AirTran Holdings 10-Q 2010
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarterly period ended June 30, 2010
For the transition period from to
Commission file number 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o N/A ¨
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 ¨ Smaller reporting company ¨
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 July 19, 2010:135,421,111 par value $0.001
For the Quarter Ended June 30, 2010
TABLE OF CONTENTS
AirTran Holdings, Inc.
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
See accompanying Notes to Condensed Consolidated Financial Statements.
AirTran Holdings, Inc.
Condensed Consolidated Balance Sheets
See accompanying Notes to Condensed Consolidated Financial Statements.
AirTran Holdings, Inc.
Condensed Consolidated Balance Sheets (Continued)
See accompanying Notes to Condensed Consolidated Financial Statements.
AirTran Holdings, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands) (Unaudited)
See accompanying Notes to Condensed Consolidated Financial Statements.
AirTran Holdings, Inc.
Condensed Consolidated Statement of Stockholders’ Equity
See accompanying Notes to Condensed Consolidated Financial Statements.
Notes to Condensed Consolidated Financial Statements
Note 1 –Accounting Policies and Business
Basis of Presentation
Our unaudited Condensed Consolidated Financial Statements include the accounts of AirTran Holdings, Inc. (the Company, AirTran, or Holdings) and our wholly-owned subsidiaries, including our principal subsidiary, AirTran Airways, Inc. (AirTran Airways or Airways) (collectively, we, our, or us). 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, except as otherwise disclosed, are of a normal recurring nature, necessary to present fairly the Company’s 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 U.S. generally accepted accounting principles 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 for the year ended December 31, 2009.
The preparation of the accompanying unaudited Condensed Consolidated Financial Statements in conformity with U.S. generally accepted accounting principles 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.
We manage our operations on a system-wide basis due to the interdependence of our route structure in the various markets we serve. Most of our revenues are earned in the United States. Because we offer only one service (i.e., air transportation), management has concluded that we only have one segment of business.
Through AirTran Airways, we offer scheduled airline services, using Boeing B717-200 aircraft (B717) and Boeing B737-700 aircraft (B737), to 71 locations throughout the United States, Mexico, and the Caribbean. Approximately half of our flights originate or terminate at our largest hub in Atlanta, Georgia and we serve a number of markets with non-stop service from our focus cities of Baltimore, Maryland; Milwaukee, Wisconsin; and Orlando, Florida. Air travel in our markets tends to be seasonal, with the highest levels occurring during the winter months to Florida and the summer months to the Northeastern and Western United States. The second quarter tends to be our strongest revenue quarter.
Certain 2009 amounts have been reclassified to conform to 2010 presentation. These reclassifications have no material impact on the Condensed Consolidated Statements of Operations, Condensed Consolidated Balance Sheets, Condensed Consolidated Statements of Cash Flows or Condensed Consolidated Statement of Stockholders’ Equity.
New Accounting Pronouncements
In October 2009, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU No. 2009-13) pertaining to multiple-deliverable revenue arrangements. The new guidance will affect accounting and reporting for companies that enter into multiple-deliverable revenue arrangements with their customers when those arrangements are within the scope of Accounting Standards Codification (ASC) 605-25 “Revenue Recognition - Multiple-Element Arrangements”. The new guidance will eliminate the residual method of allocation and require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The new guidance will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted and the guidance may be applied retrospectively. We are currently evaluating the impact that ASU No. 2009-13 will have on our condensed consolidated financial position, results of operations, and cash flows.
In January 2010, the FASB issued ASU 2010-06 “Improving Disclosures about Fair Value Measurements”. ASU 2010-06 requires additional disclosures about fair value measurements including transfers in and out of Levels 1 and 2 and more disaggregation for the different types of financial instruments. This ASU is effective for annual and interim reporting periods beginning after December 15, 2009 for most of the new disclosures and for periods beginning after December 15, 2010 for the new Level 3 disclosures. Comparative disclosures are not required in the first year the disclosures are required. We did not have any significant transfers in or out of Level 1 and Level 2 fair value measurements during the six months ended June 30, 2010 and 2009.
Note 2 – Commitments and Contingencies
Aircraft Related Commitments, Financing Arrangements and Transactions
We have agreed to purchase 51 B737 aircraft. During June 2010, we entered into amendments to our aircraft purchase agreements with The Boeing Company to defer delivery dates for nine B737 aircraft originally scheduled for delivery between 2011 and 2014 to delivery dates between 2015 and 2017.
During June 2010, we agreed to lease two used B717 aircraft for a term of 10 years commencing in 2011.
The table below summarizes, as of June 30, 2010, all scheduled aircraft fleet additions:
As of June 30, 2010, our aircraft purchase commitments for the remainder of 2010 and for the next five years and thereafter, in aggregate, are (in millions): 2010—$20; 2011—$140; 2012—$270; 2013—$280; 2014—$370; 2015—$510; and thereafter—$580. These amounts include payment commitments, including payment of pre-delivery deposits, for aircraft on firm order. Aircraft purchase commitments include the forecasted impact of contractual price escalations. Our intention is to finance the aircraft on order through either debt financing, lease financing, or a mix thereof. We have financing commitments from a lender to finance a majority of the acquisition price of two B737 aircraft scheduled for delivery to us in 2011 or 2012. We have not yet arranged for aircraft financing for any of the other aircraft deliveries.
There are multiple variables including capital market conditions, asset valuations, and our own operating performance that could affect the availability of satisfactory financing for our future B737 aircraft deliveries. While there was limited availability of satisfactory aircraft financing in early 2009, it is our view that the aircraft financing market has improved. While we cannot provide assurance that sufficient financing will be available, we expect to be able to obtain acceptable financing for future deliveries. Our view is based upon our discussions with prospective lenders and lessors, the consummation of aircraft financing transactions by other airlines, our own operating performance, and our recent ability to refinance two B737 aircraft.
Our B737 contract with Boeing requires us to make pre-delivery deposits to Boeing. Although we typically have financed a significant portion of our pre-delivery deposit requirements with debt from banks or other financial institutions, we currently have no such financing in place for future deliveries.
Credit Card Processing Arrangements
We have agreements with organizations that process credit card transactions arising from purchases of air travel by customers of Airways. Each of our agreements with our credit card processors allows, under specified conditions, the processor to retain cash related to future travel that such processor otherwise would remit to us (i.e., a holdback). Holdbacks are classified as restricted cash on our consolidated balance sheets. Our exposure to credit card holdbacks consists of advanced ticket sales that customers purchase with credit cards. Once the customer travels, any related holdback is remitted to us.
Each agreement with our two largest credit card processors provides that a processor may holdback amounts that would otherwise be remitted to us in the event that a processor reasonably determines that there has been a material adverse occurrence or certain other events occur. Our agreement with our largest credit card processor also provides that the processor may holdback amounts that would otherwise be remitted to us in the event that our aggregate unrestricted cash and investments (as defined) falls below agreed upon levels. Should the processor be entitled in the future to withhold amounts that would otherwise be remitted to us, we retain the contractual right to eliminate or reduce the amounts withheld by providing the processor with letters of credit. As of June 30, 2010, a $50 million letter of credit had been issued under our letter of credit facility for the benefit of our largest credit card processor. Drawings may be made by the processor only if we do not satisfy our obligations to reimburse the processor for chargebacks.
As of June 30, 2010, we had advance ticket sales of $341.8 million related to all credit card sales, we were in compliance with our credit card processing agreements, and our two largest processors were holding back no cash remittances from us. Our maximum potential exposure to cash holdbacks by our two largest credit card processors, based upon advance ticket sales as of June 30, 2010, was $272.0 million (after considering the $50 million letter of credit issued in favor of our largest credit card processor). Even had there been no letter of credit issued for the benefit of our largest credit card processor, as of June 30, 2010, neither of our two largest credit card processors would have been entitled to holdback any cash remittances from us.
We remit a variety of taxes and fees to various governmental authorities, including income taxes, transportation fees and taxes collected from our customers, property taxes, sales and use taxes, payroll taxes, and fuel taxes. The taxes and fees remitted by us are subject to review and audit by the applicable governmental authorities which could result in liability for additional assessments. Contingencies for taxes, which are not based on income, are accounted for in accordance with the ASC Contingencies Topic. Uncertain income tax positions taken on income tax returns are accounted for in accordance with the ASC Income Taxes Topic. Although management believes that the positions taken on previously filed tax returns are reasonable, we nevertheless have recorded accrued liabilities in recognition that various taxing authorities may challenge certain of the positions we have taken, which may also potentially result in additional liabilities for taxes and interest in excess of accrued liabilities. These accrued liabilities are reviewed periodically and are adjusted as events occur that affect the estimates, such as the availability of new information, the lapsing of applicable statutes of limitations, the conclusion of tax audits, the measurement of additional estimated liability based on current calculations, the identification of new tax contingencies, or the rendering of relevant court decisions.
A complaint alleging violations of federal antitrust laws and seeking certification as a class action was filed against Delta Air Lines, Inc. (Delta) and AirTran in the United States District Court for the Northern District of Georgia in Atlanta on May 22, 2009. The complaint alleges, among other things, that AirTran conspired with Delta in imposing $15-per-bag fees for the first item of checked luggage. The initial complaint sought treble damages on behalf of a putative class of persons or entities in the United States who directly paid Delta and/or AirTran such fees on domestic flights beginning December 5, 2008. Subsequent to the filing of the May 2009 complaint, various other nearly identical complaints also seeking certification as class actions were filed in federal district courts in Atlanta, Georgia; Orlando, Florida; Las Vegas, Nevada; and Oakland, California. All of the cases were consolidated before a single judge in Atlanta. An amended complaint filed in February 2010 in the consolidated action broadened the allegations to add claims that Delta and AirTran also cut capacity on competitive routes and raised prices. The amended complaint seeks injunctive relief against a broad range of alleged anticompetitive activities and attorneys fees. AirTran denies all allegations of wrongdoing, including those in the amended complaint, and intends to defend vigorously any and all such allegations.
In addition to the above litigation, AirTran is a party to other claims, and litigation incidental to its business, for which it is not currently possible to determine the ultimate liability, if any. While the outcome of such claims and litigation is subject to uncertainty, based on an evaluation of information currently available and consultation with legal counsel, management believes that resolution of such claims, and litigation is not likely to have a material effect on the financial position, cash flows, or results of operations of the Company. The Company expenses legal costs as they are incurred.
Restricted Cash and Letters of Credit
Restricted cash consists primarily of amounts escrowed related to aircraft leases, letters of credit for airports and insurance, credit card holdbacks for advance ticket sales, derivative financial instruments, and cash escrowed for future interest payments. As of June 30, 2010, $17.2 million of restricted cash relates to outstanding letters of credit, primarily for airport facilities and insurance.
We provide counterparties to our derivative financial instrument arrangements with collateral when the fair value of our obligation exceeds specified amounts. The collateral is classified as restricted cash if the funds are held in our name. The collateral, when applicable, is classified as deposits held by counterparty to derivative financial instruments if the funds are held by the counterparty.
We have a letter of credit facility which provides for a financial institution to issue letters of credit for the benefit of our credit card processors. The letter of credit facility is supported by a variety of assets. As of June 30, 2010, no amount was drawn against the $50 million letter of credit.
Note 3 – Financial Instruments
The estimated fair value of financial instruments, excluding debt, approximates their financial statement carrying amount.
Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash and cash equivalents, restricted cash, short-term investments, accounts receivable, and derivative financial instruments (including deposits held by counterparties). We maintain cash and cash equivalents and short-term investments in what we believe are high-credit-quality financial institutions or in what we believe are in short-duration, high-quality debt securities. Investments are stated at fair value. We periodically evaluate the relative credit standing of those financial institutions that are considered in our investment strategy. We use specific identification of securities for determining gains and losses. All of our investments are available for sale securities. As of June 30, 2010, we had no short-term investments.
The majority of our receivables result from the sale of tickets to individuals, mostly through the use of major credit cards. These receivables are generally settled shortly after sale subject to any applicable holdbacks.
We enter into various derivative financial instruments with financial institutions to seek to reduce the variability of the ultimate cash flows associated with fluctuations in jet fuel prices. From time to time, we enter into fuel-related swap and option derivative financial arrangements. We do not hold or issue derivative financial instruments for trading purposes. Under jet fuel swap arrangements, we pay a fixed rate per gallon and receive the monthly average price of Gulf Coast jet fuel. The fuel-related option arrangements may include collars, purchased call options, and sold call options. Depending on market conditions at the time a derivative contract is entered into, we generally use jet fuel, heating oil, or crude oil as the underlying commodity. Additionally, from time to time, we enter into refinery-margin swap agreements pursuant to which we pay a fixed rate per gallon and receive the monthly average price of jet fuel refinery costs.
As of June 30, 2010, we had entered into fuel-related option agreements which pertain to 122 million gallons or 64 percent of our projected July through December 2010 fuel requirements, 169 million gallons or 43 percent of our projected 2011 fuel requirements, and 20 million gallons or 5 percent of our projected 2012 fuel requirements. As of June 30, 2010, we had no swap agreements or refinery-margin swap agreements.
Realized and unrealized gains and losses on derivatives that are not designated as hedges for financial accounting purposes or that do not qualify for hedge accounting are recognized in Other (Income) Expense. In order to simplify the financial reporting for fuel-related derivatives, effective January 1, 2009, we ceased designating new fuel-related derivative financial instruments as accounting hedges. As of January 1, 2010, all of our fuel-related derivative financial instruments accounted for as hedges have expired and no additional amounts remain in Other Comprehensive Income (Loss) (“OCI”). For our fuel-related derivative financial instruments entered into prior to January 1, 2009, a substantial portion did not qualify to be accounted for as hedges. Consequently, a majority of the gains and losses on such fuel-related derivative financial instruments were classified as Other (Income) Expense based on changes in estimated fair value. Realized gains and losses on other fuel-related derivative financial instruments, previously designated as hedges for financial accounting purposes, were classified as a component of fuel expense.
We have interest-rate swap agreements that effectively convert a portion of our floating-rate debt to a fixed-rate basis for the remaining life of the debt, thus reducing the impact of interest rate changes on future interest expense and cash flows. Under these agreements, which expire between 2016 and 2020, we pay fixed rates between 2.95 percent and 5.085 percent and receive either three-month or six-month USD London Interbank Offered Rate (LIBOR) on the notional values. During the six months ended June 30, 2010, we entered into three interest-rate swap arrangements pertaining to $65.0 million notional amount of outstanding debt. The notional amount of outstanding debt related to interest-rate swaps as of June 30, 2010 was $497.5 million. The primary objective for our use of interest-rate swaps is to reduce the impact of the volatility of interest rates on our operating results. These interest-rate swap arrangements are accounted for as cash flow hedges. The ineffective portion of the change in fair value of each derivative is recognized in Other (Income) Expense, and the effective portion of the change in fair value is recorded as a component of OCI. The effective portion is reclassified to interest expense during the period in which the hedged transaction affects earnings. The differences to be paid or received under the swap agreements are reflected as an adjustment to interest expense.
The following table summarizes the fair value of our derivative financial instruments (in thousands):
The following tables summarize the effects of derivative financial instruments on the Statements of Operations and on Other Comprehensive Income (in thousands):
Based on fair values as of June 30, 2010, we do not expect to reclassify any material net (gains) losses on derivative instruments from accumulated other comprehensive income to earnings during the next twelve months.
Outstanding financial derivative instruments expose us to credit loss in the event of nonperformance by the counterparties to the agreements. However, we do not expect any of the counterparties to fail to meet their obligations. Our credit exposure related to these financial instruments is represented by the fair value of contracts reported as assets. To manage credit risk, we select and periodically review counterparties based on credit ratings. We provide the counterparties with collateral when the fair value of our obligation exceeds specified amounts. The collateral is classified as restricted cash if the funds are held in our name. The collateral is classified as deposits held by counterparty to derivative financial instruments if the funds are held by the counterparty. For financial reporting purposes, we do not offset the collateral provided to counterparties against the fair value of our obligation. Any outstanding collateral is released to us upon settlement of the related derivative financial instrument liability. As of June 30, 2010, we provided the counterparties with collateral aggregating $25.1 million, of which $21.7 million was classified as restricted cash.
Note 4 –Debt
The components of debt were (in thousands):
As discussed below, we have a combined Credit Facility consisting of a letter of credit facility and a revolving line of credit facility.
Maturities of debt for the remainder of 2010 and for the next four years and thereafter, in aggregate, are (in millions): 2010-$124; 2011-$66; 2012-$63; 2013-$73; 2014-$72; thereafter-$655. As of June 30, 2010, no amounts were outstanding under the revolving line of credit facility. Holders of 94% of our 7.0% convertible notes aggregating $90.4 million principal amount exercised their right to require us to repurchase the notes in July 2010. We elected to pay the repurchase price in cash in July 2010. The $90.4 million principal of the 7.0% convertible notes which we were required to repurchase is included in the 2010 maturity amount and is classified as a current liability as of June 30, 2010. Maturities of debt for the remainder of 2010, excluding the repayment of the 7.0% convertible notes, aggregate $34.0 million.
As of June 30, 2010, the following assets served as collateral for outstanding debt:
Airways’ obligations under the Credit Facility are guaranteed by AirTran. Airways’ obligations and the related AirTran guarantee rank senior in right of payment to the subordinated indebtedness of the applicable company and rank equally with senior indebtedness of the applicable company.
B737 Aircraft Purchase Financing
During the first quarter of 2010, we refinanced the debt borrowed to acquire two B737 aircraft that were delivered to Airways in 2009. Under the refinancings, we repaid $49.0 million of existing aircraft indebtedness and borrowed $52.5 million of new aircraft debt. Each note issued is secured by a first mortgage on the B737 aircraft to which it relates. Each note has a stated maturity of 10 years and bears interest at a floating rate per annum above the three-month LIBOR in effect at the commencement of each three-month period. Principal and interest under each note is payable every three months.
We have a combined secured letter of credit facility and a revolving line of credit facility. We refer to the combined letter of credit facility and revolving line of credit facility as the Credit Facility, and we refer to its components as the letter of credit facility and the revolving line of credit facility, respectively. The terms of the Credit Facility were amended effective July 1, 2010. The following discussion summarizes the terms of the amended Credit Facility.
We and the lender have agreed to extend the term of the Credit Facility to December 31, 2012 subject to our satisfaction of a condition precedent which the Company expects to satisfy prior to December 31, 2010. Under the revolving line of credit facility, we are permitted to borrow, upon two business days notice, up to $50 million for general corporate purposes. Under the letter of credit facility, we are entitled to the issuance by a financial institution of letters of credit up to a maximum aggregate amount of $50 million for the benefit of one or more of our credit card processors. Amounts borrowed under the revolving line of credit facility bear interest at a rate of 12 percent per annum and must be repaid within three business days to the extent that our aggregate unrestricted cash and investment amount exceeds $450 million at any time. We may borrow once a month and are permitted to repay amounts borrowed at any time without penalty. As of December 31, 2009, we had $125 million in outstanding borrowings under the revolving line of credit facility. We had no borrowings outstanding as of either June 30, 2010 or July 19, 2010. As of June 30, 2010, the stated amount of the letter of credit issued for the benefit of our largest credit card processor was $50 million.
The aggregate of amounts borrowed and outstanding letters of credit under the Credit Facility is not permitted to exceed the estimated value of the collateral securing such facility. Drawings under any letter of credit may be made only to satisfy our obligation to a beneficiary credit card processor to cover chargebacks arising from tickets sold during the period of exposure to be covered by the letter of credit. Drawings may be made by the processor only if we do not satisfy our obligations to reimburse the credit card processor for chargebacks. A letter of credit issued under the letter of credit facility has never been drawn.
7.0% Convertible Notes
Holders of 94% of our 7.0% convertible notes, aggregating $90.4 million principal amount, exercised their right to require us to repurchase the notes in July 2010. We elected to pay the repurchase price in cash in July 2010. An aggregate of $5.4 million of our 7.0% convertible notes remain outstanding.
Our 7.0% convertible notes bear interest at seven percent, payable semi-annually on January 1 and July 1. The 7.0% convertible notes are convertible into shares of our common stock at a conversion rate of 89.9281 shares per $1,000 in principal amount of the notes which equal an initial conversion price of approximately $11.12 per share. We may redeem the 7.0% convertible notes, in whole or in part, for cash, beginning July 5, 2010, at a redemption price equal to the principal amount of the notes plus any accrued and unpaid interest. The holders of the 7.0% convertible notes have the right to require us to repurchase the notes on July 1, 2013 and 2018 at a repurchase price of 100 percent of principal amount plus any accrued and unpaid interest. We may, at our option, elect to pay the repurchase price in cash, in shares of our common stock, or in any combination of the two. If we elect to pay the repurchase price, in whole or in part in shares of our common stock, the number of shares to be delivered in exchange for the portion of the repurchase price to be paid in our common stock will be equal to that portion of the repurchase price divided by 97.5% of the closing sale price of our common stock for the five trading days ending on the third business day prior to the applicable repurchase date. If the holders of the 7.0% convertible notes require us to repurchase the notes, it is our policy to pay the repurchase price in cash.
We separately account for the debt and equity components of the 7.0% convertible notes in a manner that reflects our estimated non-convertible debt borrowing rate of 15% as of May 2003. The principal amount, unamortized discount, net carrying amount of the debt, and equity components are (in thousands):
We recorded contractual interest expense of $1.7 million and $3.4 million for the three and six months ended June 30, 2010, respectively, and $1.7 million and $3.9 million for the three and six months ended June 30, 2009, respectively. We also recorded interest expense related to debt discount amortization of $1.8 million and $3.6 million for the three and six months ended June 30, 2010, respectively and $1.7 million and $3.7 million for the three and six months ended June 30, 2009, respectively. At June 30, 2010, the discount had been fully amortized.
In 2009, our Board of Directors authorized, at management’s discretion, the repurchase, from time-to-time, of up to $50 million of our 7.0% convertible notes in open market transactions at prevailing market prices or in privately negotiated purchases. During the six months ended June 30, 2009, we repurchased $29.2 million of our 7.0% convertible notes resulting in a gain of $4.3 million classified as Other (Income) Expense.
Note 5 - Fair Value Measurements
The Fair Value Measurements and Disclosures Topic defines fair value, establishes a consistent framework for measuring fair value, and expands disclosures for each major asset and liability category measured at fair value on either a recurring or a nonrecurring basis. The Fair Value Measurements and Disclosures Topic states that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the Fair Value Measurements and Disclosures Topic establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:
Level 1- observable inputs such as quoted prices in active markets;
Level 2- inputs, other than the quoted market prices in active markets, which are observable, either directly or indirectly; and
Level 3- unobservable inputs for which there is little or no market data, which require the reporting entity to develop its own assumptions.
Assets and liabilities are to be measured at fair value and are based on one or more of the three valuation techniques. The valuation techniques are as follows:
Assets (liabilities) measured at fair value on a recurring basis during the period were as follows (in thousands):
The financial statement carrying amounts and estimated fair values of our debt at June 30, 2010 were as follows (in thousands):
The fair value of our debt was estimated using quoted market prices where available. For long-term debt not actively traded, the fair value was estimated using a discounted cash flow analysis based on our current borrowing rates for instruments with similar terms. The fair values of our other financial instruments and borrowings under our revolving line of credit facility approximate their respective carrying values. Given the current volatility in the credit markets, there is an atypical element of uncertainty associated with valuing debt securities, including our debt securities.
The reconciliation of our fuel derivatives that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the period January 1, 2010 through June 30, 2010 is as follows (in thousands):
Note 6 – Income Taxes
We reported income before income taxes during the three and six months ended June 30, 2010; however, we did not recognize income tax expense because the tax effect of the pre-tax income was offset by a corresponding decrease in the valuation allowance. Our effective rate was 0.9 percent and 0.7 percent for the three and six months ended June 30, 2009. Our effective tax rate can differ from the 37.2 percent composite statutory tax rate (35 percent federal statutory rate plus the 2.2 percent state composite statutory rate) due to changes in the valuation allowance on our deferred tax assets, certain expenses which are not deductible for income tax purposes and non-recurring discrete items related to restricted stock vesting. Non-deductible expense items and discrete items tend to increase the effective tax rate when pre-tax income is reported and tend to decrease the effective tax rate when a pre-tax loss is reported.
Income tax benefits recorded on losses result in deferred tax assets for financial reporting purposes. We are required to provide a valuation allowance for deferred tax assets to the extent management determines that it is more likely than not that such deferred tax assets will ultimately not be realized. We expect to realize a portion of our deferred tax assets (including the deferred tax asset associated with loss carry-forwards) through the reversal of existing temporary differences. However, we have determined that it is more likely than not that our deferred tax assets in excess of our deferred tax liabilities will not ultimately be realized, in part due to our cumulative losses in recent years. Therefore, we are required to provide a valuation allowance for our deferred tax assets in excess of our deferred tax liabilities. As a result, beginning with the third quarter of 2008, our losses were not reduced by any tax benefit. As of June 30, 2010, we had recorded a $4.1 million valuation allowance applicable to our net deferred tax assets and our deferred tax assets net of the valuation allowance equaled our gross deferred tax liabilities. During the three months ended June 30, 2009, we recognized $0.7 million of income tax expense related to our repurchase of our 7% convertible notes. Regardless of the financial accounting for income taxes, our net operating loss carry-forwards currently are available for use on our income tax returns to offset future taxable income.
Note 7 – Earnings Per Common Share
The following table sets forth the computation of basic and diluted earnings (loss) per common share (in thousands, except per share amounts):
n/a – not applicable because the security was not outstanding during the period
Excluded from the diluted earnings per share calculation for the three months ended June 30, 2010 are the impacts on the weighted average shares outstanding of the following which would have been anti-dilutive for the period in 2010 totaling 12.6 million shares: 8.6 million shares related to our 7.0% convertible notes that would have been issuable upon conversion because the effect of including these shares would have been anti-dilutive for the period; 1.9 million shares related to our outstanding stock options; and 2.1 million shares related to our unvested restricted stock and unvested performance share awards.
Excluded from the diluted earnings per share calculation for the six months ended June 30, 2010 are the impacts on the weighted average shares outstanding of the following which would have been anti-dilutive for the period in 2010 totaling 49.7 million shares: 8.6 million shares related to our 7.0% convertible notes that would have been issuable upon conversion; 18.1 million shares related to our 5.5% convertible notes that are issuable upon conversion; 18.9 million shares related to our 5.25% convertible notes that are issuable upon conversion; 1.9 million shares related to our outstanding stock options; and 2.2 million shares related to our unvested restricted stock and unvested performance share awards.
Excluded from the diluted earnings per share calculations for the three months ended June 30, 2009 are the impacts on the weighted average shares outstanding of the following which would have been anti-dilutive for the period in 2009 totaling 3.5 million shares: 1.9 million shares related to our outstanding stock options; and 1.6 million shares related to our unvested restricted stock and unvested performance share awards. The 5.25% convertible notes were issued in the fourth quarter of 2009.
Excluded from the diluted earnings per share calculations for the six months ended June 30, 2009 are the impacts on the weighted average shares outstanding of the following which would have been anti-dilutive for the period in 2009 totaling 3.7 million shares: 2.0 million shares related to our outstanding stock options; and 1.7 million shares related to our unvested restricted stock and unvested performance share awards. The 5.25% convertible notes were issued in the fourth quarter of 2009.
Note 8 – Accumulated Other Comprehensive Income (Loss)
Other comprehensive income (loss) is composed of changes in the fair value of certain of our derivative financial instruments and the funded status of our postemployment obligations. The components of Accumulated other comprehensive income (loss) are as follows (in thousands):
Total comprehensive income (loss) was $(4.7) million and $(21.6) million for the three and six months ended June 30, 2010, respectively, and $94.9 million and $121.9 million for the three and six months ended June 30, 2009, respectively.
Note 9 – Stock Option Awards and Restricted Stock Awards
Restricted stock awards, market-based (performance stock) awards, and stock options have been granted to certain of our officers, directors and key employees. Restricted stock awards are grants of shares of our common stock, which typically vest over time (generally three years). Our market-based awards are grants of our common stock that vest, if at all, at the end of the specified performance period (currently three years) in amounts that are largely dependent on the achievement of specified goals which are expressed in terms of threshold, target, and maximum award achievement levels. During the first six months of 2010 and 2009, we granted restricted stock awards for approximately 619,000 and 664,000 shares, respectively, and approximately 633,000 and 528,000 shares, respectively, of restricted stock vested. During the first six months of 2010 and 2009, we granted market-based awards for up to 640,006 and 360,360 shares, respectively, of our common stock. The estimated fair value of the market-based share awards at the date of grant will be recognized ratably as compensation expense over the three-year service period. No stock options were granted in either period.
Compensation expense for our performance stock awards was $0.3 million and $0.5 million during the three and six months ended June 30, 2010, respectively, and $0.1 million and $0.1 million during the three and six months ended June 30, 2009, respectively. As of June 30, 2010, we have $2.1 million in total unrecognized future compensation expense that will be recognized over the next two years relating to awards for up to approximately 1.0 million performance stock awards which were outstanding at such date, but which had not yet vested.
As of June 30, 2010, options to purchase 2.0 million shares of common stock, at exercise prices between $3.90 and $13.80 per share were outstanding. All outstanding options to purchase common shares were exercisable as of June 30, 2010.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS>
The information contained in this section 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. 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 results of litigation or investigation. Our forward-looking statements often 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. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise.
All of the flight operations of AirTran Holdings, Inc. (the Company, AirTran, or Holdings) are conducted by our wholly-owned subsidiary, AirTran Airways, Inc. (AirTran Airways or Airways) (collectively we, our, or us). AirTran Airways is one of the largest low cost scheduled airlines in the United States in terms of departures and seats offered. We operate scheduled airline service throughout the United States and to selected international locations. Approximately half of our flights originate or terminate at our largest hub in Atlanta, Georgia and we serve a number of markets with non-stop service from our focus cities of Baltimore, Maryland; Milwaukee, Wisconsin; and Orlando, Florida. As of July 19, 2010, we operated 86 Boeing B717-200 aircraft (B717) and 52 Boeing B737-700 aircraft (B737) offering approximately 730 scheduled flights per day to 71 locations in the United States, including San Juan, Puerto Rico; as well as to Cancun, Mexico; Montego Bay, Jamaica; Nassau, The Bahamas; and Orangestad, Aruba. The traditional elements of our success include: competitive fares; superior service; an attractive network; product value; low unit costs; adaptability; flexibility; innovation; and the enthusiasm and skills of our employees.
Key Initiatives to Respond to High Fuel Costs and Weak Economic Conditions
Prior to 2008, we positioned ourselves as a growth airline. In 2008, to respond to the challenges of a volatile fuel cost environment, a weak macroeconomic environment, and adverse capital market conditions, we recast our plans which resulted in a more conservative growth plan.
By adjusting our business strategy, implementing and managing ancillary fees, controlling employment levels, and reducing other capital expenditures, we positioned AirTran to more effectively deal with a volatile fuel-cost environment and reduced demand for air travel due to weak macroeconomic conditions. As a result of our actions, our capacity growth slowed to 4.9 percent in 2008, and we reduced capacity by 2.2 percent in 2009. During 2009, we continued to develop and diversify our route network by: substantially increasing our presence in Orlando, Baltimore, and Milwaukee; initiating service to seven domestic locations; and initiating service to three international destinations.
During 2009, we returned to solid profitability from the substantial loss we incurred in 2008. The pronounced reduction in jet fuel price levels during 2009 compared to 2008, coupled with the actions that we undertook to reduce and redeploy capacity, increase ancillary revenues, and control costs produced the improved operating results. For 2009, we reported net income of $134.7 million. The 2009 results include a non-operating gain on derivative financial instruments of $30.6 million.
In 2010, we are continuing to develop and diversify our route network. During the six months ended June 30, 2010, we commenced service to six new destinations. Additionally, in the first quarter of 2010, SkyWest Airlines Inc., with whom we have a marketing agreement to support our Milwaukee hub, expanded its presence in Milwaukee. Under this agreement, SkyWest Airlines now offers regional jet service between Milwaukee and six destinations. We, together with our marketing partner, currently serve 23 non-stop destinations to and from Milwaukee.
Second Quarter 2010 Operating Results
Our second quarter 2010 operating income increased by $2.1 million compared to the second quarter of 2009, as the favorable impact of an increase in our total unit revenue exceeded the unfavorable impact of the 37.2 percent increase in our average cost of jet fuel per gallon. Our total operating revenue increased $96.9 million to $700.6 million. The increase in our total operating revenue was driven by a 4.9 percent increase in capacity (as measured by available seat miles) and a 10.7 percent increase in total revenue per available seat mile to 11.19 cents. The increase in our average cost of jet fuel per gallon resulted in a $62.2 million increase in our aircraft fuel expense during the second quarter of 2010 compared to what fuel expense would have been had jet fuel prices been at the average level we experienced during the second quarter of 2009.
Due largely to net losses on derivative financial instruments, our net income for the three months ended June 30, 2010 was unfavorable compared to the analogous period in 2009. During the second quarter 2010, we reported operating income of $68.2 million, net income of $12.4 million, and diluted earnings per common share of $0.09. Included in our second quarter 2010 results is a non-operating loss on derivative financial instruments of $34.0 million. The non-operating loss on derivative financial instruments was largely attributable to unrealized declines in the fair value of our fuel-related derivative assets. During the three months ended June 30, 2009, we reported operating income of $66.2 million, net income of $78.4 million, and diluted earnings per common share of $0.56. Included in our second quarter 2009 results is a non-operating gain on derivative financial instruments of $27.3 million and a non-operating gain on extinguishment of debt of $4.0 million.
2010 Year to Date Accomplishments
In January 2010, AirTran Airways was awarded the prestigious 2009 Market Leadership Award from a leading industry publication, Air Transport World, for AirTran’s innovative combination of low-cost, high-quality service and response to the global financial crisis.
In April 2010, AirTran Airways was selected as the top low-cost carrier for the third consecutive year in the prestigious Airline Quality Rating (AQR). Our rating is the highest of all low-cost carriers and significantly higher than our legacy airline competitors. This independent rating is conducted by professors at Purdue University’s Department of Aviation Technology and the W. Frank Barton School of Business at Wichita State University. The AQR evaluates airlines in four major areas: on-time performance, denied boardings, mishandled baggage, and customer complaints.
During July 2010, we repurchased $90.4 million of our 7.0% convertible notes pursuant to the terms of such notes. The repurchase price was paid in cash.
During the first six months of 2010, we also:
We expect to face challenges during the remainder of 2010. Managing costs and increasing unit revenues in the face of volatile fuel costs and a slow economic recovery will continue to be a primary focus. Fuel prices remain volatile and may again increase during the remainder of 2010. While we have been able to effectively manage costs and increase unit revenues, the pace and extent of the continuing recovery and growth of airline industry revenue are uncertain in the context of improving but still generally unfavorable macroeconomic conditions.
Our pilots’ collective bargaining agreement became amendable in 2005 and is currently in mediation. Our flight attendants’ collective bargaining agreement became amendable in December 2008 and is currently the subject of negotiation. The impact on our operating results of any new collective bargaining agreements is not known.
Compared to the analogous period of 2009, we expect our capacity, as measured by available seat miles (ASMs), to increase approximately one percent for the third quarter. We also expect our third quarter passenger revenue per ASM and total revenue per ASM to increase by 14.5 to 16.5 percent and 12.5 to 14.5 percent, respectively, compared to the third quarter of 2009. We project our unit non-fuel costs per ASM to increase by four to five percent for the third quarter and for 2010 as a whole.
We anticipate that our 2010 non-fuel unit operating costs will increase due to: increases in aircraft maintenance costs, higher employee compensation costs due to higher wage rates attributable to higher average employee seniority and wage scales, increased revenue related costs, and higher airport rents and landing fees. We expect our aircraft maintenance costs to increase due to the aging of each of our aircraft types.
Air travel in our markets tends to be seasonal, with the highest levels occurring during the winter months to Florida and the summer months to the Northeastern and Western United States. The second quarter tends to be our strongest revenue quarter.