2008 ANNUAL REPORT North of Expected North of Expected is Alaska Spirit in action. It is simply our way of demonstrating our values and passion for providing an experience that is above and beyond the expected in everything we do. From our commitment to safety and dependability, to our compassion for those around us, North of Expected describes a unique airline, because it defines the people who create it each and every day. Over the years much has changed, but our heritage serves as our compass to point us in the right direction. The magnetic “North” of our compass is the promise we make every day to provide travel that is safe, dependable, and delivered with genuine and caring service. Combine this with a passion for innovation that makes travel easier, and we’ll chart a clear course to customer satisfaction. Alaska Air Group 2008 Annual Report Our goal is to create a diverse and inclusive environment where our people thrive in their quest to deliver an exceptional customer experience. To Our Shareholders In the face of last year’s unprecedented oil prices and the current economic crisis, it would be easy to get bogged down in the daily litany of bad news. One thing we’ve learned is — just as in flying an airplane — you have to climb above the clouds if you want a clear view of where you’re heading. We are confident in our ability to weather the current storm. And we have not forgotten that over the long term we need to run our business in a way that always puts safety first, and that provides the best air travel value for our customers, excellent career opportunities for our employees, and a reasonable return on investment for our shareholders. If that sounds familiar, it should. Alaska Airlines President Brad Tilden, Alaska Air Group Chairman, While our short-term strategy varies President and Chief Executive Officer Bill Ayer, and Horizon Air President with changes in our business and Chief Executive Officer Jeff Pinneo environment, our long-term strategy does not. It is based on sound business principles that work. To achieve our goals and build a company that produces lasting value for all stakeholders, some important things are required: relentless execution, a willingness to try new things, and a laser- like focus on controlling what we can control. And that includes the seemingly “uncontrollable” aspects of our business, such as inclement weather and volatile fuel prices, the effects of which we have been able to moderate through technology and careful risk management. Let’s take a look at how we performed in 2008 as well as our goals for 2009 and beyond. 2008 Financial and Operational Results Alaska Air Group Net Profit In 2008 Alaska Air Group reported an adjusted net profit of $4.4 million, or $0.12 Generally Accepted Accounting Principles (GAAP) Adjusted for unusual items per diluted share. Though far short of our 150 135.8 124.3 plan, things would have been much worse 91.6 100 84.5* had we not hedged a portion of our fuel 55.0 needs and achieved consistent reductions 50 13.5 in non-fuel unit costs at Alaska and Horizon 5.2 4.4 0 over the past several years. -15.3 -30.8 ($ millions) -50 -43.4 -54.5 As airfares rose last year to cover the -67.2 -67.5 -100 -88.3 skyrocketing cost of fuel, we reduced planned capacity in the fourth quarter and -135.9 -150 for all of 2009. When the depth of the 2001 2002 2003 2004 2005 2006 2007 2008 global economic recession began to *(5.9) mil. after accounting change See reconciliation of GAAP to adjusted amounts on page 112. emerge, oil prices fell as precipitously as they had risen. Lower oil prices have provided welcome relief, but they are a byproduct of the recession, and demand for air travel has continued to decline. Because we had already planned to decrease capacity – albeit for a different reason – we were better prepared for the economic downturn. In addition to taking seats out of our network, Alaska Airlines Unit Costs we shifted some capacity from under-performing 9.0¢ and high-frequency markets to new, longer-haul 8.73¢ routes, including Seattle-Minneapolis/St. Paul, 8.52¢ 8.5¢ Seattle-Maui and Seattle-Kona, which we began 8.34¢ 7.92¢ serving in 2008, and Portland-Maui and Seattle- 8.0¢ 7.90¢* Austin, which we will inaugurate in 2009. We 7.76¢* 7.50¢* 7.49¢* also retimed service in our Seattle-Los Angeles 7.5¢ and Seattle-San Francisco markets to better Cost per Available Seat Mile (excluding fuel and unusual items) serve our customers. 7.0¢ 20012002 2003 2004 2005 2006 2007 2008 2008 also marked Horizon’s first-ever foray *Represents Alaska Airlines mainline flying south of the border as they began serving the Los Angeles-Loreto and Los Angeles-La Paz Horizon Air Unit Costs markets. We also announced two new Horizon routes: Los Angeles to Flagstaff and Prescott, 20¢ 18.95¢ Ariz., and Los Angeles to Mammoth Lakes, Calif. 18¢ So far, we believe we’ve made the right cuts in 15.99¢ the right markets, as evidenced by our relatively 16¢ 15.80¢ 14.59¢ 14.52¢ constant year-over-year load factors. The 14.20¢ 14¢ 13.58¢ redeployment of capacity into new markets has 13.35¢ brought important additional revenue into our Cost per Available Seat Mile (excluding fuel and unusual items) network as demand in core markets has 12¢ 20012002 2003 2004 2005 2006 2007 2008 declined. 2 Improving Operations In 2008, our key initiative was to improve our operation. Thanks to the hard work of employees around our system, we executed several projects that raised Alaska’s on-time performance by six points and helped us achieve our customer satisfaction targets for eight straight months. At Horizon, our 83.1 percent on-time rating was a 2.4-point improvement over the prior year and would have earned us second place among all DOT reporting carriers, were we required to report. Projects that contributed to our operational gains included completion of the “Airport of the Future” terminal remodel at Seattle-Tacoma Airport to make the check-in process faster and easier for customers, implementation of the “Super A Check” to maintain Alaska’s jets more efficiently, and process improvements in several other areas. At Horizon, year-over-year reliability improvements were also achieved through modifications to the Q400s and a highly successful project that used “Lean” techniques to significantly reduce the time and cost of maintenance heavy checks. In 2008, we also achieved our goal of a single Boeing 737 fleet type at Alaska, and we simplified Horizon’s fleet from three types to two – Bombardier Q400 turboprops and CRJ700 regional jets. Ultimately, we plan to have a single fleet of Q400s at Horizon, giving both airlines the most fuel- efficient aircraft available while streamlining maintenance, training and scheduling. 2008 Milestones • Achieved our goal of a single 737 fleet type at Alaska. And at Horizon, reduced fleet to two aircraft types on our way to a single Q400 fleet. • Significantly improved Alaskas’ operation in Seattle and are now extending new processes throughout the rest of the system. • Reached a long-term agreement with Delta, designating Alaska Airlines as the carrier’s preferred partner on the West Coast. This agreement, together with our alliances with other important partners such as American Airlines, will give our customers greater access to a global network and position us for future growth. • Achieved Alaska’s unit cost goal of 7.5 cents, excluding fuel, in spite of reducing capacity. And Horizon finished the year slightly under the unit cost goal of 14.6 cents, also on reduced capacity. Looking Ahead We don’t know how deep the recession will be or how long it will last. The economy is undergoing major structural change, and it is important that we continue adapting to the new realities. Our intent is to improve our competitive position and gain a bigger share of what, in the near term, will be a smaller travel market. 3 Average Revenue Per Passenger Last year, we moved our business forward Horizon Air through better planning and execution. We Alaska Airlines will apply those same skills to achieve our $175 157 key initiative for 2009, which is to optimize revenue while sustaining the operational $150 143 145 130 improvements we achieved in 2008. As part 122 124 $125 118 118 of that effort, we have embarked on an ad campaign showcasing the service our 98 $100 94* 90 92* employees provide every day that’s truly 84* 81 81 82 “North of Expected.” $75 $50 The most significant risks for 2009 and 20012002 2003 2004 2005 2006 2007 2008 beyond are the level of customer demand and *Includes Frontier Jet Express flying under a capacity purchase agreement. the possible return of higher fuel prices. Unit revenues and unit costs are lower for this flying than for the rest of Maintaining a relatively strong balance sheet Horizon’s network. and a consistent fuel-hedging program are among our long-term objectives to guard against such risks. As of the end of 2008, our fuel- hedging program had saved us just under a half billion dollars since 2002. We maintained our strong cash position, but we did so at the expense of additional debt, which increased our debt-to-capitalization ratio to 81 percent. While that’s higher than we’d like it to be, we believe it is prudent to maintain a higher cash level in the near term.