UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Commission file number 1-8957

ALASKA AIR GROUP, INC.

19300 Pacific Highway South, Seattle, Washington 98188
(Address of principal executive offices)

Registrant’s telephone number, including area code: (206) 392-5040

     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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes (X) No (  )

APPLICABLE ONLY TO CORPORATE ISSUERS:

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

     The registrant has 26,803,691 common shares, par value $1.00, outstanding at March 31, 2004.

TABLE OF CONTENTS

Cautionary Note regarding Forward-Looking Statements

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements that relate to future events of our future financial performance and involve a number of risks and uncertainties. These forward-looking statements are intended to be subject to the safe harbor protection provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. In some cases, you can identify forward-looking statements by terminology such as “forecast,” “may,” “will,” “could,” “should,” “expect,” “plan,” “believe,” “potential” or other similar words indicating future events or contingencies. Some of the things that could cause our actual results to differ from our expectations are: the competitive environment and other trends in our industry; economic conditions; our reliance on automated systems; actual or threatened terrorist attacks, global instability and potential U.S. military involvement; our ability to meet our cost reduction goals; labor disputes; changes in our operating costs including fuel and insurance; changes in laws and regulations; liability and other claims asserted against us; failure to expand our business; interest rates and the availability of financing; our ability to attract and retain qualified personnel; changes in our business plans; our significant indebtedness; downgrades of our credit ratings; and inflation. For a discussion of these and other risk factors, review the information under the caption “Business Risks” in Item 1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. All of the forward-looking statements are qualified in their entirety by reference to the risk factors discussed therein. Our forward-looking statements are based on the information currently available to us and speak only as of the date of this report. 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. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this report to conform them to actual results. 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.

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PART I. FINANCIAL STATEMENTS

See accompanying notes to consolidated financial statements.

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CONSOLIDATED BALANCE SHEETS (unaudited)
Alaska Air Group, Inc.

LIABILITIES AND SHAREHOLDERS’ EQUITY

See accompanying notes to consolidated financial statements.

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CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Alaska Air Group, Inc.

See accompanying notes to consolidated financial statements.

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CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (unaudited)
Alaska Air Group, Inc.

See accompanying notes to consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Alaska Air Group, Inc.

See accompanying notes to consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Alaska Air Group, Inc.

Note 1. Basis of Presentation and Significant Accounting Policies

The accompanying unaudited consolidated financial statements of Alaska Air Group, Inc. (Air Group or the Company) include the accounts of the parent company, Alaska Air Group, Inc., and its principal subsidiaries, Alaska Airlines, Inc. (Alaska) and Horizon Air Industries, Inc. (Horizon), through which the Company conducts substantially all of its operations. These interim consolidated financial statements are unaudited and should be read in conjunction with the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. In the opinion of management, all adjustments have been made which are necessary to present fairly the Company’s financial position as of March 31, 2004, as well as the results of operations for the three months ended March 31, 2003 and 2004. The adjustments made were of a normal recurring nature.

The Company’s consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) and the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities, as well as the reported amounts of revenues and expenses. Significant estimates made include assumptions used to record liabilities, expenses and revenues associated with the Company’s Mileage Plan, lease return provisions, the fair market value of surplus aircraft, engines and parts, and the amounts of certain accrued liabilities. Actual results may differ from the Company’s estimates.

Reclassification of Gains and Losses Associated with Fuel Hedging

The Company has made changes to its classification of fuel hedging gains and losses which are described in the following paragraphs.

Impact on First Quarter 2004 Press Release

In its press release of first quarter results on April 23, 2004, the Company classified gains and losses associated with the ineffective portion of changes in fair value of its fuel hedge positions as a component of aircraft fuel expense rather than nonoperating income (expense) and reclassified the first quarter of 2003 to conform to the 2004 presentation. The consolidated financial statements included herein have been revised to present those gains and losses in nonoperating income (expense), consistent with the Company’s historical presentation. There was no impact on pretax loss, net loss, loss per share, or balance sheet information in the April 23 press release.

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The following table reconciles the classification changes:

The airline data schedules and non-GAAP disclosures on pages 14 through 16 have also been modified accordingly.

Revision to Previously Filed Financial Statements and SEC Filings

The Company previously recorded unrealized gains and losses related to the ineffective portion of changes in fair value of its fuel hedge positions as non-operating income (expense) and then reclassified those gains and losses to fuel expense as those hedges were settled. This practice was not consistent with the Company’s policy, which was to record the ineffective portion in non-operating income (expense). The Company will amend its consolidated financial statements previously filed with the Securities and Exchange Commission to adjust its historical presentation of such items. Such revisions will result in reclassification between operating income (loss) and nonoperating income (expense) in the consolidated statements of operations. The revisions have no impact on previously reported pretax income (loss), net income (loss), earnings (loss) per share, the consolidated balance sheets, the consolidated statement of shareholders equity or the consolidated statements of cash flows for any prior periods.

Stock Options

The Company has three stock option plans that provide for the grant of options to purchase Air Group common stock at stipulated prices on the date of the grant to officers and employees of Air Group and its subsidiaries. The Company applies 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. Accordingly, no compensation cost has been recognized for these plans as the exercise price of options equals the fair market value on the date of grant.

The following table represents the effect of net loss and loss per share if the Company had applied the fair value based method and recognition provisions of Statement on Financial Accounting Standards No. 123 (SFAS No. 123) to its stock-based employee compensation (in millions, except per share amounts):

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Note 2. Other Assets

At December 31, 2003 and March 31, 2004, other assets consisted of the following (in millions):

Note 3. Frequent Flyer Program

Alaska’s Mileage Plan liabilities are included under the following balance sheet captions (in millions):

Note 4. Employee Benefit Plans

Pension Plans-Defined Benefit

Net pension expense for the three months ended March 31 included the following components (in millions):

The Company made no contributions to its defined benefit pension plans during the three months ended March 31, 2003. The Company made $16.5 million in contributions during the three months ended March 31, 2004, and expects to contribute an additional $32.5 million to these plans during the remainder of 2004.

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Pension Plans-Noncontributory

Net pension expense for the unfunded, noncontributory defined benefit plans for the three months ended March 31 included the following components (in millions):

Other Postretirement Benefits

Net periodic benefit cost for the postretirement medical plans for the three months ended March 31 included the following components:

Note 5. Loss Per Share

Loss per share calculations were as follows (in millions except per share amounts). Stock options are excluded from the computation of diluted loss per share because the impact would be antidilutive. For the three months ended March 31, 2003 and 2004, options to purchase 3.7 million shares and 3.9 million shares of common stock, respectively, were excluded from the calculations.

Diluted shares also excludes the shares of common stock issuable upon conversion of the Company’s floating rate senior convertible notes due in 2023 (the Notes) issued on March 21, 2003, because the closing prices of Air Group’s common stock during the first quarter did not trigger the convertibility feature. Holders may surrender the notes for conversion into shares of the Company’s common stock (or cash, at the election of the Company) if the closing sale price of the Company’s common stock exceeds 110% of the accreted conversion price under the Notes for 20 days in the 30 trading-day period ending on the last day of the fiscal quarter. In addition, holders may require the Company to purchase all or a portion of their Notes, for a purchase price equal to principal plus accrued interest, on the 5th, 10th and 15th anniversaries of the issuance of the Notes, or upon the occurrence of a change of control or tax event.

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For each $1,000 of original principal amount per Note, the conversion price through March 21, 2008 is equal to the original principal amount of the Notes, divided by 38.4615. At the date of issuance, the conversion price was equal to $26.00 per share and 110% of the conversion price, or the conversion trigger price, was equal to $28.60 per share. After March 21, 2008, the conversion price and conversion trigger price increase based on the variable yield of the notes. Once the closing sale price of the Company’s common stock exceeds the conversion trigger price for the requisite period, the notes will be convertible at any time thereafter at the option of the holder, through maturity, and will be included in the Company’s calculation of diluted EPS on a go-forward basis. In the event that a security holder decides to convert its Notes, the Company intends to satisfy this obligation with cash.

The Company may redeem all or a portion of the Notes in cash or common stock or a combination of cash and common stock at any time on or after the third anniversary of the issuance of the Notes.

Note 6. Operating Segment Information

Operating segment information for Alaska and Horizon for the three-month period ended March 31 was as follows (in millions):

* Includes the parent company, Alaska Air Group, Inc, including its investments in Alaska and Horizon, which are eliminated in consolidation.

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Note 7. Long-Term Debt and Capital Lease Obligations

At December 31, 2003, and March 31, 2004, long-term debt and capital lease obligations were as follows (in millions):

During the first three months of 2004, Alaska issued $62.6 million of debt secured by flight equipment, having interest rates that vary with LIBOR and payment terms ranging from 14 to 16 years.

In January 2004, Horizon leased two Bombardier Q400s, which were treated as capital leases, each with a 14-year term. The net present value of these leases was determined to be $34.2 million and is included in flight equipment with the corresponding lease obligation included in long-term debt and capital lease obligations in the consolidated balance sheet as of March 31, 2004.

Note 8. Contingencies

The Company is a party to routine litigation incidental to its business and with respect to which no material liability is expected. Management believes the ultimate disposition of these matters is not likely to materially affect the Company’s financial position or results of operations. However, this belief is based on management’s current understanding of the relevant law and facts; it is subject to various contingencies, including the potential costs and risks associated with litigation and the actions of judges and juries.

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Alaska Airlines Financial and Statistical Data (Unaudited (b))

NM = Not Meaningful

(a) See Note 1 on Page 16.

(b) See Note 1 “Reclassification of Gains and Losses Associated With Fuel Hedging” on Page 8.

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Horizon Air Financial and Statistical Data (Unaudited)(b)

NM = Not Meaningful

(a) See Note 1 on Page 16.

* Excludes contract flying for Frontier Airlines.

(b) See Note 1 “Reclassification of Gains and Losses Associated With Fuel Hedging” on Page 8.

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Note 1:

Pursuant to Item 10 of Regulation S-K, we are providing disclosure of the reconciliation of reported non-GAAP financial measures to our most directly comparable financial measures reported on a GAAP basis. The non-GAAP financial measures provide us the ability to measure and monitor our performance both with and without the cost of aircraft fuel and the impairment charge related to Horizon’s F-28 aircraft and spare engines. Because the cost and availability of aircraft fuel are subject to many economic and political factors beyond our control, it is our view that the measurement and monitoring of performance without fuel is important. In addition, we believe the disclosure of financial performance without impairment charges is useful to investors in evaluating our ongoing operational performance. Finally, these non-GAAP financial measures are also more comparable to financial measures reported to the Department of Transportation by other major network airlines.

The following table reconciles operating expenses excluding fuel and operating expenses per ASM excluding fuel for both Alaska Airlines, Inc. and Horizon Air Industries, Inc.:

Alaska Airlines, Inc.:
($ in millions)

Horizon Air Industries, Inc.:
($ in millions)

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our consolidated financial statements and the related notes contained elsewhere in this quarterly report on Form 10-Q. 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.

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. As used in this Form 10-Q, the terms “Air Group,” “our,” “we” and the “Company” refer to Alaska Air Group, Inc. and its subsidiaries, unless the context indicates otherwise.

Reclassification of Gains and Losses Associated with Fuel Hedging
We have made changes to our classification of fuel hedging gains and losses which are described in the following paragraphs.

Impact on First Quarter 2004 Press Release
In our press release of first quarter results on April 23, 2004, we classified gains and losses associated with the ineffective portion of changes in fair value of our fuel hedge positions as a component of aircraft fuel expense rather than nonoperating income (expense) and reclassified the first quarter of 2003 to conform to the 2004 presentation. The consolidated financial statements included herein have been revised to present those gains and losses in nonoperating income (expense), consistent with our historical presentation. There was no impact on pretax loss, net loss, loss per share, or balance sheet information in the April 23 press release. There was also no impact on cost per ASM (CASM) excluding fuel, a non-GAAP measure we believe is important to some users of our financial statements. See page 16.

The following table reconciles the classification changes:

The airline data schedules and non-GAAP disclosures on pages 14 through 16 have also been modified accordingly.

Revision to Previously Filed Financial Statements and SEC Filings
We previously recorded unrealized gains and losses related to the ineffective portion of changes in fair value of our fuel hedge positions as non-operating income (expense) and then reclassified those gains and losses to fuel expense as those hedges were settled. This practice was not consistent with our policy, which was to record the ineffective portion in non-operating income (expense). We will amend our consolidated financial statements previously filed with the Securities and Exchange Commission to adjust our historical presentation of such items. Such revisions will result in reclassification between operating income (loss) and nonoperating income (expense) in the consolidated statements of operations. The revisions have no impact on previously reported pretax income (loss), net income (loss), earnings (loss) per share, the consolidated balance sheets, the consolidated statement of shareholders equity or the consolidated statements of cash flows for any prior periods. It also has no impact on cost per ASM excluding fuel, a non-GAAP measure we believe is important to some users of our financial statements. See page 16.

First Quarter in Review and Current Events

Historically, our operating income is lowest during the first quarter, increases in the second quarter, reaches its peak during the third quarter and decreases again in the fourth quarter. We recorded a first quarter 2004 net loss of $42.7 million, or $1.59 per diluted share. The net loss decreased from the 2003 net loss of $56.3 million, or $2.12 per diluted share, despite very high jet fuel costs ($1.14 per gallon in 2004 compared to $1.00 per gallon in 2003) and a $2.4 million impairment charge related to Horizon’s F-28 aircraft and related spare engines. Results of operations in 2004 were positively impacted by relatively strong winter demand and improved yields. The comparison to 2003 is favorably impacted by a demand drop off in 2003 resulting from the war in Iraq.

In February 2004, Alaska initiated a fare simplification plan whereby a number of fare restrictions were eliminated, walk-up and first class fares were reduced significantly, and the gap between the highest and lowest fares was reduced. The goal of this initiative is to increase customer loyalty by driving better value while simplifying the customer’s purchase decision and reducing the costs associated with selling and maintaining a more complex fare structure.

On January 1, 2004, Horizon began operating regional jet service branded as Frontier JetExpress under a 12-year agreement with Frontier Airlines. By late May 2004 and thereafter, Horizon will operate nine regional jet aircraft under the Frontier JetExpress brand, representing roughly 24% of total Horizon capacity and approximately 9% to 10% of total Horizon revenue. During the first three months of 2004, four to eight regional jet aircraft were operated by Horizon pursuant to this agreement and accounted for 16.2% and 7.4% of Horizon’s capacity and passenger revenues, respectively.

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For 2004, Alaska and Horizon expect capacity increases of 6.5% and 20%, respectively. The expected capacity increase at Alaska is due largely to the annualization of the additional aircraft added in 2003 combined with increases in utilization. Horizon’s expected capacity increase is due largely to the annualization of aircraft additions in late 2003, the addition of two aircraft in the first quarter of 2004 and higher utilization resulting from the new contract flying for Frontier.

Results of Operations

First Quarter 2004 Compared with First Quarter 2003

We recorded consolidated operating and pre-tax losses of $58.5 million and $66.2 million, respectively, in 2004 versus $78.6 million and $87.9 million, respectively, in 2003. Financial and statistical data comparisons for Alaska and Horizon are shown on pages 14 and 15, respectively. A discussion of the three-month data follows. On page 16, we have included a reconciliation of reported non-GAAP financial measures to the most directly comparable GAAP financial measures.

Alaska Airlines Revenues

Operating revenues increased $64.3 million, or 15.1%, during 2004 as compared to 2003. For the quarter, available seat miles (ASM’s or capacity) increased 10.0% and revenue passenger miles (RPM’s or traffic) increased 13.9%. Approximately two-thirds of our 2004 ASM growth came from expansion in our Trans Continental markets and Denver. The remaining increases in capacity primarily reflect increases in service to Nevada, Anchorage/Fairbanks, Southern California and Mexico, partially offset by decreases in service to Northern Alaska, Arizona, Canada and Southeast Alaska. Traffic increases primarily reflect increases in traffic in the Trans Continental, Denver, Nevada, Pacific Northwest, Mexico, and Southern California markets, partially offset by decreases in traffic in Northern Alaska, Canada and Arizona.

Yield per passenger mile increased 1.9% and passenger load factor increased 2.4 points during the first quarter of 2004 as compared to the same period in 2003. Increases in traffic and yield resulted in a 16.1% increase in passenger revenues in 2004.

Freight and mail revenues increased slightly by $0.3 million, or 1.7%, compared to the same period in 2003.

Other-net revenues increased $1.7 million, or 7.5%, due largely to revenues received from an agreement with PenAir to provide flight services to Dutch Harbor that began in January of 2004.

Alaska Airlines Expenses

For the quarter, total operating expenses increased $50.7 million, or 10.4%, as compared to the same period in 2003. Operating expenses per ASM increased 0.4% in 2004 as compared to 2003. These increases are due largely to the 10.0% increase in capacity combined with a significant increase in fuel costs and higher wages and maintenance costs. Operating expense per ASM excluding fuel decreased 1.6% as compared to the same period in 2003. Explanations of significant period-over-period changes in the components of operating expenses are as follows:

•

Wages and benefits increased $12.8 million, or 6.8%, during the first quarter. Approximately $5.9 million of this increase reflects higher benefit costs, resulting from increases in pension

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			costs of approximately $3.8 million and higher health insurance costs of $2.1 million. The remaining $6.9 million increase primarily reflects scale and step increases.
			In May of 2004, under terms of our union contract, our pilots will receive a 4% wage rate increase.
	•		Contracted services increased $2.4 million, or 11.6%, due largely to expenses associated with an agreement with PenAir to provide flight services to Dutch Harbor that began in January of 2004.
	•		Aircraft fuel increased $16.7 million, or 21.7%, due to a 13.9% increase in the fuel cost per gallon and a 6.8% increase in fuel gallons consumed. Air Group’s fuel hedging program resulted in Alaska recognizing a $3.1 million reduction in aircraft fuel expense for hedging gains realized on hedge positions settled during the first quarter of 2004. Fuel prices remain at very high levels and continue to be volatile. At March 31, 2004, we have fuel hedge contracts in place to hedge 40%, 38% and 7% of our expected fuel consumption in 2004, 2005 and 2006, respectively, at prices ranging from $27 to $29 per crude oil barrel.
	•		Aircraft maintenance increased $5.6 million, or 14.8%, due largely to an increase in overhaul amortization resulting from the planned retirement of three Boeing 737-200Cs and an increase in costs associated with C checks as compared to 2003. We expect maintenance costs for 2004 to be 1% to 2% higher than in 2003.
	•		Aircraft rent decreased $1.0 million, or 3.3%, due to lower rates on extended leases and MD80 returns, offset by three new 737-700 aircraft.
	•		Other selling expenses and commissions increased $3.8 million, or 12.6%. This increase is due largely to planned increases in advertising expense to promote our fare simplification and computer reservation system costs, partially offset by a decrease in incentive payments made to Horizon. Incentive payments to Horizon are eliminated in consolidation at the Air Group level.
	•		Depreciation and amortization increased $4.3 million, or 15.1% reflecting accelerated depreciation on the planned retirement of three Boeing 737-200Cs and an increase in depreciation resulting from six aircraft purchased in the last twelve months.
	•		Landing fees and other rentals increased $4.5 million, or 15.7%. The higher rates primarily reflect higher fees at Seattle, Los Angeles and Oakland, combined with modest volume growth. We expect landing fees and other rentals to continue to increase as a result of airport facility expansions and increased costs for security.
	•		Other expense increased $2.8 million, or 8.2%, primarily reflecting a $2.6 million increase in professional services associated with our cost cutting initiatives, Sarbanes-Oxley Section 404 preparation and a $1.0 million increase in foreign exchange loss, partially offset by a decrease in insurance expense.

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Horizon Air Revenues

For the quarter, operating revenues increased $11.4 million, or 11.5% as compared to 2003. This increase is due largely to a 4.5% increase in revenue associated with the Horizon brand (“native network”) flying combined with $7.8 million in revenue from contract flying for Frontier Airlines, which began January 1, 2004. The arrangement with Frontier provides for reimbursement of expected costs plus a base mark up and certain incentives. However, since Horizon is not responsible for many of the typical costs of operations such as fuel, landing fees, marketing costs and station labor and rents, revenue per ASM, cost per ASM and cost per ASM excluding fuel for this flying is approximately 60% to 70% lower than compared to native network flying.

For the three months ending March 31, 2004, capacity increased 12.3% and traffic was up 26.1%, compared to the same period in 2003. Contract flying with Frontier represented approximately 16.2% of capacity and 17.0% of traffic, during the first three months of 2004. Passenger load factor increased 6.9 percentage points to 65.0%. Passenger yield decreased 10.4% to 23.6 cents, reflecting the inclusion of the Frontier contract flying, the yield for which is approximately 60% lower than native network flying. Contract revenue and higher yields in Horizon’s native network combined with the increases in traffic, resulted in an increase in passenger revenue of $12.0 million, or 12.8%.

Horizon Air Expenses

Operating expenses increased $5.8 million, or 5.1%, as compared to the same period in 2003. This increase is due largely to a 6.8% increase in fuel on 7.7% less gallons consumed, an 11.6% increase in aircraft rent and a $2.4 million impairment of F-28 aircraft and related spare engines. Operating expenses per ASM including fuel and impairment charge decreased 6.6% as compared to 2003. Operating fuel per ASM excluding fuel and the impairment charge decreased 8.9% as compared to the same period in 2003. Explanations of significant period-over-period changes in the components of operating expenses are as follows:

	•		Wages and benefits increased $2.4 million, or 6.1%, reflecting an increase in average wages combined with an increase in benefit costs, partially offset by a decrease in the average number of employees.
	•		Aircraft fuel increased $0.9 million, or 6.8%, due to a 16.0% increase in the cost per gallon of fuel, partially offset by a 7.7% decrease in gallons consumed. Air Group’s fuel hedging program resulted in Horizon recognizing a $0.4 million reduction in aircraft fuel expense for hedging gains realized on hedge positions settled during the first quarter of 2004.
	•		Aircraft maintenance expense decreased $1.3 million, or 15.1%, primarily due to fewer Q400 and CRJ heavy checks, which was offset by increases in costs related to engines now out of the warranty period. In addition, maintenance expense includes the benefit of a $1.3 million credit to spare parts inventory.
	•		Aircraft rent increased $1.9 million, or 11.6%, reflecting the addition of two CRJ’s and two Q400s in 2004 as compared to the same period in 2003.

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	•		Landing fees and other rentals increased $1.2 million, or 13.8%. Higher landing fees are a result of higher rates associated with modest volume growth, an increase in airport fees and increased costs for security. We expect landing fees and other rentals to continue to increase as a result of airport facility expansions and increased costs for security.
	•		Our first quarter 2004 operating expenses also reflect an impairment charge related to our held for sale F-28 aircraft and spare engines to lower the carrying value of these assets to their estimated fair value.

Consolidated Nonoperating Income (Expense)

Net nonoperating expense was $7.7 million in 2004 compared to $9.3 million in 2003. Interest income increased $4.0 million due to a higher marketable securities balance in 2004 combined with a negative adjustment of premium and discount amortization on our marketable securities portfolio in 2003. Interest expense (net of capitalized interest) increased $2.1 million due to increases in debt balances as compared to 2003.

Other-net includes $0.7 million and $0.4 million in hedging gains resulting from hedge ineffectiveness on fuel hedging contracts in 2003 and 2004, respectively.

Consolidated Income Tax Benefit

Accounting standards require us to provide for income taxes each quarter based on either our estimate of the effective tax rate for the full year or the actual year-to-date effective tax rate if it is our best estimate of our annual expectation. The volatility of airfares and fuel prices and the seasonality of our business make it difficult to accurately forecast full-year pretax results. In addition, a relatively small change in pretax results can cause a significant change in the effective tax rate due to the magnitude of nondeductible expenses, such as employee per diem costs, relative to pretax profit or loss. In estimating the 35.5% tax rate for 2004, we considered a variety of factors, including the U.S. federal rate of 35%, estimates of nondeductible expenses and state income taxes, and year-to-date pretax results. We evaluate this rate each quarter and make adjustments when necessary.

Critical Accounting Policies

For more information on our critical accounting policies, see Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2003.

Liquidity and Capital Resources

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

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We plan to meet our capital and operating commitments through internally generated funds from operations and cash and marketable securities on hand at March 31, 2004 totaling $829.9 million. We also have restricted cash of $17.0 million, which is intended to collateralize interest payments due in the next two years on our $150.0 million floating rate senior convertible notes due 2023 issued in 2003.

During the quarter ended March 31, 2004, our cash and marketable securities increased $17.6 million to $829.9 million at March 31, 2004. This increase reflects cash provided by operating activities of $21.6 million and cash provided by financing activities of $48.2 million, partially offset by cash used for the purchase of property and equipment of $50.2 million and $2.0 million paid for restricted deposits.

Cash Provided by Operating Activities

During the first three months of 2004, net cash provided by operating activities was $21.6 million, compared to net cash used in operating activities of $4.8 million during the first three months of 2003. The increase in cash flow from 2003 to 2004 resulted primarily from a reduction in our net loss from 2003 combined with year over year increases in air traffic liability and other current liabilities, partially offset by increases in accounts receivable-net, prepaid expenses and other current assets and a decrease in deferred taxes.

Cash Used in Investing Activities

Cash used in investing activities was $97.8 million during the first three months of 2004, compared to $168.1 million in 2003. We had net purchases of $45.6 million of marketable securities and $50.2 million for property and equipment, including the purchase of one 737-900. During the first three months of 2004, our aircraft related capital expenditures decreased $51.9 million as compared to 2003, primarily reflecting a reduction in spending for new aircraft and capitalized overhauls.

Cash Provided by Financing Activities

Net cash provided by financing activities was $48.2 million during the first three months of 2004 compared to $109.7 during the same period in 2003. Debt issuances during the quarter of $62.6 million were secured by flight equipment. These debt issuances have interest rates that vary with the London Interbank Offered Rate (LIBOR) and payment terms ranging from 14 to 16 years. Debt issuances during the quarter were offset by normal long term debt payments of $15.1 million.

In 2003, we completed the private placement of $150.0 million of floating rate senior convertible notes due in 2023 pursuant to Rule 144A of the Securities Act of 1933, as amended. Net proceeds from the offering were $144.9 million, of which $22.3 million was used to acquire U.S. government securities to fund the first three years of interest payments. In 2003, we made a capital contribution of the remaining net proceeds from the sale of the notes to Alaska Airlines. Alaska Airlines has used the remaining proceeds from the notes for working capital requirements and expects in the future to continue to use these remaining proceeds for working capital requirements as well as other general corporate purposes. Although we have not yet determined how each payment of principal or

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interest due will be funded in the future, we anticipate that these payments will be funded either by dividends, distributions, loans, advances or other payments from our subsidiaries or through new borrowings or financings by Alaska Air Group. Any such payments by our subsidiaries to us could be subject to statutory or contractual restrictions. Currently, the only contractual restrictions are contained in Alaska Airlines’ $150 million credit facility, which expires in December 2004 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 investments, lease obligations, sales of assets, and additional indebtedness. Such provisions limit the amount of funds Alaska Airlines can distribute via dividend to Alaska Air Group. As of March 31, 2004, $49.3 million was available to distribute to Alaska Air Group via dividend without violating the covenants in Alaska Airlines’ credit facility. The notes do not restrict the ability of our subsidiaries to enter into additional agreements limiting or prohibiting the distribution of earnings, loans or other payments to Alaska Air Group. We are considering various alternatives including renewing or replacing the credit facility, although there can be no assurance that this can be accomplished on acceptable terms to us.

Supplemental Disclosure of Noncash Investing and Financing Activities

In January 2004, Horizon leased two Bombardier Q400s, which were treated as capital leases, each with a 14 year term. The net present value of these leases was determined to be $34.2 million and is included in flight equipment with the corresponding lease obligation included in long-term debt and capital lease obligations in the consolidated balance sheet.

Contractual Obligations, Commitments and Off-Balance Sheet Arrangements

At March 31, 2004, we had firm orders for 14 aircraft requiring aggregate payments of approximately $324 million, as set forth below. In addition, Alaska has options to acquire 26 additional B737’s, and Horizon has options to acquire 15 Q400’s and 25 CRJ 700’s. Alaska and Horizon expect to finance the new planes with leases, long-term debt or internally generated cash. During the first quarter of 2004, Alaska converted two 737-900 aircraft it had on firm order with Boeing for two 737-800s. The planes are due for delivery in February and July of 2005. The following table summarizes aircraft deliveries by year and payments from April 1, 2004 to December 31, 2004 and by fiscal year thereafter: