Alaska Air Group 2007 Annual Report P.O. Box 68947 • Seattle, WA 98168-0947 www.alaskaair.com www.horizonair.com Alaska Airlines Reservations Horizon Air Reservations 1-800-ALASKAAIR (252-7522) 1-800-547-9308 2 0 0 7 AN N U A L RE P O R T 2007 marked not only Alaska’s 75th anniversary but the passing of Alaska Air Group’s former Chairman and CEO and long-time board member Bruce Kennedy. Bruce led Alaska as CEO from 1979 to 1991 and helped build the company into what it is today. He stepped down as chairman and CEO to serve others through missionary and humanitarian work. Later, he devoted his talents to helping produce a new airplane specially designed to serve people in remote parts of the world. He left behind a great legacy – not only through his leadership and contributions to the Alaska Air Group companies, but through his generous service to others, Bruce R. Kennedy which has left its mark on all who were privileged to know him. We will miss you, Bruce. Alaska Air Group 2007 Annual Report We promise to provide an exceptional customer experience that is safe, dependable and delivered with genuine and caring service. — Our customer promise To Our Stockholders Living up to our promises — something we all learned when we were young — seems to get more complicated as we grow up. But regardless of how difficult it becomes, keeping promises is essential to the success of any business — especially to ours. Our strategic plans at Alaska Airlines and Horizon Air revolve around living up to our promises to all our stakeholders. When Bill Ayer, Chairman and CEO customers buy tickets on our airlines, they expect us to get them where they want to go gatherings, employees forced to change major safely, on time and with their bags. Our life plans because they lost a portion of their employees trust us to provide good jobs with fair, hard-earned retirement incomes, and market-based compensation and to make good stockholders who lost their investments — on our retirement funding obligations. And we excuses simply don’t matter. believe there is an implicit, if not explicit, promise to provide investors a reasonable return While some things, such as soaring fuel prices over the long term. Keeping these core promises and a sluggish economy, are out of our direct is foundational to our future success. control, we decide how we’re going to respond to circumstances that present themselves. And it’s But let’s be frank. We haven’t always delivered. the sum of those decisions that determines our ultimate success or failure over the long term. Our industry as a whole has struggled and some airlines have outright failed to live up to their Let’s look at how we performed in 2007 and promises over the past few years. There are what we’re doing in 2008 to better position plenty of excuses to go around, but to customers ourselves to live up to our promises. who missed important meetings or family 1 Financial Results last year while Horizon contributed about 20 percent.) At $92.3 million, or $2.28 per diluted share, Alaska Air Group’s 2007 adjusted net income fell short of our plan and lagged our 2006 results. Alaska Airlines Unit Costs The primary reason was the significant rise in the 9.0¢ cost of fuel combined with our inability to pass 8.73¢ along those added costs through higher fares in 8.52¢ 8.5¢ the current competitive and economic 8.34¢ environment. 8.0¢ 7.92¢ 7.90¢* 7.75¢* 7.50¢*7.50¢* Alaska Air Group Net Profit 7.5¢ Cost per Available Seat Mile (excluding fuel and unusual items) Generally Accepted Accounting Principles (GAAP) Continuous Adjusted for unusual items 7.0¢ Improvement 150 137.7 20012002 2003 2004 2005 2006 2007 2008 125.0 target 92.3 *Represents Alaska Airlines mainline flying 100 84.5* 55.0 50 13.5 5.2 Horizon Air Unit Costs 0 ($ millions) -15.3 20¢ -30.8 -50 -43.4 18.95¢ -52.6 -67.2 -67.5 18¢ -100 -88.3 20012002 2003 2004 2005 2006 2007 15.99¢ 16¢ 15.80¢ *(5.9) mil. after accounting change See reconciliation of GAAP to adjusted amounts on page 112. 14.58¢ 14.60¢ 14.19¢ 13.58¢ 14¢ 13.35¢ Cost per Available Seat Mile (excluding fuel and unusual items) Continuous 12¢ Improvement Airlines have many moving parts, but when you 20012002 2003 2004 2005 2006 2007 2008 boil it down, there are just two main drivers of target profitability — what it costs to provide our service and what our customers pay for it. We’re proud of the progress we’ve made lowering our non-fuel unit costs. During the past Costs six years we’ve achieved $298 million in annual reductions at Alaska Airlines and $174 million at In 2007, we succeeded in lowering Alaska’s Horizon Air (measured in terms of 2007 available non-fuel unit costs (CASM excluding fuel) by seat miles). But we’re not yet where we need to 3.2 percent. CASM excluding fuel for Horizon be, and we have several initiatives underway that was up 2.8 percent, and if you exclude the costs will help us continue to lower these costs, not associated with fleet transition, Horizon’s unit the least of which is completing Alaska’s costs increased only 0.3 percent last year. (To transition to a single 737 fleet type later this provide some perspective, Alaska’s mainline year and Horizon’s transition out of smaller, operation accounted for about 80 percent of less-efficient Q200s in 2009. Alaska Air Group’s $3.5 billion in total revenues 2 We plan to replace the 37-seat Q200s with 76-seat handling performance in Seattle and are already Q400s. The Q400 provides twice as many seats for beginning to see results from some of the changes just a third more in operating cost, resulting in we’ve made. At Horizon, where an unusually high significantly lower unit costs. Lower unit costs level of planned maintenance contributed to a cost mean we can offer lower fares and stimulate new “bubble” in 2007, we are working hard to operate traffic in some of our markets, such as the Seattle- more efficiently and improve our cost structure. Portland shuttle where our primary competition is the automobile. The rising price of fuel has presented its own set of challenges. With crude oil at $65 per barrel in March 2007, who would have guessed we’d be looking at $100 or more per barrel just one year later. Fuel is now our largest expense, accounting for 28 percent of Alaska Air Group’s total operating expense on an economic basis in 2007. And even though Alaska was able to grow while consuming the same amount of fuel as the year before (through our transition to more fuel-efficient 737-800s), the airline’s fuel bill still rose by about $145 million in 2007 — and that’s after a $53.4 million benefit from our fuel hedges. To see why Horizon’s shuttle service beats driving, go to www.I-5slog.com Of course, the best way to control our fuel expense is to not burn it in the first place. Completing We’re striving to make our operation as efficient as Alaska’s fleet transition later this year means we possible to better serve our customers, and this will have one of the lowest fuel costs per available year we are making some significant investments at seat mile in the industry at a time when it matters Alaska and Horizon that will lay the foundation for most. And Horizon’s fleet changes will translate long-term service and cost benefits. We are focused into better fuel efficiency, as well. on improving Alaska’s on-time and baggage- Fuel Consumption by Narrow-body Jet Aircraft Type Alaska Airlines Fleet 17 16 15 14 13 Gallons/Seat 12 11 10 737-900 737-800 A320 757-200 737-700 737-400 A319 MD-80* DC-9 172 seats 157 seats 149 seats 182 seats 124 seats 144 seats 122 seats 140 seats 140 seats Type of Aircraft *Alaska will retire its MD-80 fleet in 2008. Based on nominal fuel burn for a trip length of 1,000 statute miles. Assumes 100% load factor and 220 lbs for each passenger plus bag. Source: The Boeing Company 3 Fuel Consumption by Regional Aircraft Type Horizon Air Fleet 12 10 8 6 Gallons/Seat 4 2 Q400 CRJ900 Embraer 190 CRJ700 Q200* CRJ200 E170 Beech 1900 76 seats 88 seats 99 seats 70 seats 37 seats 50 seats 72 seats 19 seats Type of Aircraft *Horizon will retire its Q200 fleet in 2009. Based on nominal fuel burn for a trip length of 400 statute miles. Assumes 100% load factor. Source: Bombardier We are conserving fuel in other ways, too. For Average Revenue Per Passenger example, by the end of this year almost all our Horizon Air Next-Generation aircraft will have winglets, which Alaska Airlines $150 145 reduce fuel burn by about 3 percent. We’ve also 143 developed “Required Navigation Performance” 130 122 124 (RNP) procedures that save both fuel and time $125 118 118 through more direct flight routings, allow us to perform constant-descent approaches, and * $100 * 94 decrease the need to over fly destinations due to 90 92 84* inclement weather. Last year, the RNP 81 81 82 approaches we developed kept us from having to $75 divert more than 1,200 arrivals as a result of weather, saving an estimated $8 million in the $50 process.