• Other expense decreased 4.9%, primarily due to lower legal, passenger remuneration, recruiting and supplies costs, offset by higher expenditures for insurance and utilities.

Horizon Air
Revenues
Capacity decreased by 8.5%. Traffic decreased by 8.6% and passenger load factor decreased 0.1 percentage points. Capacity, traffic, load factors and yields in all markets were adversly impacted by the September 11th terrorist attacks. For the month of September 2001 as compared to September 2000, traffic decreased 31.7% and load factor decreased 4.3 percentage points. For the third quarter, passenger yields were down 8.2%, largely due to a reduction in business passengers. The lower traffic combined with the lower yield resulted in a 16.2% decrease in passenger revenues.

Freight and mail revenues, which were also adversely impacted by the September 11th terrorist attacks, decreased 32.1% primarily due to Horizon”s decision, which was effective in June, to cease carrying general freight and focus on carrying higher-yield small packages instead. Other-net revenues increased $5.5 million, primarily due to manufacturer support received as compensation for delays in delivery of CRJ 700 aircraft. Additional support is expected during the fourth quarter of 2001.

Expenses
Operating expenses decreased by 6.3% as a result of an 8.5% decrease in capacity and a 2.3% increase in cost per ASM. Cost per ASM excluding fuel increased 6.1%. Unit costs were adversely impacted by the capacity reductions that resulted from the September 11th terrorist attacks. Additionally, Horizon”s expenses have been adversely impacted by delivery of the CRJ 700 aircraft, which was delayed by the manufacturer from January 2001 to July 2001. The Company hired and trained pilots, flight attendants and mechanics, and purchased spare parts in anticipation of the new fleet. These preparations have increased costs, but the total expected benefits of the new and more efficient aircraft have not yet occurred. Explanations of significant year-over-year changes in operating expenses are as follows:

• Wages and benefits increased 8.8% due to an 11.9% increase in average wages and benefits per employee, partly offset by a 2.8% decrease in the number of employees. Average wage rates are up due to a $0.6 million credit to profit sharing in 2000, longevity and merit increases, higher health insurance rates and having a greater percentage of pilots and mechanics in 2001. A new pilot contract became effective in September 2001 and increased wages and benefits expense approximately $0.6 million for September.
  
  
• Fuel expense decreased 24.6%, due to an 11.0% decrease in the cost per gallon of fuel and by a 15.5% decrease in gallons consumed. The lower fuel prices saved $1.7 million.
  
  
• Aircraft maintenance expense decreased 46.7%, due to an 11.5% decrease in aircraft block hours, the greater use of new aircraft in 2001 and unusually high expenses in 2000 related to the phasing out of the Fokker F-28 jet aircraft.

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• Aircraft rent increased 16.0%, due to higher rental rates incurred on new Dash 8-400 and CRJ 700 aircraft rented in 2001.
  
  
• Depreciation and amortization expense increased 24.1%, largely due to added depreciation on Fokker F-28 jet aircraft spare parts and airframes.
  
  
• Landing fees and other rentals increased 12.9%, due to increased rates at Seattle, Portland and several smaller airports. The higher rates are expected to continue during the remainder of 2001.
  
  
• Other expense increased 6.1%, primarily due to higher expenditures for insurance and personnel expenses, offset by lower costs for computers.

Consolidated Nonoperating Income (Expense)  Net nonoperating income was $25.5 million in 2001 compared to $1.4 million in 2000. The $24.1 million increase was primarily due to recording $18.7 million for Alaska and $10.4 million for Horizon of U.S government compensation under the Act described above under Industry Conditions. Interest expense, net of capitalized interest, increased $5.0 million due to new debt incurred during the past twelve months. Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. SFAS 133 requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Consequently, a $0.5 million charge was recorded in the third quarter of 2001 to recognize the reduction in fair value of fuel hedging contracts in accordance with the new standard.

Nine Months 2001 Compared with Nine Months 2000
The consolidated net loss for the nine months ended September 30, 2001 was $3.1 million, or $(0.12) per share compared with an income before accounting change (and excluding a special charge in 2000) of $30.3 million, or $1.15 per share (diluted) in 2000. The consolidated operating loss for the first nine months of 2001 was $25.4 million compared with an operating income (excluding a special charge) of $57.7 million for 2000. A discussion of operating results for the two airlines follows.

Alaska Airlines  Operating income (excluding a special charge in 2000) decreased from $50.5 million income in 2000 to a $5.5 million loss in 2001. The main reason for the operating income reduction was that revenues did not grow as fast as expenses. A 6.7% capacity increase combined with a 2.7% decrease in revenue per ASM resulted in a 3.7% increase in operating revenues. The lower revenue per ASM was due to a 1.4% decrease in yield and a 1.3 point drop in load factor. The 6.7% capacity increase combined with a 1.5% increase in expense per ASM resulted in an 8.3% increase in operating expenses (excluding a special charge in 2000). Changes in operating expense items are generally due to the same reasons stated above in the third quarter comparison.

Horizon Air  Operating income decreased from $8.0 million income in 2000 to a $18.9 million loss in 2001. Changes in operating revenues and operating expenses are generally due to the same reasons stated above in the third quarter comparison.

Consolidated Nonoperating Income (Expense)  Net nonoperating income was $20.6 million in 2001 compared to $4.3 million in 2000. The $16.3 million change was due to recording $29.1 million of U.S government compensation, offset by higher interest expense and a $3.1 million reduction in fair value of fuel hedging contracts.

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Consolidated Income Tax Credit Accounting standards require the Company to provide for income taxes each quarter based on its estimate of the effective tax rate for the full year. The volatility of air fares and fuel prices and the seasonality of the Company”s 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 goodwill amortization and employee per diem costs. In estimating the 35.4% tax rate for the first nine months of 2001, the Company considered a variety of factors, including the U.S. federal rate of 35%, estimates of nondeductible expenses and state income taxes, and the 39.1% and 39.2% tax rates used for full years 1998 and 1999. This rate is evaluated each quarter and adjustments are made if necessary.

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

The Company’s cash and marketable securities portfolio increased by $205.6 million during the first nine months of 2001. Operating activities provided $269.5 million of cash (including $50.4 million of U.S. government cash compensation under the Act) during this period. Additional cash was provided by the issuance of $359.5 million of new debt (including $150.0 million borrowed under Alaska”s credit facility) and the return of $72.5 million of flight equipment deposits. Cash was used for $351.6 million of capital expenditures, including the purchase of eight new and one used Boeing 737 aircraft, flight equipment deposits, spare parts and airframe and engine overhauls, for $128.2 million of debt repayment and for $18.7 million of restricted deposits.

Shareholders’ equity decreased $1.8 million, due to the net loss of $3.1 million, which was partly offset by stock issued for stock options exercised.

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Commitments  At September 30, 2001, the Company had firm orders for 39 aircraft requiring aggregate payments of approximately $863 million, as set forth below. In the wake of the terrorists attacks on September 11, Alaska and Horizon are re-evaluating their fleet plans and the fleet additions shown below may change in the near future. In addition, Alaska has options to acquire 26 more B737s, and Horizon has options to acquire 15 Dash 8-400s and 25 CRJ 700s. Alaska and Horizon expect to finance the new planes with leases, long-term debt or internally generated cash.