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 condensed consolidated financial statements and the accompanying notes. All statements in the following discussion that are not statements of historical information or descriptions of current accounting policy are forward-looking statements. Please consider our forward-looking statements in light of the risks referred to in this report's introductory cautionary note and the risks mentioned in the Company's filings with the Securities and Exchange Commission, including those listed in Part I, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2008. This overview summarizes MD&A, which includes the following sections:

· Second Quarter in Review - highlights from the second quarter of 2009 outlining some of the major events that happened during the period and how they affected our financial performance.

· Results of Operations - an in-depth analysis of the results of operations of Alaska and Horizon for the three and six months ended June 30, 2009. We believe this analysis will help the reader better understand our condensed consolidated statements of operations. This section also includes forward-looking statements regarding our view of the remainder of 2009.

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

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

SECOND QUARTER IN REVIEW
Our consolidated pretax income was $47.7 million during the second quarter of 2009 compared to $98.2 million in the second quarter of 2008. The decline in our pretax earnings was primarily due to the $86.9 million decline in operating revenues and a $35.8 million charge in this year's quarter related to the new pilot contract, partially offset by a significant decline in aircraft fuel cost and fleet transition costs from the second quarter of 2008.

· Operating revenues declined by 9.3% driven by the continued demand weakness in the midst of the current economic recession. In the second quarter, passenger traffic across the Air Group network fell by 6.2% and consolidated unit operating revenues declined by 2.5%. Although passenger unit revenues were down 5.9% for mainline Alaska, 3.3% for purchased capacity flying, and just under 1% for Horizon brand flying, this compares to a domestic industry average decline of 14.5% compared to the second quarter of 2008. We believe that we are making the right decisions with respect to capacity reductions and redeployments into higher-demand markets. We also have the flexibility to substitute smaller Horizon aircraft in lower-demand markets that historically may have been served by larger jets.

· Alaska entered into a new four-year agreement with pilots in the second quarter. Among other contract items, the pilots received a one-time bonus of approximately $20.3 million, including taxes, and transitioned to a new sick-leave payment program resulting in a transition charge of $15.5 million.

· Economic fuel averaged $1.84 per gallon in the second quarter of 2009, compared to $3.26 in 2008. This, along with a decline in consumption, resulted in a $169.1 million reduction in our economic fuel expense compared to the second quarter of 2008.

Other significant developments during the second quarter of 2009 and through the filing of this Form 10-Q are described below.

Highest in Customer Satisfaction
For the second year in a row, Alaska Airlines ranked "Highest in Customer Satisfaction among Traditional Network Carriers" in 2009 by J.D. Power & Associates.

Common Stock Repurchase
On June 11, 2009, our Board of Directors authorized the Company to repurchase up to $50 million of our common stock. Through June 30, 2009, we had repurchased 700,000 shares of our common stock for approximately $11.8 million under this new program. The repurchased shares have been recorded as treasury shares in our condensed consolidated balance sheets.

New Markets
In the second quarter, we announced that Alaska would begin daily non-stop service between San Jose and Austin, Texas on September 2, 2009. This is in addition to new service announced previously to Houston and Atlanta beginning in September and October of 2009, respectively.

New Mileage Plan Affinity Card Agreement In June 2009, we revised our Mileage Plan affinity credit card agreement with Bank of America. This revised agreement enhances the economics of our Mileage Plan program and provides for, among other things, an increase in the rate at which we sell miles to the bank. This revised agreement was retroactive to January 1, 2009 and resulted in approximately $15 million of incremental revenue for the first six months of 2009. The agreement expires on December 31, 2014. We expect to record an additional $15 million in the second half of 2009 as a result of this agreement.

First Bag Service Charge
We recently announced that we will join nearly all major domestic carriers in charging for a first checked bag. The $15 service charge began July 7, 2009. This fee does not apply to our MVP or MVP Gold Mileage Plan members, for those traveling solely within the state of Alaska, or for certain other passengers. We believe this fee will generate at least $70 million of incremental revenue on an annual basis and $30 million of incremental revenue during the last half of 2009.

Labor Negotiations
New Pilot Contract
On May 19, 2009, we announced that Alaska's pilots, represented by the Air Line Pilots Association, ratified a new four-year contract. This negotiated agreement replaces the contract that had been in place since May 1, 2005. The terms of the 2005 contract were the result of an arbitrator's decision and included immediate wage reductions that approximated 26% across the pilot group, work rule changes, and higher employee health care contributions.

The significant terms of the new contract are as follows:

· Average pilot wages increased approximately 14% effective April 1, 2009. The contract also provides for step increases of 1.5% on the first two anniversary dates of the contract and 1.8% on the third anniversary.

· Pilots now participate in Air Group's Performance Based Pay (PBP) Plan. PBP is an incentive program that rewards participants a targeted percentage of their pay based on the achievement of goals established annually by Air Group's Board of Directors. These goals include metrics around Air Group profitability, non-fuel unit costs, safety, employee engagement, and on-time performance. The PBP Plan also covers Alaska's dispatchers, flight attendants, and non-union employees and employees classified as supervisors and above at Horizon.

· The defined-benefit pension plan for pilots is now closed to new entrants. Newly hired pilots will participate in a defined-contribution plan that includes a contribution by Alaska equal to 13.5% of eligible wages. Incumbents have the option of remaining in the defined-benefit pension plan or moving to a new blended option with an enhanced defined-contribution element. The election must be made by January 1, 2010.

· Upon retirement, pilots will be allowed to receive a cash payment of an amount equivalent to 25% of their accrued sick leave balance multiplied by their hourly rate.

· The new contract provides for better productivity and flexibility. For example, there are changes to reserve flying provisions that allow for improved scheduling efficiency, language that allows for pilots to fly more than the current 85-hour monthly limit for pay, and exceptions that allow us to suspend certain restrictions in irregular operations. We expect to realize savings from these productivity enhancements when we resume capacity growth.

The increase in wages and benefits resulting from this contract is expected to be approximately $23 million in 2009, including $5 million of incremental cost associated with post-retirement medical coverage.

Pilots received a one-time bonus of $20.3 million in the aggregate following ratification of the contract. The transition expense associated with establishing the sick-leave payout program described above was $15.5 million. These items have been combined and reported as "New pilot contract transition costs" in the condensed consolidated statements of operations.

Other Labor Updates
In August 2009, Alaska's aircraft technicians ratified a two-year extension of the current labor contract that includes, among other things, a move from the current variable-pay incentive program to the PBP Plan described above. With this new agreement, all employee groups at Alaska Airlines, other than employees represented by the International Association of Machinists (IAM), now participate in the PBP Plan. Alaska is in discussions with the IAM and has offered a contract extension that includes participation in the PBP Plan. To date, the offer has not been accepted.

Horizon's dispatchers, represented by the Transportation Workers Union, ratified a new contract in July 2009, expiring in October 2010. This new contract includes a transition from the former profit-sharing plan to the PBP Plan for the dispatchers beginning in 2010.

Horizon Fleet Transition
Horizon's goal is to transition to an all-Q400 fleet. In the first quarter, Horizon removed the final six Q200 aircraft from operations. There was a charge of $4.8 million associated with removing these aircraft from operation in the first quarter that was based on market information available at that time. In the second quarter, there was an additional charge of $5.2 million based on more recent market information. There may be additional charges once any final transactions have been executed.

Although we have been actively pursuing various alternatives to dispose of our 18 CRJ-700 aircraft in the most economically feasible way, the current economic conditions have hindered the remarketing efforts. As a result, the transition to an all-Q400 fleet will be delayed and we will continue to hold the CRJ-700 aircraft in our operating fleet. We have deferred future Q400 deliveries to maintain our current fleet size and capacity plans.

Outlook
Looking ahead, year-over-year advance booked load factor for August is up about one point for Alaska mainline operations and down about one point for Horizon brand flying. September advance booked load factor is down for both mainline Alaska and Horizon brand flying, although the trend has been for the year-over-year comparison to improve as we get closer to the date of travel. These advance booked load factors are on expected capacity declines of 5% and 10%, respectively, at Alaska and Horizon for the third quarter 2009. We are continuing to see soft unit revenues and ticket yields due to the current economic recession and resulting low-fare environment. However, the impact of our new first bag fee and new affinity card agreement, along with other revenue initiatives, is expected to help ease the impact of revenue declines from low yields.

RESULTS OF OPERATIONS

COMPARISON OF THREE MONTHS ENDED JUNE 30, 2009 TO THREE MONTHS ENDED JUNE 30, 2008

Our consolidated net income for the second quarter of 2009 was $29.1 million, or $0.79 per diluted share, compared to net income of $63.1 million, or $1.74 per diluted share, in the second quarter of 2008. Both periods include adjustments to reflect the timing of net unrealized mark-to-market gains or losses related to our fuel hedge positions. In the second quarter of 2009 we recognized net mark-to-market gains of $39.8 million ($24.9 million after tax, or $0.68 per share) compared to gains of $155.3 million ($97.3 million after tax, or $2.69 per share) in the second quarter of 2008. The second quarter of 2009 also included new pilot contract transition charges of $35.8 million ($22.3 million after tax, or $0.61 per share) The second quarter of 2008 included fleet transition charges of $32.1 million ($20.1 million after tax, or $0.56 per share) related to the planned transitions out of the MD-80 and CRJ-700 fleets.

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 the results of other airlines;

· our results excluding these adjustments related to fuel hedge accounting is the basis for our various employee incentive plans, thus the information allows investors to better understand the changes in variable incentive pay expense in our condensed consolidated statements of operations;

· our results excluding these items are 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 $42.1 million in the second quarter of 2009, while Horizon reported pretax income of $6.5 million. Financial and statistical data for Alaska and Horizon are shown on pages 26 and 33, respectively. An in-depth discussion of the results of Alaska and Horizon begins on pages 27 and 34, respectively.

Alaska Airlines Financial and Statistical Data
(unaudited)

                                             Three Months Ended June 30                     Six Months Ended June 30
Financial Data (in millions):               2009          2008       % Change             2009          2008       % Change
Operating Revenues:
Passenger                              $   602.5       $ 682.7          (11.7 )      $ 1,142.3     $ 1,290.0          (11.4 )
Freight and mail                            24.2          26.6           (9.0 )           42.5          47.9          (11.3 )
Other - net                                 54.9          33.3           64.9             88.1          67.7           30.1
Total mainline operating revenues          681.6         742.6           (8.2 )        1,272.9       1,405.6           (9.4 )
Passenger - purchased capacity              67.7          77.8          (13.0 )          129.5         148.2          (12.6 )
Total Operating Revenues                   749.3         820.4           (8.7 )        1,402.4       1,553.8           (9.7 )

Operating Expenses:
Wages and benefits                         198.4         184.3            7.7            395.8         376.4            5.2
Variable incentive pay                      16.1           3.3          387.9             23.2           5.9          293.2
Aircraft fuel, including hedging
gains and losses                           107.4         151.2          (29.0 )          239.3         384.9          (37.8 )
Aircraft maintenance                        46.6          37.4           24.6             92.9          79.5           16.9
Aircraft rent                               28.1          27.9            0.7             54.6          56.1           (2.7 )
Landing fees and other rentals              40.6          42.7           (4.9 )           81.4          84.6           (3.8 )
Contracted services                         28.4          33.9          (16.2 )           58.9          68.6          (14.1 )
Selling expenses                            28.3          36.0          (21.4 )           47.4          62.5          (24.2 )
Depreciation and amortization               44.2          41.6            6.3             87.5          80.4            8.8
Food and beverage service                   11.9          12.6           (5.6 )           22.9          24.3           (5.8 )
Other                                       38.5          47.4          (18.8 )           81.3          89.2           (8.9 )
New pilot contract transition costs         35.8             -             NM             35.8             -             NM
Fleet transition costs - MD-80                 -          26.0             NM                -          26.0             NM
Total mainline operating expenses          624.3         644.3           (3.1 )        1,221.0       1,338.4           (8.8 )
Purchased capacity costs                    68.9          84.5          (18.5 )          131.6         161.2          (18.4 )
Total Operating Expenses                   693.2         728.8           (4.9 )        1,352.6       1,499.6           (9.8 )

Operating Income                            56.1          91.6                            49.8          54.2

Interest income                              9.5          12.3                            19.6          25.4
Interest expense                           (22.1 )       (22.2 )                         (45.1 )       (44.0 )
Interest capitalized                         1.8           5.4                             4.3          11.3
Other - net                                 (3.2 )         0.2                            (4.8 )         0.6
                                           (14.0 )        (4.3 )                         (26.0 )        (6.7 )

Income Before Income Tax               $    42.1       $  87.3                       $    23.8     $    47.5

Mainline Operating Statistics:
Revenue passengers (000)                   3,983         4,425          (10.0 )          7,556         8,505          (11.2 )
RPMs (000,000) "traffic"                   4,613         4,872           (5.3 )          8,792         9,398           (6.4 )
ASMs (000,000) "capacity"                  5,852         6,238           (6.2 )         11,372        12,322           (7.7 )
Passenger load factor                       78.8 %        78.1 %          0.7  pts        77.3 %        76.3 %          1.0  pts
Yield per passenger mile                   13.06 ¢       14.01 ¢         (6.8 )          12.99 ¢       13.73 ¢         (5.3 )
Operating revenue per ASM (RASM)           11.65 ¢       11.90 ¢         (2.2 )          11.19 ¢       11.41 ¢         (1.9 )
Passenger revenue per ASM                  10.30 ¢       10.94 ¢         (5.9 )          10.04 ¢       10.47 ¢         (4.1 )
Operating expenses per ASM                 10.67 ¢       10.33 ¢          3.3            10.74 ¢       10.86 ¢         (1.1 )
Aircraft fuel cost per ASM                  1.84 ¢        2.42 ¢        (24.0 )           2.11 ¢        3.13 ¢        (32.6 )
New pilot contract transition costs
per ASM                                     0.61 ¢        0.00 ¢           NM             0.31 ¢        0.00 ¢           NM
Fleet transition charges per ASM            0.00 ¢        0.42 ¢           NM             0.00 ¢        0.21 ¢           NM
Aircraft fuel cost per gallon          $    1.41       $  1.75          (19.4 )      $    1.60     $    2.23          (28.3 )
Economic fuel cost per gallon          $    1.84       $  3.24          (43.2 )      $    1.88     $    2.98          (36.9 )
Fuel gallons (000,000)                      76.5          86.4          (11.5 )          149.8         172.3          (13.1 )
Average number of full-time
equivalent employees                       8,937         9,880           (9.5 )          8,979         9,881           (9.1 )
Aircraft utilization (blk hrs/day)           9.9          10.9           (9.2 )            9.9          10.8           (8.3 )
Average aircraft stage length
(miles)                                    1,020           974            4.7            1,018           971            4.8
Operating fleet at period-end                116           115          1 a/c              116           115          1 a/c

Purchased Capacity Operating
Statistics:
RPMs (000,000)                               264           302          (12.6 )            479           569          (15.8 )
ASMs (000,000)                               359           399          (10.0 )            675           762          (11.4 )
Passenger load factor                       73.5 %        75.7 %         (2.2 )pts        71.0 %        74.7 %         (3.7 ) pts
Yield per passenger mile                   25.64 ¢       25.76 ¢         (0.5 )          27.04 ¢       26.05 ¢          3.8
Operating revenue per ASM                  18.86 ¢       19.50 ¢         (3.3 )          19.19 ¢       19.45 ¢         (1.4 )
Operating expenses per ASM                 19.19 ¢       21.18 ¢         (9.4 )          19.50 ¢       21.15 ¢         (7.8 )

NM = Not Meaningful

ALASKA REVENUES

Total operating revenues decreased $71.1 million, or 8.7%, during the second
quarter of 2009 as compared to the same period in 2008. The changes are
summarized in the following table:

                                                    Three Months Ended June 30
     (in millions)                                 2009          2008       % Change
     Passenger revenue - mainline             $   602.5       $ 682.7          (11.7 )
     Freight and mail                              24.2          26.6           (9.0 )
     Other - net                                   54.9          33.3           64.9
     Total mainline revenues                  $   681.6       $ 742.6           (8.2 )
     Passenger revenue - purchased capacity        67.7          77.8          (13.0 )
     Total operating revenues                 $   749.3       $ 820.4           (8.7 )

Operating Revenues - Mainline

Mainline passenger revenue fell 11.7% on a 6.2% reduction in capacity and a 5.9% decline in passenger unit revenue. The decline in passenger unit revenue was driven by a 6.8% drop in yield from the prior-year period, slightly offset by the modest increase in passenger load factor. The decline in yield reflects the overall economic climate and the resulting discounting of fares and is also a result of longer average trip lengths. Passenger revenue per available seat mile (PRASM) declined 2.0% in April, 7.4% in May, and 8.1% in June. We believe the April results were favorably impacted by the timing of the Easter holiday.

Our load factor in July 2009 was 84.3%, compared to 79.7% in July 2008. Our advance bookings currently suggest that load factors will be up just over one point in August and down less than half a point in September compared to the prior year.

Ancillary revenue included in passenger revenue increased from $19.6 million in the second quarter of 2008 to $21.9 million in the second quarter of 2009. The increase is primarily due to the implementation of our second checked bag fee in the third quarter of 2008 and an increase in other fees, partially offset by a decline in the number of passengers. Ancillary revenue will increase further in the third quarter and beyond as the first bag service charge became effective on July 7, 2009.

Freight and mail revenue declined $2.4 million, or 9%, primarily as a result of lower mail volumes and lower fuel surcharges, partially offset by higher freight volumes and yield.

Other - net revenue increased $21.6 million, or 64.9%, from the prior-year quarter. Mileage Plan revenue increased by $21.4 million primarily as a result of an increase in the commission recognized from the sale of Mileage Plan miles. The increase in the commission component from the prior-year period is driven by two primary factors - the slight decline in the value assigned to miles as our award structure changed in 2008 and the increase in the rate paid to us by our affinity credit card partner for miles sold. The new affinity card agreement was effective January 1, 2009.

Passenger Revenue - Purchased Capacity
Passenger revenue - purchased capacity declined by $10.1 million to $67.7 million because of a 12.6% drop in passenger traffic and a 3.3% weakening in unit revenue compared to the prior year. Unit revenue declined as a result of a 2.2-point decline in load factors and slightly weaker yield compared to 2008.

ALASKA EXPENSES
For the quarter, total operating expenses declined $35.6 million compared to the
same period in 2008, mostly as a result of the significant decline in fuel
expense and the lack of fleet transition costs, partially offset by a $23.8
million increase in mainline non-fuel operating costs. We believe it is useful
to summarize operating expenses as follows, which is consistent with the way
expenses are reported internally and evaluated by management:

                                                 Three Months Ended June 30,
        Operating Expenses (in millions)         2009          2008       % Change
        Mainline                           $    624.3       $ 644.3           (3.1 )
        Purchased capacity costs                 68.9          84.5          (18.5 )
        Total operating expenses           $    693.2       $ 728.8           (4.9 )

Mainline Operating Expenses
Total mainline operating costs for the second quarter of 2009 decreased $20.0 million, or 3.1%, to $624.3 million compared to $644.3 million in the same period of 2008. Significant individual expense variances from the second quarter of 2008 are described more fully below.

Wages and Benefits
Wages and benefits were up $14.1 million, or 7.7%, compared to the second
quarter of 2008. The primary components of wages and benefits are shown in the
following table:
                                                              Three Months Ended June 30,
(in millions)                                                2009             2008       % Change
Wages                                                  $    133.8       $    135.9           (1.5 )
Pension and defined-contribution retirement benefits         29.2             16.7           74.9
Medical benefits                                             21.4             18.1           18.2
Other benefits and payroll taxes                             14.0             13.6            2.9
Total wages and benefits                               $    198.4       $    184.3            7.7

Wages declined 1.5% on a 9.5% reduction in full-time equivalent employees (FTE) compared to the second quarter of 2008. Wages have not declined in step with the FTE reduction because of higher wage rates for the pilot group in connection . . .