Results of Operations

The U.S. domestic airline environment continues to be extremely challenging as a result of two predominant factors. First, is the extremely weak revenue environment caused by widespread price competition and continued increases in industry capacity. We have encountered aggressive responses from our competitors trying to protect or regain market share through fare matching, price discounts, targeted sale promotions and frequent flyer travel initiatives, all of which are usually matched by other airlines. The second factor is the record high aircraft fuel prices caused by the sharp rise in crude oil prices. Hurricanes Katrina and Rita disrupted a significant portion of the oil production and refining operations in and around the Gulf of Mexico, resulting in unprecedented high fuel prices. The competitive industry environment, record high fuel prices and increased capacity on the routes we fly, including capacity that was added by us, have all affected our ability to increase fares. As a result, we experienced a significant reduction in our profitability in 2005.

Year 2005 Compared to Year 2004

We had a net loss of $20 million for the year 2005 compared to net income of $46 million for the year 2004. We had operating income of $48 million, a decrease of $63 million over 2004, and our operating margin was 2.8%, down 6.0 points from 2004. Diluted loss per share was $0.13 for 2005 and diluted earnings per share was $0.28 for 2004.

Operating Revenues. Operating revenues increased 34.5%, or $436 million, primarily due to an increase in passenger revenues. Increased passengers resulting from a 23.7% increase in departures, or $345 million, and a 3.5% increase in yields, or $55 million, drove the increase in passenger revenue of $400 million for the year 2005. Additionally, three major hurricanes during the third and fourth quarters resulted in estimated lost revenue of $8 to $10 million. Other revenue increased 78.4%, or $36 million, primarily due to increased LiveTV third party revenues of $13 million, increased change fees of $6 million resulting from more passengers and the marketing component of TrueBlue point sales of $7 million.

Operating Expenses. Operating expenses increased 43.3%, or $499 million, primarily due to operating an average of 16.9 additional aircraft, which provided us with higher capacity, and a 52.0% increase in average fuel price per gallon. Operating capacity increased 25.3% to 23.7 billion available seat miles in 2005 due to having 28.0% more average aircraft in-service offset by lower utilization of the EMBRAER 190. Operating expenses per available seat mile increased 14.4% to 6.98 cents. In detail, operating costs per available seat mile were (percent changes are based on unrounded numbers):

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Had fuel prices remained at 2004 levels, our cost per available seat mile, or CASM, would have only increased by 4.3% to 6.37 cents. The following table reconciles our operating expenses reported in accordance with U.S. generally accepted accounting principles, or GAAP, with those that we would have achieved had aircraft fuel prices remained at the 2004 levels. In management's view, comparative analysis of period-to-period operating results can be enhanced by excluding the significant volatility in the price of aircraft fuel, which is subject to many economic and political factors that are beyond our control, in addition to the impact of hedging activities. We believe that the presentation of this non-GAAP financial measure is useful to management and investors because it is more indicative of our ability to manage our costs and also assists in understanding the significant impact that fuel prices have had on our operations. Investors should consider these non-GAAP financial measures in addition to, and not as a substitute for, our financial performance measures prepared in accordance with GAAP.

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Salaries, wages and benefits increased 26.8%, or $91 million, due primarily to an increase in average full-time equivalent employees of 27.3% in 2005 compared to 2004. We did not record any profit sharing in 2005 compared to $14 million in 2004. This decrease was partially offset by the incurrence of $7 million in non-cash stock-based compensation expense related to the accelerated vesting of 19.9 million stock options in December 2005. The decision to accelerate the vesting of these options was made primarily to avoid recognizing related compensation costs in future consolidated financial statements upon our adoption of SFAS No. 123(R) in January 2006. All other terms and conditions applicable to such options, including the exercise prices, remain unchanged. Following the acceleration, 28.4 million, or 91.4%, of our outstanding options were vested. Cost per available seat mile remained relatively flat as a result of higher wages being offset by lower profit sharing.

Aircraft fuel expense increased 91.1%, or $233 million, due to 62 million more gallons of aircraft fuel consumed resulting in $66 million of additional fuel expense and, even after giving effect to $43 million of fuel hedging gains, a 52.0% increase in average fuel cost per gallon, or $167 million. Our fuel costs represented 29.5% and 22.1% of our operating expenses in 2005 and 2004, respectively. During 2005, aircraft fuel prices remained at historically high levels, with our average fuel price per gallon at $1.61 compared to $1.06 in 2004. Based on our expected fuel volume for 2006, a $0.10 per gallon increase in the cost of aircraft fuel would increase our annual fuel expense by approximately $40 million. Cost per available seat mile increased 52.4% due to the increase in average fuel cost per gallon.

Landing fees and other rents increased 22.5%, or $20 million, due to a 23.7% increase in departures over 2004 offset by lower landing fee rates. Cost per available seat mile decreased 2.3% due to higher capacity and an increase in average stage length. Landing fees and other rents are expected to increase approximately $10 million in 2006 as a result of ground rent on our new terminal at JFK, which is under construction.

Depreciation and amortization increased 49.3%, or $38 million, primarily due to having an average of 51.9 owned aircraft in 2005 compared to 35.6 in 2004. Cost per available seat mile increased 19.1% due to a higher percentage of our aircraft fleet being owned and as a result of placing into service our new hangars and training center during 2005.

Aircraft rent increased 5.7%, or $4 million, due to $2 million in higher rates and $2 million related to new aircraft leases. Cost per available seat mile decreased 15.6% due to higher capacity and a lower percentage of our fleet being leased.

Sales and marketing expense increased 28.9%, or $18 million, due to higher credit card fees resulting from increased passenger revenues. On a cost per available seat mile basis, sales and marketing expense increased 2.9% primarily due to higher credit card fees resulting from higher average fares. We book all of our reservations through a combination of our website and our agents (77.5% and 22.5% in 2005, respectively).

Maintenance materials and repairs increased 43.5%, or $19 million, due to 16.9 more average aircraft in 2005 compared to 2004 and a gradual aging of our fleet. Cost per available seat mile increased 14.5% year-over-year due to the completion of 63 airframe checks in 2005 compared to 54 in 2004, as well as increased engine and component repairs, and is expected to increase significantly as our fleet ages.

Effective July 1, 2005, we executed a ten-year engine services agreement with MTU covering the scheduled and unscheduled repair of the engines on our Airbus A320 aircraft. This agreement requires monthly payments to MTU at rates based on number of flight hours each engine was operated during each month. MTU has assumed the responsibility to repair and overhaul our engines as required during the term of the agreement. These payments will be expensed as the flight hours are incurred. This agreement will eliminate the significant judgment in determining estimated costs of overhauls and is expected to result in lower maintenance costs than on a time and materials basis.

Other operating expenses increased 35.8%, or $76 million, primarily due to higher variable costs associated with increased capacity and number of passengers served. Cost per available seat mile increased 8.3% as a result of increased LiveTV third party installations, fuel related taxes and services, and a $6 million write-off of development costs related to a maintenance and inventory tracking system that will not be implemented.

Other Income (Expense). Interest expense increased 99.2% primarily due to our debt financing of 16 additional aircraft and interest on our $250 million of convertible debt issued in March 2005, resulting in $35 million of additional interest expense, and higher interest rates, which resulted in $19 million of additional interest expense. Interest income increased by $11 million due to higher interest rates. Capitalized interest increased 79.3%, or $7 million, due to higher predelivery deposit balances and increased rates.

Our effective tax rate decreased to 14.9% in 2005 from 38.2% in 2004. The effective tax rate differs from the statutory income tax rate due to the nondeductibility of certain items for tax purposes and the relationship of these items to our pre-tax loss of $24 million, which resulted primarily from higher fuel prices.

Year 2004 Compared to Year 2003

Our net income for the year 2004 decreased to $46 million from $103 million for the year 2003. We had operating income of $111 million, a decrease of $56 million over 2003, and our operating margin was 8.8%, down 8.0 points from 2003.

Diluted earnings per share was $0.28 and $0.64 for the years ended 2004 and 2003, respectively. Our results for 2003 included $23 million in Emergency War Time Act compensation which, net of profit sharing and income taxes, amounted to $11 million, or $0.07 per diluted share.

Operating Revenues. Operating revenues increased 26.7%, or $267 million, primarily due to an increase in passenger revenues. Increased passengers resulting from a 35.3% increase in departures, or $352 million, partially offset by a 7.4% decrease in yield, or $97 million, drove the increase in passenger revenue of $255 million for the year 2004. Lower yields experienced during 2004 and a 1.3 point reduction in load factor were primarily attributable to an extremely competitive environment, which included unprecedented fare discounting and frequent flyer offers by several airlines in most of the markets we serve. These carriers also added back capacity that was taken out in 2003 at the onset of hostilities in Iraq, which significantly impacted our East-West markets. Additionally, four major hurricanes during the third quarter resulted in estimated lost revenue of $8 to $10 million. Other revenue increased 35.9%, or $12 million, primarily due to increased change fees of $6 million resulting from more passengers and LiveTV third party revenues of $3 million.

Operating Expenses. Operating expenses increased 38.8%, or $323 million, primarily due to operating an average of 16.6 additional aircraft, which provided us with higher capacity. Operating capacity increased 38.6% to 19 billion available seat miles due to scheduled capacity increases and increased transcontinental flights over 2003. Operating expenses per available seat mile increased 0.1% to 6.10 cents. In detail, operating costs per available seat mile were (percent changes are based on unrounded numbers):

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Salaries, wages and benefits increased 26.1%, or $70 million, due to an increase in average full-time equivalent employees of 33.7% in 2004 compared to 2003. Cost per available seat mile decreased 9.0% principally as a result of a $17 million lower profit sharing provision, of which $3 million was attributable to Emergency War Time Act compensation in 2003.

Aircraft fuel expense increased 73.3%, or $108 million, due to 68 million more gallons of aircraft fuel consumed resulting in $58 million of additional fuel expense and, even after giving effect to the $37 million of fuel hedging gains, a 24.5% increase in average fuel cost per gallon, or $50 million. Our fuel costs represented 22.1% and 17.8% of our operating expenses in 2004 and 2003, respectively. During 2004, aircraft fuel prices remained at or near historically high levels, with our average fuel price per gallon at $1.06 compared to $0.85 in 2003. Cost per available seat mile increased 25.0% due to the increase in average fuel cost per gallon.

Landing fees and other rents increased 31.3%, or $22 million, due to a 35.3% increase in departures over 2003. Cost per available seat mile decreased 5.3% due to higher capacity and an increase in average stage length.

Depreciation and amortization increased 51.3%, or $26 million, primarily due to having an average of 35.6 owned aircraft in 2004 compared to 23.2 in 2003. Cost per available seat mile increased 9.1% due to a higher percentage of our aircraft fleet being owned.

Aircraft rent increased 17.1%, or $10 million, due to having an average of 25.0 aircraft operated under operating leases during 2004 compared to 20.8 in 2003. Cost per available seat mile decreased 15.5% due to higher capacity and a smaller percentage of our fleet being leased.

Sales and marketing expense increased 17.9%, or $9 million, due to higher credit card fees resulting from increased passenger revenues. On a cost per available seat mile basis, sales and marketing expense decreased 14.9% primarily due to the increases in capacity exceeding increases in advertising costs. We book the majority of our reservations through a combination of our website and our agents, 75.4% and 22.9% in 2004, respectively.

Maintenance materials and repairs increased 94.3%, or $22 million, due to 16.6 more average aircraft in 2004 compared to 2003 and a gradual aging of our fleet. The cost per available seat mile increased 40.1% year-over-year due to the completion of 54 airframe checks in 2004 compared to 34 in 2003, as well as increased engine and component repairs, and is expected to increase significantly as our fleet ages.

Other operating expenses increased 34.8%, or $56 million, primarily due to higher variable costs associated with increased capacity and number of passengers served. Cost per available seat mile decreased 2.8% as a result of our fixed costs being spread over higher capacity.

Other Income (Expense). Interest expense increased 85.1% primarily due to our debt financing of 15 additional aircraft and interest on our 3½% convertible notes, resulting in $24 million of additional interest expense. Interest income increased by $3 million due to higher interest rates. Other income also includes the ineffective gains(losses) on our derivative contracts, which were de minimis in 2004 and resulted in a gain of $2 million in 2003.

Our effective tax rate declined to 38.2% in 2004 compared to 40.8% in 2003 primarily as a result of $2 million in California State Enterprise Zone tax credits in 2004.

Quarterly Results of Operations

The following table sets forth selected financial data and operating statistics for the four quarters ended December 31, 2005. The information for each of these quarters is unaudited and has been prepared on the same basis as the audited consolidated financial statements appearing elsewhere in this Form 10-K.

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(1) During the fourth quarter of 2005, we recorded $7 million in stock-based compensation expense related to the acceleration of stock options and wrote off $6 million in development costs related to a maintenance and inventory tracking system.

(2) Excludes results of operations and employees for LiveTV, LLC, which are unrelated to our airline operations.

Although we have continued to experience significant revenue growth, this trend may not continue. We expect our expenses to continue to increase significantly as we acquire additional aircraft, as our fleet ages and as we expand the frequency of flights in existing markets and enter into new markets. Accordingly, the comparison of the financial data for the quarterly periods presented may not be meaningful. In addition, we expect our operating results to fluctuate significantly from quarter to quarter in the future as a result of various factors, many of which are outside our control. Consequently, we believe that quarter-to-quarter comparisons of our operating results may not necessarily be meaningful and you should not rely on our results for any one quarter as an indication of our future performance.