million, 2.5 million and 3.4 million stock options, respectively, were excluded from the calculation of diluted EPS because they were antidilutive.


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EPS calculations were as follows (in millions except per-share amounts):


	2007		2006			2005
Basic Earnings (Loss) Per Share
Income (loss) before accounting change	$	125.0	$	(52.6	)	$	84.5
Weighted-average shares outstanding		40.125		37.939			27.609

EPS before accounting change	$	3.12	$	(1.39	)	$	3.06

Cumulative effect of accounting change, net of tax	$	—	$	—		$	(90.4	)
Weighted-average shares outstanding		40.125		37.939			27.609

Per share cumulative effect of accounting change	$	—	$	—		$	(3.27	)

Net income (loss)	$	125.0	$	(52.6	)	$	(5.9	)
Weighted-average shares outstanding		40.125		37.939			27.609

EPS	$	3.12	$	(1.39	)	$	(0.21	)

Diluted Earnings (Loss) Per Share
Income (loss) before accounting change	$	125.0	$	(52.6	)	$	84.5
Interest on convertible notes, net of tax		NA		NA			5.5

Diluted income (loss) before accounting change	$	125.0	$	(52.6	)	$	90.0
Weighted-average shares outstanding		40.424		37.939			33.917

Diluted EPS before accounting change	$	3.09	$	(1.39	)	$	2.65

Cumulative effect of accounting change, net of tax	$	—	$	—		$	(90.4	)
Weighted-average shares outstanding		40.424		37.939			33.917

Per share cumulative effect of accounting change	$	—	$	—		$	(2.66	)

Net income (loss)	$	125.0	$	(52.6	)	$	(5.9	)
Interest on convertible notes, net of tax		NA		NA			5.5

Diluted income (loss)	$	125.0	$	(52.6	)	$	(0.4	)
Weighted average shares outstanding		40.424		37.939			33.917

Diluted EPS	$	3.09	$	(1.39	)	$	(0.01	)


86

NOTE 10. RESTRUCTURING CHARGES

In July 2006, Alaska reached new four-year agreements with approximately 3,700 clerical, office and passenger service employees and the ramp service and stores agents, all represented by the International Association of Machinists. These agreements included a signing bonus, in aggregate, of $1.9 million paid in July 2006, which is included in wages and benefits in the consolidated statement of operations, and an immediate 2% wage increase. Additionally, the agreements included a severance package offered to employees in the top four wage-scale steps that included cash payments based on years of service, one year of medical coverage after the severance date, and continued travel privileges for a period of time. The resulting charge was $21.0 million in 2006.

A new four-year contract with the Association of Flight Attendants for Alaska’s approximately 2,500 flight attendants was ratified on April 26, 2006. Under this agreement, the Company paid a signing bonus, in aggregate, of $2.7 million in May 2006, which is included in wages and benefits in the consolidated statement of operations. The new agreement also included an immediate 3% pay increase. Additionally, Alaska offered a voluntary severance package to a number of flight attendants that included, among other things, a lump-sum payment of $2,000 per year of service up to a maximum of 25 years and continuing travel privileges. As a result, the Company recorded a restructuring charge of $3.8 million related to the severance amounts.

During the second quarter of 2005, Alaska contracted out ramp services at the Seattle-Tacoma International Airport. This event resulted in a reduction of approximately 475 employees in Seattle. Severance and related costs associated with this restructuring were originally estimated at $16.1 million, which was recorded in the second quarter of 2005.

The following table displays the activity and balance of the severance and related cost components of the Company’s restructuring accrual as of and for the years ended December 31, 2007, 2006 and 2005 (in millions):


Accrual for Severance and Related Costs	2007			2006			2005
Balance at beginning of year	$	19.9		$	3.1		$	38.7
Restructuring charges		—			32.4			16.1
Restructuring charge adjustments		—			(7.6	)		(3.7	)
Cash payments		(19.2	)		(8.0	)		(48.0	)

Balance at end of year	$	0.7		$	19.9		$	3.1

The Company will make the majority of the remaining cash payments in the first quarter of 2008. The accrual for severance and related costs is included in accrued wages, vacation and payroll taxes in the consolidated balance sheets.

During March 2005, the Company notified the Port of Oakland of its decision to terminate the lease for the Oakland hangar as part of its ongoing restructuring efforts. Accordingly, the Company recorded an impairment charge of $7.7 million in the first quarter of 2005 for the leasehold improvements that were abandoned as a result of the lease termination. Additionally, the Company recorded a charge of $0.3 million for certain costs associated with the lease termination, which have been paid.


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NOTE 11. DETAIL OF OTHER FINANCIAL STATEMENT CAPTIONS

Receivables

Receivables consisted of the following at December 31 (in millions):


	2007			2006
Airline traffic receivables	$	59.4		$	59.5
Mileage Plan receivables		39.0			31.4
Receivables from fuel-hedging counterparties		12.3			4.8
Other receivables		28.9			41.4
Allowance for doubtful accounts		(1.6	)		(2.9	)

	$	138.0		$	134.2

Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consisted of the following at December 31 (in millions):


	2007		2006
Prepaid aircraft rent	$	51.1	$	51.2
Prepaid fuel		13.6		14.2
Other		20.7		22.7

	$	85.4	$	88.1

Other Assets

Other assets consisted of the following at December 31 (in millions):


	2007		2006
Restricted deposits (primarily restricted investments)	$	90.4	$	91.2
Deferred costs and other*		36.1		31.9

	$	126.5	$	123.1

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

At December 31, 2007, 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 market.

Other Accrued Liabilities (current)

Other accrued liabilities consisted of the following at December 31 (in millions):


	2007		2006
Mileage Plan current liabilities	$	239.7	$	196.6
Pension liability (nonqualified plans)		2.0		2.0
Postretirement medical benefits liability		4.7		3.9
Other*		202.1		201.8

	$	448.5	$	404.3

*	Other consists of property and transportation taxes and accruals related to ground operations, facilities rent, maintenance, and fuel, among other items.

Other Liabilities (noncurrent)

Other liabilities consisted of the following at December 31 (in millions):


	2007		2006
Pension liability (qualified plans)	$	146.3	$	215.4
Pension liability (nonqualified plans)		32.9		32.6
Postretirement medical benefits liability		97.0		93.6
Mileage Plan liability		21.0		20.7
FIN 48 tax liability (see Note 13)		27.9		—
Other*		83.0		113.3

	$	408.1	$	475.6

*	Other consists of accrued aircraft rent, workers’ compensation, and deferred credits on aircraft purchases, among other items.

Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss consisted of the following at December 31 (in millions, net of tax):


	2007			2006
Unrealized loss (gain) on marketable securities considered available-for-sale		(3.1	)		0.2
Related to pension plans		121.8			172.5
Related to postretirement medical benefits		14.6			18.7

	$	133.3		$	191.4


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NOTE 12. STOCK-BASED COMPENSATION PLANS

As noted in Note 1, the Company adopted SFAS 123R, effective for all stock options granted beginning January 1, 2006. For stock options granted prior to January 1, 2006, for which the vesting period is not complete, the “modified prospective method” for transition permitted by SFAS 123R was used. Under this method, the Company accounts for the unvested portion of these awards on a prospective basis, with expense recognized in the consolidated statements of operations beginning January 1, 2006 using the grant-date fair values previously calculated for pro-forma disclosures.

Stock Options

The Company has stock option awards outstanding under a number of long-term incentive equity plans, only one of which (the 2004 Long-Term Incentive Equity Plan) continues to provide for the granting of options to purchase the Company’s common stock at market prices on the date of grant to directors, officers and employees of the Company and its subsidiaries. Under the various plans, options for 7,513,563 shares have been granted and, at December 31, 2007, 632,411 shares were available for future grant of either options or stock awards. Under all plans, the stock options granted have terms of up to ten years. For all plans except the 1997 Long-term Incentive Equity Plan (1997 Plan), when options are exercised, new common shares are issued. When options granted under the 1997 Plan are exercised, shares are issued from the Company’s treasury shares. The total number of outstanding options from the 1997 Plan as of December 31, 2007 is 448,995. Substantially all grantees are 25% vested after one year, 50% after two years, 75% after three years, and 100% after four years. Compensation cost is amortized over the service period using the straight-line method.

The tables below summarize stock option activity for the year ended December 31, 2007:


	Shares		Weighted- Average Exercise Price Per Share		Weighted- Average Contractual Life (Years)	Aggregate Intrinsic Value (in millions)
Outstanding, December 31, 2006...	2,539,268		$	32.08
Granted	191,513			39.74
Exercised	(110,655	)		28.24
Forfeited or expired	(132,265	)		35.32

Outstanding, December 31, 2007..	2,487,861		$	32.67	4.5	$	1.3

Exercisable at December 31, 2007	1,914,486		$	31.72	3.5	$	1.3

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2007, 2006, and 2005:


	2007			2006			2005
Expected volatility		43	%		44	%		43	%
Expected term		6 years			5.7 years			5 years
Risk-free interest rate		4.79	%		4.70	%		4.39	%
Expected dividend yield		—			—			—
Weighted-average fair value of options granted	$	19.51		$	18.32		$	14.38

The expected market price volatility of the common stock is based on the historical volatility over a time period commensurate with the expected term of the awards. The risk-free interest rate is based on the U.S. Treasury yield curve in effect for the term nearest the expected term of the option at the time of grant. The dividend yield is zero as the Company does not pay dividends and has no plans to do so in the immediate future. The expected term of the options and the expected forfeiture rates are based on historical experience for various homogenous employee groups. Prior to the


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adoption of SFAS 123R, the expected term was based on an average historical term of all options and there was no estimate of forfeiture rate as forfeitures were accounted for when they occurred.

The Company recorded stock-based compensation expense related to stock options of $3.9 million ($2.6 million, net of tax) and $3.4 million ($2.5 million, net of tax) in 2007 and 2006, respectively. The total intrinsic value of options exercised during 2007 was $1.5 million. Cash received from option exercises during 2007 totaled $3.2 million. A total of 312,156 options vested during 2007 with an aggregate fair value of $3.9 million. As of December 31, 2007, $7.4 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 2.6 years.

The following table summarizes stock options outstanding and exercisable at December 31, 2007 with their weighted-average exercise prices and remaining contractual lives:


Range of Exercise prices	Remaining Life (years)	Shares	Price Per Share
Outstanding:
$10 to $20	4.8	192,255	$	18.68
$21 to $28	5.0	589,308		26.21
$29 to $34	4.3	850,483		31.64
$35 to $45	5.3	695,615		39.78
$46 to $58	0.3	160,200		47.79

Options outstanding	4.5	2,487,861	$	32.67


Range of Exercise prices	Shares	Price Per Share
Exercisable:
$10 to $20	192,255	$	18.68
$21 to $28	489,927		26.17
$29 to $34	699,476		31.42
$35 to $45	372,628		39.38
$46 to $58	160,200		47.79

Options exercisable	1,914,486	$	31.72

Restricted Stock Awards

The Company grants restricted stock units (RSUs) under the 2004 Long-term Incentive Equity Plan. As of December 31, 2007, 534,201 total RSUs have been granted under this plan. The RSUs are non-voting and are not eligible for dividends. The fair value of the RSU awards is based on the closing price of the Company’s common stock on the date of grant. Compensation cost for RSUs is recognized over three years from the date of grant as the awards “cliff vest” after three years. The Company recorded stock-based compensation expense related to RSUs of $5.3 million ($3.3 million after tax) and $3.8 million ($2.4 million after tax) in 2007 and 2006, respectively. These amounts are included in wages and benefits in the consolidated statements of operations.

The following table summarizes information about outstanding RSUs:


	Number of Units		Weighted- Average Grant Date Fair Value
Non-vested at December 31, 2006	449,250		$	32.89
Granted	69,726			40.42
Vested	(118,410	)		28.41
Forfeited	(7,840	)		33.04

Non-vested at December 31, 2007	392,726		$	35.57

As of December 31, 2007, $5.9 million of compensation cost associated with unvested restricted stock awards attributable to future service had not yet been recognized. This amount will be recognized as expense over a weighted-average period of 1.6 years.

Performance Stock Awards

During the first quarter of 2007, the Company awarded Performance Share Unit awards (PSUs) to certain executives. PSUs are similar to RSUs, but vesting is based on a performance condition tied to the Company achieving a specified pretax margin over a three-year period. The PSU plan allows a portion of the PSUs to vest even if the


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specified pretax margin falls below the target, and additional shares to be granted if the margin target is exceeded, subject to a maximum. The Company intends to regularly review its assumptions about meeting the performance goal and expected vesting, and to adjust the related compensation expense accordingly. The Company recorded compensation expense related to PSUs of $0.4 million for the year ended December 31, 2007.

Employee Stock Purchase Plan

The Company sponsors an ESPP, which is intended to qualify under Section 423 of the Internal Revenue Code. Under the terms of the ESPP, employees can purchase Company common stock at 85% of the closing market price on the first day of the offering period or the quarterly purchase date, whichever is lower. Because of these attributes, the ESPP is considered compensatory under SFAS 123R and as such, compensation cost is recognized. Compensation cost for the Company’s ESPP was $1.6 million and $1.0 million in 2007 and 2006, respectively. The grant date fair value is calculated using the Black-Scholes model in the same manner as the Company’s option awards for 85% of the share award plus the intrinsic value of the 15% discount. Proceeds received from the issuance of shares are credited to stockholders’ equity in the period in which the shares are issued. In 2007 and 2006, 126,584 shares and 93,342 shares, respectively, were purchased by Company employees under the ESPP, resulting in cash proceeds of $3.0 million and $2.4 million, respectively.

Summary of Stock-Based Compensation

The table below summarizes the components of total stock-based compensation for the years ended December 31, 2007 and 2006:


(in millions)	2007		2006
Stock options	$	3.9	$	3.4
Restricted stock units		5.3		3.8
Performance share units		0.4		—
Employee stock purchase plan		1.6		1.0

Total stock-based compensation	$	11.2	$	8.2

NOTE 13. INCOME TAXES

In July 2006, the FASB issued FASB Interpretation No 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48). The purpose of FIN 48 is to clarify certain aspects of the recognition and measurement related to accounting for income tax uncertainties. Under FIN 48, the impact of an uncertain income tax position must be recognized at the largest amount that is more likely than not of being sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained.

The Company was subject to the provisions of FIN 48 as of January 1, 2007. Upon adoption, no cumulative effect of accounting change was necessary or recorded in the consolidated financial statements. The total amount of unrecognized tax benefits as of the date of adoption was $26.2 million. This number includes a $24.5 million increase in the tax liability and a corresponding increase in deferred tax assets for unrecognized tax benefits as a result of the implementation of FIN 48 and $1.7 million of tax benefits that, if recognized, would impact the effective tax rate.

Changes in the FIN 48 liability for unrecognized tax benefits during 2007 are as follows (in millions):


Upon transition to FIN 48 at January 1, 2007	$	26.2
Gross increases—tax positions in prior period		—
Gross decreases—tax positions in prior period		(11.5	)
Gross increases—current-period tax positions		13.2
Settlements		—
Lapse of statute of limitations		—

Balance at December 31, 2007	$	27.9

At December 31, 2007, the total amount of unrecognized tax benefits of $27.9 million includes $26.2 million recorded as a liability and


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a corresponding increase in deferred tax assets and $1.0 million of tax benefits that, if recognized, would impact the effective tax rate.

Accrued interest on tax positions is recorded as a component of interest expense. Total accrued interest on tax positions included in the FIN 48 liability was zero at January 1, 2007 and $0.7 million at December 31, 2007. No penalties were accrued at January 1, 2007 or at December 31, 2007.

The periods subject to examination for the Company’s federal income tax returns are the 2003 through 2006 tax years; however, the 2003 tax return is subject to examination only to the extent of the net operating loss carryforwards from 2003 that were utilized in 2005. The periods subject to examination for the Company’s major state income tax returns other than California are also the years 2003 through 2006. In California, the income tax years 2002 through 2006 remain open to examination.

The Company does not believe that it is reasonably possible that the total unrecognized tax benefit would significantly increase or decrease in the next 12 months. The FIN 48 liability for the Company’s unrecognized tax benefit is classified in other liabilities (noncurrent) in the consolidated balance sheets. The Company anticipates that total unrecognized tax benefits will not materially decrease due to the expiration of the statute of limitations for tax years prior to December 31, 2007.

During the first quarter of 2007, the Company received a favorable decision in a matter with the State of California. As a result of the decision, the Company reduced its FIN 48 liability by $0.7 million, recorded a previously unrecognized tax benefit of $1.0 million, and accrued interest income of $1.5 million. The refund was received in August 2007.

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):


	2007			2006
Excess of tax over book depreciation	$	431.7		$	466.0
Fuel hedge contracts		30.9			10.9
Other—net		6.7			7.7

Gross deferred tax liabilities		469.3			484.6

Mileage Plan		(242.1	)		(204.0	)
Alternative minimum tax		(1.3	)		(9.6	)
Leased aircraft return provision		(2.7	)		(3.5	)
Inventory obsolescence		(19.2	)		(16.6	)
Deferred revenue		(22.1	)		(23.6	)
Asset impairment		—			(89.6	)
Employee benefits		(128.6	)		(149.5	)
Loss carryforwards*		(1.2	)		(1.8	)
Other—net		(4.4	)		(6.0	)

Gross deferred tax assets		(421.6	)		(504.2	)

Net deferred tax (assets) liabilities	$	47.7		$	(19.6	)

Current deferred tax asset	$	(84.9	)	$	(134.2	)
Noncurrent deferred tax liability		132.6			114.6

Net deferred tax (asset) liability	$	47.7		$	(19.6	)

*	State loss carryforwards of $32.6 million ($1.2 million tax effected) expire beginning in 2008 and ending in 2026.

The Company has concluded that it is more likely than not that its deferred tax assets will be realizable and thus no valuation allowance has been recorded as of December 31, 2007. This conclusion is based on the expected future reversals of existing taxable temporary differences and does not rely on future taxable income. The Company will continue to reassess the need for a valuation allowance during each future reporting period.

The components of income tax expense (benefit) were as follows (in millions):


	2007		2006			2005
Current tax expense (benefit):
Federal	$	12.8	$	0.6		$	2.1
State		4.8		2.4			0.8

Total current		17.6		3.0			2.9

Deferred tax expense (benefit):
Federal		55.5		(31.6	)		45.2
State		3.5		(6.6	)		4.6

Total deferred		59.0		(38.2	)		49.8

Total tax expense (benefit) related to income (loss) before accounting change	$	76.6	$	(35.2	)	$	52.7


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In 2005, the deferred tax benefit related to the cumulative effect of the accounting change for federal and state income taxes was $48.9 million and $5.4 million, respectively.

Income tax expense (benefit) reconciles to the amount computed by applying the U.S. federal rate of 35% to income (loss) before income tax and accounting change as follows (in millions):


	2007			2006			2005
Income (loss) before income tax and accounting change	$	201.6		$	(87.8	)	$	137.2
Expected tax expense (benefit)		70.6			(30.7	)		48.0
Nondeductible expenses		3.4			3.0			2.4
State income taxes		4.9			(1.7	)		3.5
Other—net*		(2.3	)		(5.8	)		(1.2	)

Actual tax expense (benefit)	$	76.6		$	(35.2	)	$	52.7

Effective tax rate		38.0	%		40.1	%		38.4	%

In 2007, other-net includes $1.0 million of tax benefits due to a favorable decision in a matter with the State of California and $1.0 million of tax benefits related to the recognition of California income tax credit carryforwards. Other-net in 2006 includes $5.5 million of tax benefits associated with the reduction of certain tax contingency accruals for periods for which the statute of limitations expired in 2006.

NOTE 14. FINANCIAL INSTRUMENTS

The majority of the Company’s financial instruments are carried at fair value. Those include cash and cash equivalents, marketable securities (Note 4), securities lending collateral, restricted deposits (Note 11), and fuel hedge contracts (Note 3). 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 December 31, 2007	$	1,300.5	$	1,321.2
Long-term debt at December 31, 2006		1,150.8		1,162.5

The fair value of cash equivalents and securities lending collateral approximates carrying values 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.

Concentrations of Credit

The Company continually monitors its positions with, and the credit quality of, the financial institutions that are counterparties to its fuel-hedging contracts and does not anticipate nonperformance by the counterparties.

The Company could realize a material loss in the event of nonperformance by any single counterparty to its fuel hedge positions. However, the Company enters into transactions only with large, well-known financial institution counterparties that have strong credit ratings. In addition, the Company limits the amount of investment credit exposure with any one institution.

The Company’s trade receivables do not represent a significant concentration of credit risk at December 31, 2007 due to the frequency that settlement takes place and the dispersion across many industry and government segments.


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NOTE 15. OPERATING SEGMENT INFORMATION

SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, as amended (SFAS 131), requires that a public company report annual and interim financial and descriptive information about its reportable operating segments. Operating segments, as defined, are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and in assessing performance. The Company has two primary operating and reporting segments, consisting of Alaska and Horizon. These segments are more fully described in Note 1 under Nature of Operations.

Financial information for Alaska and Horizon follows (in millions):


	2007			2006			2005
Operating revenues:
Alaska—mainline(1)	$	2,788.5		$	2,676.1		$	2,399.2
Alaska—purchased capacity(1)		281.4			16.4			16.9

Total Alaska	$	3,069.9		$	2,692.5		$	2,416.1
Horizon		718.4			644.0			556.4
Other(2)		1.1			1.1			1.1
Elimination of inter-company revenues		(283.4	)		(3.2	)		1.7

Consolidated		3,506.0			3,334.4			2,975.3

Depreciation and amortization expense:
Alaska(3)		142.3			137.8			125.4
Horizon		33.9			18.5			16.8
Other(2)		1.2			1.2			1.2

Consolidated		177.4			157.5			143.4

Interest income:
Alaska(3)		64.8			56.3			32.5
Horizon		4.5			3.7			1.6
Other(2)		—			—			0.2
Elimination of inter-company accounts		(15.4	)		(5.7	)		(3.4	)

Consolidated		53.9			54.3			30.9

Interest expense:
Alaska(3)		86.2			73.3			51.2
Horizon		16.6			7.4			5.5
Other(2)		0.6			3.0			9.7
Elimination of inter-company accounts		(15.4	)		(5.7	)		(3.4	)

Consolidated		88.0			78.0			63.0

Income (loss) before income tax and accounting change:
Alaska—mainline		237.4			(94.3	)		122.3
Alaska—purchased capacity		(21.4	)		2.1			1.9

Total Alaska		216.0			(92.2	)		124.2
Horizon		(10.6	)		11.7			26.4
Other(2)		(3.8	)		(7.3	)		(13.4	)

Consolidated		201.6			(87.8	)		137.2


94


	2007			2006			2005
Capital expenditures(4):
Alaska(3)		606.5			565.5		373.8
Horizon		227.9			116.6		43.1

Consolidated		834.4			682.1		416.9

Total assets at end of period:
Alaska(3)		4,221.1			3,712.0
Horizon		629.0			409.0
Other(2)		1,130.3			916.8
Elimination of inter-company accounts		(1,489.5	)		(960.7	)

Consolidated	$	4,490.9		$	4,077.1

(1)	Alaska mainline revenue represents revenue from passengers aboard Alaska jets, freight and mail revenue, and all other revenue. Purchased capacity revenue represents that revenue earned by Alaska on capacity provided by Horizon and a small third party under a capacity purchase arrangement.

(2)	Includes the parent company, Alaska Air Group, Inc., including its investments in Alaska and Horizon, which are eliminated in consolidation.

(3)	There are no interest or depreciation expenses associated with purchased capacity flying at Alaska, nor are there any associated assets or capital expenditures.

(4)	Capital expenditures include aircraft deposits, net of deposits returned.

NOTE 16. IMPACT OF STAFF ACCOUNTING BULLETIN NO. 108 (SAB 108)

In September 2006, the SEC issued SAB 108. SAB 108 expresses SEC staff views regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether those misstatements are material to the Company’s financial statements. SAB 108 was effective for fiscal years ending after November 15, 2006. The transition provisions of the bulletin permit the Company to adjust beginning retained earnings for the cumulative effect of immaterial errors relating to prior years. The Company adopted SAB 108 in the fourth quarter of 2006, with an effective date of January 1, 2006. In accordance with the bulletin, the Company adjusted beginning retained earnings for 2006 in the accompanying consolidated financial statements for the items described below. Management of the Company considers these adjustments to be immaterial to prior periods.

Depreciation of Leasehold Improvements

The Company historically has depreciated substantially all leasehold improvements over the shorter of the lease term or their estimated economic useful life. However, leasehold improvements at airports were generally depreciated over their estimated useful lives. The Company followed the practice of depreciating leasehold improvements over the longer period due to the expectation that the underlying lease would be renewed for at least the period over which the leasehold improvements were being depreciated. In February 2005, the Office of the Chief Accountant of the Securities and Exchange Commission (“SEC”) issued interpretive guidance clarifying its position that leasehold improvements in an operating lease should be depreciated by the lessee over the shorter of their economic lives or the remaining lease term, as defined in SFAS 13. Our airport lease agreements do not generally carry a renewal right in them, which is a key consideration for SFAS 13 “lease term” definitions.

The difference between the depreciation expense recorded and the depreciation expense that would have been recorded had the Company depreciated those leasehold improvements using the shorter life of the lease term was not material to the consolidated statements of operations in any individual year, nor was the accumulated difference deemed material to the


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Company’s consolidated balance sheets. However, the accumulated difference would have been material to the consolidated statements of operations. As such, in order to correct the accumulated depreciation of leasehold improvements to depreciate them over the shorter of their economic lives or the remaining lease term, the Company adjusted its beginning retained earnings for 2006.

Horizon Fleet Subsidy

In connection with the purchase of certain aircraft, the manufacturer paid Horizon a “market subsidy” payment as an inducement to purchase larger aircraft. This market subsidy was paid quarterly for seven years for Q200 aircraft and eight years for Q400 aircraft following delivery of the aircraft.

Previously, the fleet subsidy credit was recognized as the cash was received, i.e. over the payment period. However, upon further review, management determined that the correct method of accounting would have been to recognize the credit ratably over the full lease term of the aircraft, generally 15 to 17 years, rather than at the time of the cash payments.

The difference between the Company’s historical accounting practice and the current practice for income statement recognition was not material to the consolidated statements of operations in any individual year, nor was the deferred credit that should have been recorded deemed material to the Company’s consolidated balance sheets. However, the accumulated difference would have been material to the consolidated statements of operations. As such, in order to correct the amount of deferred credit recognized, the Company adjusted its beginning retained earnings for 2006.

Impact of Adjustments

The impact of each of the items noted above, net of tax, on 2006 beginning balances are presented below (in millions):


	Cumulative Effect as of January 1, 2006
Accumulated depreciation	$	10.3		$	—		$	10.3
Other liabilities		—			19.4			19.4
Deferred income taxes		(4.3	)		(6.8	)		(11.1	)
Retained earnings		(6.0	)		(12.6	)		(18.6	)

Total	$	—		$	—		$	—

NOTE 17. CHANGE IN ACCOUNTING PRINCIPLE

Effective January 1, 2005, the Company changed its method of accounting for major airframe and engine overhauls from the capitalize and amortize method to the direct expense method. Under the former method, these costs were capitalized and amortized to maintenance expense over the shorter of the life of the overhaul or the remaining lease term. Under the direct expense method, overhaul costs are expensed as incurred. The Company believes that the direct expense method is preferable because it eliminates the judgment and estimation needed to determine overhaul versus repair allocations in maintenance activities. Additionally, the Company’s approved maintenance program for the majority of its airframes now focuses more on shorter, but more frequent, maintenance visits. Management also believes that the direct expense method is the predominant method used in the airline industry. Accordingly, effective January 1, 2005, the Company wrote off the net book value of its previously capitalized airframe and engine overhauls for all aircraft resulting in a charge of $144.7 million pretax ($90.4 million after tax). The Company does not believe disclosing the effect of adopting the direct expense method on net income for 2005 provides meaningful information because of changes in the Company’s maintenance program, including the execution of a “power-by-the-hour” engine maintenance agreement with a third party in late 2004.


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NOTE 18. CONTINGENCIES

Grievance with International Association of Machinists

In June 2005, the International Association of Machinists (IAM) filed a grievance under its Collective Bargaining Agreement (CBA) with Alaska alleging that Alaska violated the CBA by, among other things, subcontracting the ramp service operation in Seattle. The dispute was referred to an arbitrator and hearings on the grievance commenced in January 2007, with a final hearing date in August. It is likely that a decision from the arbitrator will not be issued until early to mid-2008.

Other items

The Company is a party to routine litigation matters incidental to its business and with respect to which no material liability is expected.


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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None

ITEM 9A. CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

As of December 31, 2007, 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 current and periodic reports filed with or submitted to 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 accumulated and communicated to our management, including our certifying officers, on a timely basis. Our certifying officers concluded, based on their evaluation, that disclosure controls and procedures were effective as of December 31, 2007.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

During 2007, Alaska and Horizon converted to an integrated Human Resources, Benefits and Payroll system. Prior to the conversion, the companies operated on separate systems. There were no changes to the Company’s internal control over financial reporting, including the changes described above, identified in management’s evaluation during the year ended December 31, 2007, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Framework). Based on our evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2007.

We intend to regularly review and evaluate the design and effectiveness of our disclosure controls and procedures and internal control 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 control over financial reporting are effective, future events affecting our business may cause us to modify our controls and procedures.

The Company’s independent registered public accounting firm has issued an attestation report regarding its assessment of the Company’s internal control over financial reporting as of December 31, 2007, which report appears on page 99.


98

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders

Alaska Air Group, Inc.:

We have audited Alaska Air Group, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Alaska Air Group, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting (Item 9A). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Alaska Air Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Alaska Air Group, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2007, and our report dated February 19, 2008, expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

Seattle, Washington

February 19, 2008


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ITEM 9B. OTHER INFORMATION

None


100

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

See “Executive Officers of the Registrant” under Item 1, “Our Business,” in Part I of this Form 10-K for information on the executive officers of Air Group and its subsidiaries. Except as provided herein, the remainder of the information required by this item is incorporated herein by reference from the definitive Proxy Statement for Air Group’s 2008 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 2007 (hereinafter referred to as our “2008 Proxy Statement”).

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is incorporated herein by reference from our 2008 Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT, AND RELATED STOCKHOLDER MATTERS

The information required by this item is incorporated herein by reference from our 2008 Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this item is incorporated herein by reference from our 2008 Proxy Statement.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item is incorporated herein by reference from our 2008 Proxy Statement.


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PART IV

ITEM 15. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES

The following documents are filed as part of this report:

1.	Financial Statement Schedules: Financial Statement Schedule II, Valuation and Qualifying Accounts, for the years ended December 31, 2007, 2006 and 2005 on page 107.

2.	Exhibits: See Exhibit Index on page 104.


102

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 AIR GROUP, INC.

By:	/s/ WILLIAM S. AYER	Date: February 20, 2008
	William 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 February 20, 2008 on behalf of the registrant and in the capacities indicated.


/s/ WILLIAM S. AYER William S. Ayer		Chairman, President, Chief Executive Officer and Director (Principal Executive Officer)

/s/ BRADLEY D. TILDEN Bradley D. Tilden		Executive Vice President/Finance and Planning and Chief Financial Officer (Principal Financial Officer)

/s/ BRANDON S. PEDERSEN Brandon S. Pedersen		Vice President/Finance and Controller (Principal Accounting Officer)

/s/ PATRICIA M. BEDIENT Patricia M. Bedient		Director

/s/ PHYLLIS J. CAMPBELL Phyllis J. Campbell		Director

/s/ MARK R. HAMILTON Mark R. Hamilton		Director

/s/ JESSIE J. KNIGHT, JR. Jessie J. Knight, Jr.		Director

/s/ R. MARC LANGLAND R. Marc Langland		Director

/s/ DENNIS F. MADSEN Dennis F. Madsen		Director

/s/ BYRON I. MALLOTT Byron I. Mallott		Director

/s/ J. KENNETH THOMPSON J. Kenneth Thompson		Director

/s/ RICHARD A. WIEN Richard A. Wien		Director


		103

EXHIBIT INDEX

Certain of the following exhibits have heretofore been filed with the Securities and Exchange Commission and are incorporated by reference from the documents described in parentheses. Certain others are filed herewith. The exhibits are numbered in accordance with Item 601 of Regulation S-K.


3.1		Amended and Restated Certificate of Incorporation of Registrant (Filed as Exhibit 3(i) to Registrants Quarterly Report on Form 10-Q for the period ended June 30, 2006, filed on August 8, 2006 and incorporated herein by reference.)

3.2		Bylaws of Registrant, as amended December 14, 2007 (Filed as Exhibit 3(ii) to Registrant’s Current Report on Form 8-K, filed on December 20, 2007 and incorporated herein by reference.)

10.1#		Credit Agreement, dated March 25, 2005, among Alaska Airlines, Inc., as borrower, Bank of America, N.A. as administrative agent, Citicorp USA, Inc. as syndication agent, U.S. Bank National Association as documentation agent, and other lenders (Filed as Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-Q for the period ended March 31, 2005, filed on May 6, 2005 and incorporated herein by reference.)

10.1.1†		First Amendment to March 25, 2005 Credit Agreement, dated September 29, 2005

10.1.2#		Second Amendment to March 25, 2005 Credit Agreement, dated April 25, 2007 (Filed as Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-Q for the period ended March 31, 2007, filed on May 8, 2007 and incorporated herein by reference.)

10.1.3		Third Amendment to March 25, 2005 Credit Agreement, dated July 30, 2007 (Filed as Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-Q for the period ended September 30, 2007, filed on November 7, 2007 and incorporated herein by reference.)

10.2#		Credit Agreement, dated October 19, 2005, among Alaska Airlines, Inc., as borrower, HSH Nordbank AG New York Branch, as security agent, and other loan participants (Filed as Exhibit 10.2 to Registrant’s Quarterly Report on Form 10-Q for the period ended September 30, 2005, filed on November 9, 2005 and incorporated herein by reference.)

10.2.1†#		First Amendment to October 19, 2005 Credit Agreement, dated March 27, 2007

10.2.2†#		Second Amendment to October 19, 2005 Credit Agreement, dated November 26, 2007

10.3#		Aircraft General Terms Agreement, dated June 15, 2005, between the Boeing Company and Alaska Airlines, Inc. (Filed as Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-Q for the period ended June 30, 2005, filed on August 5, 2005 and incorporated herein by reference.)

10.4#		Purchase Agreement No. 2497, dated June 15, 2005, between the Boeing Company and Alaska Airlines, Inc. (Filed as Exhibit 10.2 to Registrant’s Quarterly Report on Form 10-Q for the period ended June 30, 2005, filed on August 5, 2005 and incorporated herein by reference.)

10.5#		Supplement to Master Purchase Agreement, dated October 18, 2005, between Horizon Air Industries, Inc. and Bombardier Inc. (Filed as Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-Q for the period ended September 30, 2005, filed on November 9, 2005 and incorporated herein by reference.)

10.6#		Lease Agreement, dated January 22, 1990, between International Lease Finance Corporation and Alaska Airlines, Inc., summaries of 19 substantially identical lease agreements and Letter Agreement #1, dated January 22, 1990 (Filed as Exhibit 10-14 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 1990, filed on April 11, 1991 and incorporated herein by reference.)


104


10.7†*		Alaska Air Group Performance Based Pay Plan (formerly “Management Incentive Plan”), as amended and restated November 30, 2007

10.8*		Alaska Air Group, Inc. 2004 Long-Term Incentive Plan and original form of stock option and restricted stock unit agreements (Filed as Exhibit 10.2 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004, filed on February 25, 2005 and incorporated herein by reference.)

10.8.1†*		Alaska Air Group, Inc. 2004 Long-Term Incentive Plan Nonqualified Stock Option Agreement

10.8.2†*		Alaska Air Group, Inc. 2004 Long-Term Incentive Plan Stock Unit Award Agreement

10.8.3*		Alaska Air Group, Inc. 2004 Long-Term Incentive Plan Performance Stock Unit Award Agreement (Filed as Exhibit 10.3 to Registrant’s Current Report on Form 8-K, filed on February 14, 2008 and incorporated herein by reference.)

10.9*		Alaska Air Group, Inc. 1999 Long-Term Incentive Equity Plan (Filed as Exhibit 99.1 to Registrant’s Registration Statement on Form S-8, Registration No. 333-87563, filed on September 22, 1999 and incorporated herein by reference.)

10.10*		Alaska Air Group, Inc. 1997 Non Officer Long-Term Incentive Equity Plan (Filed as Exhibit 99.2 to Registrant’s Registration Statement on Form S-8, Registration No. 333-39889, filed on November 10, 1997 and incorporated herein by reference.)

10.11*		Alaska Air Group, Inc. 1996 Long-Term Incentive Equity Plan (Filed as Exhibit 99.1 to Registrant’s Registration Statement on Form S-8, Registration No. 333-09547, filed on August 5, 1996 and incorporated herein by reference.)

10.12*		Alaska Air Group, Inc. Non Employee Director Stock Plan (Filed as Exhibit 99.1 to Registrant’s Registration Statement on Form S-8, Registration No. 333-33727, filed on August 15, 1997 and incorporated herein by reference.)

10.13*		Alaska Airlines, Inc. and Alaska Air Group, Inc. Supplementary Retirement Plan for Elected Officers, as amended November 7, 1994 (Filed as Exhibit 10.15 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 1997, filed on February 10, 1998 and incorporated herein by reference.)

10.14*		Alaska Air Group, Inc. 1995 Elected Officers Supplementary Retirement Plan, 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 (Filed as Exhibit 10.13 to Amendment No. 1 to Registrant’s Registration Statement on Form S-1, Registration No. 333-107177, filed on September 23, 2003 and incorporated herein by reference.)

10.15*		Alaska Air Group, Inc. Change of Control Agreement dated October 27, 1999 (Filed as Exhibit 10.18 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 1999, filed on February 25, 2000 and incorporated herein by reference.)

10.16†*		Form of Alaska Air Group, Inc. Change of Control Agreement for named executive officers, as amended and restated November 28, 2007

10.17†*		Alaska Air Group, Inc. Nonqualified Deferred Compensation Plan, as amended and restated on January 1, 2005

10.18*		Employment, Retirement and Non-Compete Agreement by and between Kevin Finan and Alaska Airlines, Inc. (Filed as Exhibit 10.1 to Registrant’s Current Report on Form 8-K, filed on April 30, 2007 and incorporated herein by reference.)


		105


10.18.1*		Consulting Agreement by and between Kevin Finan and Alaska Airlines, Inc. (Filed as Exhibit 10.2 to Registrant’s Current Report on Form 8-K, filed on April 30, 2007 and incorporated herein by reference.)

12.1†		Statement of Computation of Ratio of Earnings to Fixed Charges

21†		Subsidiaries of Registrant

23.1†		Consent of Independent Registered Public Accounting Firm (KPMG LLP)

31.1†		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2†		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1†		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2†		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

†	Filed herewith.

*	Indicates management contract or compensatory plan or arrangement.

#	Pursuant to 17 CFR 240.24b-2, confidential information has been omitted and filed separately with the Securities and Exchange Commission pursuant to a Confidential Treatment Application filed with the Commission.


106

Schedule II

ALASKA AIR GROUP, INC.

VALUATION AND QUALIFYING ACCOUNTS


(In Millions)	Beginning Balance		Additions Charged to Expense		Deductions			Ending Balance
Year Ended December 31, 2005
Reserve deducted from asset to which it applies:
Allowance for doubtful accounts	$	3.0	$	1.2	$	(1.5	)	$	2.7

Obsolescence allowance for flight equipment spare parts	$	18.9	$	5.9	$	(4.1	)	$	20.7

Year Ended December 31, 2006
Reserve deducted from asset to which it applies:
Allowance for doubtful accounts	$	2.7	$	1.6	$	(1.4	)	$	2.9

Obsolescence allowance for flight equipment spare parts	$	20.7	$	3.6	$	(3.8	)	$	20.5

Year Ended December 31, 2007
Reserve deducted from asset to which it applies:
Allowance for doubtful accounts	$	2.9	$	1.6	$	(2.9	)	$	1.6

Obsolescence allowance for flight equipment spare parts	$	20.5	$	5.5	$	(1.4	)	$	24.6


		107

First Amendment to March 25, 2005 Credit Agreement

Exhibit 10.1.1

FIRST AMENDMENT TO

CREDIT AGREEMENT

THIS FIRST AMENDMENT TO CREDIT AGREEMENT (this “Amendment”) is entered into on September 29, 2005 by and among ALASKA AIRLINES, INC., an Alaska corporation (the “Borrower”), each lender identified on the signature page hereof (collectively, (“Lenders”), and BANK OF AMERICA, N.A., as agent for Lenders (“Agent”).

RECITALS

A. Borrower, Agent and Lenders are parties to that certain Credit Agreement dated as of March 25, 2005 (the “Credit Agreement”), pursuant to which Lenders established a revolving line of credit to Borrower; and

B. Borrower and Lenders wish to amend the Credit Agreement: (i) to exclude Permitted Progress Payment Loans (as defined below) from the calculation of the Fixed Charge Coverage Ratio; (ii) to permit certain Liens securing such Permitted Progress Payment Loans; and (iii) to change the Collateral Review Date, in each case, as set forth herein;

NOW, THEREFORE, the parties agree as follows:

AGREEMENT

1. Definitions. Capitalized terms used herein and not otherwise defined shall have the meaning given in the Credit Agreement and shall be construed in accordance with the rules of construction set forth therein.

2. Amendments to Section 1.01. In Section 1.01 of the Credit Agreement, the following definitions are amended and restated to read as follows:

“Fixed Charge Coverage Ratio” means, for the four quarters preceding the applicable date of calculation, the ratio of (a) to (b) where (a) equals the sum of (i) Borrower’s and its Subsidiaries’ consolidated earnings before interest expense (net of capitalized interest) and taxes during such period, plus, to the extent such amounts are deducted when determining consolidated earnings, (ii) consolidated depreciation and amortization expense (other than airframe and engine overhaul amortization) during such period, plus (iii) Consolidated Lease Expense during such period, plus (iv) amounts related to Permitted Asset Adjustments, plus (v) non-cash asset impairment charges incurred prior to December 31, 2004 related to the 737-200 fleet, plus (vi) 100% of Government Compensation in the quarter in which it was received with such amount decreasing by 25% per quarter in subsequent calculation periods until decreased to 0%, excluding (x) unusual, non-cash special charges and credits (excluding Permitted Asset Adjustments), and (y) the marked-to-market Swap Termination value for Swap Contracts that have not been closed out, and (b) equals the sum of (1) Consolidated Lease Expense during such period, plus (2) consolidated interest expense (net of capitalized interest) during such period in respect of Consolidated Funded Debt and Leases, plus (3) the principal amount of the scheduled current portion of all Consolidated Funded Debt and

Leases excluding any Loans, or short-term borrowings or debt outstanding between Borrower and its Affiliates, or any Permitted Progress Payment Loans, each without duplication and determined in accordance with GAAP.

3. New Definitions in Section 1.01. The following new definitions are added to Section 1.01 of the Credit Agreement:

“Permitted Progress Payment Loans” means loans to Borrower from lenders (which may or may not be Lenders hereunder) in an outstanding principal amount not to exceed at any one time One Hundred Seventy-two Million ($172,000,000) to finance Borrower’s progress payments for aircraft purchases from The Boeing Company. Any such progress payment loan shall constitute a “Permitted Progress Payment Loan” only if it is due on or before the first day of the calendar month during which the related aircraft is scheduled and available for delivery (provided that if the aircraft is scheduled but not available for delivery, a delay in payment will not cause such loans to cease to be Permitted Progress Payment Loans so long as such delay is acceptable to the progress payment lenders).

4. Amendment to Section 6.15(c). Clause (iii) of Section 6.15(c) is restated to read:

(iii) the Added Engine is a Stage 3 Engine of the same or improved make and model as the Removed Engine, provided that a JT8D-217C and a JT8D-219 shall be considered to be interchangeable.

5. Amendment to Section 7.01. The following is added as a new Section 7.01(k):

(k) Liens on Borrower’s rights under an aircraft purchase agreement with respect to an aircraft securing any Permitted Progress Payment Loan made with respect to such aircraft.

Section 7.01(k) is renumbered as Section 7.01(l) and the reference to “clauses (a) – (j)” is changed to “clauses (a) – (k).”

6. Amendment to Section 6.15(a). Section 6.15(a) is amended and restated to read as follows:

Collateral Review Date. On or before the last Business Day of each July and January (each a “Collateral Review Date”), Borrower shall provide to the Administrative Agent (which shall provide to each Lender) a Qualified Appraisal showing the Current Market Value of each Pledged Aircraft as of a Valuation Date that is no earlier than 30 days prior to the applicable Collateral Review Date.

7. Conditions to Effectiveness. This Amendment shall be effective upon the Agent’s receipt of counterparts of this Amendment, duly executed and delivered by Borrower, Agent and Lenders constituting the Requisite Lenders, sufficient in number for distribution to Agent, Lenders and Borrower.

8. Representations and Warranties. Borrower hereby represents and warrants to Agent and each Lender that: (i) each of the representations and warranties set forth in Article V of the Credit Agreement is true and correct in each case as if made on and as of the date of this Amendment or, if any such representation or warranty is stated to have been made as of or with respect to a specific date, as of or with respect to such specific date; and (ii) Borrower’s loan agreement with HSH Norbank AG governing Permitted Progress Payment Loans (the “Progress Payment Loan Agreement”) will not, following execution of this Amendment, constitute a Default under the Credit Agreement. Borrower agrees that representations and warranties made in this Amendment shall constitute representations and warranties under Article V of the Credit Agreement.

9. Reimbursement for Expenses. Borrower shall reimburse Agent for all expenses actually incurred by Agent in connection with the preparation of this Amendment. Such expenses shall include all other costs or expenses incurred by Agent or Bank of America as Lender in connection with this Amendment or the transactions contemplated hereby, including, without limitation, all attorney costs incurred in connection with the preparation, negotiation and execution of this Amendment.

10. No Further Amendment; Waiver and Release. Except as expressly modified by this Amendment, the Credit Agreement and the other Loan Documents shall remain unmodified and in full force and effect and the parties hereby ratify their respective obligations thereunder. Borrower hereby reaffirms its obligations under the Loan Documents and waives any defense that it may now have or hereafter acquire with respect thereto based on or otherwise relating to any events or circumstances that occurred or existed on or before the date of this Amendment.

11. Miscellaneous.

(a) Entire Agreement. This Amendment comprises the entire agreement of the parties with respect to the subject matter hereof and supersedes all prior oral or written agreements, representations or commitments.

(a) Counterparts. This Amendment may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original, and all of which taken together shall constitute one and the same Amendment.

(b) Governing Law. This Amendment and the other agreements provided for herein and the rights and obligations of the parties hereto and thereto shall be construed and interpreted in accordance with the laws of the State of Washington, excluding its conflict of laws rules.

(c) Oral Agreements Not Enforceable.

ORAL AGREEMENTS OR ORAL COMMITMENTS TO LOAN MONEY, EXTEND CREDIT, OR TO FOREBEAR FROM ENFORCING REPAYMENT OF A DEBT ARE NOT ENFORCEABLE UNDER WASHINGTON LAW.

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed as of the date first above written.


BORROWER:						ALASKA AIRLINES, INC.

						By:
						Name: Jay Schaefer
						Title: Director, Treasury & Acting Treasurer

LENDERS:						BANK OF AMERICA, N.A.,

						By:
						Name: Mark N. Crawford
						Title: Senior Vice President

						CITICORP USA, INC., as a Lender

						By:
						Name: Hans Lin
						Title: Vice President

						U.S. BANK NATIONAL ASSOCIATION

						By:
						Name: James R. Farmer
						Title: Vice President


						HSH NORDBANK AG, NEW YORK BRANCH, as a Lender

						By:
						Name: Jack Campbell Mikal Sanne
						Title: SVP AVP

						MERRILL LYNCH CAPITAL CORPORATION, as a Lender

						By:
						Name: Nancy E. Meadows
						Title: Vice President

						WACHOVIA BANK, NATIONAL ASSOCIATION, as a Lender

						By:
						Name: Robert G. McGill, Jr.
						Title: Director

						RZB FINANCE LLC, as a Lender

						By:
						Name: Christoph Hoedl Dan Dobrjanskyj
						Title: Group Vice President Vice President

						JPMORGAN CHASE BANK, as a Lender

						By:
						Name: Matthew H. Massie
						Title: Managing Director


ADMINISTRATIVE AGENT:						BANK OF AMERICA, N.A., as Agent

						By:
						Name: Dora A. Brown Tiffany Shin
						Title: Vice President Assistant Vice President

First Amendment to October 19, 2005 Credit Agreement

Exhibit 10.2.1

FOIA CONFIDENTIAL

TREATMENT REQUESTED

AMENDMENT NO. 1 TO CREDIT AGREEMENT [HSH/AS B737-8001]

THIS AMENDMENT NO. 1 TO CREDIT AGREEMENT, dated as of March 27, 2007 (this “Amendment”), is to the Credit Agreement, dated as of October 19, 2005 (the “Credit Agreement”), among (i) ALASKA AIRLINES, INC., an Alaska corporation (the “Borrower”), (ii) EACH LOAN PARTICIPANT IDENTIFIED ON SCHEDULE I HERETO, and (iii) HSH NORDBANK AG NEW YORK BRANCH, as the Security Agent acting on behalf of the Loan Participants (the “Security Agent”).

W I T N E S S E T H:

WHEREAS, the parties hereto have previously entered into the Credit Agreement; and

WHEREAS, the parties hereto desire to amend the Credit Agreement in certain respects as provided herein.

NOW THEREFORE, in consideration of the mutual agreements contained herein, the parties hereto agree as follows:

Section 1 Defined Terms. Unless otherwise amended by the terms of this Amendment, terms used in this Amendment shall have the meanings assigned in the Credit Agreement.

Section 2 Amendments to Credit Agreement. This Amendment shall be effective as of March 30, 2007 (the “Amendment Effective Date”), provided that the conditions precedent in Section 3 has been satisfied to the satisfaction of the Loan Participants and the Security Agent. From the Amendment Effective Date, the Credit Agreement (and to the extent of an amendment to the definitions in Annex A to the Credit Agreement, Annex A to each other document between the parties) shall be amended as follows:

(a) Section 2.2(a) of the Credit Agreement is hereby amended and restated in its entirety to read as follows:

“The Borrower agrees to give the Security Agent at least five (5) Business Days’ prior written notice (the “Funding Notice”) of the Borrowing Date for each Advance, which Borrowing Date shall be a Business Day not later than the Commitment Termination Date and, in respect of an Advance, shall be either (i) the last Business Day of the calendar month in which the Borrower paid the Manufacturer in respect of such Advance, in accordance with the scheduled dates therefor set forth in Schedule III, or (ii) the last Business Day of any subsequent calendar month provided that the Aircraft the subject of such Advance is able to be the subject of a Drawing on such Business Day as contemplated in Schedule III and the Borrower has previously paid the Manufacturer in respect of such Advance, including its Cash Contribution. The Funding Notice shall specify any funding instructions and shall be in substantially the form of Exhibit A.”

[Amendment No. 1 to Credit Agreement HSH/AS B737-800]

(b) Section 2.2(b) of the Credit Agreement is hereby amended and restated in its entirety to read as follows:

“In the event that any Drawing shall not be consummated in accordance with the terms hereof on the Borrowing Date specified in a Funding Notice, the Loan Participants and the Borrower shall cooperate with each other to arrange a mutually acceptable postponement of such date provided that such date may not be later than the last Business Day of the third month following the month in which the Advance to which the Drawing relates is scheduled to occur as set forth in Schedule III. (the “Delayed Borrowing Date”). In the event that the Drawing shall not be consummated in accordance with the terms hereof by 11 :00 a.m. (New York time) on the Delayed Borrowing Date or, if earlier, the date on which the Borrower notifies the Loan Participants that the Drawing will not occur, the Loan Participant may cancel or terminate any funding arrangements that they may have made to enable them to fund their Commitments and the Borrower shall pay to each Loan Participant on demand their Break Amount (as reasonably determined by such Loan Participants and certified to the Borrower). In consideration of making their funds available on the specified Borrowing Date, the Borrower shall compensate the Loan Participants for their net loss of earnings on such funds, by paying the Loan Participants interest on the aggregate amount thereof (calculated on the basis of a 360-day year and actual days elapsed) at a rate equal to the Loan Participants’ cost of funds for the period from and including the specified Borrowing Date to but excluding the earlier of (x) the Business Day on which the Borrowing shall actually occur, (y) the Business Day on which the Borrower shall notify the Loan Participants that the Borrowing will not occur prior to the Delayed Borrowing Date (if such notice is given prior to 10:00 a.m. (New York time) or if later, until the Business Day subsequent to such notice date), or (z) the Delayed Borrowing Date.”

“On the Borrowing Date for each Drawing specified in a Funding Notice referred to in Section 2.2(a), subject to the terms and conditions of this Agreement, each Loan Participant, through or on behalf of the Security Agent, agrees to pay the amount of its Commitment for each such Advance directly to the Borrower by wiring such amounts to the account or accounts specified in such Funding Notice.”

(d) Section 2.4 of the Credit Agreement is hereby amended and restated in its entirety to read as follows:

“The Borrower agrees that the actual transfer of the proceeds of Drawings to the bank designated by the Borrower shall constitute conclusive evidence that the Drawings were made, and neither the failure of any Holder to endorse on the schedule attached to any Loan Certificate the amount of its Drawing, nor any failure of the bank designated by the Borrower to credit proceeds of a Drawing to the Borrower’s account maintained at such bank shall affect the Borrower’s obligations hereunder.”

[Amendment No. 1 to Credit Agreement HSH/AS B737-800]

(e) Section 4.2(c) of the Credit Agreement is hereby amended and restated in its entirety to read as follows:

“The Borrower shall have paid to the Manufacturer the Advance the subject of the Drawing, including its Cash Contribution.”

(f) Section 5.2(d) of the Credit Agreement is hereby amended and restated in its entirety to read as follows:

“The principal of the Drawings of each Series shall be due and payable in full upon the earlier of (i) the last Business Day of the month (being an Interest Payment Date) preceding the month in which Delivery Date of the Aircraft related to such Series shall occur, as notified by the Borrower to the Security Agent five (5) Business Days prior to such day, and (ii) the Final Repayment Date.”

(g) Section 5.10(a) of the Credit Agreement is hereby amended and restated in its entirety to read as follows:

“On at least five Business Days prior written notice, the Borrower may prepay on the date specified in such notice of prepayment, in whole or in part, the Loan Certificates then outstanding at the principal amount thereof (or portion thereof to be repaid), and provided that any partial prepayment shall be in an aggregate original principal amount of at least $5,000,000 and in $500,000 multiples thereof, and the amount thereof shall be specified in such written notice. The Security Agent will give prompt notice of the Borrower’s intent to prepay to the Holders. As long as the Borrower is entitled to borrow against any such Aircraft hereunder, Borrower may re-borrow the amount prepaid as permitted in Section 2.2(a) hereof.”

(h) Section 9 of the Credit Agreement is hereby amended by adding a new Section (i) which provides:

“Manufacturer’s change of Month of Aircraft Delivery. In the event that the Manufacturer reschedules the Scheduled Delivery Date of an Aircraft so that it changes the month in which the Aircraft will be delivered to the Borrower, the Borrower shall promptly notify the Security Agent. If the Borrower so notifies the Security Agent, Schedule III may be amended by the agreement of all parties hereto to reflect the changed Scheduled Delivery Date of such Aircraft.”

(i) Schedule III to the Credit Agreement is hereby replaced with a new Schedule III in the form of Schedule II.

[Amendment No. 1 to Credit Agreement HSH/AS B737-800]

(j) In Annex A, add a new definition of “Amendment Effective Date” in the appropriate alphabetical position as follows:

““Amendment Effective Date” means March 30, 2007, being the date of Amendment No. 1 to Credit Agreement [HSH/AS B737-800] among the Borrower, the Security Agent and each Loan Participant identified on Schedule 1 thereto.”

(k) In Annex A, the definition of “Borrowing Date” is hereby amended and restated in its entirety to read as follows:

““Borrowing Date” means (a) the Effective Date, and (b) a day on or before the Commitment Termination Date that is either (i) the last Business Day of a calendar month on which an Advance is payable in respect of an Aircraft under the Boeing Purchase Agreement as set forth in Schedule III to the Credit Agreement, or (ii) the last Business Day of a subsequent calendar month, as specified by the Borrower in accordance with Section 2.2(a), provided that the Aircraft the subject of such Advance is able to be the subject of a Drawing on such Business Day as contemplated in Schedule III.”

(l) In Annex A, the definition of “Commitment Fee” is hereby amended and restated in its entirety to read as follows:

““Commitment Fee” means a fee calculated monthly (but, for the avoidance of doubt, payable quarterly) by multiplying the Commitment Fee Percentage by the outstanding unutilized Maximum Commitment of each Loan Participant, as cancelled or reduced under Section 3.5 of the Credit Agreement.”

(m) In Annex A, add a new definition of “Commitment Fee Percentage” in the appropriate alphabetical position as follows:

““Commitment Fee Percentage” means, for the purposes of calculating the Commitment Fee:

(a) if 0% of the Maximum Borrowing Capacity is being utilized, 0.65% per annum;

(b) if more than 0% but equal to or less than 15% of the Maximum Borrowing Capacity is being utilized, 0.60% per annum;

(d) if more than 25% but equal to or less than 60% of the Maximum Borrowing Capacity is being utilized, 0.5% per annum; and

[Amendment No. 1 to Credit Agreement HSH/AS B737-800]

(e) if more than 60% of the Maximum Borrowing Capacity is being utilized, 0.42% per annum.”

(n) In Annex A, , the definition of “Commitment Termination Date” is hereby amended and restated in its entirety to read as follows:

““Commitment Termination Date” means the last Business Day of the calendar month of the last Advance specified in Schedule III to the Credit Agreement, however, if an Excusable Delay (as defined in the Boeing Purchase Agreement) occurs, or if any other delay occurs which does not result in a termination of either Purchase Agreement or an Event of Default hereunder, then the Commitment Termination Date may be a date not more than 90 days after such date, or as extended by agreement of all Loan Participants.”

(o) In Annex A, the definition of “Interest Payment Date” is hereby amended and restated in its entirety to read as follows:

““Interest Payment Date” means each Interest Payment Date occurring prior to the Amendment Effective Date, then April 1, 2007 and thereafter the last day of each month occurring after the Amendment Effective Date, provided that, if any such date shall not be a Business Day, then the relevant Interest Payment Date shall be the immediately preceding Business Day (the last Business Day of the Month).”

(p) In Annex A, add a new definition of “Maximum Borrowing Capacity” in the appropriate alphabetical position as follows:

““Maximum Borrowing Capacity” means, in respect of any month, that part of the Maximum Commitment that can be utilized by the Borrower to fund deliveries, as specified in Schedule III to the Credit Agreement.”

Section 3 Condition Precedent. The effectiveness of this Amendment is subject to the receipt by the Security Agent of a certificate of the Secretary or an Assistant Secretary of the Borrower as to the incumbency and specimen signature of the officer of the Borrower who shall have executed this Amendment on behalf of the Borrower on or about the date hereof, which shall be satisfactory to the Security Agent in form and substance.

Section 4 Scope and Effectiveness of Amendment.

(a) This Amendment and the agreements set forth herein shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns from and after the Amendment Effective Date. This Amendment shall not have retroactive effect and the original provisions contained in the Credit Agreement shall apply up to the Amendment Effective Date.

[Amendment No. 1 to Credit Agreement HSH/AS B737-800]

(b) On and after the Amendment Effective Date (i) this Amendment shall become a part of the Credit Agreement, and (ii) each reference in (x) the Credit Agreement to “this Agreement”, “hereof’ or “hereunder” or words of like import, and (y) any other Operative Document to the “Credit Agreement”, shall be a reference to the Credit Agreement, as amended or modified hereby.

(c) Except as expressly amended or modified hereby, the Credit Agreement, as amended prior to the date hereof, shall remain in full force and effect and is hereby ratified and confirmed by the parties hereto.

(d) Each party hereto agrees and acknowledges that this Amendment constitutes an “Operative Document” under the Credit Agreement.

Section 5 Miscellaneous.

5.1 Notices. Section 10 of the Credit Agreement shall apply hereto as if set out in full in this Amendment.

5.2 Successors and Assigns. This Amendment shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns.

5.3 Expenses. The Borrower agrees to pay the costs and expenses of the Security Agent and the Lenders, including reasonable fees and expenses of Vedder, Price, Kaufman & Kammholz, P.C. in connection with the negotiation, preparation, execution and delivery of this Amendment.

5.4 Captions. Captions and section headings appearing herein are included solely for convenience of reference and are not intended to affect the interpretation of any provision of this Amendment.

5.5 Counterparts. This Amendment may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument and any of the parties hereto may execute this Amendment by signing any such counterpart.

5.6 Governing Law; Consent to Jurisdiction; Waiver of Jury Trial.

(a) ‘This Agreement shall in all respects be governed by, and construed in accordance with, the law of the State of New York.

(b) Each party hereby irrevocably and unconditionally submits, for itself and its property, to the nonexclusive jurisdiction of the Supreme Court of the State of New York sitting in New York County and of the United States District Court of the Southern District of New York, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Agreement, or for recognition or enforcement of any judgment, and each of the parties hereto hereby irrevocably and unconditionally agrees that all claims in respect of any such action or proceeding may be heard and determined in such New York State or, to the extent permitted by law, in such Federal court. Each of the parties hereto agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions

[Amendment No. 1 to Credit Agreement HSH/AS B737-800]

by suit on the judgment or in any other manner provided by law. Nothing in this Agreement shall affect any right that any party may otherwise have to bring any action or proceeding relating to this Agreement against another party or its properties in the courts of any jurisdiction.

(c) Each party hereby irrevocably and unconditionally waives, to the fullest extent it may legally and effectively do so, any objection which it may now or hereafter have to the laying of venue of any suit, action or proceeding arising out of or relating to this Agreement in any court referred to in Section 56(b). Each of the parties hereto hereby irrevocably waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such action or proceeding in any such court.

(d) Each party to this Agreement irrevocably consents to service of process in the manner provided for notices in Section 10 of the Credit Agreement. Nothing in this Agreement will affect the right of any party to this Agreement to serve process in any other manner permitted by law.

(e) EACH PARTY HERETO HEREBY WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY RIGHT IT MAY HAVE TO A TRIAL BY JURY IN ANY LEGAL PROCEEDING DIRECTLY OR INDIRECTLY ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY (WHETHER BASED ON CONTRACT, TORT OR ANY OTHER THEORY). EACH PARTY HERETO (A) CERTIFIES THAT NO REPRESENTATIVE, AGENT OR ATTORNEY OF ANY OTHER PARTY HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT SUCH OTHER PARTY WOULD NOT, IN THE EVENT OF LITIGATION, SEEK TO ENFORCE THE FOREGOING WAIVER AND (B) ACKNOWLEDGES THAT IT AND THE OTHER PARTIES HERETO HAVE BEEN INDUCED TO ENTER INTO THIS AGREEMENT BY, AMONG OTHER THINGS, THE MUTUAL WAIVERS AND CERTIFICATION IN THIS SECTION.

Section 6 Direction. The Lenders direct the Security Agent to execute this Amendment.

[Signatures Follow]

[Amendment No. 1 to Credit Agreement HSH/AS B737-800]

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed by their respective officers as of the day and year first above written.


ALASKA AIRLINES, INC., Borrower

By:		[**]
Name:		[**]
Title:		[**]

HSH NORDBANK AG NEW YORK BRANCH

By:		[**]
Name:		[**]
Title:		[**]

By:		[**]
Name:		[**]
Title:		[**]

LOAN PARTICIPANTS

HSH NORDBANK AG NEW YORK BRANCH

By:		[**]
Name:		[**]
Title:		[**]

*	Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

[Amendment No. 1 to Credit Agreement HSH/AS B737-800]



By:		[**]
Name:		[**]
Title:		[**]

NORDDEUTSCHE LANDESBANK GIROZENTRALE

By:		[**]
Name:		[**]
Title:		[**]

By:		[**]
Name:		[**]
Title:		[**]

DEKABANK DEUTSCHE GIROZENTRALE

By:		[**]
Name:		[**]
Title:		[**]

By:		[**]
Name:		[**]
Title:		[**]

RZB FINANCE LLC

By:		[**]
Name:		[**]
Title:		[**]

		[**]
		[**]
		[**]

*	Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

[Amendment No. 1 to Credit Agreement HSH/AS B737-800]



HYPO PUBLIC FINANCE USA, INC.

By:		[**]
Name:		[**]
Title:		[**]

By:		[**]
Name:		[**]
Title:		[**]

KAUPTHING BANK HF.

By:		[**]
Name:		[**]
Title:		[**]

*	Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

[Amendment No. 1 to Credit Agreement HSH/AS B737-800]

SCHEDULE I

LOAN PARTICIPANTS

HSH Nordbank AG New York Branch

Norddeutsche Landesbank Girozentrale

DekaBank Deutsche Girozentrale

RZB Finance LLC

Hypo Public Finance USA, Inc.

Kaupthing Bank hf.

[Amendment No. 1 to Credit Agreement HSH/AS B737-800]

SCHEDULE II

1) In regard to any amounts that exceed the aggregate Maximum Commitment of (a) US$172,000,000 at any time during the term of the Facility, the Lenders are not required to fund more than US$172,000,000 in total. The Borrower will be required to advance any difference in cash until the Facility decreases below the aggregate Maximum Commitment.

[***]*

*	Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

Second Amendment to October 19, 2005 Credit Agreement

Exhibit 10.2.2

FOIA CONFIDENTIAL

TREATMENT REQUESTED

AMENDMENT NO. 2 TO CREDIT AGREEMENT [HSH/AS B737-8001]

THIS AMENDMENT NO. 2 TO CREDIT AGREEMENT, dated as of November 26, 2007 (this “Amendment”), is to the Credit Agreement, dated as of October 19, 2005 (as amended and supplemented from time to time, the “Credit Agreement”), among (i) ALASKA AIRLINES, INC., an Alaska corporation (the “Borrower”), (ii) EACH LOAN PARTICIPANT IDENTIFIED ON SCHEDULE I HERETO, and (iii) HSH NORDBANK AG NEW YORK BRANCH, as the Security Agent acting on behalf of the Loan Participants (the “Security Agent”), as amended by Amendment No 1 to Credit Agreement dated as of March 27, 2007 among the Borrower, each Loan Participant and the Security Agent.

W I T N E S S E T H:

WHEREAS, the parties hereto have previously entered into the Credit Agreement; and

WHEREAS, the parties hereto desire to amend the Credit Agreement in certain respects as provided herein.

NOW THEREFORE, in consideration of the mutual agreements contained herein, the parties hereto agree as follows:

Section 1 Defined Terms. Unless otherwise amended the terms of this Amendment, terms used in this Amendment shall have the meanings assigned in the Credit Agreement.

Section 2 Amendments to Credit Agreement. This Amendment shall be effective as of November 26, 2007 (the “Amendment Effective Date”), provided that all Loan Participants, the Borrower and the Security Agent have signed this Amendment and the conditions precedent in Section 3 have been satisfied to the satisfaction of the Loan Participants and the Security Agent. From the Amendment Effective Date, the Credit Agreement (and to the extent of an amendment to the definitions in Annex A to the Credit Agreement, Annex A to each other document between the parties) shall be amended as follows:

(a) Section 3.6 of the Credit Agreement shall be amended and restated in its entirety as follows:

“3.6 Non Continuing Loan Participant. (a) Provided that no Event of Default is continuing, on August 31, 2009, or if such day is not a Business Day, on the next preceding Business Day (the “Non Continuing Repayment Date”), all Drawings made by the Non Continuing Loan Participant (together with accrued interest and any other amounts due and owing to the Non Continuing Loan Participant) shall be repaid by the Borrower to the Non Continuing Loan Participant Upon receipt of payment, the Non Continuing Loan Participant’s Commitment shall be cancelled and, if requested by the Borrower, the Non Continuing Loan Participant shall return or cancel its Loan Certificate.

[Amendment No. 2 to Credit Agreement HSH/AS B737-800]

(b) On and from cancellation of the Non Continuing Loan Participant’s Commitment, and repayment of the Non Continuing Loan Participant’s Drawings, the aggregate Maximum Commitment of the Loan Participants under the Operative Documents and the Facility Amount shall be reduced to US$152,000,000, as if the Borrower had canceled such Facility Amount accordance with Section 3.5. The Maximum Commitment of each Continuing Loan Participant shall be unchanged.

[Amendment No. 2 to Credit Agreement HSH/AS B737-800]

(c) Unless the Borrower gives notice to the Continuing Loan Participants five Business Days prior to the Non Continuing Repayment Date, on the Non Continuing Repayment Date, provided that no Event of Default is continuing, the Borrower shall make a Drawing from the Continuing Loan Participants in an amount equal to the principal amount of the Drawing repaid by the Borrower to the Non Continuing Loan Participant pursuant to Section 3.6(a) on Non Continuing Repayment Date, or such lesser amount such that no more than the aggregate Maximum Commitment applying on and from the Non Continuing Repayment Date is outstanding. Subject to satisfaction of the conditions precedent specified in Sections 4.2 of the Credit Agreement, such Drawing shall be made available by each Continuing Loan Participant in accordance with their Participation Percentage. If the Borrower fails to repay the Non Continuing Loan Participant on the Non Continuing Repayment Date then no Drawing shall be made by a Continuing Loan Participant and the Borrower shall pay any Break Costs associated with a Continuing Loan Participant’s failed Drawing in accordance herewith”

(b) In Schedule I to the Credit Agreement, each occurrence of the following contact details:

[***]*

shall be replaced with the following:

[***]*

*	Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

[Amendment No. 2 to Credit Agreement HSH/AS B737-800]

(c) Schedule III to the Credit Agreement is hereby replaced with a new Schedule III in the form specified in Annex A hereto.

(d) In Annex A, the definition of “Loan Participant” is hereby amended and restated in its entirety to read as follows:

““Loan Participant” means those parties identified in Schedule I to the Credit Agreement, and their successors and assigns, provided that, subject to repayment by the Borrower of the Non Continuing Loan Participant on the Non Continuing Repayment Date in accordance with Section 3.6(a) of the Credit Agreement, from the Non Continuing Repayment Date, the Non Continuing Loan Participant shall not be a Loan Participant.”

(d) In Annex A, add a new definition of “Continuing Loan Participant” in the appropriate alphabetical position as follows:

““Continuing Loan Participant” means each Loan Participant other than the Non Continuing Loan Participant.”

(e) In Annex A, the definition of “Facility Amount” shall be amended and restated in its entirety as follows:

““Facility Amount” means $172,000,000, or such lesser amount as is specified in Schedule III to the Credit Agreement, as cancelled or reduced by the Borrower under Section 3.5 or Section 3.6(a) of the Credit Agreement “

(f) In Annex A, the definition of “Final Repayment Date” shall be amended and restated in its entirety as follows:

““Final Repayment Date” means, for the Non Continuing Loan Participant, the Non Continuing Repayment Date, and, for the Continuing Loan Participants, August 31, 2011.”

(g) In Annex A, add a new definition of “Non Continuing Loan Participant” in the appropriate alphabetical position as follows:

““Non Continuing Loan Participant” means Kaupthing Bank hf. and its assigns.”

(h) In Annex A, add a new definition of “Non Continuing Repayment Date” in the appropriate alphabetical position as follows:

““Non Continuing Repayment Date” has the meaning given in Section 36(a) of the Credit Agreement.”

[Amendment No. 2 to Credit Agreement HSH/AS B737-800]

Section 4 Scope and Effectiveness of Amendment.

(b) On and after the Amendment Effective Date (i) this Amendment shall become a part of the Credit Agreement (ii) each reference in (x) the Credit Agreement to “this Agreement”, “hereof’ or “hereunder” or words of like import, and (y) any other Operative Document to the “Credit Agreement”, shall be a reference to the Credit Agreement, as amended or modified hereby.

(c) Except as expressly amended or modified hereby, the Credit Agreement, as amended prior to the date hereof, shall remain in full force aid effect and is hereby ratified and confirmed by the parties hereto.

(d) Each party hereto agrees and acknowledges that this Amendment constitutes an “Operative Document” under the Credit Agreement.

Section 5. Miscellaneous.

5.1 Notices. Section 10 of the Credit Agreement shall apply hereto as if set out in full in this Amendment.

5.2 Successors and Assigns. This Amendment shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns.

5.4 Captions. Captions and section headings appearing herein are included solely for convenience of reference and are not intended to affect the interpretation of any provision of this Amendment.

5.6 Governing Law; Consent to Jurisdiction; Waiver of Jury Trial.

(a) This Agreement shall in all respects be governed by, and construed in accordance with, the law of the State of New York.

[Amendment No. 2 to Credit Agreement HSH/AS B737-800]

Section 6. Direction. The Lenders direct the Security Agent to execute this Amendment.

[Signatures Follow]

[Amendment No. 2 to Credit Agreement HSH/AS B737-800]

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed by their respective officers as of the day and year first above written.


ALASKA AIRLINES, INC., Borrower

By:		[**]
Name:		[**]
Title:		[**]

HSH NORDBANK AG NEW YORK BRANCH

By:		[**]
Name:		[**]
Title:		[**]

By:		[**]
Name:		[**]
Title:		[**]

NORDDEUTSCHE LANDESBANK GIROZENTRALE

By:		[**]
Name:		[**]
Title:		[**]

By:		[**]
Name:		[**]
Title:		[**]

*	Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

[Amendment No. 2 to Credit Agreement HSH/AS B737-800]


DEKABANK DEUTSCHE GIROZENTRALE

By:		[**]
Name:		[**]
Title:		[**]

By:		[**]
Name:		[**]
Title:		[**]

RZB FINANCE LLC

By:		[**]
Name:		[**]
Title:		[**]
		[**] [**] [**]

HYPO PUBLIC FINANCE USA, INC.

By:		[**]
Name:		[**]
Title:		[**]

By:		[**]
Name:		[**]
Title:		[**]

*	Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

[Amendment No. 2 to Credit Agreement HSH/AS B737-800]


KAUPTHING BANK HF.

By:		[**]
Name:		[**]
Title:		[**]
		[**] [**] [**]

*	Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

[Amendment No. 2 to Credit Agreement HSH/AS B737-800]

SCHEDULE I

LOAN PARTICIPANTS

HSH Nordbank AG New York Branch

Norddeutsche Landesbank Girozentrale

DekaBank Deutsche Girozentrale

RZB Finance LLC

Hypo Public Finance USA, Inc.

Kaupthing Bank hf.

[Amendment No. 2 to Credit Agreement HSH/AS B737-800]

ANNEX A

(to Amendment No. 2 to Credit Agreement)

SCHEDULE II TO CREDIT AGREEMENT

1) In regard to any amounts that exceed the aggregate Maximum Commitment of (a) US$172,000,000 until the Non Continuing Repayment Date, and (b) US$152,000,000 from the Non Continuing Repayment Date until the Final Repayment Date, at any time during the term of the Facility, the Lenders are not required to fund more than US$172,000,000 (prior to the Non Continuing Repayment Date) or US$152,000,000 (following the Non Continuing Repayment Date) in total. The Borrower will be required to advance any difference in cash until the Facility decreases below the aggregate Maximum Commitment.

[***]*

*	Indicates that certain information contained herein has been omitted and filed separately with the Securities and Exchange Commission. Confidential treatment has been requested with respect to the omitted portions.

Alaska Air Group Performance Based Pay Plan

Exhibit 10.7

ALASKA AIR GROUP PERFORMANCE BASED PAY PLAN

(formerly, the “Management Incentive Plan” or “MIP”)

(Amended and Restated November 30, 2007)

The Board of Directors (the “Board”) of Alaska Air Group, Inc. (the “Company”) has adopted a plan to reward employees of Alaska Airlines, Inc. (“Alaska”) and Horizon Air Industries, Inc. (“Horizon”). The plan, formerly known as the Management Incentive Plan, has been renamed as the Performance Based Pay Plan (“Plan”). This memorandum is provided to explain the key elements of how the Plan will operate. The Performance Based Pay award (“Award”) of each eligible Participant will depend upon the degree to which the Company achieves the performance goals and award modifier set by the Compensation Committee of the Board for each calendar year (a “Plan Year”) and the discretion of the Compensation Committee of the Board and Chief Executive Officer explained below. This Plan is effective beginning with the 2003 Plan Year and each year thereafter until amended, restated or terminated, pursuant to paragraph 8.

1.	ELIGIBILITY

Eligibility to participate in the Plan during a Plan Year is limited to officers and other employees of Alaska and Horizon who (a) are designated by the Compensation Committee, and (b) are full-time employees of Alaska or Horizon as of December 31 of the Plan Year, or (c) were full-time employees during the Plan Year and do not meet the requirement of (b) because their employment ended due to retirement at age 52 or older, disability or death (each a “Participant,” or collectively “Participants”). Individuals may become Participants during the Plan Year if they are newly hired or promoted during the year and meet the requirements of the preceding sentence. Participants who are on temporary medical leave, military leave, or otherwise not working either full-time or part-time for Alaska or Horizon for reasons approved by the Board, but who remain employed, also retain eligibility as Participants. Participation in the Plan does not guarantee that any Award will be paid if applicable performance goals specified for the Plan Year are not achieved for the year. Unless otherwise provided for in a separate Award agreement, an individual whose employment with Alaska or Horizon ends for any reason not described in (c) above, such as resignation or termination, forfeits eligibility upon such end of employment.

2.	BASIS FOR PARTICIPATION

A Participant’s Basis for a Plan Year is used to determine the dollar amount or initial target value of the Participant’s Award for that year. The “Basis” is the actual Basic Salary of the Participant earned during the Plan Year multiplied by the percentage selected for that Participant by the Board. “Basic Salary” means the compensation earned by the Participant for services performed for Alaska or Horizon, including amounts that the Participant could have received in cash had the Participant not elected to contribute the amount to an employee benefit plan maintained by Alaska, Horizon or the Company and any other voluntary payment the Participant makes which reduces his/her compensation (such as the Participant’s voluntary contribution to an Internal Revenue Code (“Code”) Section 401(k) Plan, Code Section 125 medical account, dependent day care spending account, or charitable gift), but excluding commissions, all awards (including any Award under this Plan), and all other forms of incentive or other supplemental pay, employee benefits paid by the employer (such as employer contributions to a Code Section 401(k) Plan), cash and non-cash fringe benefits and perquisites (such as auto allowance and travel

reimbursement). Awards may be paid in cash or by act of the Compensation Committee of the Board, the Company’s Common Stock. Alternatively, Awards may, by act of the Compensation Committee of the Board, be denominated in shares of the Company’s Common Stock that are subject to conditions and restrictions established by the Compensation Committee and based on the achievement of performance goals as provided for in a Performance Share Award Agreement (such shares of Common Stock are referred to as “Performance Shares”).

3.	CALCULATION OF THE AWARD

The size of the Award earned for a Plan Year will depend upon the extent to which the performance goals and award modifier of the Company have been achieved during that Plan Year and the discretion of the Compensation Committee of the Board. Separate performance weighting has been established for each performance goal. The Award will equal either (i) in the case of cash-based Awards, the dollar amount achieved by multiplying the Participant’s Basis by the sum of the weighted percentage achievement factors, or (ii) in the case of Common Stock Based Awards, the number of shares which is equal to the cash award under the preceding clause (i) divided by the closing price of the Company’s Stock on the NYSE on the date of such Award, or (iii) in the case of Awards denominated in Performance Shares, the actual number of shares of Common Stock earned by the Participant will be determined based on the achievement of performance goals as described in the applicable Performance Share Award Agreement, in each case, as such amounts may be adjusted in the Compensation Committee’s discretion pursuant to paragraph 6 or pursuant to the terms of an applicable Performance Share Award Agreement. All calculations will be performed by the Human Resources Department of Alaska and will be subject to approval solely by the Board. Once approved by the Compensation Committee of the Board, such calculations shall be conclusively presumed to be accurate.

4.	PERFORMANCE WEIGHTING

In order to achieve any Award for a particular performance goal, a “Threshold” must be achieved. A full entitlement is achieved when the “Target” is reached, and a double entitlement is possible if the “Maximum” is achieved. This weighting applies to each goal individually. Once the Threshold is achieved, the percentage of the difference between the Threshold and Target achieved is multiplied by the weighting factor as specified in the attachment for the applicable Plan Year. If the Target is exceeded, the percentage of the difference between the Target and the Maximum achieved is multiplied by the weighting factor as specified in the attachment for the applicable Plan Year. Since the difference between the Threshold and Target is, in most cases, arithmetically different from the difference between the Target and the Maximum, calculations will be performed utilizing either the Threshold-Target range, or Target-Maximum range, as applicable, to locate the percentage of the Target, or the percentage of the Maximum, as applicable, that has been achieved. Additional performance weighting criteria and the methodology for determining the number of shares issued to a Participant pursuant to an Award of Performance Shares may be set forth or described in an applicable Performance Share Award Agreement.

5.	PERFORMANCE GOALS AND APPLICABLE PERFORMANCE WEIGHTING FACTORS

The Compensation Committee of the Board will establish the performance goals and award modifier for each Plan Year during the life of this Plan, and will provide an annex to this Plan that outlines goals, award modifiers and the weighting factors.

2 of 8

6.	DISCRETIONARY FACTOR

In the case of a Participant described in paragraph 1(c) who retired due to age, terminated employment due to disability, or died during the year, or a Participant who took a leave of absence or worked a reduced schedule during any portion of the year, the Compensation Committee of the Board retains absolute discretionary authority to adjust the Award to such Participant based upon the Compensation Committee’s determination of such Participant’s contribution to the Company.

7.	TIMING OF AWARDS

After approval of the Audit Committee of the Board, it is the intent of the Board to distribute the Award, or actual shares of the Company’s Common Stock for Awards denominated in Performance Shares, for a Plan Year no later than March 15 of the following year for each Plan Year that Participants have become entitled to an Award. The terms and conditions of an Award denominated in Performance Shares will be set forth in a Performance Share Award Agreement with a Participant. A deceased Participant’s Award will be paid, or shares of the Company’s Common Stock underlying an Award denominated in Performance Shares will be distributed, to the beneficiary designated by the Participant for purposes of the Company’s group term life insurance plan covering the deceased Participant, and in the absence of any designation, will be paid or distributed to the Participant’s estate.

8.	AMENDMENT

The Board, acting through the Compensation Committee, retains the right to modify the Plan at any time in any manner that it deems appropriate, provided that (a) no amendment that adversely affects the rights of Participants or their beneficiaries shall be effective for a Plan Year that ended prior to the Plan Year in which the amendment was adopted, and (b) it will not terminate the Plan for any Plan Year during that Plan Year unless it is clear that Participants will not receive an Award for that Plan Year. It is understood that the Compensation Committee of the Board will review the Plan yearly and may make changes to the Plan for the next Plan Year.

9.	MISCELLANEOUS

This memorandum, including its attachments, constitutes the entire understanding relating to an Award to any employee of Alaska or Horizon, and supersedes all prior oral or written agreements, representations or commitments relating to such Awards.

This Plan is not a commitment of the Company, Alaska or Horizon, to any officer or employee of such company, to continue that individual in its employ in order to qualify for an Award. Nothing contained in this Plan may be considered to be a promise of continued employment. Any employee who shall file suit against his or her employer for wrongful termination shall automatically cease to be a Participant.

In the event that a Participant has a written employment agreement with Alaska or Horizon which entitles such Participant to participate in the Management Incentive Plan, this Plan is intended, for the purpose of such agreements, to be considered to be the same plan and may continue to be referred to as the MIP.

This memorandum and the rights and obligations provided for herein shall be construed and interpreted in accordance with the law of the state of Washington, excluding its conflicts of law rules.

3 of 8

No unpaid Award will be subject to the debts, liabilities, contracts or engagements of any Participant, and may not be alienated, pledged, garnished or sold, and any attempt to do so shall be void.

Awards of Common Stock, Performance Shares, and the issuance of shares of the Company’s Common Stock underlying Awards of Performance Shares, are deemed to be made pursuant to the Company’s 2004 Long-Term Incentive Plan, or any such successor plan.


Dated November 30, 2007						Alaska Air Group, Inc.

						/s/ Phyllis J. Campbell
						Phyllis J. Campbell Chair, Compensation Committee Alaska Air Group, Inc. Board of Directors

4 of 8

ANNEX 1

PERFORMANCE BASED PAY PLAN GOALS AND MEASURES FOR 2008

This Annex sets forth the goals for the Alaska Air Group Performance Based Pay Plan for the 2008 Plan year.

The performance goals for 2008 are divided into two groups: Operational Performance and Financial Performance. The Operational Performance goals, which are based on safety, employee engagement and cost per available seat mile (CASM) measures, represent 30% of the total weight. The Financial Performance goal is based on the Company’s profitability and represents 70% of the total weight.

Operational Performance. Operational Performance is equally divided into three categories:

Safety (10%)

A Safety payout requires the attainment of stated goals for lost time injury rates. No award for Safety will be earned if there is an employee on-the-job or operationally related passenger fatality.

The basis for achievement of this goal is improvement over the preceding year’s performance. The performance goals for 2008 for Alaska and Horizon are reflected below:

For Alaska:

Threshold _____ or fewer lost time injuries per _____ full time employees

Target _____ or fewer lost time injuries per _____ full time employees

Maximum _____ or fewer lost time injuries per _____ full time employees

For Horizon:

Threshold _____ or fewer lost time injuries per _____ full time employees

Target _____ or fewer lost time injuries per _____ full time employees

Maximum _____ or fewer lost time injuries per _____ full time employees

Employee Engagement/Customer Satisfaction (10%)

Employee Engagement/Customer Satisfaction will be measured by the number of times each airline meets or exceeds the monthly Operational Performance Rewards (OPR) Customer Satisfaction goal. The OPR goal is measured through online surveys of recent customers and is based % on employee attitude, courtesy & helpfulness, % on satisfaction on the most recent flight, and % on satisfaction over the past months.

5 of 8

For Alaska:

Threshold Total of _____ months with OPR score of __% or higher

Target Total of _____ months with OPR score of __% or higher

Maximum Total of _____ months with OPR score of __% or higher

For Horizon:

Threshold Total of _____ months with OPR score of __% or higher

Target Total of _____ months with OPR score of __% or higher

Maximum Total of _____ months with OPR score of __6% or higher

CASM (cost per available seat mile) ex. fuel (10%).

CASM calculations exclude fuel costs and may be adjusted for certain Excluded Items and Alternative Accounting Treatments (as defined below), as appropriate in the discretion of the Compensation Committee.

Alaska CASM ex. fuel:

Threshold _____¢

Target _____¢

Maximum _____¢

Horizon CASM ex. fuel:

Threshold _____¢

Target _____¢

Maximum _____¢

Financial Performance. (70% of the total). Financial Performance is measured by the Company’s Profitability.

Alaska Air Group Profitability (70% of the total).

The Profitability measure is the Adjusted Pre-Tax Profit of the Company, as defined below.

Threshold $ _____

Target $ _____

Maximum $ _____

“Adjusted Pretax Profit” means the net income of Alaska Air Group, Inc. as computed under Generally Accepted Accounting Principles (GAAP), adjusted for Excluded Items and Alternative Accounting Treatments. “Excluded Items” means (a) income taxes, (b) pretax expense under any Alaska Air Group (or subsidiary) profit sharing, performance-based pay, operational performance rewards, variable pay plan, or similar such programs as determined in the discretion of the Compensation Committee, and (c) special income or expense

6 of 8

items that, in the discretion of the Compensation Committee, should be excluded because recognizing them would not appropriately serve the goals of the Plan. These may include, without limitation, gain or loss on disposition of capital assets, impairments or other fleet exit costs, expenses from voluntary or involuntary severance programs, government refunds or assistance and cumulative effect of accounting changes. “Alternative Accounting Treatments” means expense or income items that, for purposes of calculating Adjusted Pretax Profit, the Company (or any subsidiary) will account for based on non-GAAP methods because, in the discretion of the Compensation Committee, using GAAP accounting methods would not appropriately serve the goals of the Plan. These may include, without limitation, fuel hedge accounting on an “as settled” basis.

Modifier. The Performance-Based Pay modifier results in plus or minus percentage points based on the performance of the key metrics as detailed below.

For Alaska,

The application of the modifier is based on the number of the months that Alaska achieves its on-time performance goals under the OPR program. The modifier will be applied as follows:


Number of Months Alaska Hits On-Time Goal		PBP Modifier

Performance-Based Pay shall be determined and then the modifier shall be applied. If, for example, Alaska Airlines achieved months of on-time performance at goal under the OPR program and Performance-Based Pay without the modifier resulted in a payout of %, then application of the modifier would result in a payout of %.

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For Horizon:

The application of the modifier is based on the Horizon Air pre-tax profit margin.


QX Profit Margin*		PBP Modifier

*	If Horizon Air final pre-tax profit margin is between percentage points, modifier will be adjusted based on movement through the scale, for example:


QX Profit Margin		PBP Modifier

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Alaska Air Group, Inc. 2004 Long-Term Incentive Plan

Exhibit 10.8.1

ALASKA AIR GROUP, INC.

2004 LONG-TERM INCENTIVE PLAN

NONQUALIFIED STOCK OPTION AGREEMENT

THIS NONQUALIFIED STOCK OPTION AGREEMENT (this “Option Agreement”) dated , by and between ALASKA AIR GROUP, INC., a Delaware corporation (“Air Group”), and (the “Grantee”) evidences the nonqualified stock option (the “Option”) granted by Air Group to the Grantee as to the number of shares of Air Group’s Common Stock first set forth below.


Number of Shares of Common Stock¹:		Award Date:
Exercise Price per Share¹:	$	Expiration Date^1,2:

Vesting^1,2The Option shall become vested as to 25% of the total number of shares of Common Stock subject to the Option on each of the first, second, third and fourth anniversaries of the Award Date.

The Option is granted under the Alaska Air Group, Inc. 2004 Long-Term Incentive Plan (the “Plan”) and subject to the Terms and Conditions of Nonqualified Stock Option (the “Terms”) attached to this Option Agreement (incorporated herein by this reference) and to the Plan. The Option has been granted to the Grantee in addition to, and not in lieu of, any other form of compensation otherwise payable or to be paid to the Grantee. Capitalized terms are defined in the Plan if not defined herein. The parties agree to the terms of the Option set forth herein. The Grantee acknowledges receipt of a copy of the Terms, the Plan and the Prospectus for the Plan.


GRANTEE						ALASKA AIR GROUP, INC. a Delaware Corporation

						By:
						William S. Ayer
						Chairman, President and CEO

Co-Mail Code

Home Address

City, State, Zip

¹	Subject to adjustment under Section 6 of the Plan

²	Subject to early termination under Section 4 of the Terms and Section 13 of the Plan

TERMS AND CONDITIONS OF NONQUALIFIED STOCK OPTION

1.	Vesting; Limits on Exercise; Incentive Stock Option Status; Possible Acceleration.

The Option shall vest and become exercisable in percentage installments of the aggregate number of shares subject to the Option as set forth on the cover page of this Option Agreement. The Option may be exercised only to the extent the Option is vested and exercisable.

•

Cumulative Exercisability. To the extent that the Option is vested and exercisable, the Grantee has the right to exercise the Option (to the extent not previously exercised), and such right shall continue, until the expiration or earlier termination of the Option.

•

No Fractional Shares. Fractional share interests shall be disregarded, but may be cumulated.

•

Minimum Exercise. No fewer than 100 shares of Common Stock (subject to adjustment under Section 6 of the Plan) may be purchased at any one time, unless the number purchased is the total number at the time exercisable under the Option.

•

Nonqualified Stock Option. The Option is a nonqualified stock option and is not, and shall not be, an incentive stock option within the meaning of Section 422 of the Code.

Notwithstanding any other provision herein or in the Plan, the Option, to the extent not then vested, shall become fully vested if (i) the Grantee’s employment with the Company is terminated by the Company without Cause or by the Grantee for Good Reason, and (ii) such termination occurs at any time within the period commencing six (6) months before a Change of Control and ending twenty-four (24) months after such Change of Control. (For these purposes, the terms “Cause,” “Change of Control” and “Good Reason” shall have the meanings ascribed to them in Exhibit A attached hereto.) In the event that, upon the occurrence of a Change of Control, the Grantee is entitled to accelerated vesting of the Option pursuant to this paragraph in connection with a termination of the Grantee’s employment prior to such Change of Control, the Option, to the extent it had not vested and was cancelled or otherwise terminated upon or prior to the date of such Change of Control solely as a result of such termination of employment, shall be reinstated and shall automatically become fully vested, and the Grantee shall be given a reasonable opportunity to exercise such accelerated portion of the Option before it terminates.

2.	Continuance of Employment/Service Required; No Employment/Service Commitment.

The vesting schedule requires continued employment or service through each applicable vesting date as a condition to the vesting of the applicable installment of the Option and the rights and benefits under this Option Agreement. Employment or service for only a portion of the vesting period, even if a substantial portion, will not entitle the Grantee to any proportionate vesting or avoid or mitigate a termination of rights and benefits upon or following a termination of employment or services as provided in Section 4 below or under the Plan.

Nothing contained in this Option Agreement or the Plan constitutes a continued employment or service commitment by the Company, affects the Grantee’s status, if he or she is an employee, as an employee at will who is subject to termination without cause, confers upon the Grantee any right to remain employed by or in service to the Company, interferes in any way with the right of the Company at any time to terminate such employment or service, or affects the right of the Company to increase or decrease the Grantee’s other compensation.

3.	Method of Exercise of Option.

The Option shall be exercisable by the delivery to the Secretary of Air Group (or such other person as the Committee may require pursuant to such administrative exercise procedures as the Committee may implement from time to time) of:

•

a written notice stating the number of shares of Common Stock to be purchased pursuant to the Option or by the completion of such other administrative exercise procedures as the Committee may require from time to time,

•

payment in full for the Exercise Price of the shares to be purchased in cash, check or by electronic funds transfer to Air Group, or (subject to compliance with all applicable laws, rules, regulations and listing requirements and further subject to such rules as the Committee may adopt as to any non-cash payment) in shares of Common Stock already owned by the Grantee, valued at their Fair Market Value on the exercise date;

•

if required by the Committee, any written statements or agreements that the Committee may deem necessary or desirable to assure compliance with all applicable legal and accounting requirements; and

•

satisfaction of the tax withholding provisions of Section 15 of the Plan.

The Committee also may, but is not required to, authorize a non-cash payment alternative by notice and third party payment in such manner as may be authorized by the Committee, or, subject to such procedures as the Committee may adopt, authorize a “cashless exercise” with a third party who provides simultaneous financing for the purposes of (or who otherwise facilitates) the exercise of the Option.

4.	Early Termination of Option.

4.1 Possible Termination of Option upon Certain Corporate Events. The Option is subject to termination in connection with certain corporate events as provided in Section 13 of the Plan.

4.2 Termination of Option upon a Termination of Grantee’s Employment or Services. Subject to earlier termination on the Expiration Date of the Option or pursuant to Section 4.1 above, if the Grantee ceases to be employed by or ceases to provide services to the Company, the following rules shall apply (the last day that the Grantee is employed by or provides services to the Company is referred to as the Grantee’s “Severance Date”):

•

other than as expressly provided below in this Section 4.2, the Option (whether vested or not) shall terminate on the Severance Date;

•

if the termination of the Grantee’s employment or services is the result of the Grantee’s Retirement (as defined below), (a) the Option, to the extent not vested on the Severance Date and scheduled to vest at any time within the three-year period following the Severance Date, shall become fully vested as of the Severance Date, (b) the Grantee will have until the date that is three (3) years after the Grantee’s Severance Date to exercise the Option, provided, however, that any portion of the Option that becomes vested pursuant to the foregoing clause (a) shall become exercisable only at such times as such portion would have otherwise vested pursuant to the original vesting schedule as provided herein had the Grantee’s employment not terminated, (c) the Option, to the extent not vested on the Severance Date (after giving effect to the foregoing clause (a)), shall terminate on the Severance Date, and (d) the Option,

to the extent exercisable at any time during the 3-year period following the Severance Date and not exercised on or prior to the last day of such period, shall terminate at the close of business on the last day of the 3-year period;

•

if the termination of the Grantee’s employment or services is the result of the Grantee’s death or Total Disability (as defined below), (a) the Option, to the extent not vested on the Severance Date, shall become fully vested as of the Severance Date, (b) the Grantee (or his or her beneficiary or personal representative, as the case may be) will have until the date that is three (3) years after the Grantee’s Severance Date to exercise the Option, and (c) the Option, to the extent exercisable for the three-year period following the Severance Date and not exercised during such period, shall terminate at the close of business on the last day of the three-year period.

For purposes of the Option, “Retirement” means that, as of the Grantee’s Severance Date, the Grantee has either (i) attained age 55 with at least five (5) full years of service with the Company, or (ii) has attained age 60, or (iii) is a participant in and is entitled to commence a benefit under a Company-sponsored defined benefit plan and has at least 10 years of service with the Company. For purposes of the Option, “Total Disability” means a “permanent and total disability” (within the meaning of Section 22(e)(3) of the Code or as otherwise determined by the Committee).

In all events the Option is subject to earlier termination on the Expiration Date of the Option or as contemplated by Section 4.1. The Committee shall be the sole judge of whether the Grantee continues to render employment or services for purposes of this Option Agreement.

5.	Non-Transferability.

The Option and any other rights of the Grantee under this Option Agreement or the Plan are nontransferable and exercisable only by the Grantee, except as set forth in Section 11 of the Plan.

6.	Notices.

Any notice to be given under the terms of this Option Agreement shall be in writing and addressed to Air Group at its principal office to the attention of the Secretary, and to the Grantee at the address last reflected on the Company’s payroll records, or at such other address as either party may hereafter designate in writing to the other. Any such notice shall be delivered in person or shall be enclosed in a properly sealed envelope addressed as aforesaid, registered or certified, and deposited (postage and registry or certification fee prepaid) in a post office or branch post office regularly maintained by the United States Government. Any such notice shall be given only when received, but if the Grantee is no longer employed by the Company, shall be deemed to have been duly given five business days after the date mailed in accordance with the foregoing provisions of this Section 6.

Plan.

The Option and all rights of the Grantee under this Option Agreement are subject to the terms and conditions of the Plan, incorporated herein by this reference. The Grantee agrees to be bound by the terms of the Plan and this Option Agreement. The Grantee acknowledges having read and understanding the Plan, the Prospectus for the Plan, and this Option Agreement. Unless otherwise expressly provided in other sections of this Option Agreement, provisions of the Plan that confer discretionary authority on the Board or the Committee do not and shall not be deemed to create any rights in the Grantee unless such rights are expressly set forth herein or are otherwise in the sole discretion of the Board or the Committee so conferred by appropriate action of the Board or the Committee under the Plan after the date hereof.

8.	Entire Agreement.

This Option Agreement and the Plan together constitute the entire agreement and supersede all prior understandings and agreements, written or oral, of the parties hereto with respect to the subject matter hereof. The Plan and this Option Agreement may be amended pursuant to Section 14 of the Plan. Such amendment must be in writing and signed by Air Group. Air Group may, however, unilaterally waive any provision hereof in writing to the extent such waiver does not adversely affect the interests of the Grantee hereunder, but no such waiver shall operate as or be construed to be a subsequent waiver of the same provision or a waiver of any other provision hereof.

9.	Governing Law.

This Option Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Delaware without regard to conflict of law principles thereunder.

10.

Effect of this Agreement.

Subject to Air Group’s right to terminate the Option pursuant to Section 13 of the Plan, this Option Agreement shall be assumed by, be binding upon and inure to the benefit of any successor or successors to Air Group.

11.

Counterparts.

This Option Agreement may be executed simultaneously in any number of counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument.

12.

Section Headings.

The section headings of this Option Agreement are for convenience of reference only and shall not be deemed to alter or affect any provision hereof.

EXHIBIT A

DEFINITIONS

For purposes of the Option, the following terms shall have the meanings set forth is this Exhibit A.

“Cause” means the occurrence of any of the following:

(i)

the Grantee is convicted of, or has pled guilty or nolo contendere to, a felony (other than traffic related offenses or as a result of vicarious liability); or

(ii)

the Grantee has engaged in acts of fraud, material dishonesty or other acts of willful misconduct in the course of his or her duties to the Company; or

(iii)

the Grantee willfully and repeatedly fails to perform or uphold his or her duties to the Company; or

(iv)

the Grantee willfully fails to comply with reasonable directives of the Board which are communicated to him or her in writing;

provided, however, that no act or omission by the Grantee shall be deemed to be “willful” if the Grantee reasonably believed in good faith that such acts or omissions were in the best interests of the Company.

“Change of Control” means the occurrence of any of the following:

(i)

the consummation of:

(A) any consolidation or merger of Air Group in which Air Group is not the continuing or surviving corporation or pursuant to which shares of common stock of Air Group would be converted into cash, securities or other property, other than a merger of Air Group in which the holders of common stock of Air Group immediately prior to the merger have the same proportionate ownership of common stock of the surviving corporation immediately after the merger; or

(B) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, the assets of Air Group.

(ii)

at any time during a period of twenty-four (24) months, fewer than a majority of the members of the Board are Incumbent Directors. “Incumbent Directors” means (A) individuals who constitute the Board at the beginning of such period; and (B) individuals who were nominated or elected by all of, or a committee composed entirely of, the individuals described in (A); and (C) individuals who were nominated or elected by individuals described in (B).

(iii)

any Person (meaning any individual, entity or group within the meaning of Section 13(d)(3) or 14(d) of the Exchange Act) shall, as a result of a tender or exchange offer, open market purchases, privately-negotiated purchases or otherwise, become the beneficial owner (within the meaning of Rule 13d-3 under the Exchange Act), directly or indirectly, of the then-outstanding securities of Air Group ordinarily (and apart from

rights accruing under special circumstances) having the right to vote in the election of members of the Board (“Voting Securities” to be calculated as provided in paragraph (d) of Rule 13d-3 in the case of rights to acquire common stock of Air Group) representing 20% or more of the combined voting power of the then-outstanding Voting Securities.

(iv)

approval by the stockholders of Air Group of any plan or proposal for the liquidation or dissolution of Air Group.

Unless the Board shall determine otherwise, a Change of Control shall not be deemed to have occurred by reason of any corporate reorganization, merger, consolidation, transfer of assets, liquidating distribution or other transaction entered into solely by and between Air Group and any affiliate thereof, provided such transaction has been approved by at least two-thirds (2/3) of the Incumbent Directors (as defined above) then in office and voting.

Notwithstanding the foregoing, in no event shall a transaction or other event that occurred prior to the date of grant of the Option constitute a Change of Control, and no Change of Control after the first Change of Control to occur after the grant date shall be considered for purposes of the Option.

“Good Reason” means, without the Grantee’s express written consent, the occurrence of any one or more of the following:

(i)

a material reduction in the Grantee’s annual base salary;

(ii)

a material diminution or reduction of the Grantee’s authority, duties, or responsibilities;

(iii)

a material change in the geographic location at which the Grantee must perform services; or

(iv)

any material breach by the Company of any other provision of this Agreement;

provided, however, that any such condition shall not constitute “Good Reason” unless both (x) the Grantee provides written notice to the Company of the condition claimed to constitute Good Reason within ninety (90) days of the initial existence of such condition, and (y) the Company fails to remedy such condition within thirty (30) days of receiving such written notice thereof; and provided, further, that in all events the termination of the Grantee’s employment with the Company shall not be treated as a termination for “Good Reason” unless such termination occurs not more than two (2) years following the initial existence of the condition claimed to constitute “Good Reason.”

Alaska Air Group, Inc. 2004 Long-Term Incentive Plan

Exhibit 10.8.2

ALASKA AIR GROUP, INC.

2004 LONG-TERM INCENTIVE PLAN

STOCK UNIT AWARD AGREEMENT

THIS STOCK UNIT AWARD AGREEMENT (this “Agreement”) dated , by and between ALASKA AIR GROUP, INC., a Delaware corporation (“Air Group”), and (the “Participant”) evidences the award of restricted stock units (the “Award”) granted by Air Group to the Participant as to the number of stock units (the “Stock Units”) first set forth below.


Number of Stock Units¹:		Award Date:

Vesting¹ The Award shall vest and become nonforfeitable with respect to 100% of the total number of Stock Units subject to the Award on the third anniversary of the Award Date.

The Award is granted under the Alaska Air Group, Inc. 2004 Long-Term Incentive Plan (the “Plan”) and subject to the Terms and Conditions of Stock Unit Award (the “Terms”) attached to this Agreement (incorporated herein by this reference) and to the Plan. The Award has been granted to the Participant in addition to, and not in lieu of, any other form of compensation otherwise payable or to be paid to the Participant. Capitalized terms are defined in the Plan if not defined herein. The parties agree to the terms of the Award set forth herein. The Participant acknowledges receipt of a copy of the Terms, the Plan and the Prospectus for the Plan.

The Participant hereby confirms that the Award is granted in consideration for (among other things) the Participant’s entering into that certain Amended and Restated Change of Control Agreement, effective as of [ ], by and between the Participant and Air Group.


GRANTEE						ALASKA AIR GROUP, INC. a Delaware Corporation

						By:
						William S. Ayer
						Chairman, President and CEO

Co-Mail Code

Home Address

City, State, Zip

¹	Subject to adjustment under Section 6 of the Plan.

TERMS AND CONDITIONS OF STOCK UNIT AWARD

1. Stock Units. As used herein, the term “stock unit” shall mean a non-voting unit of measurement which is deemed for bookkeeping purposes to be equivalent to one outstanding share of Air Group’s Common Stock (subject to adjustment as provided in Section 6 of the Plan) solely for purposes of the Plan and this Agreement. The Stock Units shall be used solely as a device for the determination of the payment to eventually be made to the Participant if such Stock Units vest pursuant to this Agreement. The Stock Units shall not be treated as property or as a trust fund of any kind.

2. Vesting; Possible Acceleration. Subject to Section 7 below, the Award shall vest and become nonforfeitable as set forth on the cover page of this Agreement. Notwithstanding any other provision herein or in the Plan, the Award, to the extent not then vested, shall become fully vested if (i) the Participant’s employment with the Company is terminated by the Company without Cause or by the Participant for Good Reason, and (ii) such termination occurs at any time within the period commencing six (6) months before a Change of Control and ending twenty-four (24) months after such Change of Control. (For these purposes, the terms “Cause,” “Change of Control” and “Good Reason” shall have the meanings ascribed to them in Exhibit A attached hereto.) In the event that, upon the occurrence of a Change of Control, the Participant is entitled to accelerated vesting of the Award pursuant to this Section 2 in connection with a termination of the Participant’s employment prior to such Change of Control, the Award, to the extent it had not vested and was cancelled or otherwise terminated upon or prior to the date of such Change of Control solely as a result of such termination of employment, shall be reinstated and shall automatically become fully vested.

3. Continuance of Employment. The vesting schedule requires continued employment or service through each applicable vesting date as a condition to the vesting of the applicable installment of the Award and the rights and benefits under this Agreement. Employment or service for only a portion of the vesting period, even if a substantial portion, will not entitle the Participant to any proportionate vesting or avoid or mitigate a termination of rights and benefits upon or following a termination of employment or services as provided in Section 7 below or under the Plan.

Nothing contained in this Agreement or the Plan constitutes an employment or service commitment by Air Group, affects the Participant’s status as an employee at will who is subject to termination without cause, confers upon the Participant any right to remain employed by or in service to the Company, interferes in any way with the right of the Company at any time to terminate such employment or services, or affects the right of the Company to increase or decrease the Participant’s other compensation or benefits. Nothing in this paragraph, however, is intended to adversely affect any independent contractual right of the Participant without his or her consent thereto.

4. Limitations on Rights Associated with Units. The Participant shall have no rights as a stockholder of Air Group, no dividend rights and no voting rights, with respect to the Stock Units and any shares of Common Stock underlying or issuable in respect of such Stock Units until such shares of Common Stock are actually issued to and held of record by the Participant. No adjustments will be made for dividends or other rights of a holder for which the record date is prior to the date of issuance of the stock certificate.

5. Restrictions on Transfer. Neither the Award, nor any interest therein or amount or shares payable in respect thereof may be sold, assigned, transferred, pledged or otherwise disposed of, alienated or encumbered, either voluntarily or involuntarily. The transfer restrictions in the preceding sentence shall not apply to (a) transfers to Air Group, or (b) transfers by will or the laws of descent and distribution.

6. Timing and Manner of Payment of Stock Units. On or as soon as administratively practical following each vesting of the applicable portion of the total Award pursuant to the terms hereof (and in all events within two and one-half months after such vesting event), Air Group shall deliver to the Participant a number of shares of Common Stock (either by delivering one or more certificates for such shares or by entering such shares in book entry form, as determined by Air Group in its discretion) equal to the number of Stock Units subject to this Award that vest on the applicable vesting date, unless such Stock Units terminate prior to the given vesting date pursuant to Section 7. Air Group’s obligation to deliver shares of Common Stock or otherwise make payment with respect to vested Stock Units is subject to the condition precedent that the Participant or other person entitled under the Plan to receive any shares with respect to the vested Stock Units deliver to Air Group any representations or other documents or assurances that the Committee may deem necessary or desirable to assure compliance with all applicable legal and accounting requirements. The Participant shall have no further rights with respect to any Stock Units that are paid or that terminate pursuant to Section 7.

7. Effect of Termination of Employment. The Participant’s Stock Units shall terminate to the extent such units have not become vested prior to the first date the Participant is no longer employed by the Company, regardless of the reason for the termination of the Participant’s employment with the Company; provided, however, that (i) if the Participant’s employment terminates as a result of the Participant’s death or Total Disability (as defined below), the Participant’s Stock Units, to the extent such units are not then vested, shall become fully vested as of the date of termination of the Participant’s employment and shall be paid in accordance with Section 6; and (ii) if the Participant’s employment terminates as a result of the Participant’s Retirement (as defined below), the Participant’s Stock Units, to the extent such units are not then vested and were scheduled to vest within the three-year period following the date of such termination, shall become fully vested as of the date of such termination and shall be paid in accordance with Section 6 on or as soon as practicable after the date such Stock Units would have otherwise vested pursuant to the original vesting schedule as provided herein had the Participant’s employment not terminated. If any unvested Stock Units are terminated hereunder, such Stock Units shall automatically terminate and be cancelled as of the applicable termination date without payment of any consideration by Air Group and without any other action by the Participant, or the Participant’s beneficiary or personal representative, as the case may be.

For purposes of this Agreement, “Total Disability” means a “permanent and total disability” (within the meaning of Section 22(e)(3) of the Code or as otherwise determined by the Committee). For purposes of this Agreement, “Retirement” means that, as of the date of the termination of the Participant’s employment with the Company, the Participant has either (i) attained age 55 with at least five (5) full years of service with the Company, or (ii) has attained age 60, or (iii) is a participant in and is entitled to commence a benefit under a Company-sponsored defined benefit plan and has at least 10 years of service with the Company.

8. Adjustments Upon Specified Events. The Committee may accelerate payment and vesting of the Stock Units in such circumstances as it, in its sole discretion, may determine. In addition, upon the occurrence of certain events relating to Air Group’s stock contemplated by Section 6 of the Plan (including, without limitation, an extraordinary cash dividend on such stock), the Committee shall make adjustments in accordance with such section in the number of Stock Units then outstanding and the number and kind of securities that may be issued in respect of the Award. No such adjustment shall be made with respect to any ordinary cash dividend paid on the Common Stock.

9. Tax Withholding. Subject to Section 19 of the Plan, upon any distribution of shares of Common Stock in respect of the Stock Units, Air Group shall automatically reduce the number of shares to be delivered by (or otherwise reacquire) the appropriate number of whole shares, valued at their then Fair Market Value (determined in accordance with the applicable provisions of the Plan), to satisfy any

withholding obligations of the Company with respect to such distribution of shares at the minimum applicable withholding rates. In the event that Air Group cannot legally satisfy such withholding obligations by such reduction of shares, or in the event of a cash payment or any other withholding event in respect of the Stock Units, the Company shall be entitled to require a cash payment by or on behalf of the Participant and/or to deduct from other compensation payable to the Participant any sums required by federal, state or local tax law to be withheld with respect to such distribution or payment.

10. Notices. Any notice to be given under the terms of this Agreement shall be in writing and addressed to Air Group at its principal office to the attention of the Secretary, and to the Participant at the Participant’s last address reflected on Air Group’s records, or at such other address as either party may hereafter designate in writing to the other. Any such notice shall be given only when received, but if the Participant is no longer an employee of the Company, shall be deemed to have been duly given by Air Group when enclosed in a properly sealed envelope addressed as aforesaid, registered or certified, and deposited (postage and registry or certification fee prepaid) in a post office or branch post office regularly maintained by the United States Government.

11. Plan. The Award and all rights of the Participant under this Agreement are subject to the terms and conditions of the provisions of the Plan, incorporated herein by reference. The Participant agrees to be bound by the terms of the Plan and this Agreement. The Participant acknowledges having read and understanding the Plan, the Prospectus for the Plan, and this Agreement. Unless otherwise expressly provided in other sections of this Agreement, provisions of the Plan that confer discretionary authority on the Board or the Committee do not (and shall not be deemed to) create any rights in the Participant unless such rights are expressly set forth herein or are otherwise in the sole discretion of the Board or the Committee so conferred by appropriate action of the Board or the Committee under the Plan after the date hereof.

12. Entire Agreement. This Agreement and the Plan together constitute the entire agreement and supersede all prior understandings and agreements, written or oral, of the parties hereto with respect to the subject matter hereof. The Plan and this Agreement may be amended pursuant to Section 14 of the Plan. Such amendment must be in writing and signed by Air Group. Air Group may, however, unilaterally waive any provision hereof in writing to the extent such waiver does not adversely affect the interests of the Participant hereunder, but no such waiver shall operate as or be construed to be a subsequent waiver of the same provision or a waiver of any other provision hereof.

13. Limitation on Participant’s Rights. Participation in the Plan confers no rights or interests other than as herein provided. This Agreement creates only a contractual obligation on the part of Air Group as to amounts payable and shall not be construed as creating a trust. Neither the Plan nor any underlying program, in and of itself, has any assets. The Participant shall have only the rights of a general unsecured creditor of Air Group with respect to amounts credited and benefits payable, if any, with respect to the Stock Units, and rights no greater than the right to receive the Common Stock as a general unsecured creditor with respect to Stock Units, as and when payable hereunder.

14. Counterparts. This Agreement may be executed simultaneously in any number of counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument.

15. Section Headings. The section headings of this Agreement are for convenience of reference only and shall not be deemed to alter or affect any provision hereof.

16. Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Delaware without regard to conflict of law principles thereunder.

17. Construction. It is intended that the terms of the Award will not result in the imposition of any tax liability pursuant to Section 409A of the Code. This Agreement shall be construed and interpreted consistent with that intent.

EXHIBIT A

DEFINITIONS

For purposes of the Award, the following terms shall have the meanings set forth is this Exhibit A.

“Cause” means the occurrence of any of the following:

(i)

the Participant is convicted of, or has pled guilty or nolo contendere to, a felony (other than traffic related offenses or as a result of vicarious liability); or

(ii)

the Participant has engaged in acts of fraud, material dishonesty or other acts of willful misconduct in the course of his or her duties to the Company; or

(iii)

the Participant willfully and repeatedly fails to perform or uphold his or her duties to the Company; or

(iv)

the Participant willfully fails to comply with reasonable directives of the Board which are communicated to him or her in writing;

provided, however, that no act or omission by the Participant shall be deemed to be “willful” if the Participant reasonably believed in good faith that such acts or omissions were in the best interests of the Company.

“Change of Control” means the occurrence of any of the following:

(i)

the consummation of:

(B) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, the assets of Air Group.

(ii)

(iii)

(iv)

approval by the stockholders of Air Group of any plan or proposal for the liquidation or dissolution of Air Group.

Notwithstanding the foregoing, in no event shall a transaction or other event that occurred prior to the date of grant of the Award constitute a Change of Control, and no Change of Control after the first Change of Control to occur after the grant date shall be considered for purposes of the Award.

“Good Reason” means, without the Participant’s express written consent, the occurrence of any one or more of the following:

(i)

a material reduction in the Participant’s annual base salary;

(ii)

a material diminution or reduction of the Participant’s authority, duties, or responsibilities;

(iii)

a material change in the geographic location at which the Participant must perform services; or

(iv)

any material breach by the Company of any other provision of this Agreement;

provided, however, that any such condition shall not constitute “Good Reason” unless both (x) the Participant provides written notice to the Company of the condition claimed to constitute Good Reason within ninety (90) days of the initial existence of such condition, and (y) the Company fails to remedy such condition within thirty (30) days of receiving such written notice thereof; and provided, further, that in all events the termination of the Participant’s employment with the Company shall not be treated as a termination for “Good Reason” unless such termination occurs not more than two (2) years following the initial existence of the condition claimed to constitute “Good Reason.”

Form of Alaska Air Group, Inc. Change of Control Agreement

Exhibit 10.16

Amended and Restated

Change Of Control Agreement

THIS CHANGE OF CONTROL AGREEMENT (this “Agreement”) by and between Alaska Air Group, Inc., a Delaware corporation (“Air Group”), and NAME (the “Executive”) is hereby amended and restated effective as of the DATE day of MONTH, YEAR. Except as expressly noted herein, the provisions hereof shall be effective as of such date.

The Board of Directors (the “Board”) of Air Group has determined that it is in the best interests of Air Group and its stockholders to ensure that Air Group and its subsidiaries will have the continued dedication of the Executive, notwithstanding the possibility, threat or occurrence of a Change of Control (as defined in Section 2). The Board believes that it is imperative to diminish the inevitable distraction of the Executive by virtue of the personal uncertainties and risks created by a pending or threatened Change of Control and to encourage the Executive’s full attention and dedication to Air Group currently and in the event of any threatened or pending Change of Control, and to provide the Executive with compensation and benefits arrangements upon a Change of Control that ensure that the compensation and benefits expectations of the Executive will be satisfied, are competitive with those of other corporations, and align the Executive’s interests with those of Air Group’s stockholders. Therefore, in order to accomplish these objectives, the Board has caused Air Group to enter into this Agreement.

NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:

1.	Certain Definitions

(a) “Accrued Obligations” is defined in Section 6(a)(i).

(b) “affiliated company” means any company controlled by, controlling or under common control with Air Group.

(d) “Annual Bonus” is defined in Section 4(b)(ii).

(e) “Business Combination” means (i) a reorganization, exchange of securities, merger or consolidation involving Air Group or (ii) the sale or other disposition of all or substantially all the assets of Air Group.

(f) The “Change of Control Period” means the period commencing on the date hereof and ending on the third anniversary of the date that Air Group gives notice to the Executive that the Change of Control Period shall be terminated.

(g) “Cause” means basis for termination for reason of admission by the Executive or substantiation by the Employer of:

(i)

embezzlement, dishonesty or other fraud, conviction of a felony or conspiracy against the Employer; or

(ii)

if prior to a Change of Control, any willful or intentional injury to either the Employer, its property, or its employees in connection with the business affairs of the Employer.

(h) “Code” means the Internal Revenue Code of 1986, as amended.

(i) “Effective Date” means the first date during the Change of Control Period on which a Change of Control occurs. Anything in this Agreement to the contrary notwithstanding, if a Change of Control occurs and if the Executive’s employment with the Employer is terminated prior to the date on which the Change of Control occurs, and if it is reasonably demonstrated by the Executive that such termination of employment (i) was at the request of a third party who has taken steps reasonably calculated to effect the Change of Control or (ii) otherwise arose in connection with or anticipation of the Change of Control, then for all purposes of this Agreement the “Effective Date” shall mean the date immediately prior to the date of such termination of employment.

(j) “Employer” means, collectively, Air Group and any of its subsidiaries that employs the Executive.

(k) “Employment Period” is defined in Section 3.

(l) “Exchange Act” means the Securities Exchange Act of 1934, as amended.

(m) “Good Reason Separation” means the Executive’s voluntary Separation from Service within two years after the occurrence without the Executive’s consent of one or more of the following events:

(i)

the material reduction in the Executive’s annual base salary;

(ii)

the material diminution or reduction of the Executive’s authority, duties, or responsibilities;

(iii)

a material change in the geographic location at which the Executive must perform services; or

(iv)

any material breach by the Employer of any other provision of this Agreement;

provided, however, that an Executive shall not be entitled to a Good Reason Separation unless the Executive shall have furnished written notice to the Employer of the condition claimed to constitute the basis for the Good Reason Separation within 90 days of the initial existence of such condition, and the Employer shall have not remedied such condition within a period of 30 days after its receipt of such notice from the Executive.

(n) “Incentive Plan” means Air Group’s Management Incentive Plan.

(o) “Incumbent Director” means a member of the Board who has been either (i) nominated by a majority of the directors of Air Group then in office or (ii) appointed by directors so nominated, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of either an actual or threatened election contest (as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Exchange Act) or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board.

(p) “Notice of Termination” is defined in Section 5(a).

(q) “Person” means any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d) of the Exchange Act).

(r) “Recent Average Bonus” is defined in Section 4(b)(ii).

(s) “Retirement Plan” means the Employer’s funded pension plan or any successor plan thereto.

(t) “Separation from Service” (and its derivatives, such as “Separates from Service”) means a termination of services provided by the Executive to the Employer, whether such termination of services is voluntary or involuntary, as determined by the Board in accordance with Section 409A of the Code and Treasury Regulation Section 1.409A-1(h).

(u) “Welfare Benefit Continuation” is defined in Section 6(b).

2.	Change of Control

For the purpose of this Agreement, a “Change of Control” means the occurrence of any of the following:

(a) the consummation of:

(i)

any consolidation or merger of Air Group in which Air Group is not the continuing or surviving corporation or pursuant to which shares of common stock of Air Group would be converted into cash, securities or other property, other than a merger of Air Group in which the holders of common stock of Air Group immediately prior to the merger have the same proportionate ownership of common stock of the surviving corporation immediately after the merger; or

(ii)

any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, the assets of Air Group.

(b) at any time during a period of twenty-four (24) months, fewer than a majority of the members of the Board are Incumbent Directors. “Incumbent Directors” means:

(i)

individuals who constitute the Board at the beginning of such period; and

(ii)

individuals who were nominated or elected by all of, or a committee composed entirely of, the individuals described in (i); and

(iii)

individuals who were nominated or elected by individuals described in (ii).

(c) any Person shall, as a result of a tender or exchange offer, open market purchases, privately-negotiated purchases or otherwise, become the beneficial owner (within the meaning of Rule 13d-3 under the Exchange Act), directly or indirectly, of the then-outstanding securities of Air Group ordinarily (and apart from rights accruing under special circumstances) having the right to vote in the election of members of the Board (“Voting Securities” to be calculated as provided in paragraph (d) of Rule 13d-3 in the case of rights to acquire common stock of Air Group) representing 20% or more of the combined voting power of the then-outstanding Voting Securities.

(d) approval by the stockholders of Air Group of any plan or proposal for the liquidation or dissolution of Air Group.

Unless the Board shall determine otherwise, a Change of Control shall not be deemed to have occurred by reason of any corporate reorganization, merger, consolidation, transfer of assets, liquidating distribution or other transaction entered into solely by and between Air Group and any Affiliate thereof, provided such transaction has been approved by at least two-thirds (2/3) of the Incumbent Directors (as defined above) then in office and voting.

3.	Employment Period

Air Group hereby agrees to continue the Executive in its employ, and the Executive hereby agrees to remain in the employ of Air Group, in accordance with the terms and provisions of this Agreement, for the period commencing on the Effective Date and ending on the third anniversary of such date (the “Employment Period”), in an executive capacity, responsible for, among other things, duties associated with such capacity, and, subject to the general supervision of the Board as required by the Delaware General Corporation Law, such other duties and responsibilities as are not inconsistent with the express terms of this Agreement. Such employment may be with Air Group or any of its principal operating subsidiaries, as appropriate to the management structure developed by Air Group. Air Group agrees that it will not take any action, or make any demands on the Executive, that may be deemed to arbitrarily, unreasonably or unnecessarily interfere with the performance of the services to be rendered by the Executive hereunder.

Prior to the Effective Date, the Executive’s employment with the Employer is at will.

4.	Terms of Employment

(a) Position and Duties.

(i) During the Employment Period, (A) the Executive’s position (including status, offices, titles and reporting requirements), authority, duties and responsibilities shall be in accordance with Section 3 and (B) the Executive’s services shall be performed within the metropolitan area in which the Executive was situated immediately prior to the Effective Date, except for required travel in the Employer business to the extent consistent with the Executive’s duties in Section 3.

(ii) During the Employment Period, and excluding any periods of vacation and sick leave to which the Executive is entitled, the Executive agrees to devote reasonable attention and time during normal business hours to the business and affairs of the Employer and, to the extent necessary to discharge the responsibilities assigned to the Executive hereunder, to use the Executive’s reasonable best efforts to perform faithfully and efficiently such responsibilities. During the Employment Period it shall not be a violation of this Agreement for the Executive to (A) serve on corporate, civic or charitable boards or committees, (B) deliver lectures, fulfill speaking engagements or teach at educational institutions, or (C) manage personal investments, so long as such activities do not significantly interfere with the performance of the Executive’s responsibilities as an employee of the Employer in accordance with this Agreement. It is expressly understood and agreed that to the extent that any such activities have been conducted by the Executive prior to the Effective Date, the continued conduct of such activities (or the conduct of activities similar in nature and scope thereto) subsequent to the Effective Date shall not thereafter be deemed to interfere with the performance of the Executive’s responsibilities to the Employer.

(b) Compensation.

(i) Base Salary. During the Employment Period, the Executive shall receive an annual base salary (“Annual Base Salary”), which shall be paid in equal installments in accordance with the regular payroll schedule applicable to similarly-situated executives, at least equal to 12 times the highest monthly base salary paid or payable to the Executive by the Employer in respect of the 12-month period immediately preceding the month in which the Effective Date occurs. For purposes of this Agreement, Annual Base Salary shall not include any payments by the Employer on the Executive’s behalf pursuant to any incentive, savings or retirement plans, any welfare benefit plans or any fringe benefit plans, in each case, of the Employer or any affiliated company, of the type identified in paragraphs (iii) through (vi) of this Section 4(b), or any reimbursement of expenses by the Employer or any affiliated company in accordance with paragraph (v) of this Section 4(b), but shall include vacation pay in accordance with paragraph (viii) of this Section 4(b). During the Employment Period, the Annual Base Salary shall be reviewed at least annually and shall be increased at any time and from time to time as shall be substantially consistent with increases in base salary generally awarded in the ordinary course of business to other peer executives of the Employer and any affiliated companies. Any increase in Annual Base Salary shall not serve to limit or reduce any other obligation to the Executive under this Agreement. Annual Base Salary shall not be reduced after any such increase, and the term Annual Base Salary as utilized in this Agreement shall refer to Annual Base Salary as so increased.

(ii) Annual Bonus. In addition to Annual Base Salary, the Executive shall be awarded, for each fiscal year ending during the Employment Period, an annual bonus (the “Annual Bonus”) in cash at least equal to the greater of (A) the Executive’s target annual bonus (annualized if such target bonus is based on a period of less than 12 full months) in effect on the Effective Date and (B) the average annualized (for any fiscal year consisting of less than 12 full months or with respect to which the Executive has been employed by the Employer for less than 12 full months) bonus paid or payable, including by reason of any deferral, to the Executive by the Employer in respect of the three fiscal years immediately preceding the fiscal year in which the Effective Date occurs (the “Recent Average Bonus”). Each such Annual Bonus shall be paid between January 1 and March 15 of the year next following the fiscal year for which the Annual Bonus is awarded, unless the Executive shall elect, pursuant to the terms of the AAGI Nonqualified Deferred Compensation Plan (or any successor to that plan), to defer the receipt of such Annual Bonus.

(iii) Incentive, Savings and Retirement Plans. During the Employment Period, the Executive shall be entitled to participate in all incentive, savings and retirement plans, practices, policies and programs applicable generally to other peer executives of the Employer, but in no event shall such plans, practices, policies and programs provide the Executive with incentive opportunities (measured with respect to both regular and special incentive opportunities, to the extent, if any, that such distinction is applicable), savings opportunities and retirement benefit opportunities, in each case, that are less favorable, in the aggregate, than the most favorable of those provided by the Employer for the Executive under such plans, practices, policies and programs as in effect at any time during the 90-day period immediately preceding the Effective Date or, if more favorable to the Executive, those provided generally at any time after the Effective Date to other peer executives of the Employer.

(iv) Welfare Benefit Plans. During the Employment Period, the Executive and/or the Executive’s family, as the case may be, shall be eligible for participation in and shall receive all benefits under welfare benefit plans, practices, policies and programs provided by the Employer (including, without limitation, medical, prescription, dental, disability, salary continuance, employee life, group life, accidental death and travel accident insurance plans and programs) to the extent applicable generally to other peer executives of the Employer, but in no event shall such plans, practices, policies and programs provide the Executive with benefits that are less favorable, in the aggregate, than the most favorable of such plans, practices, policies and programs in effect for the Executive at any time during the 90-day period immediately preceding the Effective Date or, if more favorable to the Executive, those provided generally at any time after the Effective Date to other peer executives of the Employer.

(v) Expenses. During the Employment Period, the Executive shall be entitled to reimbursement promptly, but in no event later than the end of the calendar year following the year in which the expense is incurred, for all reasonable employment expenses incurred by the Executive in accordance with the most favorable policies, practices and procedures of the Employer in effect for the Executive at any time during the 90-day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally at any time thereafter with respect to other peer executives of the Employer.

(vi) Fringe Benefits. During the Employment Period, the Executive shall be entitled to fringe benefits in accordance with the most favorable plans, practices, programs and policies of the Employer in effect for the Executive at any time during the 90-day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally at any time thereafter with respect to other peer executives of the Employer. To the extent that a plan, practice, program, or policy provides for the reimbursement of the Executive’s expenses, such reimbursements shall be made promptly, but in no event later than the end of the calendar year following the year in which the expense is incurred.

(vii) Vacation. During the Employment Period, the Executive shall be entitled to paid vacation in accordance with the most favorable plans, policies, programs and practices of the Employer as in effect for the Executive at any time during the 90-day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally at any time thereafter with respect to other peer executives of the Employer.

5.	Termination of Employment

(a) Termination. The Executive’s employment shall terminate automatically upon the Executive’s death during the Employment Period. The Executive’s employment may be terminated at any time during the Employment Period for any reason by either the Executive or by the Employer, communicated by a notice of termination to the other party hereto given in accordance with Section 12(b) (a “Notice of Termination”).

(b) Date of Termination. “Date of Termination” means (i) if the Executive’s employment is terminated by the Employer or by the Executive, the date of receipt of the Notice of Termination or any later date specified therein, as the case may be, and (ii) if the Executive’s employment is terminated by reason of death, the date of death of the Executive.

6.	Obligations of the Employer Upon Certain Terminations; Release

If the Executive’s employment is terminated during the Employment Period by the Executive in a Good Reason Separation or by the Employer without Cause, and such termination constitutes a Separation from Service:

(a) the Employer shall pay to the Executive in a lump sum in cash the aggregate of the following amounts:

(i) A lump sum amount equal to all payments to which the Executive would have been entitled during the Employment Period, but for the Separation from Service, including, without limitation, the aggregate amounts of the Executive’s Annual Base Salary (calculated in accordance with Section 4(b)(i) hereof) and the aggregate amounts of the Executive’s Annual Bonus (calculated in accordance with Section 4(b)(ii) hereof), payable in each case during the Employment Period, less any amounts comprising any portion of Annual Base Salary or Annual Bonus actually received by the Executive during the period commencing on the Effective Date and ending on the date of such Separation from Service.

(ii) A separate lump sum supplemental retirement benefit equal to the difference between (1) the actuarial equivalent (utilizing for this purpose the actuarial assumptions utilized with respect to the Employer defined benefit retirement plan during the 90-day period immediately preceding the Effective Date) of the benefits payable under the Employer defined benefit retirement plans, the 1995 Elected Officers’ Supplementary Retirement Plan (or if applicable to the Executive the Defined Contribution OSRP Plan feature of the AAGI Nonqualified Deferred Compensation Plan) and any similar plans (other than the deferred bonus or deferred retention incentive features of the AAGI Nonqualified Deferred Compensation Plan) providing benefits for the Executive that the Executive would receive if the Executive’s employment continued at the compensation level provided for in Section 4(b) and for the remainder of the Employment Period (assuming for this purpose that all accrued benefits are fully vested and that benefit accrual formulas are no less advantageous to the Executive than those in effect during the 90-day period immediately preceding the Effective Date), and (2) the actuarial equivalent (utilizing for this purpose the same assumptions as outlined above) of the Executive’s actual benefit paid (or payable), if any, under the foregoing plans; and

(b) for the remainder of the Employment Period, or such longer period as any plan, program, practice or policy may provide, the Employer shall continue benefits to the Executive and/or the Executive’s family at least equal to those that would have been provided to them in accordance with the plans, programs, practices and policies described in Sections 4(b)(iv) if the Executive had not incurred a Separation from Service in accordance with the most favorable plans, practices, programs or policies of the Employer as in effect and applicable generally to other executives and their families during the 90-day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally at any time thereafter with respect to other peer executives of the Employer and their families; provided, however, that if the Executive becomes reemployed with another employer and is eligible to receive medical or other welfare benefits under another employer-provided plan, the medical and other welfare benefits described herein shall be secondary to those provided under such other plan during such applicable period of eligibility (such continuation of such benefits for the applicable period herein set forth shall be hereinafter referred to as “Welfare Benefit Continuation”). For purposes of determining eligibility of the Executive for retiree benefits pursuant to such plans, practices, programs and policies, the Executive shall be considered to have remained employed until the end of the Employment Period and to have retired on the last day of such period; provided, however, that the Executive shall be entitled to the more favorable of the retiree benefits in effect on the date of the Executive’s Separation from Service or the retiree benefits in effect on the date that would have been the last date of the Employment Period if the Executive had remained employed. Notwithstanding anything in this Section 6(b) to the contrary, in no event shall any health care benefit (whether for medical, dental, or vision care) that is subject to Code Section 409A be continued for a period longer than 18 months after the date of the Executive’s Separation from Service;

(c) to the extent not theretofore paid or provided, the Employer shall timely pay or provide to the Executive and/or the Executive’s family any other amounts or benefits required to be paid or provided or which the Executive and/or the Executive’s family is eligible to receive pursuant to Section 4(b)(v) and (vi) of this Agreement under any plan, program, policy or practice or contract or agreement of the Employer as in effect and applicable generally to other peer executives and their families during the 90-day period immediately preceding the Effective Date or, if more favorable to the Executive, as in effect generally thereafter with respect to other peer executives of the Employer and their families (such other amounts and benefits shall be hereinafter referred to as the “Other Benefits”). Notwithstanding anything in this Section 6(c) to the contrary, in no event shall any Other Benefit be paid to the extent that such payment would trigger any additional tax, penalty or interest imposed by Code Section 409A.

(d) Release. Notwithstanding anything else contained in this Agreement to the contrary, as a condition precedent to any Employer obligation to the Executive pursuant to this Section 6, the Executive shall, upon or promptly following his or her Separation from Service with the Employer, provide the Employer with a valid, executed general release agreement in substantially the form attached hereto as Exhibit A, and such release agreement shall have not been revoked by the Executive pursuant to any revocation rights afforded by applicable law; provided, however, that this release requirement shall not apply unless the Effective Date of this Agreement occurs on or after January 1, 2011. The Employer shall have no obligation to make any payment to the Executive pursuant to this Section 6 unless and until the release agreement contemplated by this Section 6(d) becomes irrevocable by the Executive in accordance with all applicable laws, rules and regulations.

(e) Timing of Payment. The lump sum amount specified in Section 6(a) above shall be paid upon or as soon as practicable after (and in all events within two and one-half months after) the date of the Executive’s Separation from Service; provided, however, that if the Employer’s obligation to make such payment is subject to the release requirement set forth in Section 6(d), such payment shall be made in the second calendar month following the month in which the Separation from Service occurs.

7.	Nonexclusivity of Rights

Nothing in this Agreement shall prevent or limit the Executive’s continuing or future participation in any plan, program, policy or practice provided by the Employer and for which the Executive may qualify, nor shall anything herein limit or otherwise affect such rights as the Executive may have under any contract or agreement with the Employer. Amounts that are vested benefits or that the Executive is otherwise entitled to receive under any plan, policy, practice or program of or any contract or agreement with the Employer or any of its affiliated companies at or subsequent to the Date of Termination shall be payable in accordance with such plan, policy, practice or program or contract or agreement except as explicitly modified by this Agreement.

8.	Full Settlement; Resolution of Disputes

(a) The Employer obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action that the Employer may have against the Executive or others. In no event shall the Executive be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Executive under any of the provisions of this Agreement, and, except as provided in Section 6(b), such amounts shall not be reduced whether or not the Executive obtains other employment. The Employer agrees to pay promptly upon invoice, to the full extent permitted by law, all legal fees and expenses that the Executive may incur as a result of any contest (regardless of the outcome thereof) by the Employer, the Executive or others of the validity or enforceability of, or liability under, any provision of this Agreement or any guarantee of performance thereof (including as a result of any contest by the Executive about the amount of any payment pursuant to this Agreement).

(b) If there shall be any dispute between the Employer and the Executive (i) in the event of any termination of the Executive’s employment by the Employer, whether such termination was in connection with or in anticipation of a Change of Control so as to trigger the Effective Date under Section 1(i), then, unless and until there is a final, nonappealable judgment by a court of competent jurisdiction declaring that such termination was in connection with or in anticipation of a Change of Control, the Employer shall pay all amounts, and provide all benefits, to the Executive and/or the Executive’s family or other beneficiaries, as the case may be, that the Employer would be required to pay or provide pursuant to Section 6 as though such termination were in connection with or in anticipation of a Change of Control; provided, however, that the Employer shall not be required to pay any disputed amounts pursuant to this Section 8(b) except upon receipt of an undertaking by or on behalf of the Executive to repay all such amounts to which the Executive is ultimately adjudged by such court not to be entitled.

9.	Certain Adjustments

(a) In the event that the Effective Date of this Agreement occurs before January 1, 2011, the Executive becomes entitled to the payments or other benefits described in Section 6 hereof and the Executive becomes subject to the tax imposed by Section 4999 of the Code or any successor provision (the “Excise Tax”) as a result of such payments and benefits and any other payments or benefits from the Employer required to be taken into account under Code Section 280G(b)(2) (collectively, “Parachute Payments”), the Employer shall pay to Executive an additional amount (the “Make-Whole Payment”) equal to the sum of (i) the Excise Tax payable to the Executive prior to the Make-Whole Payment and (ii) the Federal, state and local income tax and Excise Tax (including any interest or penalties thereon) payable upon all payments made under subparagraphs (i) and (ii) of this Section 9(a). The amount provided for in this Section 9(a) shall be paid as soon as it is administratively practicable for the Employer to determine such amount, but no later than the end of the calendar year next following the year in which the Executive remits the applicable taxes.

(b) In the event that the Effective Date of this Agreement occurs on or after January 1, 2011 and the Executive becomes entitled to any Parachute Payments, the Employer shall pay to the Executive a Make-Whole Payment in the amount and at the time determined in accordance with Section 9(a); provided, however, that if a reduction in the amount of the Parachute Payments by an amount up to but not in excess of ten percent (10%) of the amount of the Parachute Payments would avoid the imputation of any Excise Tax on the remaining Parachute Payments (after such reduction), then the Parachute Payments shall be reduced (but not below zero) so that the maximum amount of the Parachute Payments (after reduction) shall be one dollar ($1.00) less than the amount which would cause the Parachute Payments to be subject to the Excise Tax. Unless the Executive shall have given prior written notice to Air Group to effectuate a reduction in the Parachute Payments if such a reduction is required, Air Group shall reduce or eliminate the Parachute Payments by first reducing or eliminating any cash severance benefits, then by reducing or eliminating any accelerated vesting of stock options, then by reducing or eliminating any accelerated vesting of other equity-based awards, then by reducing or eliminating any other remaining Parachute Payments. The preceding provisions of this Section 9(b) shall take precedence over the provisions of any other plan, arrangement or agreement governing the Executive’s rights and entitlements to any benefits or compensation.

(c) All determinations required to be made under this Section 9, including whether the Executive has received a Parachute Payment, shall be made by KPMG LLP (the “Accounting Firm”) which shall provide detailed supporting calculations to both the Employer and the Executive within 15 business days of the receipt of notice from the Executive that the Executive has received a payment under Section 6, or such earlier time as is requested by the Employer. In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting the Change of Control, the Executive shall appoint another nationally recognized accounting firm to make the determinations required hereunder (which accounting firm shall then be referred to as the Accounting Firm hereunder). All fees and expenses of the Accounting Firm shall be borne solely by the Employer. If the Accounting Firm determines that no Excise Tax is payable by the Executive, it shall furnish the Executive with a written opinion that failure to report the Excise Tax on the Executive’s applicable federal income tax return would not result in the imposition of a negligence or similar penalty. Any determination by the Accounting Firm shall be binding upon the Employer and the Executive.

10.

Confidential Information

The Executive shall hold in a fiduciary capacity for the benefit of the Employer all secret or confidential information, knowledge or data relating to the Employer or any of its affiliated companies, and their respective businesses, that shall have been obtained by the Executive during the Executive’s employment by the Employer or any of its affiliated companies and that shall not be or become public knowledge (other than by acts by the Executive or representatives of the Executive in violation of this Agreement). After termination of the Executive’s employment with the Employer, the Executive shall not, without the prior written consent of the Employer or as may otherwise be required by law or legal process, communicate or divulge any such information, knowledge or data to anyone other than the Employer and those designated by it. In no event shall an asserted violation of the provisions of this Section 10 constitute a basis for deferring or withholding any amounts otherwise payable to the Executive under this Agreement.

11.

Successors

(a) This Agreement is personal to the Executive and without the prior written consent of the Employer shall not be assignable by the Executive otherwise than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by the Executive’s legal representatives.

(b) This Agreement shall inure to the benefit of and be binding on the Employer and its successors and assigns.

(c) The Employer will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all the business and/or assets of the Employer to assume expressly and agree to perform this Agreement in the same manner and to the same extent that the Employer would be required to perform it if no such succession had taken place. As used in this Agreement, Employer shall mean the Employer as hereinbefore defined and any successor to its business and/or assets as aforesaid that assumes and agrees to perform this Agreement by operation of law, or otherwise.

12.

Miscellaneous

(a) This Agreement shall be governed by and construed in accordance with the laws of the state of Washington, without reference to principles of conflict of laws. The captions of this Agreement are not part of the provisions hereof and shall have no force or effect. This Agreement may not be amended or modified otherwise than by a written agreement executed by the parties hereto or their respective successors and legal representatives.

(b) All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows:

If to the Executive:

_____________________________

If to Air Group:

Alaska Air Group, Inc.

P.O. Box 68947

Seattle, WA 98168

Attention: Corporate Secretary

or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee.

(c) The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement.

(d) The Employer may withhold from any amounts payable under this Agreement such federal, state or local taxes as shall be required to be withheld pursuant to any applicable law or regulation.

(e) The Executive’s or the Employer’s failure to insist on strict compliance with any provision hereof or any other provision of this Agreement or the failure to assert any right the Executive or the Employer may have hereunder, shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement.

(f) The Executive and the Employer acknowledge that, except as may otherwise be provided under any other written agreement between the Executive and the Employer, the employment of the Executive by the Employer is “at will” and, prior to the Effective Date, may be terminated by either the Executive or the Employer at any time. Moreover, if prior to the Effective Date, the Executive’s employment with the Employer terminates, then the Executive shall have no further rights under this Agreement.

(g) This Agreement may be executed in counterparts, each of which counterparts shall be deemed an original, but all of which together shall constitute one and the same instrument.

(h) Section 409A.

(i) It is intended that any amounts payable under this Agreement and the Employer’s and the Executive’s exercise of authority or discretion hereunder shall either be exempt from or comply with Section 409A of the Code (including the Treasury regulations and other published guidance relating thereto) (“Section 409A”) so as not to subject the Executive to payment

of any interest or additional tax imposed under Section 409A. To the extent that any amount payable under this Agreement would trigger the additional tax, penalty or interest imposed by Section 409A, this Agreement shall be modified to avoid such additional tax, penalty or interest yet preserve (to the nearest extent reasonably possible) the intended benefit payable to the Executive.

(ii) Notwithstanding any provision of this Agreement to the contrary, if the Executive is a “specified employee” (within the meaning of Treasury Regulation Section 1.409A-1(i)), the Executive shall not be entitled to any payments upon a termination of the Executive’s employment until the earlier of (i) the date which is six (6) months after the Executive’s Separation from Service with the Employer for any reason other than death, or (ii) the date of the Executive’s death. Furthermore, with regard to any benefit to be provided upon a termination of employment, to the extent required by Section 409A, the Executive shall pay the premium for such benefit during the aforesaid period and be reimbursed by the Employer therefor promptly after the end of such period. Any amounts otherwise payable to the Executive following a termination of his employment that are not so paid by reason of this Section 12(h)(ii) shall be paid as soon as practicable after the date that is six (6) months after the Executive’s Separation from Service (or, if earlier, the date of the Executive’s death). The provisions of this Section 12(h)(ii) shall only apply if, and to the extent, required to comply with Section 409A.

IN WITNESS WHEREOF, the Executive has hereunto set the Executive’s hand and, pursuant to authorization from the Board, Air Group has caused this Agreement to be executed in its name and on its behalf, all as of the day and year first above written.


ALASKA AIR GROUP, INC.

By
		Its Chairman and Chief Executive Officer

EXECUTIVE


		NAME
		TITLE

EXHIBIT A

GENERAL RELEASE AGREEMENT

1. Release. [ ] (the “Executive”), on behalf of himself or herself, his or her descendants, dependents, heirs, executors, administrators, assigns, and successors, and each of them, hereby covenants not to sue and fully releases and discharges Alaska Air Group, Inc. (“Air Group”) and each of its parents, subsidiaries and affiliates, past and present, as well as its and their trustees, directors, officers, members, managers, partners, agents, attorneys, insurers, employees, stockholders, representatives, assigns, and successors, past and present, and each of them (hereinafter together and collectively referred to as the “Releasees”) with respect to and from any and all claims, wages, demands, rights, liens, agreements or contracts (written or oral), covenants, actions, suits, causes of action, obligations, debts, costs, expenses, attorneys’ fees, damages, judgments, orders and liabilities of whatever kind or nature in law, equity or otherwise, whether now known or unknown, suspected or unsuspected, and whether or not concealed or hidden (each, a “Claim”), which the Executive now owns or holds or has at any time heretofore owned or held or may in the future own or hold as against any of said Releasees (including, without limitation, any Claim arising out of or in any way connected with the Executive’s service as an officer, director, employee, member or manager of any Releasee, the Executive’s separation from his or her position as an officer, director, employee, manager and/or member, as applicable, of any Releasee, or any other transactions, occurrences, acts or omissions or any loss, damage or injury whatever), resulting from any act or omission by or on the part of said Releasees, or any of them, committed or omitted prior to the date of this General Release Agreement (this “Agreement”), including, without limiting the generality of the foregoing, any Claim under Title VII of the Civil Rights Act of 1964, the Americans with Disabilities Act, or any other federal, state or local law, regulation or ordinance; provided, however, that the foregoing release does not apply to any obligation of the Employer to Executive pursuant to any of the following: (1) Section 6 of the Amended and Restated Change of Control Agreement between the Executive and Air Group dated as of [ , 2007] (the “Change of Control Agreement”); (2) any equity-based awards previously granted by Air Group to the Executive, to the extent that such awards continue after the termination of the Executive’s employment with Air Group and its subsidiaries in accordance with the applicable terms of such awards (and subject to any limited period in which to exercise such awards following such termination of employment); (3) any right to indemnification that Executive may have pursuant to the Bylaws or Certificate of Incorporation of Air Group or under any written indemnification agreement with Air Group (or any of its subsidiaries or affiliates) or under applicable state law with respect to any loss, damages or expenses (including but not limited to attorneys’ fees to the extent otherwise provided) that the Executive may in the future incur with respect to his or her service as an employee, officer or director of Air Group or any of its subsidiaries or affiliates; (4) with respect to any rights that the Executive may have to insurance coverage for such losses, damages or expenses under any directors and officers liability insurance policy of Air Group (or any of its subsidiaries or affiliates); (5) any rights to continued medical or dental coverage that the Executive may have under the Consolidated Omnibus Budget Reconciliation Act; or (6) any rights to payment of the Executive’s accrued and vested benefits (if any) that Executive may have under a retirement plan sponsored or maintained by Air Group or any of its subsidiaries or affiliates that is intended to qualify under Section 401(a) of the Internal Revenue Code of 1986, as amended. In addition, this Release does not cover any Claim that cannot be so released as a matter of applicable law. The Executive acknowledges and agrees that he or she has received any and all leave and other benefits that he or she has been and is entitled to pursuant to the Family and Medical Leave Act of 1993.

2. Acknowledgement of Payment of Wages. The Executive acknowledges that he or she has received all amounts owed for his or her regular and usual salary (including, but not limited to, any bonus or other wages), and usual benefits through the date of this Agreement.

3. Unknown Claims. It is the intention of the Executive in executing this Agreement that the same shall be effective as a bar to each and every Claim hereinabove specified. The Executive acknowledges that he or she may hereafter discover Claims or facts in addition to or different from those which the Executive now knows or believes to exist with respect to the subject matter of this Agreement and which, if known or suspected at the time of executing this Agreement, may have materially affected this settlement. Nevertheless, the Executive hereby waives any right, Claim or cause of action that might arise as a result of such different or additional Claims or facts.

4. ADEA Waiver. The Executive expressly acknowledges and agrees that by entering into this Agreement, he or she is waiving any and all rights or claims that he may have arising under the Age Discrimination in Employment Act of 1967, as amended (“ADEA”), which have arisen on or before the date of execution of this Agreement. The Executive further expressly acknowledges and agrees that:

(a) In return for this Agreement, the Executive will receive consideration beyond that which he or she was already entitled to receive before entering into this Agreement;

(b) The Executive is hereby advised in writing by this Agreement to consult with an attorney before signing this Agreement;

(c) The Executive has voluntarily chosen to enter into this Agreement and has not been forced or pressured in any way to sign it;

(d) The Executive was given a copy of this Agreement on [ ] and informed that he or she had twenty-one (21) days within which to consider the Agreement and that if he or she wished to execute this Agreement prior to expiration of such 21-day period, he or she should execute the Acknowledgement and Waiver attached hereto as Exhibit A-1;

(e) Nothing in this Agreement prevents or precludes the Executive from challenging or seeking a determination in good faith of the validity of this waiver under the ADEA, nor does it impose any condition precedent, penalties or costs from doing so, unless specifically authorized by federal law; and

(f) The Executive was informed that he or she has seven (7) days following the date of execution of this Agreement in which to revoke this Agreement, and this Agreement will become null and void if the Executive elects revocation during that time. Any revocation must be in writing and must be received by Air Group during the seven-day revocation period. In the event that the Executive exercises his or her right of revocation, neither Air Group nor the Executive will have any obligations under this Agreement.

5. No Transferred Claims. The Executive warrants and represents that the Executive has not heretofore assigned or transferred to any person not a party to this Agreement any released matter or any part or portion thereof and he or she shall defend, indemnify and hold Air Group and each of its subsidiaries and affiliates harmless from and against any claim (including the payment of attorneys’ fees and costs actually incurred whether or not litigation is commenced) based on or in connection with or arising out of any such assignment or transfer made, purported or claimed.

6. Miscellaneous. The following provisions shall apply for purposes of this Agreement:

(b) The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement.

(c) The Executive’s or Air Group’s failure to insist on strict compliance with any provision hereof or any other provision of this Agreement or the failure to assert any right the Executive or Air Group may have hereunder, shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement.

(d) This Agreement may be executed in counterparts, each of which counterparts shall be deemed an original, but all of which together shall constitute one and the same instrument.

[Remainder of page intentionally left blank]

The undersigned have read and understand the consequences of this Agreement and voluntarily sign it. The undersigned declare under penalty of perjury under the laws of the State of Washington that the foregoing is true and correct.

EXECUTED this day of 20 , at County, .

EXECUTIVE

[Name]

EXECUTED this day of 20 , at County, .


ALASKA AIR GROUP, INC.

By:
[Name]
[Title]

EXHIBIT A-1

ACKNOWLEDGMENT AND WAIVER

I, , hereby acknowledge that I was given 21 days to consider the foregoing General Release Agreement and voluntarily chose to sign the General Release Agreement prior to the expiration of the 21-day period.

I declare under penalty of perjury under the laws of the State of Washington that the foregoing is true and correct.

EXECUTED this day of 20__, at County, .

[Name]

Alaska Air Group, Inc. Nonqualified Deferred Compensation Plan

Exhibit 10.17

ALASKA AIR GROUP, INC.

NONQUALIFIED DEFERRED COMPENSATION PLAN

Effective January 1, 1998

Restated As Of January 1, 2005

TABLE OF CONTENTS


		Page
PREAMBLE		1

SECTION 1: DEFINITIONS		1

1.1	409A ACCOUNT	1
1.2	ACCOUNT	2
1.3	ADMINISTRATIVE COMMITTEE	2
1.4	AFFILIATED COMPANIES	2
1.5	BENEFICIARY	2
1.6	BOARD	3
1.7	CHANGE OF CONTROL	3
1.8	CHANGE OF CONTROL BENEFIT	4
1.9	CODE	4
1.10	CODE SECTION 409A	4
1.11	COMPANY	4
1.12	COMPENSATION COMMITTEE	4
1.13	CONTRIBUTION	4
1.14	DEFERRAL ELECTION FORM	4
1.15	DEFERRAL PERIOD	5
1.16	EFFECTIVE DATE	5
1.17	ELECTED OFFICER	5
1.18	ELIGIBLE EMPLOYEE	5
1.19	EMPLOYER	5
1.20	ENROLLMENT PERIOD	5
1.21	ERISA	6
1.22	GRANDFATHERED ACCOUNT	6
1.23	INTEREST BEARING FUND	6
1.24	INTEREST RATE	6
1.25	INVESTMENT FUND	6
1.26	INVOLUNTARY TERMINATION.	6
1.27	KEY EMPLOYEE	7
1.28	MIP	7
1.29	PARTICIPANT	7
1.30	PBP	7
1.31	PLAN	7
1.32	PLAN ADMINISTRATOR	8
1.33	PLAN YEAR	8
1.34	PLAN YEAR ACCOUNT	8
1.35	QUALIFIED PLAN	8
1.36	RE-DEFERRAL ELECTION	8
1.37	REVIEW PANEL	8
1.38	SEPARATION FROM SERVICE	9
1.39	UNFORESEEABLE EMERGENCY	10
1.40	VALUATION DATE	10
1.41	ADDITIONAL DEFINITIONS IN PLAN	10
(a)	Deferred Retention Incentive: As defined in Section 9.1(a)	10
(b)	Deferred Retention Incentive Account: As defined in Section 9.1(b)	10
(c)	Deferred Retention Incentive Agreement: As defined in Section 9.1(c)	10
(d)	Highly Compensated Employee: As defined in Section 9.1(d)	10
(e)	Irrevocability Date: As defined in Section 9.1(e)	10
(f)	1995 OSRP: As defined in Section 10.1	10
(g)	Defined Contribution OSRP Plan: As defined in Section 10.1	10
(h)	Eligibility Effective Date: As defined in Section 10.1(a)	10


January 1, 2005 Restatement		Page i


(i)	Eligible Elected Officer: As defined in Section 10.1(b)	10
(j)	Irrevocability Date: As defined in Section 10.1(c)	10
(k)	OSRP Account: As defined in Section 10.1(d)	10
(l)	OSRP Eligible Compensation: As defined in Section 10.1(e)	10
(m)	OSRP Employer Contribution: As defined in Section 10.1(f)	10

SECTION 2: ELIGIBILITY AND PARTICIPATION		11

2.1	ENROLLMENT	11
2.2	TERMINATION OF PARTICIPATION	11
2.3	INACTIVE PARTICIPATION	11
2.4	ANNUAL DEFERRAL ELECTION	11
(a)	Annual Deferral Election Procedure	11
(b)	Deadline for Deferral Election Form	11

SECTION 3: PLAN CONTRIBUTIONS		12

3.1	PARTICIPANT DEFERRALS	12
(a)	Election of Deferral Percentage	12
(b)	Deferral Election Form; Enrollment Period	12
3.2	CANCELLATION OF ELECTION	13
3.3	DEFERRAL PERIOD ELECTION	13
3.4	EMPLOYER CONTRIBUTIONS	13

SECTION 4: ACCOUNTS		13

4.1	ACCOUNT(S)	13
(a)	In General	13
(b)	Grandfathered Accounts and 409A Accounts	13
4.2	INVESTMENT EARNINGS ON ACCOUNTS	14
(a)	Posting of Earnings to Accounts	14
(b)	Interest Rate	14
(c)	Investment Funds on and after January 1, 2007	15

SECTION 5: PAYMENT OF BENEFITS		16

5.1	TIMING OF PAYMENTS FROM THE PLAN	16
(a)	For Plan Year Accounts within a Grandfathered Account	16
(b)	For Plan Year Accounts within a 409A Account	16
5.2	BENEFIT AMOUNT	17
5.3	PAYMENT FORM	18
(a)	For Grandfathered Account	18
(b)	For 409A Account	18
5.4	PAYMENT-FORM ELECTION	18
(a)	For Each Plan Year Account in a Grandfathered Account	18
(b)	For Each Plan Year Account in a 409A Account	18
(c)	Re-Deferral Election for a Plan Year Account of a 409A Account	19
(d)	Special Transition-Year Election of Form of Payment	19
5.5	HARDSHIP DISTRIBUTIONS	19
(a)	For Grandfathered Accounts	19
(b)	For 409A Accounts	20

SECTION 6: CHANGE OF CONTROL BENEFITS		20

6.1	CHANGE OF CONTROL BENEFIT	21
6.2	FORM OF PAYMENT	21
6.3	TERMINATION OF GRANDFATHERED ACCOUNT FEATURES OF PLAN	21

SECTION 7: DEATH BENEFITS		21

7.1	DEATH AFTER BENEFIT PAYMENTS BEGIN	21
7.2	DEATH BEFORE BENEFIT PAYMENTS BEGIN	21


January 1, 2005 Restatement		Page ii


SECTION 8: VESTING		22

8.1	VESTING	22

SECTION 9: DEFERRED RETENTION INCENTIVE ACCOUNTS		22

9.1	PURPOSE	22
9.2	DEFINITIONS	22
(a)	Deferred Retention Incentive	22
(b)	Deferred Retention Incentive Account	22
(c)	Deferred Retention Incentive Agreement	22
(d)	Highly Compensated Employee	23
(e)	Irrevocability Date	23
9.3	DEFERRED RETENTION INCENTIVE ACCOUNT	23
(a)	Election of Form of Benefit Payment	23
(b)	Special Rules for Form and Timing of Payments	23
(c)	Vesting	24
(d)	Other Terms Applicable to a Deferred Retention Incentive Account	24

SECTION 10: DEFINED CONTRIBUTION OSRP ACCOUNTS		24

10.1	PURPOSE	24
10.2	DEFINITIONS	25
(a)	Eligibility Effective Date	25
(b)	Eligible Elected Officer	25
(c)	Irrevocability Date	26
(d)	OSRP Account	26
(e)	OSRP Eligible Compensation	26
(f)	OSRP Employer Contribution	26
10.3	TERMS APPLICABLE TO OSRP ACCOUNTS	27
(a)	Election of Form of Benefit Payment	27
(b)	Special Rules for Form and Timing of Payments	27
(c)	Vesting	27
(d)	Other Terms Applicable to an OSRP Account	28

SECTION 11: ADMINISTRATIVE POWERS AND DUTIES		28

11.1	ADMINISTRATIVE OVERSIGHT; APPOINTMENT OF PLAN ADMINISTRATOR	28
11.2	POWERS AND DUTIES	28
11.3	COMMITTEE PROCEDURES	29
(a)	Compensation Committee After July 1, 2006	29
(b)	Administrative Committee Prior to July 1, 2006	29
11.4	APPOINTMENT OF AGENTS	30
11.5	ADMINISTRATIVE EXPENSES	30
11.6	DETERMINATIONS	30
11.7	CLAIM AND REVIEW PROCEDURE	30
(a)	Application for Benefits	30
(b)	Denial of Application	31
(c)	Review Panel	31
(d)	Request for Review	31
(e)	Decision on Review	32
(f)	Rules and Procedures	32
(g)	Exhaustion of Administrative Remedies	32
11.8	EXEMPTION FROM LIABILITY/INDEMNIFICATION	33

SECTION 12: AMENDMENT AND TERMINATION		33

12.1	AMENDMENT OR TERMINATION	33
(a)	Right to Amend or Terminate	33
(b)	Plan Termination	34
(c)	Procedures	34


January 1, 2005 Restatement		Page iii


SECTION 13: MISCELLANEOUS PROVISIONS		34

13.1	APPENDICES	34
13.2	ERISA STATUS	35
13.3	UNFUNDED NATURE OF THE OBLIGATION	35
13.4	FACILITY OF PAYMENT	35
13.5	GOVERNING LAW	35
13.6	LIMITATION ON ASSIGNMENT; DOMESTIC RELATIONS ORDERS	35
(a)	Limitation on Assignment, Attachment, Garnishment	35
(b)	Domestic Relations Orders	35
13.7	NO ADDITIONAL RIGHTS.	36
13.8	NOTICE	36
13.9	SEVERABILITY	36
13.10	TAX CONSEQUENCES AND WITHHOLDING	36


APPENDIX I: PARTICIPATING EMPLOYERS				38

APPENDIX II: DEFERRED RETENTION INCENTIVE ACCOUNTS				39

APPENDIX III: OSRP ACCOUNTS				40


January 1, 2005 Restatement		Page iv

PREAMBLE

The purpose of this Alaska Air Group, Inc. Nonqualified Deferred Compensation Plan is to attract and retain capable individuals to serve as executive employees of Alaska Air Group, Inc. (the “Company”) and of certain affiliated companies by providing a select group of executive or management employees the opportunity to defer receipt of compensation, to which the executives otherwise would be entitled currently.

The Plan is intended to qualify for exemption from Parts 2, 3 and 4 of Subtitle B of Title I of the Employee Retirement Income Security Acts of 1974, as amended (“ERISA”), as a plan which is unfunded and which is maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees under Section 201(2), 301(a)(3) and 401(a)(1) of ERISA.

The Plan set forth in the following pages is adopted by the Company, effective January 1, 1998, as amended.

Effective January 1, 2003, the Plan was amended to incorporate the Performance Based Pay Plan (PBP), modifications in the claims and appeals procedures, and certain other minor modifications.

Effective January 1, 2005, the Plan was amended and restated to establish terms for 409A Accounts that are intended to comply with Code Section 409A, to preserve without modification the terms and conditions that apply to certain Grandfathered Accounts established prior to the 409A effective date, and to incorporate certain design modifications – for 409A Accounts – as approved by the Board.

Section 1: DEFINITIONS

Whenever capitalized in this Plan, the following capitalized terms shall have the meanings set forth below except where otherwise provided. As used in the Plan, the masculine, feminine, and neuter genders shall each be deemed to include the other or others.

1.1	409A Account

“409A Account” means the portion (if any) of a Participant’s Account that is governed by Code Section 409A by virtue of an amount having been deferred (or having become vested) on or after January 1, 2005. A Participant’s 409A Account shall consist of:

(a)

any Plan Year Account for a deferred PBP bonus award earned by the Participant during 2005 or any later year (and credited to the Participant’s Account in 2006 or any later year);

(b)

any Deferred Retention Incentive Account held by the Participant; and

(c)

any OSRP Account held by the Participant.


January 1, 2005 Restatement		Page 1

1.2

Account

“Account” means one or more book reserve records maintained by the Company for the purpose of determining a Participant’s benefits under the Plan. Also see the definitions for “409A Account” and “Grandfathered Account.”

1.3	Administrative Committee

Prior to July 1, 2006, “Administrative Committee” means a committee appointed by the Chairman of the Board to serve as Plan Administrator pursuant to Section 11.

1.4	Affiliated Companies

“Affiliated Companies” or “Affiliate” means:

(a)

the Company;

(b)

any other corporation which is a member of a controlled group of corporations which includes the Company (as defined in Code Section 414(b));

(c)

any other trade or business under common control with the Company (as defined in Code Section 414(c)); or

(d)

any other member of an affiliated service group which includes the Company (as defined in Code Section 414(m)).

1.5	Beneficiary

“Beneficiary” means the person or persons entitled to receive a Participant’s benefits payable under the Plan in the event of the Participant’s death. The Beneficiary is the person or persons named in the Participant’s latest written designation filed with the Plan Administrator, provided that the consent of the Participant’s spouse (if any) is required for the election of a non-spouse Beneficiary and for any subsequent changes of the Participant’s Beneficiary designation. Spousal consent must be in writing, name the designated Beneficiary and be notarized.

If no designation has been filed with the Plan Administrator, or if the person or persons designated do not survive the Participant, the Beneficiary shall be the following persons in the following order of priority: (1) the surviving spouse (regardless of length of marriage), and (2) the estate of the Participant.

If the Beneficiary dies after the death of the Participant, but before full distribution has been made to that Beneficiary, the balance, if any, shall be distributed to the estate of that deceased Beneficiary.


January 1, 2005 Restatement		Page 2

1.6

Board

“Board” means the Board of Directors of the Company, or a committee composed of fewer than all of the members of the Board of Directors of the Company that is authorized to act on behalf of the Board.

1.7	Change of Control

“Change of Control” means the occurrence of any of the following:

(a)

the Board approves (or, if approval of the Board is not required as a matter of law, the shareholders of the Company approve):

(i)

any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or pursuant to which shares of common stock of the Company would be converted into cash, securities or other property, other than a merger of the Company in which the holders of common stock of the Company immediately prior to the merger have the same proportionate ownership of common stock of the surviving corporation immediately after the merger;

(ii)

any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, the assets of the Participant’s Employer; or

(iii)

the adoption of any plan or proposal for the liquidation or dissolution of the Participant’s Employer;

(b)

at any time during a period of twenty-four (24) months, fewer than a majority of the members of the Board are Incumbent Directors. “Incumbent Directors” means:

(i)

individuals who constituted the Board at the beginning of such period; and

(ii)

individuals who were nominated or elected by all of, or a committee composed entirely of, the individuals described in (i); and

(iii)

individuals who were nominated or elected by individuals described in (ii).

(c)

any person (as such term is used in Section 13(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) shall, as a result of a tender or exchange offer, open market purchases, privately-negotiated purchases or otherwise, become the beneficial owner (within the meaning of Rule 13d-3 under the Exchange Act), directly or indirectly, of the then-outstanding securities of the Company ordinarily (and apart from rights accruing under special circumstances) having the right to vote in the election of members of the Board (“Voting Securities” to be calculated as provided in paragraph (d) of Rule 13d-3 in the case of rights to acquire common stock of the Company) representing 20% or more of the combined voting power of the then-outstanding Voting Securities.


January 1, 2005 Restatement		Page 3

Unless the Board shall determine otherwise, a Change of Control shall not be deemed to have occurred by reason of any corporate reorganization, merger, consolidation, transfer of assets, liquidating distribution or other transaction entered into solely by and between the Company and an Employer, or any Affiliates thereof, provided such transaction has been approved by at least two-thirds (2/3) of the Incumbent Directors (as defined above) then in office and voting.

1.8	Change of Control Benefit

“Change of Control Benefit” shall apply to a Participant’s Grandfathered Account (and not a Participant’s 409A Account) and shall have the meaning stated in Section 6.1.

1.9

Code

“Code” means the Internal Revenue Code of 1986, as amended, and regulations promulgated under the Code.

1.10	Code Section 409A

“Code Section 409A” means the provisions of section 409A of the Code, as interpreted by any and all proposed or final regulations, or other published guidance of the Department of the Treasury or Internal Revenue Service.

1.11

Company

“Company” means Alaska Air Group, Inc., a corporation organized and existing under the laws of the State of Delaware, and its successors in interest.

1.12	Compensation Committee

“Compensation Committee” means the Compensation Committee of the Board.

1.13	Contribution

“Contribution” means a Participant’s deferral of compensation that would otherwise have been payable currently to the Participant but which is instead allocated to the Participant’s Account pursuant to Section 3.

1.14	Deferral Election Form

“Deferral Election Form” means an agreement between a Participant and the Company whereby the Participant elects pursuant to Section 3 to reduce his or her PBP (or pre-2003 MIP) bonus for a future Plan Year and the Company promises to pay the deferred compensation from the Plan in the future. The form and content of the Deferral Election Form shall be prescribed by the Plan Administrator. To comply with Code Section 409A, effective January 1, 2005, any Deferral Election Form that is delivered by an Eligible Employee on or after that date shall include: (a) the portion (if any) of the corresponding PBP bonus that the Eligible Employee elects to defer to a Plan Year Account, (b) the Deferral Period for that Plan Year Account, and (c) the form of payment elected by the Eligible Employee for that Plan Year Account in the case of a distribution


January 1, 2005 Restatement		Page 4

resulting from the expiration of the Deferral Period. Notwithstanding the prior sentence, subject to any other applicable terms of this Plan, the Deferral Election Form may state a default time and/or form of payment, and any such default shall apply in the absence of an express election on the Deferral Election Form to the contrary.

1.15	Deferral Period

“Deferral Period” means the number of years selected by a Participant pursuant to Section 3 during which payment of his or her Contribution for a Plan Year shall be deferred, in the absence of an intervening event that results in an earlier distribution in accordance with other terms of this Plan.

1.16	Effective Date

“Effective Date” means January 1, 1998.

1.17	Elected Officer

“Elected Officer” means an officer of an Employer that is elected by the Board, pursuant to the bylaws of the Employer.

1.18	Eligible Employee

“Eligible Employee” means an Employee who is eligible to defer any or all of his or her PBP (or pre-2003 MIP) bonus under the terms of Sections 2 through 8 of this Plan. An Eligible Employee shall be any individual who is:

(a)

employed by an Employer as a common law employee for federal employment tax purposes;

(b)

eligible for the PBP (or pre-2003 MIP); and

(c)

named by the Compensation Committee (or, prior to July 1, 2006, the Board), or whose position is at a level or title approved by the Compensation Committee (or, prior to July 1, 2006, the Board), to participate in the Plan.

1.19

Employer

“Employer” means each and any employing company that participates in this Plan. Employers shall include the Company and any Affiliate that adopts this Plan in writing with the consent of the Board, and agrees to be bound by the terms and conditions of the Plan and any amendments or modifications thereto, and which is listed in Appendix I. In the event an Employer ceases participation in the Plan, the date participation ceases shall be indicated in the Appendix.

1.20	Enrollment Period

“Enrollment Period” means an election period that is established by the Plan Administrator for submission of a Deferral Election Form pursuant to Section 3.1. The deadline for an Enrollment Period, and the date as of which a Deferral Election Form shall become irrevocable, shall be as stated in Section 2.4(b).


January 1, 2005 Restatement		Page 5

1.21

ERISA

“ERISA” means the Employee Retirement Income Security Act of 1974, as amended from time to time, and regulations promulgated thereto.

1.22	Grandfathered Account

“Grandfathered Account” means the portion (if any) of a Participant’s Account that is exempt from Code Section 409A by virtue of a PBP (or MIP) bonus (or any portion thereof) having been deferred and vested on or before December 31, 2004, and earnings (and losses) thereafter accruing. A Grandfathered Account shall consist of any one or more Plan Year Accounts for deferred, vested amounts derived from PBP (or MIP) bonus awards earned during 2004 or any prior year (credited to the Plan in 2005 or any prior year). Because a PBP bonus program participant in 2004 (under the terms of the PBP program, as then administered) accrued a vested right to a PBP bonus on December 31st of that year if he was an active Employee of the Employer on that date, the PBP bonus awarded in 2005 (and contributed to this Plan on or about the date when awarded), is considered vested on December 31, 2004, and that Contribution (if any) would therefore be considered part of a Participant’s Grandfathered Account, in combination with any Plan Year Accounts for any prior years.

1.23	Interest Bearing Fund

“Interest Bearing Fund” means an Investment Fund offered under the Plan, on and after January 1, 2007, as further described in Section 4.2(b)(ii).

1.24	Interest Rate

“Interest Rate” shall have the meaning stated in Section 4.2(b).

1.25	Investment Fund

“Investment Fund” means the Interest Bearing Fund, and each of the other book-entry investment accounts offered to Participants by the Plan on and after January 1, 2007, to enable a Participant to direct the investment of his or her Contributions and Account. Each Investment Fund shall reflect the investment performance of a corresponding investment fund under the AlaskaSaver 401(k) Plan, as further described in Section 4.2(c).

1.26	Involuntary Termination.

“Involuntary Termination” and its derivatives as the context requires (such as “involuntarily Terminated”) means no longer employed by an Employer or Affiliated Company as a common law employee for federal employment tax purposes due to discharge, lay off, or similar Employer action.


January 1, 2005 Restatement		Page 6

1.27	Key Employee

The term “Key Employee” shall apply to any 409A Account and shall mean a “specified employee” (within the meaning of Code Section 409A(a)(2)(B)(i)). Whether a Participant is a Key Employee (and a “specified employee”) shall be determined as follows:

(a)

ascertain the 12-month period from April 1 to March 31 in which the date of the Participant’s Separation from Service has occurred;

(b)

the determination date for Key Employee status shall be the December 31 immediately preceding the start of the 12-month period established in “(a)”; and

(c)

determine whether, as of the determination date established in “(b)” the Participant was a “key employee” as defined by Code §416(i)(1)(A)(i), (ii) or (iii), without regard to Code §416(i)(5).

For a Participant whose Separation from Service date triggers a distribution under this Plan and results in a finding of Key Employee status pursuant to this Section, the distribution of the Participant’s 409A Account shall be subject to the six-month payment delay stated in Section 5.1(b)(iii).

This “Key Employee” definition shall apply only so long as securities of the Company are publicly traded on an established securities market.

1.28

MIP

Before January 1, 2003, “MIP” means the Alaska Air Group, Inc. Management Incentive Program, under which incentive compensation earned in 2002 and certain prior years were awarded annually.

1.29	Participant

“Participant” means each Eligible Employee (as provided in Sections 1.18 and 2), each eligible Highly Compensated Employee under Section 9 and each Eligible Elected Officer under Section 10, who participates in this Plan.

1.30

PBP

“PBP” means the Alaska Air Group, Inc. Performance Based Pay Plan, which became effective January 1, 2003.

1.31

Plan

“Plan” means the Alaska Air Group, Inc. Nonqualified Deferred Compensation Plan, as set forth herein and amended from time to time.


January 1, 2005 Restatement		Page 7

1.32	Plan Administrator

Effective July 1, 2006, “Plan Administrator” means a person appointed by the Compensation Committee, with responsibility for day-to-day administration of the Plan, and day-to-day administrative oversight of any third-party recordkeeper or other administrator(s) appointed by the Compensation Committee or Plan Administrator on or after that date. Prior to July 1, 2006, “Plan Administrator” means the Administrative Committee.

1.33

Plan Year

“Plan Year” means the calendar year beginning on the Effective Date and each subsequent calendar year.

1.34	Plan Year Account

As applied to deferred PBP (or pre-2003 MIP) bonuses, a “Plan Year Account” for a Participant means the sub-account of the Participant’s Account that tracks the Contribution credited to the Participant’s Account in a given Plan Year in accordance with the PBP (or pre-2003 MIP) deferral election made by the Participant in advance of that Plan Year (including investment earnings and losses on such Contribution).

As applied to a Deferred Retention Incentive, a Plan Year Account means the entire amount of a Participant’s Deferred Retention Incentive Account (including investment earnings and losses thereon).

As applied to a Participant in the Defined Contribution OSRP Plan, a Plan Year Account means the entire amount of a Participant’s OSRP Account, including all allocations credited to such OSRP Account (and investment earnings and losses thereon), in any and all Plan Years.

1.35	Qualified Plan

“Qualified Plan” means any defined contribution retirement plan that is qualified or is intended to be qualified under Code Section 401(k) and that is maintained by an Affiliated Company.

1.36	Re-Deferral Election

“Re-Deferral Election,” as applied to any Plan Year Account (or any Deferred Retention Incentive Account or OSRP Account) within a Participant’s 409A Account, means an election delivered by the Participant, in accordance with Section 5.4(c), to change the form of payment otherwise payable from such Account.

1.37	Review Panel

“Review Panel” shall have the meaning stated in Section 11.8(c).


January 1, 2005 Restatement		Page 8

1.38	Separation from Service

The term “Separation from Service” shall apply to any 409A Account (but not any Grandfathered Account) and shall be interpreted consistently with guidance issued pursuant to Code Section 409A, and shall generally mean as follows:

(a)

An Employee who is a Participant shall be deemed to have a “Separation from Service” when the Employee ceases to be employed by the Employer as a direct result of the Employee’s death or his or her termination of employment for any reason (other than a transfer to a company affiliated with the Employer). However, for purposes of this definition of Separation from Service, the employment relationship is treated as continuing intact while the individual is on military leave, sick leave, or other bona fide leave of absence (such as temporary employment by the government) if the period of such leave does not exceed six months, or if longer, so long as the individual’s right to reemployment with the Employer is provided either by statute or by contract. If the period of leave exceeds six months and the individual’s right to reemployment is not provided either by statute or by contract, the employment relationship is deemed to terminate on the first date immediately following such six-month period.

(b)

Whether a termination of employment has occurred is determined based on the facts and circumstances.

(c)

If, after a change in employment status, a Participant continues to be treated as a common-law employee of the Employer as evidenced by the payroll records of the Employer, the change in employment status shall not be treated as a Separation from Service if the Employee, after the change of status, either (i) performs hours of service per month that amount to 20 percent or more of the average hours of service per month performed for the Employer during the three-year period prior to the change in employment status (or, if shorter, the period during which the Employee was employed by the Employer), and (ii) receives remuneration at an annualized rate that is 20 percent or more of the average remuneration received by the Employee for the period of time described in clause (i).

(d)

If, after a change in employment status, a Participant is not treated as a common-law employee of the Employer as evidenced by the payroll records of the Employer, the change in employment status shall not be treated as a Separation from Service if the Employee, after the change of status, either (i) performs hours of service per month that amount to 50 percent or more of the average hours of service per month performed for the Employer during the three-year period prior to the change in employment status (or, if shorter, the period during which the Employee was employed by the Employer), and (ii) receives remuneration at an annualized rate that is 50 percent or more of the average remuneration received by the Employee for the period of time described in clause (i).


January 1, 2005 Restatement		Page 9

1.39	Unforeseeable Emergency

The term “Unforeseeable Emergency” shall apply to a Participant’s 409A Account other than a Deferred Retention Incentive Account or an OSRP Account, shall be interpreted consistently with guidance issued pursuant to Code Section 409A, and shall generally mean a Participant’s severe financial hardship resulting from either:

(a)

an illness or accident of the Participant, or his or her spouse or “dependent” (as defined in Code Section 152(a)), and the related extraordinary and unforeseeable medical expenses;

(b)

loss of a Participant’s property due to casualty (including the need to rebuild a home following damage to a home not otherwise covered by insurance);

(c)

other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant, such as the imminent foreclosure of or eviction from the Participant’s primary residence, or extraordinary funeral expenses of a spouse or dependent (as defined above).

Generally, the purchase of a home and the payment of college tuition are not Unforeseeable Emergencies. Whether an event constitutes an Unforeseeable Emergency shall be determined by the Plan Administrator based on the relevant facts and circumstances of each case.

1.40	Valuation Date

Effective January 1, 2007, “Valuation Date” means each business day that is a valuation date under the terms of the AlaskaSaver 401(k) Plan. Prior to January 1, 2007, “Valuation Date” means the first day of each month or any other date the Plan Administrator designates from time to time.

1.41	Additional Definitions in Plan

The following terms are defined in the following subsections of Sections 9 and 10 of the Plan:

(a)

Deferred Retention Incentive: As defined in Section 9.1(a)

(b)

Deferred Retention Incentive Account: As defined in Section 9.1(b)

(c)

Deferred Retention Incentive Agreement: As defined in Section 9.1(c)

(d)

Highly Compensated Employee: As defined in Section 9.1(d)

(e)

Irrevocability Date: As defined in Section 9.1(e)

(f)

1995 OSRP: As defined in Section 10.1

(g)

Defined Contribution OSRP Plan: As defined in Section 10.1

(h)

Eligibility Effective Date: As defined in Section 10.1(a)

(i)

Eligible Elected Officer: As defined in Section 10.1(b)

(j)

Irrevocability Date: As defined in Section 10.1(c)

(k)

OSRP Account: As defined in Section 10.1(d)

(l)

OSRP Eligible Compensation: As defined in Section 10.1(e)

(m)

OSRP Employer Contribution: As defined in Section 10.1(f)


January 1, 2005 Restatement		Page 10

Section 2: ELIGIBILITY AND PARTICIPATION

2.1	Enrollment

Each Eligible Employee shall become a Participant on the later of:

(a)

the Effective Date, or

(b)

the first day of the Plan Year to which the Eligible Employee’s first Deferral Election Form relates.

2.2	Termination of Participation

A Participant’s participation in the Plan will terminate when the Participant’s Account balance under this Plan has been paid in full.

2.3	Inactive Participation

A Participant shall cease to be an active Participant upon written notification by the Board.

In that event, the Participant shall be considered an inactive Participant. An inactive Participant shall continue participation with respect to amounts credited to his or her Account, but no additional Contributions shall be credited to his or her Account pursuant to Section 3 after the date the Participant becomes inactive. The Accounts of inactive Participants shall continue to be adjusted for earnings and payments pursuant to Section 4. Effective January 1, 2007 and thereafter, an inactive Participant shall have the same rights as an active Participant to reallocate the investment of his or her Account among the Investment Funds of the Plan.

2.4	Annual Deferral Election

(a)

Annual Deferral Election Procedure

The Plan shall offer an annual enrollment and deferral election process, consisting of an Enrollment Period of at least 10 business days during which each Eligible Employee shall be offered the opportunity to complete and deliver a Deferral Election Form. An individual who becomes an Eligible Employee shall be eligible to receive and deliver a Deferral Election Form during the annual Enrollment Period that next follows the date as of which he or she becomes an Eligible Employee.

(b)

Deadline for Deferral Election Form

(i)

For a Grandfathered Account

For Enrollment Periods in 2004 and prior years, the Enrollment Period shall occur in December of the calendar year in which the PBP (or pre-2003 MIP) award is being earned. The deadline date as of which any deferral election shall become irrevocable shall be determined and stated by the Plan Administrator in the notices accompanying a Deferral Election Form but shall not be later than December 31st of such year.


January 1, 2005 Restatement		Page 11

(ii)

For a 409A Account

To comply with Code Section 409A, commencing with the Enrollment Period in 2005 pertaining to potential deferral of the PBP bonus to be awarded in the next following calendar year, and in each year thereafter, the deadline for the irrevocability of the Deferral Election Form shall not be later than:

(A)

June 30, in any year in which the PBP bonus being earned in such year is “performance-based” (as defined under Code Section 409A); or

(B)

December 31 of the calendar year prior to the year in which the PBP bonus will be earned, if the PBP bonus to be earned in the following year will not be “performance-based” (as defined under Code Section 409A).

Section 3: PLAN CONTRIBUTIONS

3.1	Participant Deferrals

(a)

Election of Deferral Percentage

Except as provided in Section 3.2, a Participant may elect to defer receipt of some or all of a PBP (or a pre-2003 MIP) payment for a future Plan Year by completing a Deferral Election Form that specifies a percentage of the future PBP (or MIP) payment (in 1% increments) which the Participant elects to defer, and authorizes the Employer to make a corresponding payroll reduction from the Participant’s PBP (or MIP) award.

(b)

Deferral Election Form; Enrollment Period

Each Eligible Employee shall be afforded an opportunity to make an annual deferral election during an Enrollment Period for a Plan Year as described in Section 2.4. Except as provided in Section 3.2, after the last day of the Enrollment Period for a Plan Year, a Participant cannot change or revoke the amount of PBP (or MIP) deferral elected on the Deferral Election Form, and the Participant may not thereafter modify the form or timing of distribution elected on the Deferral Election Form unless he or she complies with the requirements of the applicable provisions of Section 5.4. If a Participant fails to complete and submit a Deferral Election Form before the end of an Enrollment Period, the Participant is deemed to have elected not to defer any PBP (or pre-2003 MIP) bonus for the Plan Year to which the Enrollment Period applies.


January 1, 2005 Restatement		Page 12

3.2	Cancellation of Election

If a Participant receives a hardship distribution under a Qualified Plan any Deferral Election Form that applies to a PBP (or pre-2003 MIP) bonus payable during the six-month period following the date of the hardship distribution is deemed canceled. The Participant may resume deferrals for a future Plan Year by submitting another Deferral Election Form during any subsequent Enrollment Period that applies to a PBP (or pre-2003 MIP) bonus payable after the six-month period expires.

3.3	Deferral Period Election

On each Deferral Election Form, a Participant must elect a Deferral Period. The Deferral Period is measured from the first day of the Plan Year to which the Deferral Election Form relates. For example, a Deferral Election Form delivered on June 30, 2005 for the PBP bonus payable in Plan Year 2006 would have a Deferral Period measured from January 1, 2006. The Deferral Period elected must be stated in whole Plan Years, and in no event will a Deferral Period be shorter than two (2) Plan Years. A Deferral Election Form shall become irrevocable on the last day of the Enrollment Period in which it is delivered.

3.4	Employer Contributions

No Employer Contributions are authorized under the Plan.

Section 4: ACCOUNTS

4.1	Account(s)

(a)

In General

Each Plan Year, the Plan Administrator (or the designated third-party recordkeeper, if any) shall establish on the Company’s books and records a Plan Year Account for that Plan Year in the name of each Participant for whom the PBP (or pre-2003 MIP) bonus for that Plan Year is deferred, in whole or in part. The Plan Administrator (or third-party recordkeeper) shall credit the Participant’s Account as of the date the PBP (or pre-2003 MIP) was paid with the Participant’s Contribution for that Plan Year. The Plan Administrator (or third-party recordkeeper) will credit earnings to each Account pursuant to Section 4.2.

(b)

Grandfathered Accounts and 409A Accounts

Grandfathered Accounts shall be administered in accordance with the terms of this Plan that were in effect on or before October 3, 2004.

409A Accounts shall be administered in accordance with the terms of this Plan that expressly apply to 409A Accounts.


January 1, 2005 Restatement		Page 13

Where a provision of this Plan does not distinguish between Grandfathered Accounts and 409A Accounts, and such provision has not been materially modified since October 3, 2004, then such provision shall apply to both types of Accounts.

4.2	Investment Earnings on Accounts

(a)

Posting of Earnings to Accounts

The Plan Administrator shall credit each Account with earnings as of each Valuation Date; provided, however, that this responsibility shall be delegated to the Plan’s third-party recordkeeper whenever serving in that capacity.

(b)

Interest Rate

(i)

Crediting of Interest on and before December 31, 2006

On and before December 31, 2006, Earnings on each Account shall be determined exclusively with reference to an Interest Rate. There shall be a monthly Valuation Date, and the earnings credit for each monthly Valuation Date shall be determined by applying the Interest Rate to the Account balance determined as of the Valuation Date for which earnings are being credited, reduced by any installment payment under Section 5.3(b) for that month. The Interest Rate for a Plan Year (for 2006, or for any prior Plan Year) is the mean between the high and the low during the first eleven months of the preceding Plan Year of yields of Ba2-rated industrial bonds as determined in the discretion of the Plan Administrator, rounded to the nearest one quarter of one percent (0.25%). The Plan Administrator will notify Participants annually of the established Interest Rate for the Plan Year.

(ii)

Crediting of Interest on and after January 1, 2007

On and after January 1, 2007, the Plan shall offer a fixed principal, interest bearing fund (“Interest Bearing Fund”) as an alternative to the funds described in Section 4.2(c); provided, however, that the Interest Bearing Fund shall be closed to new investment transfers into that fund after the January 1, 2007 initial transfer of account balances held as of the close of business on December 31, 2006. Thereafter, a Participant may at any time transfer any or all of the balance of the Interest Bearing Fund to any other Investment Fund, or may hold existing balances in the Interest Bearing Fund.

There shall be a daily Valuation Date, at which time each Participant’s balance in the Interest Bearing Fund shall be credited with a day’s interest for each 24-hour period that has elapsed since the next prior daily Valuation Date, at a daily rate equal to the annual interest crediting rate for


January 1, 2005 Restatement		Page 14

such year divided by 365. The annual interest rate shall be determined not later than December of the prior year, and shall be equal to the yield on a Moody’s index of Ba2-rated industrial bonds as of November of such prior year, rounded to the nearest one quarter of one percent (0.25%).

(c)

Investment Funds on and after January 1, 2007

(i)

On and after January 1, 2007, the Plan shall offer – in addition to the Interest Bearing Fund described in Section 4.2(b)(ii) – a number of Investment Funds corresponding to, and mirroring the investment characteristics of, the respective investment funds offered under the AlaskaSaver 401(k) Plan. Except for the Interest Bearing Fund, if and when an investment fund is discontinued, or added to, the AlaskaSaver 401(k) Plan, the corresponding Investment Fund will be discontinued or added to this Plan.

(ii)

Each such Investment Fund under this Plan shall be in the form of an unfunded book-entry account which shall, in each case, be credited on each daily Valuation Date, with earnings (or losses) that mirror the day-to-day investment performance of the corresponding investment fund under the AlaskaSaver 401(k) Plan (or the applicable interest rate in the case of the Interest Bearing Fund).

(iii)

The investment fund that is designated from time to time as the default under the AlaskaSaver 401(k) Plan shall likewise serve as the default investment fund under this Plan in the event that a Participant or beneficiary neglects to make a timely election to direct the investment of his or her Account under this Plan.

(iv)

Each Participant who has an Account under the Plan shall have the right to direct the allocation of future Contributions to the Plan, and, separately, to redirect the allocation of his or her entire existing Account balance, from time to time in the manner and with the frequency determined by the Plan Administrator, as administered and interpreted by the recordkeeper for the Plan. A Participant shall not have the right to separately re-allocate the investment of the existing balance of a Plan Year Account (except in the case of a Participant whose entire Account balance consists of a single Plan Year Account).

(v)

The Plan Administrator shall have the discretion to determine rules relating to frequency, deadlines and other constraints on a Participant’s right to direct the investment of Contributions and the re-allocation of Account balances. In the absence of adoption of a rule to the contrary by the Plan Administrator, the rules for investment direction and reallocation shall be identical to the rules that apply to the corresponding investment funds under the AlaskaSaver 401(k) Plan.


January 1, 2005 Restatement		Page 15

Section 5: PAYMENT OF BENEFITS

The provisions of Sections 5.1 through 5.4 describe the timing and form of benefits under circumstances other than hardship or Unforeseeable Emergency (Section 5.5), Change of Control (Section 6), or death (Section 7).

5.1	Timing of Payments from the Plan

(a)

For Plan Year Accounts within a Grandfathered Account

The timing of payments shall be in accordance with the terms of this Plan which were in effect as of October 3, 2004, as follows:

(i)

At the End of the Deferral Period: Except as provided in Section 5.1(a)(ii), payments to a Participant from any one or more Plan Year Accounts within a Grandfathered Account shall begin as soon as administratively feasible after the first day of the April immediately following the last day of the respective Deferral Period for each such Plan Year Account.

(ii)

Upon Involuntary Termination: In the event of a Participant’s Involuntary Termination, payment of each Plan Year Account within a Grandfathered Account shall begin as soon as administratively practicable after the Participant’s date of Involuntary Termination, regardless of the Deferral Period elected.

(b)

For Plan Year Accounts within a 409A Account

(i)

General Rule: Except as provided in Section 5.1(b)(ii) through (v), the timing of payments to a Participant from any one or more Plan Year Accounts in his or her 409A Account shall be in accordance with:

(A)

Section 5.1(a)(i), in the case of payments due to the expiration of the Deferral Period, or

(B)

Section 5.1(a)(ii), in the case of payments due to Involuntary Termination. Provided, however, in no event shall payments for an Involuntary Termination begin prior to the date of a Participant’s Separation from Service.

(ii)

Separations At Early Age or With Short Service: Subject to paragraph (iii) below, if a Participant has a Separation from Service prior to the date he or she has both attained age 55 and accrued at least five full Years of Service, the entire balance of his or her Plan Year Accounts within the 409A Account shall be payable in a single lump sum as soon as administratively practicable following the date of such Separation from Service.


January 1, 2005 Restatement		Page 16

(iii)

Six-Month Delay in Payment Due to Separation from Service of a Key Employee: In the case of payments due as a result of either a Participant’s Separation from Service prior to age 55 and five Years of Service, or Involuntary Termination (without regard to age or service), if the Participant’s Separation from Service date results in a finding that he or she is to be treated as a Key Employee (as defined in this Plan), the payment date shall be delayed six months, and the distribution of all Plan Year Accounts within the 409A Account shall therefore occur (or start) as soon as administratively practicable following the date that is six months from the date of the Separation from Service. Investment earnings (or losses) shall continue to be credited to the Participant’s Account during the period of delay and on remaining balances through the date the Account is fully distributed. In the case of payments in installments, only the first installment shall be delayed by six months, and the remaining annual installments shall be payable as of the anniversary date of the Separation from Service.

(iv)

Five-Year Delay in Payment Due to Re-Deferral Election: In the case of a Participant’s Re-Deferral Election that results in a change in the form of payment of any Plan Year Account in a Participant’s 409A Account, the payment commencement date shall be delayed five years from the date the affected Plan Year Account would otherwise have commenced payment. Investment earnings shall continue to be credited to the Participant’s Account during the period of delay and through the date the Account is fully distributed. In the case of payments in the form of annual installments, all installments shall be delayed by five years. Provided, however, that the five-year delay described in this paragraph shall not apply to any distribution triggered by an event (such as death, Unforeseeable Emergency, or Separation from Service at an early age or with short service) that results, under the terms of this Plan, in a mandatory immediate distribution in the form of a lump sum.

(v)

409A Account May Not Commence Payment in 2006: Notwithstanding any other provision of this Plan to the contrary, a payment from a Plan Year Account of a 409A Account that would otherwise become payable between January 1 and December 31, 2006 shall commence instead on the later of (A) January 1, 2007, or (B) the date that is six months later than the deadline date established by the Plan Administrator for the special transition-year election in Section 5.4(d).

5.2	Benefit Amount

(a)

The amount payable from the Plan shall be based on the balance of the one or more Plan Year Accounts for which payments are then due, measured as of the most recent Valuation Date preceding the payment date.

(b)

If the form of payment is a lump sum, the amount payable shall be the entire balance of the applicable Plan-Year Account(s).


January 1, 2005 Restatement		Page 17

(c)

If the form of payment is five or 10 annual installments, the amount due shall be the balance of the applicable Plan-Year Account(s) divided by the number of annual installments remaining to be paid (including the installment then payable).

5.3	Payment Form

(a)

For Grandfathered Account

Except as provided in Section 5.4(a) (which provides for election of a lump sum as an optional form of payment), all benefits shall be paid in annual installments over ten (10) years. The amount of each installment shall be as stated in Section 5.2(c). All installment payments will be made as of April 1 of each year.

(b)

For 409A Account

Except in the case of Separation from Service at an early age or with short service (where the entire Account shall be distributed as a lump sum), a Participant may elect on his or her Deferral Election Form for a Plan Year Account (or in a timely Re-Deferral Election) to receive payment from the Plan Year Account in any of the three following forms (commencing at the time, and in the amounts, stated in Section 5.1 and 5.2):

(i)

Lump sum

(ii)

Annual installments over five years; or

(iii)

Annual installments over ten years.

5.4	Payment-Form Election

(a)

For Each Plan Year Account in a Grandfathered Account

Subject to approval of the Plan Administrator, a Participant may elect a single sum payment of his or her benefits provided that the election is made at least one (1) year before the April 1 as of which payments are to begin in accordance with the initial Deferral Election Form. Once benefit payments commence, the payment form cannot be changed by the Participant or Beneficiary. Al1 payment-form elections shall be made in the form and manner prescribed by the Plan Administrator and shall be subject to approval of the Plan Administrator.

(b)

For Each Plan Year Account in a 409A Account

(i)

Election on Deferral Election Form: For a 409A Account, at the time of completing his or her Deferral Election Form for a future PBP bonus, the Participant who is electing to defer any or all of such PBP bonus shall elect a form of payment, in accordance with Section 5.3(b), for that Plan Year Account. In the absence of a stated election of the form of payment (or in case of an election of a form of payment that is not permitted by the Plan), the Plan Year Account shall be payable in a lump-sum by default.


January 1, 2005 Restatement		Page 18

(ii)

Irrevocable Election: Except as provided in subsection (c) below, or in the absence of an intervening event that results in a lump-sum distribution becoming payable pursuant to the terms of this Plan, the Participant’s election for the Plan Year Account of the 409A Account (or, in the absence of a timely election, the default form of payment) shall become irrevocable on the deadline stated in Section 2.4(b).

(c)

Re-Deferral Election for a Plan Year Account of a 409A Account

As applied to a Plan Year Account of a 409A Account, the provisions of this subsection (c) shall be available to a Participant, with regard to either a deferred PBP bonus Account, a Deferred Retention Incentive Account or an OSRP Account. A Participant may elect to change the form of payment for a Plan Year Account (or for a Deferred Retention Incentive or OSRP Account), but only if (i) the new form of payment selected is an optional form under the then-existing terms of Section 5.3(b); and (ii) the new election form is received by the Plan Administrator in final signed form at least 12 full months prior to the date the Plan Year Account (or Deferred Retention Incentive or OSRP Account) would otherwise have been due to commence payment.

(d)

Special Transition-Year Election of Form of Payment

Not later than December 31, 2006, the Plan Administrator shall administer one or more special transition-year election processes that comply with the rule of Code Section 409A that allows a Participant to elect a form of payment for any Plan Year Account under a 409A Account as late as December 31, 2006. In each case, the Plan Administrator shall establish a deadline for the return of any such transition-year election. Any such election shall be treated as though it were a timely initial election of the form of payment of the respective Plan Year Account, rather than as a Re-Deferral Election.

5.5	Hardship Distributions

(a)

For Grandfathered Accounts

The terms of this Section 5.5(a) shall apply to each Grandfathered Account.

A Participant may apply to the Plan Administrator for a hardship distribution from his or her Grandfathered Account before the date benefits would otherwise commence. Such a hardship distribution is subject to Plan Administrator approval, and is available only for an unanticipated emergency caused by an event beyond the Participant’s control that results in a severe financial hardship. Examples of expenses that will not be considered severe financial hardships include the purchase of a residence and educational expenses. The amount of a hardship


January 1, 2005 Restatement		Page 19

distribution may not exceed the amount needed to meet the emergency and may not exceed the value of the Participant’s vested Accounts. A hardship distribution will be paid from the Employer’s general assets, and the Participant’s Account will be reduced as of the distribution date by the amount of the distribution.

(b)

For 409A Accounts

The terms of this Section 5.5(b) shall apply to a Participant’s 409A Account; provided, however, that a Participant’s Deferred Retention Incentive Account or OSRP Account shall not be eligible for hardship withdrawal under this Plan.

In the event of a Participant’s Unforeseeable Emergency, a Participant may request, and the Plan Administrator may approve, a withdrawal from the vested balance of the Participant’s 409A Account (without regard to any Deferred Retention Incentive Account or OSRP Account). In such a case, the burden of proof shall be on the Participant to produce information sufficient to demonstrate to the Plan administrator the existence of the Unforeseeable Emergency, the inadequacy or lack of availability of other resources, and the amount required to satisfy the need.

(i)

Amount of Payment: Distributions because of an Unforeseeable Emergency shall be limited to the amount that the Plan administrator determines to be reasonably necessary to satisfy the emergency need (which may include amounts necessary to pay any Federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution).

(ii)

To the Extent Other Sources Are Insufficient: A distribution on account of an Unforeseeable Emergency may not be made to the extent that the emergency is or may be relieved through reimbursement from insurance or otherwise, or by liquidation of the Participant’s assets, to the extent the liquidation of such assets would not cause severe financial hardship.

(iii)

Order of Withdrawal: The amount shall be withdrawn from a Participant’s vested Account, starting with the Plan Year Account(s) scheduled to become payable at the earliest date, and then the one or more other Plan Year Account(s) in the chronological order that they are scheduled to become payable; provided, however, that no portion of such amount may be withdrawn from any Deferred Retention Incentive Account or OSRP Account.

Section 6: CHANGE OF CONTROL BENEFITS

The provisions of this Section 6 shall apply solely to a Participant’s Grandfathered Account (if any), and not to a Participant’s 409A Account; provided, however, that a 409A Account that is


January 1, 2005 Restatement		Page 20

less than fully vested shall be 100% vested upon the occurrence of a Change of Control prior to a Participant’s Separation from Service, as stated in Sections 9.3(c)(ii) and 10.3(c)(ii). Moreover, the special restriction on Plan amendments following a Change of Control, as stated in Section 12.1(a)(iii), shall apply to any Plan amendment, whether it affects Grandfathered Accounts, 409A Accounts, or both.

6.1	Change of Control Benefit

Notwithstanding any other provision of the Plan, in the event of a Change of Control, each Participant (or his or her Beneficiary), except a Participant Terminated For Cause before the date of the Change of Control, shall receive a Change of Control Benefit in accordance with this Section 6, in lieu of any other benefits payable under this Plan. A Participant’s Change of Control Benefit shall be a lump-sum payment of the aggregate balance of the Participant’s Grandfathered Account (if any), determined as of the Valuation Date immediately preceding the date of payment.

6.2	Form of Payment

All Change of Control Benefits shall be paid in the form of a single sum payment within sixty (60) days after a Change of Control.

6.3	Termination of Grandfathered Account Features of Plan

After payment of all Change of Control Benefits, the provision of this Plan that pertain to Grandfathered Accounts shall terminate automatically, and no Participant or Beneficiary will have any further rights with regard to Grandfathered Accounts under the Plan.

Section 7: DEATH BENEFITS

7.1	Death After Benefit Payments Begin

If a Participant dies after benefit payments have begun in a form other than a single sum, but before receiving all payments to which the Participant is entitled under the Plan, the aggregate balance of the Participant’s entire Account shall be paid to the Participant’s Beneficiary in a single sum as soon as administratively feasible after the date of death.

7.2	Death Before Benefit Payments Begin

If a Participant dies before benefit payments begin, the aggregate balance of the Participant’s entire Account shall be paid to the Participant’s Beneficiary in a single sum as soon as administratively feasible, after the date of death.


January 1, 2005 Restatement		Page 21

Section 8: VESTING

8.1

Vesting

Except as provided in Section 9 (“Deferred Retention Incentive Accounts”) and Section 10 (“Defined Contribution OSRP Accounts”), each Participant shall at all times have a vested, nonforfeitable right to all portions of the Participant’s Account under this Plan.

Section 9: DEFERRED RETENTION INCENTIVE ACCOUNTS

9.1

Purpose

The Chief Executive Officer of the Company (the “CEO”), with the approval of the Compensation Committee or in accordance with a policy approved by the Compensation Committee, may, in his or her sole discretion, from time to time, and for any one or more Highly Compensated Employees, grant a Deferred Retention Incentive and cause the Plan Administrator to establish a Deferred Retention Incentive Account under the Plan, all in accordance with this Section 9.

9.2	Definitions

(a)

Deferred Retention Incentive

“Deferred Retention Incentive” means a grant negotiated and made by the CEO, with the approval of the Compensation Committee or in accordance with a policy approved by the Compensation Committee, to a Highly Compensated Employee (or to an individual who has accepted an offer of employment as a Highly Compensated Employee, subject to the individual actually commencing employment), which is expressed as a dollar amount to be credited to a Deferred Retention Incentive Account, subject to forfeiture or vesting. A Deferred Retention Incentive may serve as either a form of deferred hiring bonus, or as a form of deferred bonus for an active Employee that is intended to provide an incentive to continue to provide services to the Employer. Any Deferred Retention Incentive grants will be listed by name and date in Appendix II of this Plan.

(b)

Deferred Retention Incentive Account

“Deferred Retention Incentive Account” means a 409A Account under this Plan for a Participant who is the recipient of a Deferred Retention Incentive grant, and which represents the principal amount of such grant and the earnings (or losses) of the Investment Funds in which such Account is invested by the Participant.

(c)

Deferred Retention Incentive Agreement

“Deferred Retention Incentive Agreement” means a form-of-payment election form and a letter, in writing, from the CEO to the recipient of a Deferred


January 1, 2005 Restatement		Page 22

Retention Incentive, countersigned by the recipient, stating the dollar amount of the grant, the effective date of the establishment of the Deferred Retention Incentive Account, and any other terms applicable to such grant which are not inconsistent with the terms of this Plan, and appending a copy of this Plan.

(d)

Highly Compensated Employee

A “Highly Compensated Employee” means an Employee who is a member of a select group of management or highly compensated employees (within the meaning of §§ 201(2), 301(a)(3) and 401(a)(1) of ERISA), and who has been selected by the CEO, with the approval of the Compensation Committee or in accordance with a policy approved by the Compensation Committee, to receive a Deferred Retention Incentive under this Plan.

(e)

Irrevocability Date

For purposes of this Section 9, “Irrevocability Date” shall mean the close of business on the 30th day following the date the Deferred Retention Incentive Agreement is delivered to the grantee of the Deferred Retention Incentive.

9.3	Deferred Retention Incentive Account

(a)

Election of Form of Benefit Payment

Consistent with Section 5.3(b), the optional forms of payment for a Deferred Retention Incentive Account shall be:

(i)

Lump sum (which shall be the default form);

(ii)

Annual installments over five years; or

(iii)

Annual installments over ten years.

During the 30-day period starting with the date of delivery of a Deferred Retention Incentive Agreement and election form to a grant recipient, the recipient may elect one of the three optional forms of benefit. The form of benefit elected shall become irrevocable (except to the extent of any Re-Deferral Election under Section 5.4(c)) on the Irrevocability Date. In the absence of a complete and signed election being delivered by the Irrevocability Date, the default form of payment shall be a lump sum.

(b)

Special Rules for Form and Timing of Payments

In the event of a Participant’s Separation from Service prior to attaining age 55 and five Years of Service, the elected form of benefit shall be disregarded, and the balance of the Deferred Retention Incentive Account shall be distributed as a lump sum, as further described in Section 5.1(b)(ii) (and 5.1(b)(iii), if applicable).


January 1, 2005 Restatement		Page 23

Moreover, this Section 9.3 is subject to the terms of Section 7 (in the event of the Participant’s death).

(c)

Vesting

The balance (including investment earnings or losses) of a Deferred Retention Incentive Account shall initially be 0% vested, and the balance shall vest according to the vesting terms stated in the Deferred Retention Incentive Agreement. Provided, however, that, notwithstanding any terms in any such Agreement to the contrary, under no circumstances may any portion of a Deferred Retention Incentive Account vest earlier than the first anniversary of the Irrevocability Date.

In the absence of terms to the contrary in the Deferred Retention Incentive Agreement, the balance of the Account shall vest during active employment as follows:

(i)

100% vesting upon the death of the Participant prior to Separation from Service;

(ii)

100% vesting upon a Change of Control prior to Separation from Service;

(iii)

20% vesting upon the completion of each full “Year of Service” (as that term is defined in the AlaskaSaver 401(k) Plan), with 100% vesting occurring upon the completion of the fifth such Year of Service; provided, however, that no portion of the Account shall vest earlier than the first anniversary of the Irrevocability Date.

(d)

Other Terms Applicable to a Deferred Retention Incentive Account

In general, a Deferred Retention Incentive Account shall be subject to the terms of Sections 4, 5, 6, 7, 11, 12 and 13 of this Plan that apply to a Plan Year Account of a 409A Account. As the context requires, a reference in this Plan to a 409A Account (or a Plan Year Account of a 409A Account) shall be interpreted to include any Deferred Retention Incentive Account.

Section 10: DEFINED CONTRIBUTION OSRP ACCOUNTS

10.1

Purpose

For certain Eligible Elected Officers who are not eligible to participate in the 1995 Elected Officers Supplemental Retirement Plan (“1995 OSRP”), this Section 10 (sometimes referred to as the “Defined Contribution OSRP Plan”) serves as a complementary program for certain purposes similar to those served by the 1995 OSRP, for individuals who are not eligible to participate in the 1995 OSRP.


January 1, 2005 Restatement		Page 24

10.2	Definitions

(a)

Eligibility Effective Date

“Eligibility Effective Date” means the date determined by action of the Compensation Committee, or in accordance with a policy approved by that Committee, which shall be the effective date for a Participant’s participation in the Defined Contribution OSRP Plan.

(b)

Eligible Elected Officer

“Eligible Elected Officer” means an Employee of an Employer, as follows:

(i)

who occupies a position (or has accepted a position) as a member of a select group of management or highly compensated employees (within the meaning of §§ 201(2), 301(a)(3) and 401(a)(1) of ERISA);

(ii)

who either:

(A) (1)

commences (or re-commences) employment as an Employee of an Employer after March 31, 2003, or is re-assigned or promoted to a different classification of employment after that date, and

(2)

is not eligible upon the occurrence of the event in clause “(1)” above to actively participate in (i.e. accrue new or additional benefits under) a tax-qualified defined benefit pension plan maintained by his or her Employer for management employees;

(B)

elected the enhanced Employer match program under the tax-qualified defined contribution plan maintained by the Employer instead of the Employer’s tax-qualified defined benefit pension plan, and was promoted on or after January 1, 2006 to an elected officer position; and

(iii)

who either

(A)

is approved by the Compensation Committee as eligible to participate in the Defined Contribution OSRP Plan, or

(B)

is hired or promoted into a position at a level or with a title, in accordance with a policy approved by the Compensation Committee, that is eligible to participate in the Defined Contribution OSRP Plan.


January 1, 2005 Restatement		Page 25

(c)

Irrevocability Date

For purposes of this Section 10, “Irrevocability Date” shall mean the deadline for a Participant to elect a form of payment for the OSRP Account by returning a completed and signed form-of-benefit election form. The Irrevocability Date shall be the close of business on the 30th day following the Eligibility Effective Date.

(d)

OSRP Account

“OSRP Account” means an Account established under the terms of this Section 10 for an Eligible Elected Officer. Any OSRP Accounts will be listed by the name of the Eligible Elected Officer and the Eligibility Effective Date in Appendix III of this Plan.

(e)

OSRP Eligible Compensation

“OSRP Eligible Compensation” for a Participant for a Plan Year means the sum of:

(i)

the gross amount of base recurring salary paid to the Participant during the Plan Year (or, if less, the portion of the Plan Year during which the Participant was an Eligible Elected Officer); plus

(ii)

the gross amount of any short-term annual cash bonus awarded to the Participant, if paid or payable as of a date when the Participant was an Eligible Elected Officer.

The amounts in “(i)” and “(ii)” shall each be the gross dollar amount determined prior to any tax withholding, other deductions or withheld after-tax or pre-tax amounts, or any pre-tax deferrals to any Account in this Plan or any other qualified or nonqualified deferred compensation plan or arrangement.

(f)

OSRP Employer Contribution

“OSRP Employer Contribution” for a Plan Year means an annual Employer contribution to the OSRP Account of each Participant who is an active Eligible Elected Officer during part or all of such Plan Year. The amount of the annual OSRP Employer Contribution for a Plan Year shall be equal to:

(i)

10 percent of the Participant’s OSRP Eligible Compensation; minus

(ii)

the amount of Employer matching contributions that would have been credited during the Plan Year to the Participant’s individual account under the Qualified Plan in which he or she is eligible to participate, determined as if the Participant had contributed the maximum legally permissible amount of matchable elective deferrals to the Qualified Plan during the Plan Year (or, if less, the portion of the Plan Year in which he or she was eligible to defer to the Qualified Plan).


January 1, 2005 Restatement		Page 26

The amount of the OSRP Employer Contribution shall be determined and credited to a Participant’s OSRP Account as soon as practicable following the end of a Plan Year; provided, however, for a Participant who has a Separation from Service (or dies) during a Plan Year, the amount shall be determined and credited to the OSRP Account as soon as practicable following the event triggering a distribution.

10.3	Terms Applicable to OSRP Accounts

(a)

Election of Form of Benefit Payment

Consistent with Section 5.3(b), the optional forms of payment for an OSRP Account shall be:

(i)

Lump sum (which shall be the default form);

(ii)

Annual installments over five years; or

(iii)

Annual installments over ten years.

During the 30-day period starting with the date of delivery of an election form, the recipient of the form may elect one of the three optional forms of benefit, and the form of benefit elected shall become irrevocable (except to the extent of any Re-Deferral Election under Section 5.4(c) on the Irrevocability Date. In the absence of a complete and signed election being delivered by the Irrevocability Date, the default form of payment shall be a lump sum.

Notwithstanding the previous paragraph, a Participant who first becomes an Eligible Elected Officer prior to December 31, 2006 shall make his or her initial election of the form of payment for the OSRP Account in a special 2006 transition-year election process, as described in Section 5.4(d).

(b)

Special Rules for Form and Timing of Payments

(c)

Vesting

The balance (including investment earnings or losses) of an OSRP Account shall initially be 0% vested, and shall vest as follows:

(i)

100% vesting upon the death of the Participant prior to Separation from Service;


January 1, 2005 Restatement		Page 27

(ii)

100% vesting upon a “Change of Control prior to Separation from Service;

(iii)

(d)

Other Terms Applicable to an OSRP Account

In general, an OSRP Account shall be subject to the terms of Sections 4, 5, 6, 7, 11, 12 and 13 of this Plan that apply to a Plan Year Account of a 409A Account. As the context requires, a reference in this Plan to a 409A Account shall be interpreted to include any OSRP Account.

Section 11: ADMINISTRATIVE POWERS AND DUTIES

11.1	Administrative Oversight; Appointment of Plan Administrator

The Compensation Committee shall have the authority and responsibility to oversee the administration of the Plan, and, on and after July 1, 2006, to appoint and replace the Plan Administrator, who shall be a person who may, but need not, be an Employee or Elected Officer of an Employer.

Prior to July 1, 2006, the Plan shall be administered by the Administrative Committee which shall be appointed by the Chairman of the Board, with the Chairman of the Board serving as Chairman of the Administrative Committee. The Administrative Committee shall be composed of at least three (3) members, all of whom are Elected Officers. No bond or other security shall be required of any Administrative Committee member in such capacity. The Chairman of the Board shall be the Chairman of the Administrative Committee.

An individual serving as Plan Administrator on or after July 1, 2006 (or a member of the Administrative Committee prior to that date) may participate in the Plan if he or she is otherwise eligible to do so.

On and after July 1, 2006, the Plan Administrator shall be responsible for day-to-day administration of the Plan and shall furthermore be responsible for day-to-day oversight of the performance of duties by any third-party recordkeeper or third-party administrator(s) that provides services to the Plan.

11.2	Powers and Duties

The Plan Administrator (and, in the event of an appeal, the Review Committee) shall have the power and the duty to take all action and to make all decisions necessary or proper to carry out the Plan, including the discretionary authority to interpret the provisions of the Plan and the facts and circumstances of claims for benefits. The Plan Administrator (and, in the event of an appeal,


January 1, 2005 Restatement		Page 28

the Review Committee) shall have the absolute discretion to decide all issues of fact or law. Any decision by the Plan Administrator or Review Committee that is not shown to be an abuse of discretion must be upheld by a court of law. Without limiting the foregoing, the Plan Administrator (on and after July 1, 2006, with the oversight of the Compensation Committee) shall have the following administrative powers and duties:

(a)

to require any Participant or Beneficiary to furnish information as they may request for the purpose of the proper administration of the Plan as a condition to receiving any benefit under the Plan;

(b)

to make and enforce rules and regulations and prescribe the use of forms as they shall deem necessary for the efficient administration of the Plan;

(c)

to interpret the Plan and to resolve ambiguities, inconsistencies and omissions in a nondiscriminatory manner;

(d)

to determine tax withholding;

(e)

to compute the amount of benefits which shall be payable to any person in accordance with the provisions of the Plan; and

(f)

to delegate any of the Plan Administrator’s administrative powers or duties hereunder to any of their agents or employees, including without limitation an entity appointed to serve as a third-party recordkeeper or administrator.

11.3	Committee Procedures

(a)

Compensation Committee After July 1, 2006

A majority of the Compensation Committee members in office may fulfill any act which the Plan authorizes or requires of the Compensation Committee. A majority of Compensation Committee members may delegate in writing to the Chair of the Compensation Committee the authority to take any action, and/or to give certified notice in writing of any action, taken by the Compensation Committee or its Chair.

(b)

Administrative Committee Prior to July 1, 2006

Prior to July 1, 2006, while the Administrative Committee is serving as the Committee, no Administrative Committee member who participates in the Plan shall vote on any matter that pertains to the member or to the member’s rights and/or benefits under the Plan unless such matter pertains to all Participants or all Participant’s rights and/or benefits under the Plan. Each member of the Administrative Committee shall be excused from voting on any action pertaining solely to the member or members of the Administrative Committee or their rights and/or benefits under the Plan, and the action shall be taken by a majority of the remaining members of the Administrative Committee, or if the remaining members do not constitute a quorum, by the Compensation Committee. The


January 1, 2005 Restatement		Page 29

action of such majority of the Administrative Committee expressed from time to time by a vote at a meeting, or in writing without a meeting, shall constitute the action of the Administrative Committee and shall have the same effect for all purposes as if assented to by all Administrative Committee members.

11.4	Appointment of Agents

The Compensation Committee and the Plan Administrator may each appoint such actuaries, accountants, counsel, specialists, recordkeepers and other persons or organizations as they shall respectively deem necessary for administration of the Plan and they each shall be entitled to prudently rely upon any tables, valuations, certificates, opinions, or reports which shall be furnished to them by such persons or organizations.

11.5	Administrative Expenses

All expenses incurred by the Plan Administrator or Compensation Committee in connection with the administration of the Plan, including but not limited to the compensation of any actuary, accountant, counsel, specialist, recordkeeper or other persons or organizations who shall be employed in connection with the administration of the Plan, shall be paid by the Company.

11.6	Determinations

All determinations hereunder made by the Board, Compensation Committee or Plan Administrator shall be made in the sole and absolute discretion of the Board, Compensation Committee or Plan Administrator, as the case may be.

In the event that any disputed matter shall arise hereunder, including, without in any manner limiting the generality of the foregoing, any matter relating to the eligibility of any person to participate under the Plan, the participation of any person under the Plan, the amounts payable to any person under the Plan, and the applicability and the interpretation of the provisions of the Plan, the decision of the Board, Compensation Committee or Plan Administrator upon such matter shall be binding and conclusive upon all persons, including, without in any manner limiting the generality of the foregoing, the Company, the Board, all persons at any time in the employ of an Employer, the Participants and their Beneficiaries, and upon the respective successors, assigns, executors, administrators, heirs, next of kin, and distributees of all the foregoing.

11.7	Claim and Review Procedure

(a)

Application for Benefits

Any person or the person’s authorized representative (the “Claimant”) may apply for, claim, or request information about, Plan benefits by submitting a signed, written application to the Plan Administrator.


January 1, 2005 Restatement		Page 30

(b)

Denial of Application

If the Plan Administrator denies an application in whole or in part, the Plan Administrator shall notify the Claimant in writing or electronically of the denial and the Claimant’s right to request a review of the denial. The notice of denial shall set forth, in a manner calculated to be understood by the Claimant:

(i)

specific reasons for the denial,

(ii)

specific references to the applicable Plan provisions on which the denial was based,

(iii)

a description of any information or material necessary to perfect the application and an explanation of why such material is necessary,

(iv)

an explanation of the Plan’s review procedure and the time limits for review, and

(v)

a statement of the Claimant’s right to bring a civil action under ERISA following an adverse determination on review.

The denial notice will be given to the Claimant within ninety (90) days after the Plan Administrator receives the application unless special circumstances require an extension of time for processing the application. In no event will an extension exceed a period of ninety (90) days after the end of the initial 90-day period. If an extension is required, written notice of the extension shall be furnished to the Claimant before the end of the initial 90-day period. The extension notice will indicate the special circumstances requiring an extension of time and the date by which the Plan Administrator expects to render a decision. If a written denial notice is not given to the Claimant within the period prescribed by this Section 11.8(b), the application is deemed to have been denied for purposes of Section 11.8(d).

(c)

Review Panel

From time to time, the Chair of the Compensation Committee shall appoint a Review Panel. The “Review Panel” will consist of three (3) or more individuals who may be (but need not be) members of the Compensation Committee or Employees of an Employer and shall be the named fiduciary with authority to act on any appeal of a denied application. The Review Panel has discretionary authority to decide all issues of fact or law. Any decision by the Review Panel that is not established to be an abuse of discretion must be upheld.

(d)

Request for Review

A Claimant whose application is denied, in whole or in part, may appeal the denial by submitting to the Review Panel a written request for a review of the denial. The request for review must be submitted to the Review Panel within


January 1, 2005 Restatement		Page 31

sixty (60) days after the Claimant receives written notice of the denial. Upon request and free of charge, the Claimant shall be permitted reasonable access to, and copies of, relevant information and documents. The Review Panel shall give the Claimant an opportunity to submit written information, documents, records and comments in support of the appeal. In making its decision, the Review Panel will take the Claimant’s submissions into account, regardless of whether this information was available in considering the initial request.

(e)

Decision on Review

The Review Panel will deliver to the Claimant an electronic or written decision within a reasonable time, but no later than sixty (60) days after receipt of the Claimant’s request for review. In special circumstances, the period may be extended up to an additional sixty (60) days. If an extension is required, written notice of the extension will be furnished to the Claimant before the end of the initial 60-day period. The extension notice will indicate the special circumstances requiring an extension of time and the date by which the Review Panel expects to render a decision. If a written decision is not given to the Claimant within the period prescribed by this Section 11.8(e), the decision is deemed to be adverse. If the decision is adverse, in whole or in part, the decision shall set forth in a manner calculated to be understood by the Claimant:

(i)

specific reasons for the adverse decision with specific references to the applicable Plan provisions on which the decision was based,

(ii)

a statement that, upon request and free of charge, the claimant is entitled reasonable access to, and copies of, relevant information and documents,

(iii)

a description of any voluntary appeals procedures and a statement of the Claimant’s right to obtain information about these procedures, and

(iv)

a statement of the Claimant’s right to bring a civil action under ERISA.

(f)

Rules and Procedures

The Plan Administrator and the Review Panel shall establish additional administrative procedures in accordance with this Section 11.8 and ERISA as they deem necessary or appropriate, including safeguards to insure and verify that decisions under this Section 11.8 are made in accordance with the Plan document and are applied consistently to similarly-situated Participants and Beneficiaries. Additional administrative procedures may include, but are not limited to, protocols, guidelines, periodic review and audits.

(g)

Exhaustion of Administrative Remedies

No legal or equitable action for benefits under the Plan shall be brought unless and until the Claimant has satisfied the procedures in this Section 11.8.


January 1, 2005 Restatement		Page 32

11.8	Exemption From Liability/Indemnification

The members of the Board, Compensation Committee and Plan Administrator, collectively and individually, shall be free from all liability, joint or several, for their acts, omissions, and conduct, and for the acts, omissions, and conduct of their duly-appointed agents, in the administration of the Plan, except for those acts or omissions and conduct resulting from willful misconduct or lack of good faith.

The Company shall indemnify each member of the Board, Compensation Committee and Plan Administrator, and any other employee, officer, or director of an Employer against any claims, loss, damage, expense, or liability, by insurance or otherwise (other than amounts paid in settlement not approved by the Company), reasonably incurred by the individual in connection with any action or failure to act by reason of membership on the Board or Compensation Committee or in the role of Plan Administrator, or performance of an authorized duty or responsibility for or on behalf of the Company pursuant to the Plan, unless the same is judicially determined to be the result of the individual’s gross negligence or willful misconduct. Such indemnification by the Company shall be made only to the extent such expense or liability is not payable to or on behalf of such person under any liability insurance coverage. The foregoing right to indemnification shall be in addition to any other rights to which any such person may be entitled as a matter of law.

Section 12: AMENDMENT AND TERMINATION

12.1	Amendment or Termination

(a)

Right to Amend or Terminate

Except as otherwise provided in this Section, the Company reserves the right at any time and from time to time to amend any or all provisions of the Plan or terminate the Plan, in whole or in part, for any reason and without consent of any person, and without liability to any person for such amendment or termination. Notwithstanding the preceding sentence, no amendment of the Plan shall:

(i)

adversely affect the benefits or rights of a Participant or Beneficiary under the Plan (other than election or availability of a form of benefit payment under Section 4, 9 or 10) earned and vested as of the effective date of the amendment without the written consent of each affected Participant and Beneficiary unless such change is required by law or regulations or is necessary to avoid unfavorable tax consequences; or

(ii)

adversely affect the features of the Plan in effect as of the effective date of the amendment without the written consent of each affected Participant and Beneficiary unless such change is required by law or regulations or is necessary to avoid unfavorable tax consequences; or


January 1, 2005 Restatement		Page 33

(iii)

be adopted or become effective after a Change of Control without the written consent of all Participants and Beneficiaries.

(b)

Plan Termination

Nothing in this Plan shall be construed to require continuation of this Plan with respect to existing or future Participants or Beneficiaries.

Notwithstanding Section 12.1(a)(i), the Company may amend the Plan to cease all future Contributions and/or OSRP Employer Contributions and shall pay benefits according to the then existing or amended distribution provisions. Notwithstanding Section 12.1(a)(i), the Company may terminate the Plan and in that event, shall distribute the balance of any and all Plan Year Accounts which are Grandfathered Accounts (but not any 409A Accounts) as soon as administratively feasible in the form of single sum payments determined as though the benefits were Change of Control Benefits under Section 6.

It is the Company’s intention that, except as expressly stated to the contrary at the time of adopting an amendment, no amendment of this Plan is intended to cause a “material modification” (within the meaning of Code Section 409A) of any portion of any Participant’s Grandfathered Account. In the event that the Company determines, with the advice of counsel, that any previously adopted amendment that was not intended to be a material modification may be deemed to be a material modification, the Company shall have the right to revoke any such amendment retroactively to the full extent permitted by Code Section 409A.

Notwithstanding any provision of this Plan to the contrary, the Company may, on any date on or before December 31, 2006, amend or modify the Plan retroactively to a date as early as January 1, 2005, to the extent that the Company, with advice of counsel, determines it advisable to do so in light of the provisions and interpretations of Code Section 409A.

(c)

Procedures

Any amendment or termination of the Plan shall be adopted by the Board, made in writing, and executed on behalf of the Company by the Chair of the Compensation Committee (or, prior to July 1, 2006, by an authorized officer of the Company).

Section 13: MISCELLANEOUS PROVISIONS

13.1	Appendices

Any Appendix to this Plan, as amended from time to time, is incorporated into the Plan and made a part of the terms and conditions of this Plan.


January 1, 2005 Restatement		Page 34

13.2	ERISA Status

This Plan shall constitute a plan which is unfunded and which is maintained primarily for the purpose of providing deferred compensation benefits for a select group of management or highly compensated employees within the meaning of Sections 201(2), 301(a)(3), and 401(a)(1) of ERISA.

13.3	Unfunded Nature of the Obligation

The obligation to pay benefits under the Plan shall at all times be an unfunded, unsecured obligation of the Employer. The Employer is not obligated to purchase any annuity contracts to provide benefits under the Plan, to establish a trust for the purpose of receiving contributions and paying benefits under the Plan, or to otherwise set aside funds for the purpose of providing Plan benefits.

13.4	Facility of Payment

In the event any benefit under this Plan shall be payable to a person who is under legal disability or is in any way incapacitated so as to be unable to manage his or her financial affairs, the Plan Administrator may direct payment of such benefit to a duly appointed guardian, committee or other legal representative of such person, or in the absence of a guardian or legal representative, to a custodian for such person under a Uniform Gifts to Minors Act or to any relative of such person by blood or marriage, for such person’s benefit. Any payment made in good faith pursuant to this provision shall fully discharge the Company and the Plan of any liability to the extent of such payment.

13.5	Governing Law

The Plan shall be construed in accordance with applicable provisions of the Code, ERISA and the laws of the State of Washington, to the extent not preempted by ERISA.

13.6	Limitation on Assignment; Domestic Relations Orders

(a)

Limitation on Assignment, Attachment, Garnishment

Except as provided in “(b)”, benefits under this Plan may not be assigned, sold, transferred, or encumbered, and any attempt to do so shall be void, and a Participant’s or Beneficiary’s interest in benefits under the Plan shall not be subject to debts or liabilities of any kind and shall not be subject to attachment, garnishment or other legal process.

(b)

Domestic Relations Orders

The Plan Administrator (subject to review by the Review Panel, in accordance with Sections 11.7(c) through (g), in case of an appeal by the Participant or an alternate payee) shall follow – if, when, and to the extent a Participant is receiving a distribution (or series of distributions) of benefits under the Plan – any judgment, decree or order of a state court (including court approval of a property settlement agreement) which:

(i)

relates to the provision of child support, alimony payments or marital property rights made pursuant to a state domestic relations law (including a community property law),


January 1, 2005 Restatement		Page 35

(ii)

provides an alternate payee with a right to receive all or a stated portion of one or more subsequent distributions which would otherwise then be payable entirely to the Participant or a Beneficiary under the otherwise applicable provisions of this Plan, and

(iii)

satisfies the requirements of Code Sections 414(p)(2) and (3).

13.7	No Additional Rights.

No person shall have any rights under the Plan, except as, and only to the extent, expressly provided for in the Plan. Neither the establishment or amendment of the Plan or the creation of any fund or account, or the payment of benefits, nor any action of an Employer or the Board, Compensation Committee or Plan Administrator shall be held or construed to confer upon any person any right to be continued as an employee, or, upon dismissal, any right or interest in any account or fund other than as herein provided. The Company and the other Employers expressly reserve the right to discharge any employee at any time with or without cause.

13.8

Notice

All notices, statements, reports and other communications from the Company, Board, Compensation Committee or Plan Administrator to any employee or other person required or permitted under the Plan shall be deemed to have been duly given when delivered to, or when mailed by first-class mail, postage prepaid and addressed to, such employee, or other person at his or her address last appearing on the Employer’s records.

13.9	Severability

If any provision of this Plan is held unenforceable or invalid for any reason, such determination shall not affect the remaining provisions of this Plan which shall be construed as if the unenforceable or invalid provisions had never been included.

13.10

Tax Consequences and Withholding

The Company does not represent or guarantee that any particular federal or state income, payroll, Social Security, or other tax consequences will result from participation in the Plan. A Participant should consult with professional tax advisors to determine the tax consequences of his or her participation in the Plan.

All payments of federal or state income, Social Security, payroll, or other tax required with respect to contributions or benefits under the Plan shall be satisfied by withholding the required amount from the Participant’s salary, other current compensation or Plan benefit payment, or if


January 1, 2005 Restatement		Page 36

the Participant’s salary, other current compensation or benefit payment is insufficient to satisfy any required tax payments, the Participant shall satisfy the payments in a manner approved by the Plan Administrator.

The prior paragraph shall likewise apply to any tax withholding obligation of a Participant that results from the vesting (rather than the distribution) of any or all of any Deferred Retention Incentive Account or any OSRP Account.

Determinations by the Plan Administrator with respect to tax withholding shall be binding on the Participant and Beneficiaries.

IN WITNESS WHEREOF, the Company has caused this January 1, 2005 restatement of the Plan to be signed by the Chair of the Compensation Committee this day of August , 2006.


ALASKA AIR GROUP, INC.

By:		/s/ Phyllis Campbell
		Phyllis Campbell
		Chair, Compensation Committee


January 1, 2005 Restatement		Page 37

APPENDIX I: PARTICIPATING EMPLOYERS

In addition to the Company (Alaska Air Group, Inc.), “Employer” as defined in Section 1.19 shall also include the following employers during the following period of time.


ACKNOWLEDGED AND ACCEPTED

ALASKA AIR GROUP, INC.

By:
		Phyllis J. Campbell
		Chair, Compensation Committee

Date:


January 1, 2005 Restatement		Page 38

APPENDIX II: DEFERRED RETENTION INCENTIVE ACCOUNTS

A Deferred Retention Incentive under Section 9 has been granted to the each of the following individuals, and a Deferred Retention Incentive Account has been established effective as of the respective date indicated below.


Highly Compensated Employee		Effective Date
[None as of August 10, 2006]


ACKNOWLEDGED AND ACCEPTED

ALASKA AIR GROUP, INC.

By:
		Phyllis J. Campbell
		Chair, Compensation Committee

Date:


January 1, 2005 Restatement		Page 39

APPENDIX III: OSRP ACCOUNTS

For purposes of the Defined Contribution OSRP Plan described in Section 10, each of the following individuals has been approved as an “Eligible Elected Officer”, and an OSRP Account has been established as of the respective “Eligibility Effective Date,” as stated below:


Eligible Elected Officer		Eligibility Effective Date
Benjamin F. Forrest		March 9, 2006
Chris R. Glaeser		July 5, 2006


ACKNOWLEDGED AND ACCEPTED

ALASKA AIR GROUP, INC.

By:
		Phyllis J. Campbell
		Chair, Compensation Committee

Date:


January 1, 2005 Restatement		Page 40

Statement of Computation of Ratio of Earnings to Fixed Charges

Exhibit 12.1

COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES

Alaska Air Group, Inc.


(In thousands, except ratios)	2007			2006			2005			2004			2003
Earnings:
Income (loss) before income tax expense (benefit) and accounting change	$	125,000		$	(87,800	)	$	137,200		$	(20,600	)	$	29,000
Less: Capitalized interest		(27,800	)		(24,700	)		(8,900	)		(1,700	)		(2,300	)
Add:
Interest on indebtedness		86,099			76,056			61,698			49,801			47,508
Amortization of debt expense		1,901			1,944			1,308			1,220			1,103
Amortization of capitalized interest		5,783			4,872			4,785			4,855			4,990
Portion of rent under long-term operating leases representative of an interest factor		111,181			106,874			108,283			102,514			96,026

Earnings Available for Fixed Charges	$	302,164		$	77,246		$	304,374		$	136,090		$	176,327

Fixed Charges:
Interest		86,099			76,056			61,698			49,801			47,508
Amortization of debt expense		1,901			1,944			1,308			1,220			1,103
Portion of rent under long-term operating leases representative of an interest factor		111,181			106,874			108,283			102,514			96,026

Total Fixed Charges	$	199,181		$	184,874		$	171,289		$	153,535		$	144,637

Ratio of Earnings to Fixed Charges		1.52			0.42			1.78			0.89			1.22

Coverage deficiency	$	—		$	107,628		$	—		$	17,445			—

Subsidiaries of Registrant

Exhibit 21

SUBSIDIARIES OF ALASKA AIR GROUP, INC.


Name		State of Incorporation
Alaska Airlines, Inc.		Alaska
Horizon Air Industries, Inc.		Washington
AAG Fueling Services, Inc.		Delaware
AAG Leasing, Inc.		Delaware
AAGL-I		Delaware
Air Group Leasing Equity, Inc.		Delaware
Air Group Leasing, Inc.		Delaware

Consent of Independent Registered Public Accounting Firm

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors

Alaska Air Group, Inc.:

We consent to the incorporation by reference in the registration statements (Nos. 333-64998, 333-130272, 333-09547, 333-33727, 333-39899, 333-87563, 333-92252, and 333-117725) on Forms S-3 and S-8 of Alaska Air Group, Inc. of our reports dated February 19, 2008, with respect to the consolidated balance sheets of Alaska Air Group, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2007, and the related financial statement schedule, and the effectiveness of internal control over financial reporting as of December 31, 2007, which reports appear in the December 31, 2007 annual report on Form 10-K of Alaska Air Group, Inc.

As discussed in the notes to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123(R), Share-Based Payment, SEC Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, and SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R), effective January 1, 2006.

/s/ KPMG LLP

Seattle, Washington

February 19, 2008

Certification of Chief Executive Officer

EXHIBIT 31.1

CERTIFICATIONS

I, William S. Ayer, certify that:

1.	I have reviewed this annual report on Form 10-K of Alaska Air Group, Inc. for the period ended December 31, 2007;

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have:

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.	The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


February 20, 2008	By	/s/ WILLIAM S. AYER
		William S. Ayer
		Chairman, President & CEO

Certification of Chief Financial Officer

EXHIBIT 31.2

CERTIFICATIONS

I, Bradley D. Tilden, certify that:

1.	I have reviewed this annual report on Form 10-K of Alaska Air Group, Inc. for the period ended December 31, 2007;

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

5.	The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


February 20, 2008	By	/s/ BRADLEY D. TILDEN
		Bradley D. Tilden
		Chief Financial Officer

Certification of Chief Executive Officer

EXHIBIT 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Alaska Air Group, Inc. (the “Company”) on Form 10-K for the period ended December 31, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, William S. Ayer, Chairman, President & Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


By		/s/ WILLIAM S. AYER
		William S. Ayer
		Chairman, President & Chief Executive Officer

February 20, 2008

Certification of Chief Financial Officer

EXHIBIT 32.2

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Alaska Air Group, Inc. (the “Company”) on Form 10-K for the period ended December 31, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Bradley D. Tilden, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


By		/s/ BRADLEY D. TILDEN
		Bradley D. Tilden
		Chief Financial Officer

February 20, 2008