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AirTran Holdings 10-Q 2006 Documents found in this filing:Table of ContentsUNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended September 30, 2006 OR
For the transition period from to Commission file No. 1-15991
AirTran Holdings, Inc. (Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code: (407) 318-5600
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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer in Rule 12b-2 of the Exchange Act. Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Number of shares of Common Stock outstanding as of the close of business on October 23, 2006: 91,052,844, par value $0.001
Table of ContentsForm 10-Q For the Quarter Ended September 30, 2006 INDEX
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Table of ContentsFINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Statements of Operations (In thousands, except per share data) (Unaudited)
See accompanying Notes to Condensed Consolidated Financial Statements.
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Table of ContentsCondensed Consolidated Balance Sheets (In thousands)
(Continued on next page)
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Table of ContentsAirTran Holdings, Inc. Condensed Consolidated Balance Sheets (Continued) (In thousands)
See accompanying Notes to Condensed Consolidated Financial Statements.
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Table of ContentsCondensed Consolidated Statements of Cash Flows (In thousands) (Unaudited)
See accompanying Notes to Condensed Consolidated Financial Statements.
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Table of ContentsCondensed Consolidated Statements of Stockholders’ Equity (In thousands) (Unaudited)
See accompanying Notes to Condensed Consolidated Financial Statements.
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Table of ContentsNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1 - Summary of Significant Accounting Policies Basis of Presentation Our unaudited Condensed Consolidated Financial Statements include the accounts of AirTran Holdings, Inc. (Holdings) and our wholly-owned subsidiaries, including our principal subsidiary, AirTran Airways, Inc. (Airways). All significant intercompany accounts and transactions have been eliminated in consolidation for all periods presented. In the opinion of management, the accompanying unaudited Condensed Consolidated Financial Statements contain all adjustments, which are of a normal recurring nature (other than non-recurring adjustments, which have been separately disclosed), necessary to present fairly the financial position, results of operations, cash flows and stockholders’ equity for the periods presented. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC) for reports on Form 10-Q. These unaudited interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K/A for the year ended December 31, 2005. The preparation of the accompanying unaudited Condensed Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the amounts reported in the Condensed Consolidated Financial Statements and accompanying Notes. Actual results may differ from those estimates and such differences may be material to the Condensed Consolidated Financial Statements. Business We offer scheduled airline services primarily in short to mid-haul markets principally in the eastern United States. Our financial and operating results for any interim period are not necessarily indicative of those for the entire year. Air travel in our markets tends to be seasonal, with the highest level of travel occurring during the winter months to Florida and the summer months to the northeastern and western United States. Reclassification Certain 2005 amounts in the Condensed Consolidated Statement of Cash Flows and Statement of Operations have been reclassified to conform to current presentation. Advertising expense During 2005 we entered into an advertising barter transaction in which we exchanged flight credits in our frequent flyer program for promotional consideration. The transaction was recorded at the estimated fair value of the credits exchanged. During the third quarter of 2006, we recorded additional marketing and advertising expense of $2.4 million for a change in the estimated number of participants expected to use “free tickets” under the 2005 promotional arrangement. The revenue relating to the flight credits will be recognized as passenger revenue as the credits are utilized or expire. New Accounting Standards In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - An interpretation of FASB Statement No. 109,” or FIN 48. The Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. We have not determined the effect, if any, that the adoption of FIN 48 will have on our financial position or results of operations. We will adopt FIN 48 as of January 1, 2007, as required.
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Table of ContentsIn September 2006, the FASB issued Statement No. 158 (SFAS 158), Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB No. 87, 88, 106, and 132 (R). SFAS 158 requires the recognition of the overfunded or underfunded status of defined benefit postretirement plans as assets or liabilities on the balance sheet with changes to the funded status recognized through comprehensive income in the year in which they occur. SFAS 158 is effective for fiscal years ending after December 15, 2006. While we are currently evaluating the impact of SFAS 158 on our financial statements, we do anticipate the impact to be material. Note 2 - Stock-Based Employee Compensation Our 1993 Incentive Stock Option Plan provides for the grant of options to officers, directors and key employees to purchase up to 4.8 million shares of common stock at prices not less than the fair value of the shares on the dates of grant. Our 2002 Long-term Incentive Plan, 1996 Stock Option Plan, and 1994 Stock Option Plan respectively authorize up to 5 million, 5 million, and 4 million incentive stock options or nonqualified options, respectively, to be granted to our officers, directors, key employees and consultants. In connection with the acquisition of Airways Corporation in 1997, we assumed the Airways Corporation 1995 Stock Option Plan (Airways Plan) and the Airways Corporation 1995 Director Stock Option Plan (Airways DSOP). Under the Airways Plan, up to 1.2 million incentive stock options or nonqualified options may be granted to our officers, directors, key employees or consultants. Under the Airways DSOP, up to 150,000 nonqualified options may be granted to directors. Vesting and term of all options is determined by the Board of Directors and may vary by optionee; however, the term may be no longer than 10 years from the date of grant. Effective January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards (SFAS) 123R, Share Based Payment, which requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant date fair value of those awards in the financial statements. SFAS 123R supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25), and revises the guidance in SFAS 123, Accounting for Stock-Based Compensation. Prior to January 1, 2006, we accounted for our stock-based compensation plans in accordance with APB No. 25 and related interpretations. Accordingly, we recognized compensation expense related to restricted stock grants based on the market value of the common stock at the date of grant and recognized compensation expense for a stock option grant only if the exercise price was less than the market value of our common stock on the grant date. Prior to the adoption of SFAS 123R, as required under the disclosure provisions of SFAS 123, we provided pro forma net income and earnings per share for each period presented as if we had applied the fair value method to measure stock-based compensation expense.
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Table of ContentsThe following table illustrates the effect on net income and earnings per share for the three months and nine months ended September 30, 2005 as if we had applied the fair value method to measure stock-based compensation, as required under the disclosure provision in SFAS 123 (in thousands, except for per share amounts):
The adoption of SFAS 123R affected our accounting for stock options and our employee stock purchase plan. The change in the accounting for the stock purchase plan does not have a material impact on our statement of operations. The adoption of SFAS 123R had no impact on our accounting for restricted stock grants. Stock Options SFAS 123R is effective for all stock options granted on or after January 1, 2006. For those stock options that were granted prior to January 1, 2006, but for which the vesting period is not complete, we used the “modified prospective method” of accounting permitted under SFAS 123R. Under this method, stock option awards granted prior to January 1, 2006, but for which the vesting period is not complete, must be accounted for on a prospective basis with the related cost being recognized in the financial statements beginning with the first quarter of 2006 using the grant date fair values previously calculated for our pro forma disclosures. We will recognize the related compensation costs not previously reflected in the pro forma disclosures over the remaining vesting period. During 2005, we accelerated the vesting for certain unvested stock options awarded that had an exercise price greater than the market price on the date of the acceleration. The purpose of accelerating the vesting of these options was to avoid compensation expense in 2006 associated with the unvested options upon adoption of SFAS 123R. We have recognized $0.1 million in compensation expense related to the adoption of SFAS 123R during the nine months ended September 30, 2006. Because all outstanding options vested during the first quarter 2006, and we do not anticipate granting any options during 2006, we do not expect to incur additional expense related to the adoption of SFAS 123R for the year ending December 31, 2006. SFAS 123R also requires that the benefits associated with the tax deductions in excess of recognized compensation cost be reported as a financing cash flow rather than as a operating cash flow. For the three and nine months ended September 30, 2006, we did not record any excess tax benefit generated from option exercises. We utilize the Black-Scholes model to estimate the fair value of options at the date of grant. There were no options granted during the nine months ended September 30, 2006. A summary of stock option activity under the aforementioned plan is as follows:
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Table of ContentsThe following table summarizes information concerning outstanding and exercisable options at September 30, 2006:
The intrinsic value of the options exercised in the first nine months of 2006 and 2005, determined as of the date of exercise of the options, was $9.3 million and $2.2 million, respectively. The fair value of the options exercised during the nine months ended September 30, 2006, as determined under SFAS 123 on the date of issuance, was $2.9 million. Restricted Stock Awards Restricted stock awards have been granted to certain of our officers, directors and key employees pursuant to our 2002 Long-Term Incentive Plan. Stock awards are grants of shares of our common stock which typically vest over time and are valued at the fair market value of our publicly traded stock on the date of issuance and the value is being charged on a straight-line basis to expense over the respective vesting period (generally three years). During the first nine months of 2006, we granted awards for approximately 470,000 shares and recorded deferred compensation related to such awards of approximately $7.1 million. Approximately $3.4 million of deferred compensation was amortized as compensation expense during the first nine months of 2006. Awards for approximately 253,000 shares of restricted stock vested during the first nine months of 2006. As of September 30, 2006, awards for approximately 807,000 shares were outstanding but had not vested. Prior to our adoption of SFAS 123R, we presented unearned compensation related to restricted stock awards as a separate component of stockholders equity. In accordance with SFAS 123R, on January 1, 2006, we reclassified unearned compensation as additional paid-in capital on our consolidated balance sheet.
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Table of ContentsNote 3 - Earnings (Loss) Per Common Share The following table sets forth the computation of basic and diluted earnings per common share:
Excluded from the diluted earnings per share calculation for the three and nine month periods ended September 30, 2006 and 2005 are 11.2 million shares related to our 7% convertible notes that would be issued upon conversion because the effect of including these shares would have been anti-dilutive. Excluded from the three months ended September 30, 2006 and the nine months ended September 30, 2006 and 2005 were shares related to restricted stock because they were anti-dilutive. Additionally, excluded from the three months ended September 30, 2006 were shares related to stock options as they were anti-dilutive. In April 2006, all outstanding warrants were exercised and therefore have no impact on dilutive earnings per share as of September 30, 2006. Note 4 - Commitments and Contingencies Aircraft Purchase Commitments During the nine months ended September 30, 2006, we took delivery of 14 B737 aircraft and two B717 aircraft. Of the 14 B737 aircraft, seven were leased under operating leases while seven were purchased using debt financing. The two B717 aircraft were leased under operating leases. Total lease commitments for the seven B737s and two B717s are $446.3 million payable through 2024. During the nine months ended September 30, 2006, we exercised options to acquire 24 additional B737 aircraft with delivery dates through 2010. In September 2006, we entered into an agreement with the aircraft manufacturer to reschedule five aircraft deliveries from the second half of 2007 and three aircraft deliveries from the first quarter of 2008 to deliveries in 2009 through 2011. As of September 30, 2006 we had on order 66 B737 aircraft with delivery dates between 2006 and 2011. The table below illustrates all aircraft scheduled for delivery through 2011:
Aircraft Financing Arrangements Of the 66 B737 aircraft on order, we have secured debt financing for 13 of the aircraft, including four to be delivered in the remainder of 2006 and nine to be delivered in 2007, through arrangements with financial institutions. Additionally, we have secured sale/leaseback agreements with respect to six related spare engines to be delivered through 2010 for the B737 aircraft.
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Table of ContentsFuel Purchase Commitments Efforts to reduce our exposure to increases in the price and availability of aviation fuel include the utilization of fuel purchase contracts involving both fixed-price arrangements and cap arrangements. Fixed-price arrangements consist of an agreement to purchase defined quantities of aviation fuel from a third party at defined prices. Cap arrangements consist of an agreement to purchase defined quantities of aviation fuel from a third party at a price not to exceed a defined price, limiting our exposure to upside market risk. As of September 30, 2006, utilizing fixed-price and cap arrangements, we had committed to purchase 38.3 million and 60 million gallons at a weighted-average price per gallon, excluding taxes and into-plane fees, of $2.07 and $1.64 respectively, for the remainder of 2006 and 2007. This represents approximately 47.3 percent and 15.6 percent of our anticipated fuel needs for the remainder of 2006 and 2007, respectively. General Indemnifications and Litigation We are party to many routine contracts under which we indemnify third parties for various risks. We have not recorded any liability for any of these indemnities, as the amount is not determinable or estimable. These indemnities generally consist of the following: Certain of Airways’ debt agreements related to certain aircraft-secured notes payable through 2017 contain language whereby we have agreed to indemnify certain holders of certificates evidencing the debt associated with such notes, as necessary, to compensate them for any costs incurred by, or any reduction in receivables due to such certificate holders resulting from broadly defined regulatory changes that impose or modify any reserve, special deposit or similar requirements relating to any extensions of credit or other assets of, or any deposits with or other liabilities of such certificate holders. Additionally, if it becomes unlawful for such certificate holders to make or maintain the investment or credit evidenced by the certificates, we have agreed to pay such certificate holders an amount necessary to cause the interest rate with respect to the certificates to be a rate per annum equal to 4.88% over the rate specified by such certificate holders as the cost to them of obtaining funds in dollars in the United States in an amount equal to the pool balance of the certificates. The maximum potential payment under these indemnities cannot be determined. Airways’ aircraft lease transaction documents contain customary indemnities concerning withholding taxes under which we are responsible in some circumstances, should withholding taxes be imposed, for paying such amounts of additional rent as is necessary to ensure that the lessor still receives, after taxes, the rent stipulated in the lease agreements. These provisions apply on leases expiring through 2023. The maximum potential payment under these indemnities cannot be determined. In our aircraft financing agreements and aircraft leasing agreements, we typically indemnify the financing parties, the trustee acting on their behalf and other related parties against liabilities that arise from the manufacture, design, ownership, financing, use, operation, and maintenance of the aircraft for tort liability, whether or not these liabilities arise out of or relate to the negligence of these indemnified parties, except for their gross negligence or willful misconduct. We believe that we are covered by insurance (subject to deductibles) for most tort liabilities and related indemnities as described above with respect to the aircraft we operate. Additionally in our aircraft financing agreements, if there is a change in the law which results in the imposition of any reserve, capital adequacy, special deposit, or similar requirement the result of which is to increase the cost to the lender, we will pay the lender the additional amount necessary to compensate the lender for the actual cost increase. We have various leases with respect to real property, and various agreements among airlines relating to fuel consortia or fuel farms at airports, under which we have agreed to standard language indemnifying the lessor against environmental liabilities associated with the real property covered under the agreement, even if we are not the party responsible for the environmental damage. In the case of fuel consortia at the airports, these indemnities are generally joint and several among the airlines. We cannot quantify the maximum potential exposure under these indemnities, and we do not currently have liability insurance that protects us against environmental damages.
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Table of ContentsUnder certain contracts with third parties, we indemnify the third party against legal liability arising out of an action by a third party. The terms of these contracts vary and the potential exposure under these indemnities cannot be determined. Generally, we have liability insurance protecting us from obligations undertaken under these indemnities. From time to time, we are engaged in litigation arising in the ordinary course of our business. We do not believe that any such pending litigation will have a material adverse effect on our results of operations or financial condition. Note 5 – Long-term Debt and Capital Leases The components of our long-term debt, including capital lease obligations, were (in thousands):
Aircraft Financing Facilities Floating rate facilities: On February 14, 2006, we entered into a fourth floating rate aircraft facility (included in floating rate aircraft notes payable above), pursuant to which we financed the acquisition of two additional B737 aircraft. We took delivery of the first such aircraft in February 2006 and the second such aircraft in March 2006. In conjunction with the financing of these B737 aircraft, we issued equipment notes as aircraft were delivered for an aggregate amount of $58.0 million with maturities between February and March 2018. The notes bear interest at a floating rate per annum above the six-month LIBOR. Interest and principle payments are payable semi-annually. On August 31, 2006, we entered into a fifth floating rate facility, pursuant to which we intend to finance the acquisition of five additional B737 aircraft. The five B737 aircraft are scheduled to be delivered in 2007. In conjunction with the financing of these B737 aircraft, we will issue equipment notes as aircraft are delivered. The notes will likely bear interest at a floating rate per annum above the three-month LIBOR; however, we have the ability to fix the rate on the date such notes are issued. Interest and principle payments will be payable quarterly. One or more of these B737 may constitute one or more of the eight B737 aircraft having deliveries deferred until 2009 and beyond. We are currently in discussions with the financial institution with which we have arranged this facility regarding the deferrals. During the quarter ended September 30, 2006, we financed the acquisition of two B737 aircraft under the terms of our third floating rate facility, which was established in September 2005, thereby financing a total of four B737 under such facility during the nine months ended September 30, 2006. In conjunction with the financing of these B737 aircraft, we issued equipment notes as aircraft were delivered for an aggregate amount of $87.9 million (included in floating rate aircraft notes payable above) with maturities between May and September 2018. The notes bear interest at a floating rate per annum above the three-month LIBOR. Interest and principle payments are payable quarterly.
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Table of ContentsFixed rate facilities: During April 2006, we exercised the fixed rate option on three of our floating rate aircraft notes. The notes, which originally bore interest at a floating rate per annum above the six-month LIBOR, are payable through 2018 and bear interest at an average fixed rate of 7.02%. Payments of principal and interest are due semi-annually. PDP facilities: On August 1, 2006, we entered into two separate facilities (the “PDP facilities”) for purposes of financing our obligations to make pre-delivery payments on 14 B737 aircraft on order with an aircraft manufacturer. The PDP facilities entitle us to draw amounts up to approximately $30.3 million and $30.4 million, respectively, to fund a portion of our obligations to make pre-delivery payments in respect of 14 B737 aircraft with delivery dates scheduled through 2008. Drawings made under the PDP facilities bear interest at a floating rate per annum above one-month US Dollar LIBOR. The PDP facilities are secured by certain of our rights under our purchase agreement with the aircraft manufacturer, but only to the extent related to the B737 aircraft subject to the PDP facilities. As of September 30, 2006, approximately $4.5 million and $7.5 million, respectively, are outstanding under the PDP facilities. We are entitled to and intend to make additional drawings under the PDP facilities through December 2007, at which time we shall have satisfied all of our pre-delivery payment obligations to the aircraft manufacturer on the 14 B737 aircraft. One or more of these B737 aircraft may constitute one or more of these eight B737 aircraft having deliveries deferred until 2009 and beyond. We are currently in discussions with the financial institutions with which we have arranged these facilities regarding the deferrals. On December 7, 2005, we entered into a facility (“PDP-3”) for purposes of financing our obligations to make pre-delivery payments in respect of B737 aircraft on order with an aircraft manufacturer. The 2005 PDP facility entitles us to draw amounts up to approximately $65 million to fund a portion of our obligations to make pre-delivery payments in respect of 19 B737 aircraft with delivery dates through 2008. Drawings under the 2005 PDP facility are secured by certain of our rights under our purchase agreement with the aircraft manufacturer, but only to the extent related to the B737 aircraft subject to the 2005 PDP facility. As of September 30, 2006, approximately $58.9 million is outstanding under the 2005 PDP facility through April 2007, at which time we shall have satisfied all of our pre-delivery payment obligations to the aircraft manufacturer in respect of the 19 B737 aircraft. One or more of these B737 aircraft may constitutive one or more of the eight B737 aircraft having deliveries deferred until 2009 and beyond. We are currently in discussions with the financial institutions with which we have arranged this facilities regarding the deferrals. Credit Facility As of September 30, 2006, $13.3 million of restricted cash on the accompanying consolidated balance sheet relates to outstanding letters of credit, primarily for airport facilities. Note 6 - Income Taxes Our effective income tax rate was 39.9 percent and 37.4 percent for the three and nine months ended September 30, 2006. Our tax expense for the three and nine months ended September 30, 2005 included a one-time benefit of $1.7 million resulting from adjustments to our deferred tax liabilities which were revalued in connection with a decrease in certain of our state tax rates and additional expense of approximately $1.0 million related to the revaluation of our deferred tax assets related to certain of our state NOLs. Note 7 – Equity On April 6, 2006, 55,468 warrants were exercised for the purchase of our common stock. Each warrant entitled the purchaser to 18.0289 shares of common stock for a total of 1,000,024 warrant shares at $4.51 per warrant share. Total proceeds from aforementioned transaction amounted to approximately $4.5 million.
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Table of ContentsITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS The information contained in this section: (i) has been derived from our historical financial statements and should be read together with our historical financial statements and related notes included elsewhere in this document, in addition to our Annual Report on Form 10-K and Form 10-K/A for the year ended December 31, 2005 as filed with the U.S. Securities & Exchange Commission; and (ii) is not a comprehensive discussion and analysis of our financial condition and results of operations, but rather updates disclosures made in such Annual Report. The discussion below contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements involve risks and uncertainties including, but not limited to: consumer demand and acceptance of services offered by us, our ability to achieve and maintain acceptable cost levels, fare levels and actions by competitors, regulatory matters, general economic conditions, commodity prices, and changing business strategies. Forward-looking statements are subject to a number of factors that could cause actual results to differ materially from our expressed or implied expectations, including, but not limited to our performance in future periods, our ability to generate working capital from operations, our ability to take delivery of and to finance aircraft, the adequacy of our insurance coverage, and the cost and availability of aviation fuel. Our forward-looking statements can be identified by the use of terminology such as “anticipates,” “expects,” “intends,” “believes,” “will” or the negative thereof, or variations thereon or comparable terminology. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. OVERVIEW During the third quarter of 2006, we reported a net loss of $4.3 million compared to net income of $1.0 million reported for the third quarter of 2005. The loss was attributable in a large part to the fact that our unit revenues did not grow enough to cover our increase in jet fuel prices. During the third quarter, we experienced a slowdown in demand following the changes in airline security protocols resulting from the thwarted terrorist activity in London. While our passenger revenue per available seat mile (ASM) increased, and our non-fuel operating costs per ASM declined, they were not sufficient to offset the impact of the increase in fuel costs per ASM. We continued our expansion, increasing capacity, or available seat miles, by 27.1 percent compared to the third quarter of 2005. Revenue passenger seat miles (RPM), increased by 22.0 percent, resulting in a load factor of 73.2 percent, down 3.1 percentage points from the prior year quarter. In addition, unit revenue measured by passenger revenue per available seat mile (RASM), increased by 2.0 percent resulting in overall revenue growth greater than 30 percent. We increased the current fleet by four aircraft during the quarter, ending with 34 Boeing 737-700 and 87 Boeing 717-200 aircraft. The fleet will grow by an additional four Boeing 737 through the remainder of this year. These aircraft will be deployed through a combination of additional flights in existing markets and new point-to-point flying in markets like Boston, Chicago, Detroit and Indianapolis to Florida. We estimate our capacity (as measured by available seat miles flown) at the end of the year will be about 24 percent higher than 2005. During the quarter, we reinstated nonstop service between Gulfport-Biloxi, Mississippi and Fort Lauderdale and Tampa, Florida. The service is operated and marketed in conjunction with a number of the Gulf Coast casino resorts. During the quarter we announced plans to defer deliveries of future aircraft reducing planned deliveries in 2007 by five aircraft starting in August and three aircraft in the first quarter of 2008. We will continue to face several challenges through the remainder of the year. Managing costs and increasing revenues in the face of high fuel levels will continue to be a primary focus. Two of our largest competitors are operating in bankruptcy, which creates uncertainty in a number of competitive markets in both the near and long term. Additionally, if our fuel costs rise, we cannot guarantee that we will be able to raise revenues to match the increased fuel costs. Our financial and operating results for any interim period are not necessarily indicative of those for the entire year. Air travel in our markets tends to be seasonal, with the highest level of travel occurring during the winter months to Florida and the summer months to the northeastern and western United States. Generally, the second quarter tends to be the strongest revenue quarter for the company.
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Table of ContentsRESULTS OF OPERATIONS For the three and nine months ended September 30, 2006 and 2005 The table below sets forth selected financial and operating data for the three months and nine months ended September 30, 2006 and 2005:
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Table of ContentsFor the three months ended September 30, 2006 and 2005 Summary We recorded an operating loss of $3.6 million, net loss of $4.3 million and loss per diluted common share of $0.05 for the third quarter of 2006. For the comparative period in 2005, we recorded operating income of $3.4 million, net income of approximately $1.0 million and earnings per diluted common share of $0.01. Operating Revenues Our operating revenues for the three months ended September 30, 2006 increased $112.6 million (30.1 percent), primarily due to a 29.6 percent increase in passenger revenues. The increase in passenger revenues was due to a 22.0 percent increase in RPMs and an increase in our average yield per RPM of 6.3 percent to 12.85 cents per RPM. The increase in yield resulted primarily from an 11.0 percent increase in our average fare to $90.94. The favorable impact of the increase in yield was somewhat offset by a 3.1 percentage point decrease in our passenger load factor, resulting in a 2.0 percent increase in passenger unit revenues or RASM to 9.41 cents. Since September 30, 2005, we have taken delivery of four B717 and 18 B737 aircraft. As a result, our capacity, as measured by ASMs, increased 25.0 percent. Our traffic, as measured by RPMs, increased 24.7 percent. Operating Expenses Our operating expenses increased by $119.6 million (32.2 percent) on an ASM increase of 27.1 percent. In general, our operating expenses are significantly affected by changes in our capacity, as measured by ASMs. The following table presents our unit costs, or our operating expenses per ASM, for the three months ended September 30, 2006 and 2005, respectively:
Aircraft fuel increased 19.3 percent on an ASM basis. Aircraft fuel increased primarily due to escalated fuel prices. Our fuel price per gallon, including taxes and into-plane fees, increased 23.1 percent from $1.90 during the third quarter of 2005 to $2.33, during the third quarter of 2006. The level of our flight operations, as measured by block hours flown, increased 25.0 percent while our fuel consumption per block hour decreased by 1.3 percent to 677 gallons per block hour resulting an increase in total fuel expense for the quarter of $65.1 million, or 51.8 percent. In a continued effort to reduce our fuel costs, we have been adding winglets to a number of our B737 aircraft. These enhancements extend the aircraft range, improve performance, and reduce fuel costs. Salaries, wages and benefits decreased 5.7 percent on an ASM basis, primarily due to gains in productivity driven by the increased number of aircraft and higher daily utilization. Distribution costs decreased 20.0 percent on an ASM basis reflecting the new rates in our travel agent distributions (“GDS”) agreements that were negotiated during the fourth quarter 2005. Additionally, for the three months ended September 30, 2006, approximately 59.4 percent of our revenue sales were made via our own website, AirTran.com. We recognize significant cost savings when our sales are booked directly through our website. Aircraft insurance and security services decreased 13.3 percent on an ASM basis. While the addition of 22 new Boeing aircraft to our fleet since September 30, 2005 increased our total insured hull value and related insurance premiums, the decrease on an ASM basis was primarily due to a reduction in hull and liability insurance rates for our fleet coverage. Marketing and advertising increased 13.6 percent on an ASM basis due primarily to a $2.4 million charge attributable to a change in the number of estimated participants using “free tickets” in the highly successful 2005 Wendy’s promotional arrangement.
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Table of ContentsDepreciation increased 15.4 percent on an ASM basis, primarily due to the purchase of seven B737 aircraft since September 30, 2005 and purchases of spare aircraft parts for the new B737 fleet. With the exception of such seven B737s, all aircraft additions since September 30, 2005 were lease financed rather than purchased. Non-operating Expenses Other (income) expense, net increased by $ 0.7 million. Higher invested cash balances along with higher interest rates increased interest income by $3.3 million. Interest expense increased by $5.3 million primarily due to the effect of aircraft debt financings entered into during 2005 and 2006. Capitalized interest increased by $1.2 million due to increased deposits on future aircraft. Capitalized interest represents interest on purchase deposits for future aircraft. These amounts are classified as part of the cost of the aircraft upon delivery. Income Tax Expense Our effective income tax rate was 39.9 percent for the three months ended September 30, 2006. Our tax expense for the three months ended September 30, 2005 included a one-time benefit of $1.7 million resulting from adjustments to our deferred tax liabilities which were revalued in connection with a decrease in certain of our state tax rates and additional expense of approximately $1.0 million related to the revaluation of our deferred tax assets related to certain of our state NOLs.
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Table of ContentsFor the nine months ended September 30, 2006 and 2005 Summary We recorded operating income of $39.7 million, net income of $18.8 million and diluted earnings per common share of $0.20 for the nine months ended September 30, 2006. For the comparative period in 2005, we recorded operating income of $18.7 million, net income of $7.7 million and diluted earnings per common share of $0.09. Operating Revenues Our operating revenues for the nine months ended September 30, 2006 increased $390.8 million (37.6 percent), primarily due to a 37.2 percent increase in passenger revenues. The increase in passenger revenues was due to a 24.7 percent increase in RPMs and an increase in our average yield per RPM of 10.0 percent to 13.23 cents per RPM. The increase in yield resulted primarily from an 11.8 percent increase in our average fare to $91.52. This increase in yield, slightly offset by the impact of 0.2 percentage point decrease in our passenger load factor, resulted in a 9.7 percent increase in passenger unit revenues or RASM to 9.81 cents per ASM. Since September 30, 2005, we have taken delivery of four B717 and 18 B737 aircraft. As a result, our capacity, as measured by ASMs, increased 25.0 percent. Our traffic, as measured by RPMs, increased 24.7 percent. Operating Expenses Our operating expenses for the nine months ended September 30, 2006 increased $369.8 million (36.2 percent) related to an ASM growth of 25.0 percent. In general, our operating expenses are significantly affected by changes in our capacity, as measured by ASMs. The following table presents our unit costs, defined as operating expenses per ASM, for the nine months ended September 30, 2006 and 2005, respectively.
Aircraft fuel including taxes and into-plane fees increased 30.4 percent on an ASM basis primarily due to escalating fuel prices. Our fuel price per gallon, including taxes and into-plane fees, increased 33 percent from $1.67 during the nine months ended September 30, 2005 to $2.23 during the nine months ended September 30, 2006. The level of our flight operations, as measured by block hours flown, increased 22.4 percent and our fuel consumption per block hour decreased 0.1 percent to 672 gallons per block hour, resulting in an increase in total fuel expense for the nine months of $197.7 million, or 62.9 percent. In a continued effort to reduce our fuel costs, we have been adding winglets to a number of our B737 aircraft. These enhancements extend the aircraft range, improve performance, and reduce fuel costs. Maintenance, materials and repairs increased 21.2 percent on an ASM basis primarily due to an increase in our power by the hour contractual rates for our B717 engines. On a block hour basis, maintenance costs increased 23.6 percent from $267 during the nine months ended September 30, 2005 to $330 during the nine months ended September 30, 2006. For the quarter ended September 30, 2006, maintenance costs on a block hour basis was $283. Distribution costs decreased 15.6 percent on an ASM basis reflecting the new rates in our GDS agreements that were negotiated during the fourth quarter 2005. Additionally, for the nine months ended September 30, 2006, approximately 57.3 percent of our revenue sales were made via our internal website, AirTran.com, compared to 58.6 for the analogous period in 2005. We recognize significant cost savings when our sales are booked directly through our website. Marketing and advertising increased 8.7 percent on an ASM basis due primarily to a $2.4 million charge attributed to a change in the number of estimated participants using “free tickets” in the highly successful 2005 Wendy’s promotional arrangement. Aircraft insurance and security services decreased 13.3 percent on an ASM basis. While the addition of 22 new Boeing aircraft to our fleet since September 30, 2005 increased our total insured hull value and related insurance premiums, the decrease on an ASM basis is primarily due to a reduction in hull and liability insurance rates for our fleet coverage. Depreciation increased 16.7 percent on an ASM basis, primarily due to the purchase of seven B737 aircraft since September 30, 2005 and purchases of spare aircraft parts for the new B737 fleet. With the exception of the seven B737s, all aircraft additions since September 30, 2005 were lease financed rather than purchased. Non-operating (Income) Expense Other (income) expense, net increased by $1.8 million. Higher invested cash balances along with higher interest rates increased interest income by $8.5 million. Interest expense increased by $14.2 million primarily due to the effect of aircraft debt financings entered into during 2005 and 2006. Capitalized interest increased by $3.9 million due to increased deposits on future aircraft. Capitalized interest represents interest on purchase deposits for future aircraft. These amounts are classified as part of the cost of the aircraft upon delivery.
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Table of ContentsIncome Tax Expense Our effective income tax rate was 37.4 percent for the nine months ended September 30, 2006 compared to 29.5 percent for the nine months ended September 30, 2005. Our tax expense for the nine months ended September 30, 2005 included a one-time benefit of $1.7 million resulting from adjustments to our deferred tax liabilities which were revalued in connection with a decrease in certain of our state tax rates and additional expense of approximately $1.0 million related to the revaluation of our deferred tax assets related to certain of our state NOLs. LIQUIDITY AND CAPITAL RESOURCES Our primary sources of funds are cash provided by operating and financing activities. Our primary uses of cash are for working capital (including labor and fuel costs), capital expenditures and general corporate purposes. Our total cash, including cash and cash equivalents, restricted cash and short-term investments totaled $392.2 million and $390.1 million at September 30, 2006, and December 31, 2005, respectively. Short-term investments consist of auction rate securities with reset periods less than 12 months. Short-term investments totaled $196.0 million and $0.1 million at September 30, 2006 and December 31, 2005, respectively. Operating activities for the nine months ended September 30, 2006 generated $74.6 million of cash compared to $48.6 million for the comparable period in 2005. The increase was primarily due to an increase in passenger bookings for future travel, an increase in accounts payable and accrued liabilities, an increase in depreciation expense, a decrease in deferred tax assets and an increase in net income. Cash was used for increases in other assets, prepaid aircraft rent and spare parts, material and supplies. Investing activities for the nine months ended September 30, 2006 used $292.1 million in cash compared to $241.2 million for the comparable period in 2005. Our investing activities primarily consist of capital expenditures related to aircraft, ground service equipment and computer equipment, aircraft purchase deposits required for scheduled deliveries in future periods and purchases and sales of auction rate securities. Additionally, cash is used for the purchase of equipment related to our B717 and B737 aircraft fleets. Financing activities for the nine months ended September 30, 2006 provided $19.9 million of cash compared to $57.7 million for the comparable period in 2005. During 2006, we received cash from the issuance of debt financing for aircraft pre-delivery deposits of $56.2 million, offset by debt repayments of $44.5 million. Additionally during 2006 we received $11.5 million from the exercise of options and warrants for the purchase of common stock. Aircraft Purchase Commitments During the nine months ended September 30, 2006, we took delivery of 14 B737 aircraft and two B717 aircraft. Of the 14 B737 aircraft, seven were leased under operating leases while seven were purchased using debt financing. The two B717 aircraft were leased under operating leases. During the nine months ended September 30, 2006, we exercised options to acquire 24 additional B737 aircraft with delivery dates through 2010. In September 2006, we entered into an agreement with the aircraft manufacturer to reschedule five aircraft deliveries from the second half of 2007 and three aircraft deliveries from the first quarter of 2008 to deliveries in 2009 through 2011. As of September 30, 2006 we had on order 66 B737 aircraft with delivery dates between 2006 and 2011. The table below illustrates all aircraft scheduled for delivery through 2011:
Aircraft Financing Arrangements Of the 66 B737 aircraft on order, we have secured debt financing for 13 of the aircraft, including four to be delivered in the remainder of 2006 and nine to be delivered in 2007, through arrangements with financial institutions. Additionally, we have secured sale/leaseback agreements with respect to six related spare engines to be delivered through 2010 for the B737 aircraft. Debt Agreements Aircraft Financing Facilities Floating rate facilities: On February 14, 2006, we entered into a fourth floating rate aircraft facility pursuant to which we financed the acquisition of two additional B737 aircraft. We took delivery of the first such aircraft in February 2006 and the second such aircraft in March 2006. In conjunction with the financing of these B737 aircraft, we issued equipment notes as aircraft were delivered for an aggregate amount of $58.0 million with maturities between February and March 2018. The notes bear interest at a floating rate per annum above the six-month LIBOR. Interest and principal payments are payable semi-annually. On August 31, 2006, we entered into a fifth floating rate facility, pursuant to which we intend to finance the acquisition of five additional B737 aircraft. The five B737 aircraft are scheduled to be delivered in 2007. In conjunction with the financing of these B737 aircraft, we will issue equipment notes as aircraft are delivered. The notes will likely bear interest at a floating rate per annum above the three-month LIBOR; however, we have the ability to fix the rate on the date such notes are issued. Interest and principal payments will be payable quarterly. One or more of these B737 aircraft may constitute one or more of the eight B737 aircraft having deliveries deferred until 2009 and beyond. We are currently in discussions with the financial institution with which we have arranged this facility regarding the deferrals.
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Table of ContentsDuring the quarter ended September 30, 2006, we financed the acquisition of two B737 aircraft under the terms of our third floating rate facility, which was established in September 2005, thereby financing a total of four B737 under such facility during the nine months ended September 30, 2006. In conjunction with the financing of these B737 aircraft, we issued equipment notes as aircraft were delivered for an aggregate amount of $87.9 million with maturities between May and September 2018. The notes bear interest at a floating rate per annum above the three-month LIBOR. Interest and principal payments are payable quarterly. Fixed rate facilities: During April 2006, we exercised the fixed rate option on three of our floating rate aircraft notes. The notes, which originally bore interest at a floating rate per annum above the six-month LIBOR, are payable through 2018 and bear interest at an average fixed rate of 7.02 percent. Payments of principal and interest are due semi-annually. PDP facilities: On August 1, 2006, we entered into two separate facilities (the “PDP facilities”) for purposes of financing our obligations to make pre-delivery payments on 14 B737 aircraft on order with an aircraft manufacturer. The PDP facilities entitle us to draw amounts up to approximately $30.3 million and $30.4 million, respectively, to fund a portion of our obligations to make pre-delivery payments in respect of 14 B737 aircraft currently scheduled to be delivered through 2008. Drawings made under the PDP facilities bear interest at a floating rate per annum above one-month US Dollar LIBOR. The PDP facilities are secured by certain of our rights under our purchase agreement with the aircraft manufacturer, but only to the extent related to the B737 aircraft subject to the PDP facilities. As of September 30, 2006, approximately $4.5 million and $7.5 million, respectively, are outstanding under the PDP facilities. We are entitled to and intend to make additional drawings under the PDP facilities through December 2007, at which time we shall have satisfied all of our pre-delivery payment obligations to the aircraft manufacturer in respect of the 14 B737 aircraft. One or more of these B737 aircraft may constitute one or more of these eight B737 aircraft having deliveries deferred until 2009 and beyond. We are currently in discussions with the financial institutions with which we have arranged these facilities regarding the deferrals. On December 7, 2005, we entered into a facility (“PDP-3”) for purposes of financing our obligations to make pre-delivery payments in respect of B737 aircraft on order with an aircraft manufacturer. The 2005 PDP facility entitles us to draw amounts up to approximately $65 million to fund a portion of our obligations to make pre-delivery payments in respect of 19 B737 aircraft with delivery dates through 2008. Drawings under the 2005 PDP facility are secured by certain of our rights under our purchase agreement with the aircraft manufacturer, but only to the extent related to the B737 aircraft subject to the 2005 PDP facility. As of September 30, 2006, approximately $58.9 million is outstanding under the 2005 PDP facility through April 2007, at which time we shall have satisfied all of our pre-delivery payment obligations to the aircraft manufacturer in respect of the 19 B737 aircraft. One or more of these B737 aircraft may constitutive one or more of the eight B737 aircraft having deliveries deferred until 2009 and beyond. We are currently in discussions with the financial institutions with which we have arranged this facilities regarding the deferrals. Credit Facility As of September 30, 2006, $13.3 million of restricted cash on the accompanying consolidated balance sheet relates to outstanding letters of credit, primarily for airport facilities. Other Sources of Liquidity We have various options available to meet our capital and operating commitments including internally generated funds and various borrowing or leasing options. Additionally, we have an outstanding shelf registration which we may utilize to raise funds for aircraft financings or other purposes in the future. There can be no assurance that financing will be available for all B737 aircraft deliveries or for other capital expenditures not covered by firm financing commitments. Should fuel prices remain high and if we are unable to raise prices to cover our costs, we may slow our growth, including through the subleasing of certain of our aircraft. NEW ACCOUNTING STANDARDS In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—An interpretation o f FASB Statement No. 109,” or FIN 48. The Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. We have not determined the effect, if any, that the adoption of FIN 48 will have on our financial position or results of operations. We will adopt FIN 48 as of January 1, 2007, as required.
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Table of ContentsIn September 2006, the FASB issued Statement No. 158 (SFAS 158), Employers’ accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB No. 87, 88, 106, and 132 (R). SFAS 158 requires the recognition of the overfunded or underfunded status of defined benefit postretirement plans as assets or liabilities on the balance sheet with changes to the funded status recognized through comprehensive income in the year in which they occur. SFAS 158 is effective for fiscal years ending after December 15, 2006. We are currently evaluating the impact of SFAS 158 on our financial statements.
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Table of ContentsITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no material changes in market risk from the information provided in Part II, Item 7A “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K and Form 10-K/A for the fiscal year ended December 31, 2005, other than those discussed below. Aviation Fuel Our results of operations can be significantly impacted by changes in the price and availability of aircraft fuel. Aircraft fuel expense for the nine months ended September 30, 2006 and 2005 represented approximately 36.8 percent and 30.7 percent of our operating expenses, respectively. Efforts to reduce our exposure to increases in the price and availability of aviation fuel include the utilization of fuel purchase contracts involving both fixed-price arrangements and cap arrangements. Fixed-price arrangements consist of an agreement to purchase defined quantities of aviation fuel from a third party at defined prices. Cap arrangements consist of an agreement to purchase defined quantities of aviation fuel from a third party at a price not to exceed a defined price, limiting our exposure to upside market risk. As of September 30, 2006, utilizing fixed-price and cap arrangements, we had committed to purchase 38.3 million and 60.0 million gallons at a weighted average price per gallon, excluding taxes and into-plane fees, of $2.07 and $1.64 respectively, for the remainder of 2006 and 2007. This represents approximately 47.3 percent and 15.6 percent of our anticipated fuel needs for the remainder of 2006 and 2007, respectively. Based on our projected fuel consumption, a 10 percent increase in the average price per gallon of aircraft fuel would increase fuel expense for the remainder of the year by approximately $7.8 million including the effect of our fuel purchase contracts described above. Increases in fuel prices or a shortage of supply could have a material adverse effect on our operations, operating results, and cash flows.
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Table of ContentsITEM 4. CONTROLS AND PROCEDURES We maintain disclosure controls and procedures designed to ensure that we are able to collect the information we are required to disclose in the reports we file with the Securities and Exchange Commission (SEC), as well as to process, summarize and disclose this information within the time periods specified in the rules of the SEC. As of September 30, 2006, we carried out an evaluation, under the supervision of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15e. As a result of this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2006 and are designed to provide management with the appropriate information to allow timely decisions regarding required disclosure. Remediation of Material Weaknesses As discussed in the Form 10-K/A filing for the fiscal year ended December 31, 2005, we determined that a material weakness existed as of December 31, 2005 relating to an insufficient number of staff with financial accounting expertise. During the nine months ended September 30, 2006, we took the following steps to remediate this material weakness: we filled open accounting positions; we established and filled a Vice President and Chief Accounting Officer position for AirTran Airways; and, we began providing and will continue to provide continuing professional education for appropriate accounting and financial personnel. We also identified an additional material weakness that existed as of December 31, 2005 related to our financial accounting for fuel expense. The material weakness resulted in the restatement of our financial statements for the years ended December 31, 2004 and 2005 and the quarter ended March 31, 2006. As a consequence of the restatements the Company’s reported net income for the two years ended December 31, 2005 was increased by $4.3 million. In March 2006, we implemented revised controls in order to remediate this material weakness. Specifically, the following controls were strengthened or implemented: monthly review of our fuel expense analyses monthly reconciliations of our prepaid fuel balances to vendor statements and the outstanding balances owed to or from our fuel suppliers are periodically confirmed. After implementing and evaluating such additional controls and procedures, we concluded that, as of September 30, 2006, we have remediated the material weaknesses described above in the Company’s internal controls over financial reporting. Additionally, we will continue to monitor the effectiveness of our internal controls over financial reporting and will make any further changes that management deems appropriate. Changes in Internal Controls The changes in the third quarter implemented as a result of remediation of the material weaknesses, as noted above, were the only changes in our internal control over financial reporting (as defined in Rules 13a-15(f) under the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
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Table of ContentsOTHER INFORMATION Item 1. Legal Proceedings From time to time, we are engaged in litigation arising in the ordinary course of business. We do not believe that any such pending litigation, individually or collectively, will have a material adverse effect on our results of operations or financial condition. Item 1A. Risk Factors Information regarding risk factors appears in “MD&A — Forward-Looking Statements,” in Part I — Item 2 of this Form 10-Q and in “Risk Factors” in Part I — Item 1A of our Annual Report on Form 10-K and Form 10-K/A for the fiscal year ended December 31, 2005. While we believe there have been no material changes from the risk factors previously disclosed in such Annual Report, you should carefully consider, in addition to the other information set forth in this report, the risk factors discussed in our Annual Report which could materially affect our business, financial condition or future results. Such risk factors are expressly incorporated herein by reference. The risks described in our Annual Report are not the only risks facing our Company. In addition to risks and uncertainties inherent in forward looking statements contained in this Report on Form 10-Q, additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None Item 3. Defaults upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None None Item 6. Exhibits The following exhibits are filed with this report:
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Table of ContentsSIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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Table of ContentsEXHIBIT INDEX
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