Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2015

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 001-36718

 

 

VIRGIN AMERICA INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   20-1585173

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

555 Airport Boulevard

Burlingame, CA 94010

(Address of Principal Executive Offices) (Zip Code)

 

(650) 762-7000

(Registrant’s telephone number, including area code)

 

 

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 Website, 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  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x      Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

As of July 22, 2015, the registrant had 43,412,080 shares of common stock outstanding.

 

 

 


Table of Contents

Virgin America Inc.

FORM 10-Q

INDEX

 

PART I    FINANCIAL INFORMATION   
   Item 1. Financial Statements      3   
  

Condensed Consolidated Balance Sheets - June 30, 2015 and December 31, 2014

     3   
  

Consolidated Statements of Operations - Three Months and Six Months Ended June 30, 2015 and 2014

     5   
  

Consolidated Statements of Comprehensive Income (Loss) - Three Months and Six Months Ended June 30, 2015 and 2014

     6   
  

Condensed Consolidated Statements of Cash Flows - Six Months Ended June 30, 2015 and 2014

     7   
  

Notes to Condensed Consolidated Financial Statements

     8   
   Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations      19   
   Item 3. Quantitative and Qualitative Disclosures about Market Risk      32   
   Item 4. Controls and Procedures      32   
PART II    OTHER INFORMATION   
   Item 1. Legal Proceedings      33   
   Item 1A. Risk Factors      33   
   Item 2. Unregistered Sales of Equity Securities and Use of Proceeds      48   
   Item 3. Defaults Upon Senior Securities      48   
   Item 4. Mine Safety Disclosures      48   
   Item 5. Other Information      48   
   Item 6. Exhibits      48   
   Signatures      49   
   Exhibit Index      50   

 

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PART 1. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Virgin America Inc.

Condensed Consolidated Balance Sheets

(in thousands)

 

     June 30, 2015      December 31, 2014  
     (unaudited)         

Assets

     

Current assets:

     

Cash and cash equivalents

   $ 500,457       $ 394,643   

Receivables, net

     30,191         23,414   

Prepaid expenses and other assets

     35,404         20,874   
  

 

 

    

 

 

 

Total current assets

     566,052         438,931   

Property and equipment:

     

Property and equipment, net

     80,998         73,207   

Pre-delivery payments for flight equipment

     117,501         94,280   
  

 

 

    

 

 

 

Total property and equipment, net

     198,499         167,487   

Aircraft maintenance deposits

     223,104         211,946   

Aircraft lease deposits

     49,292         50,758   

Restricted cash

     19,744         18,775   

Other non-current assets

     127,032         112,279   
  

 

 

    

 

 

 
     419,172         393,758   
  

 

 

    

 

 

 

Total assets

   $ 1,183,723       $ 1,000,176   
  

 

 

    

 

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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Virgin America Inc.

Condensed Consolidated Balance Sheets

(in thousands)

 

     June 30, 2015     December 31, 2014  
     (unaudited)        

Liabilities and stockholders’ equity

    

Current liabilities:

    

Accounts payable

   $ 52,725      $ 52,821   

Air traffic liability

     223,187        150,479   

Other current liabilities

     92,573        100,723   

Long-term debt-current portion

     68,656        33,824   
  

 

 

   

 

 

 

Total current liabilities

     437,141        337,847   

Long-term debt-related parties

     40,477        38,848   

Long-term debt

     40,000        57,416   

Other long-term liabilities

     102,647        106,812   
  

 

 

   

 

 

 

Total liabilities

     620,265        540,923   

Contingencies and commitments (Note 4)

    

Stockholders’ equity

    

Preferred stock

     —          —     

Common stock

     434        431   

Additional paid-in capital

     1,238,505        1,237,944   

Accumulated deficit

     (675,241     (753,016

Accumulated other comprehensive loss

     (240     (26,106
  

 

 

   

 

 

 

Total stockholders’ equity

     563,458        459,253   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 1,183,723      $ 1,000,176   
  

 

 

   

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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Virgin America Inc.

Consolidated Statements of Operations

(in thousands, except per share data)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2015     2014     2015     2014  
     (unaudited)     (unaudited)     (unaudited)     (unaudited)  

Operating revenues:

        

Passenger

   $ 359,709      $ 358,108      $ 649,073      $ 636,148   

Other

     41,177        40,737        78,165        76,087   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenues

     400,886        398,845        727,238        712,235   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Aircraft fuel

     93,743        131,664        182,301        247,423   

Salaries, wages and benefits

     74,758        59,318        139,490        113,143   

Aircraft rent

     45,708        45,861        90,690        92,357   

Landing fees and other rents

     34,071        33,286        68,054        65,507   

Sales and marketing

     30,704        28,615        57,083        53,177   

Aircraft maintenance

     12,656        16,409        26,489        35,453   

Depreciation and amortization

     4,225        3,484        8,328        6,753   

Other operating expenses

     37,363        33,082        71,762        64,427   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     333,228        351,719        644,197        678,240   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income:

     67,658        47,126        83,041        33,995   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expense):

        

Interest expense-related-party

     (822     (9,558     (1,628     (18,940

Interest expense

     (1,616     (951     (2,831     (1,484

Capitalized interest

     1,242        635        2,309        1,116   

Other income (expense), net

     (1,109     (2     (2,428     258   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense

     (2,305     (9,876     (4,578     (19,050
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax

     65,353        37,250        78,463        14,945   

Income tax expense

     364        267        688        316   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 64,989      $ 36,983      $ 77,775      $ 14,629   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per share:

        

Basic

   $ 1.50      $ 20.42      $ 1.80      $ 8.08   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 1.47      $ 11.92      $ 1.75      $ 4.72   
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used for computation:

        

Basic

     43,298        702        43,239        702   

Diluted

     44,083        1,992        44,538        1,992   

See accompanying notes to the condensed consolidated financial statements

 

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Virgin America Inc.

Consolidated Statements of Comprehensive Income (Loss)

(In thousands)

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2015      2014      2015      2014  
     (unaudited)      (unaudited)      (unaudited)      (unaudited)  

Net income

   $ 64,989       $ 36,983       $ 77,775       $ 14,629   

Derivative financial instruments, net of tax:

           

Change in unrealized losses (gains)

     4,569         1,518         1,551         (1,227

Net losses reclassified into earnings

     9,080         484         24,315         501   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive income (loss)

     13,649         2,002         25,866         (726
  

 

 

    

 

 

    

 

 

    

 

 

 

Total comprehensive income

   $ 78,638       $ 38,985       $ 103,641       $ 13,903   
  

 

 

    

 

 

    

 

 

    

 

 

 

See accompanying notes to the condensed consolidated financial statements

 

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Virgin America Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

 

     Six Months Ended June 30,  
     2015     2014  
     (unaudited)     (unaudited)  

Cash flows from operating activities:

   $ 130,920      $ 25,059   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Acquisition of property and equipment and intangible assets

     (16,273     (31,070

Pre-delivery payments for flight equipment

     (5,805     (9,182
  

 

 

   

 

 

 

Net cash used in investing activities

     (22,078     (40,252
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net proceeds of equity issuance

     1,526        8   

Proceeds of term loan facility

     —          40,000   

Debt issuance costs

     (818     (494

Shares repurchased for tax withholding on vesting of restricted stock units

     (3,736     —     
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     (3,028     39,514   
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     105,814        24,321   
  

 

 

   

 

 

 

Cash and cash equivalents, beginning of period

     394,643        155,659   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 500,457      $ 179,980   
  

 

 

   

 

 

 

Non-cash transactions:

    

Non-cash loan borrowings on pre-delivery payments for flight equipment

     17,416        —     

See accompanying notes to the condensed consolidated financial statements

 

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Notes to the Condensed Consolidated Financial Statements

 

(1) Basis of Presentation

The condensed consolidated financial statements of Virgin America Inc. (the “Company”) for the three and six months ended June 30, 2014 include the accounts of the Company and its variable interest entity, VX Employee Holdings LLC, for which it was the primary beneficiary until all of the shares held by VX Employee Holdings LLC were sold to the public as part of the Company’s initial public offering (the “IPO”) in November 2014 as discussed below. These unaudited condensed consolidated financial statements and related notes should be read in conjunction with the Company’s 2014 audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 (“2014 Form 10-K”).

These unaudited condensed consolidated financial statements have been prepared as required by the U.S. Securities Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) have been condensed or omitted as permitted by the SEC. The financial statements include all adjustments, including normal recurring adjustments and other adjustments, which are considered necessary for a fair presentation of the Company’s financial position and results of operations. Operating results for the periods presented herein are not necessarily indicative of the results that may be expected for the entire year. Certain prior year amounts have been reclassified to conform to current year presentation. These amounts were not material to any of the periods presented.

In November 2014, concurrent with the pricing of the IPO, the Company entered into a recapitalization agreement (the “2014 Recapitalization”) with certain security-holders to exchange or extinguish the majority of its then-outstanding related-party debt and accrued interest (the “Related-Party Notes”) with contractual value of $684.8 million at the time and all of its convertible preferred stock and outstanding warrants. The Company repaid $156.5 million of certain Related-Party Notes with $56.5 million from the proceeds of the IPO and $100.0 million from the release of cash collateral to the Company in connection with a $100.0 million letter of credit facility issued on its behalf to certain of its credit card processors by the Virgin Group (the “Letter of Credit Facility”, which has since been terminated). The Company issued a new $50.0 million note to the Virgin Group (the “Post-IPO Note”) in exchange for the cancellation of $50.0 million of certain Related-Party Notes previously outstanding and held by the Virgin Group. The Company recorded the Post-IPO Note at the estimated fair value of $38.5 million. The Company exchanged the remainder of the Related-Party Notes for 22,159,070 shares of common stock based on the IPO offering price and the remaining outstanding contractual value of the debt, except for principal and accrued interest under certain secured notes issued in December 2011 and certain secured notes issued in May 2013 both held by Cyrus Capital, which were converted at a premium of 117% of the outstanding contractual value. The Company also converted each of 1,950,937 shares of convertible preferred stock and Class A, Class A-1, Class B, Class C and Class G common stock into shares of common stock on a one-to-one basis and exchanged related-party warrants to purchase 26,067,475 shares of common stock for 5,742,543 shares of common stock with the remaining related-party warrants to purchase 16,175,126 shares of common stock canceled in their entirety. For additional information, see the consolidated financial statements included in the 2014 Form 10-K.

During the three months ended June 30, 2015, the Company recorded an immaterial correction related to prior period Elevate loyalty revenue to increase passenger revenue and decrease deferred revenue by $3.2 million. The Company assessed the materiality of this adjustment for each quarterly and annual period and determined that the adjustment was immaterial to all reported periods.

Receivables, net

Receivable, net includes credit card holdbacks and other receivables. Credit card holdbacks and related receivables are amounts due from credit card processors associated with sales for future travel and are carried at cost. Under the terms of the Company’s credit card processing agreements, certain proceeds from advance ticket sales are held back to serve as collateral by the credit card processors, due to the Company’s credit and in part to cover any possible refunds or chargebacks that may occur. These holdbacks are short-term, as the travel for which they relate occurs within twelve months. In June 2015, the Company entered into agreements with its credit card processors to reduce the holdback requirements to 0% and, in connection with this the $100.0 million Letter of Credit Facility was terminated. The credit card processors have the right to increase the credit card holdback amount in the future depending on the Company’s financial performance. If the Company’s credit card processors were to implement a new holdback requirement, it would be funded through withholding proceeds from future ticket sales made through credit card transactions. As of June 30, 2015, the Company recorded $18.6 million in credit card receivables. As of December 31, 2014, the Company had no net holdbacks outstanding as a result of the Letter of Credit Facility and $9.6 million of credit card receivables.

 

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New Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) and International Accounting Standards Board (“IASB”) jointly issued a comprehensive new revenue recognition standard that will replace most existing revenue recognition standards under U.S. GAAP and International Financial Reporting Standards (“IFRS”). The new standard will require the Company to recognize revenue when goods or services are transferred to customers in an amount that reflects the consideration to which it expects to be entitled in exchange for those goods or services. As a result, the Company will need to use more judgments and estimates to determine when and how revenue is recognized than U.S. GAAP currently requires. The new standard will become effective for the Company on January 1, 2018. The Company believes the most significant effect of this accounting standards update will be the elimination of the incremental cost method for frequent flyer accounting, which would require the Company to re-value its liability earned by customers associated with flights points with a relative fair value approach. The Company is continuing to evaluate the new guidance and plans to provide additional information about its expected financial effect at a future date.

In February 2015, the FASB issued an accounting standards update that eliminates the deferral of FAS 167, which has allowed entities with interests in certain investment funds to follow the previous consolidation guidance in FIN 46(R), and makes other changes to both the variable interest model and the voting model. In some cases, consolidation conclusions will change. In other cases, reporting entities will need to provide additional disclosures about entities that currently aren’t considered variable interest entities (VIEs) but will be considered VIEs under the new guidance provided they have a variable interest in those VIEs. The guidance will be effective for financial statements issued for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. The Company does not expect this accounting standards update to have a material impact on the consolidated financial statements.

In April 2015, the FASB issued an accounting standards update that simplifies the guidance related to presentation of debt issuance costs. The guidance requires presentation of debt issuance costs on the balance sheet as a direct deduction from the face amount of that note, consistent with debt discounts. The guidance is to be applied retrospectively to the financial periods presented as a change in accounting principle. The guidance will be effective for financial statements issued for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. The Company does not expect this accounting standards update to have a material impact on the consolidated financial statements.

In June 2015, the FASB issued an accounting standards update that corrects differences between original accounting guidance and the accounting guidance codification, clarifies the accounting guidance, corrects references and makes minor improvements affecting a variety of accounting topics. Transition guidance varies based on the amendments in the update. The amendments in the update that require transition guidance are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. The Company does not expect this accounting standards update to have a material impact on the consolidated financial statements.

 

(2) Fair Value

The accounting guidance establishes a fair value hierarchy as follows:

 

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    Level 1    Observable inputs such as quoted prices in active markets for identical assets or liabilities.
    Level 2    Observable inputs other than Level 1 prices such as quoted prices in active markets for similar assets and liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term for the assets or liabilities.
    Level 3    Unobservable inputs in which there is little or no market data and that are significant to the fair value of the assets or liabilities.

The following is a listing of the Company’s assets and liabilities required to be measured at fair value on a recurring basis and where they are classified within the fair value hierarchy as of June 30, 2015 and December 31, 2014 respectively (in thousands):

 

     June 30, 2015 (unaudited)  
     Level 1      Level 2      Level 3      Total  

Assets (Liability)

        

Cash equivalents

   $ 444,803       $ —         $ —         $ 444,803   

Restricted cash

     19,744         —           —           19,744   

Heating oil collars - fuel derivative instruments

     —           —           —           —     

Brent calls - fuel derivative instruments

     —           1         —           1   

Heating oil swaps - fuel derivative instruments

     —           201         —           201   

Jet fuel swaps - fuel derivative instruments

     —           (259      —           (259

Interest rate swaps

     —           42         —           42   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 464,547       $ (15    $ —         $ 464,532   
  

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2014  
     Level 1      Level 2      Level 3      Total  

Assets (Liability)

        

Cash equivalents

   $ 339,211       $ —         $ —         $ 339,211   

Restricted cash

     18,775         —           —           18,775   

Heating oil collars - fuel derivative instruments

     —           (27,170      —           (27,170

Brent calls - fuel derivative instruments

     —           50         —           50   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 357,986       $ (27,120    $ —         $ 330,866   
  

 

 

    

 

 

    

 

 

    

 

 

 

A portion of the Company’s debt is privately negotiated with related parties. The estimated fair value of related-party debt was $45.9 million and $38.8 million at June 30, 2015 and December 31, 2014, respectively. The estimated fair value of the non-related party debt includes financing associated with aircraft pre-delivery payments of $68.7 million and $51.2 million at June 30, 2015 and December 31, 2014 and a $40.0 million financing of airport slots. The Company uses significant unobservable inputs in determining discounted cash flows to estimate the fair value, and therefore, such amounts are categorized as Level 3 in the fair value hierarchy.

 

(3) Financial Derivative Instruments and Risk Management

Fuel Hedges

To manage economic risks associated with the fluctuations of aircraft fuel prices, since 2012, the Company has hedged a targeted percentage of its forecasted fuel requirements over the following 12 months with a rolling strategy of entering into call options for crude oil and collar contracts for heating oil in the longer term, three to 12 months before the expected fuel purchase date; then prior to maturity of these contracts, within three months of the fuel purchase, the Company exited these contracts by entering into offsetting trades and locking in the price of a percentage of its fuel requirements through the purchase of fixed forward pricing (“FFP”) contracts in jet fuel. In 2015, the Company eliminated the use of call options and collars from its fuel hedging program and began utilizing forward swaps on jet fuel, heating oil and crude oil to lock in future fuel purchase prices.

 

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The Company utilizes FFP contracts with its fuel service provider as part of its risk management strategy, wherein fixed prices are negotiated for set volumes of future purchases of fuel. The Company takes physical delivery of the future purchases. The Company has applied the normal purchase and normal sales exception for these commitments. As of June 30, 2015, the total commitment related to FFP contracts was $38.6 million, for which the related fuel will be purchased during 2015.

The Company designates the majority of its fuel hedge derivatives contracts as cash flow hedges under the applicable accounting standard, if they qualify for hedge accounting. Under hedge accounting, all periodic changes in the fair value of the derivatives designated as effective hedges are recorded in accumulated other comprehensive income (loss) (“AOCI”) until the underlying fuel is purchased, at which point the deferred gain or loss will be recorded as fuel expense. In the event that the Company’s fuel hedge derivatives do not qualify as effective hedges, the periodic changes in fair value of the derivatives are included in fuel expense in the period they occur. If the Company terminates a fuel hedge derivative contract prior to its settlement date, the cumulative gain or loss recognized in AOCI at the termination date will remain in AOCI until the terminated intended transaction occurs. In the event it becomes improbable that such event will occur, the cumulative gain or loss is immediately reclassified into earnings. All cash flows associated with purchasing and settling of fuel hedge derivatives are classified as operating cash flows in the accompanying condensed consolidated statements of cash flows.

Interest Rate Swaps

In April 2015, the Company executed debt facility agreements to finance the Company’s 2015 aircraft deliveries. Refer to Note 4 - Contingencies and Commitments for additional information. The Company entered into interest rate swaps in May 2015 to protect the Company against adverse fluctuations in interest rates by reducing its exposure to variability in cash flows relating to future interest payments on the committed financing for an aircraft to be delivered in November 2015. The interest rate swaps hedge the risk of changes in the Company’s cash flows (i.e., interest payments attributable to changes in the three-month USD-LIBOR-BBA swap rate, the designated benchmark interest rate being hedged) on an amount of the debt principal equal to the committed financing amount. As such, the swap terms match the payment terms on the debt. The interest rate swaps are designated cash flow hedges. The gains and losses related to the changes in fair value of the swaps are included in AOCI in the accompanying condensed consolidated balance sheet. The effect of such swaps is to convert the floating interest rate to a fixed rate until the aircraft is delivered in November 2015, when the debt funding occurs. Hedge accounting will cease once the interest rate has been contractually fixed upon aircraft delivery, and the outstanding AOCI balance associated with the interest rate swap will be amortized using the interest method over the term of the debt. The fair value of the interest rate swaps is reflected in other current assets in the accompanying condensed consolidated balance sheet. The measurement of hedge effectiveness is based on the hypothetical-derivative method in which the cumulative change in the fair value of the hedging instrument will be compared to the cumulative change in fair value of the hypothetical derivative.

 

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The following tables present the fair value of derivative assets and liabilities that are designated and not designated as hedging instruments, as well as the location of the asset and liability balances within the condensed consolidated balance sheets as of June 30, 2015 and December 31, 2014 (in thousands):

 

Derivatives designated as cash flow hedges

   Consolidated
balance sheet location
     Fair value of derivatives as of  
      June 30,
2015
    December 31,
2014
 
            (unaudited)        

Fuel derivative instruments—Heating oil collars

     Current liabilities         —          (24,762

Fuel derivative instruments—Brent calls

     Current liabilities         —          (84

Fuel derivative instruments—Heating oil swaps

     Current liabilities         317        —     

Fuel derivative instruments—Jet fuel swaps

     Current liabilities         (259     —     

Interest rate swaps

     Current assets         42        —     
     

 

 

   

 

 

 

Total current assets (liabilities)

      $ 100      $ (24,846
     

 

 

   

 

 

 

Derivatives not designated as cash flow hedges

   Consolidated
balance sheet location
     Fair value of derivatives as of  
      June 30,
2015
    December 31,
2014
 
            (unaudited)        

Fuel derivative instruments—Heating oil collars

     Current liabilities         —          (2,408

Fuel derivative instruments—Brent calls

     Current liabilities         1        134   

Fuel derivative instruments—Heating oil swaps

     Current liabilities         (116     —     
     

 

 

   

 

 

 

Total current assets (liabilities)

      $ (115   $ (2,274
     

 

 

   

 

 

 

As of June 30, 2015, the Company had no margin call balances with its counterparties. At December 31, 2014, the Company had deposited $14.4 million as collateral with one of its counterparties to comply with margin call requirements related to fuel derivative losses that exceed the portfolio’s credit limit. The Company had recorded the margin call deposits in other current liabilities in the accompanying condensed consolidated balance sheet as of December 31, 2014, offsetting the net hedge liability of $27.1 million. Thus the total net current hedge liability was $12.7 million at December 31, 2014.

The following table summarizes the effect of fuel derivative instruments in the condensed consolidated statements of operations for the three and six months ended June 30, 2015 and 2014 (in thousands):

 

Derivatives accounted for as hedging instruments under ASC 815

   Consolidated
financial
statement location
   Gains (losses) on derivative
contracts for the three
months ended
    Gains (losses) on
derivative
contracts for the six
months ended
 
          June 30,
2015
    June 30,
2014
    June 30,
2015
    June 30,
2014
 
          (unaudited)     (unaudited)     (unaudited)     (unaudited)  

Fuel derivative instruments

   Aircraft fuel expense    $ (9,219   $ (549   $ (24,434   $ (677
     

 

 

   

 

 

   

 

 

   

 

 

 

Total impact to the consolidated statements of operations

      $ (9,219   $ (549   $ (24,434   $ (677
     

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Derivatives not accounted for as hedging instruments under ASC 815

   Consolidated
financial
statement location
   Gains (losses) on derivative
contracts for the three
months ended
    Gains (losses) on
derivative
contracts for the six
months ended
 
          June 30,
2015
     June 30,
2014
    June 30,
2015
     June 30,
2014
 
          (unaudited)      (unaudited)     (unaudited)      (unaudited)  

Fuel derivative instruments

   Aircraft fuel expense    $ 800       $ (476   $ 353       $ (928
     

 

 

    

 

 

   

 

 

    

 

 

 

Total impact to the consolidated statements of operations

      $ 800       $ (476   $ 353       $ (928
     

 

 

    

 

 

   

 

 

    

 

 

 

At June 30, 2015, the Company estimated that approximately $0.3 million of net derivative losses related to its cash flow fuel hedges included in AOCI will be reclassified into earnings within the next nine months.

Interest rate swaps did not affect the condensed consolidated statement of operations as of June 30, 2015. At June 30, 2015, the Company estimates that an immaterial amount of net derivative gains related to its interest rate swaps included in AOCI will be reclassified into earnings within the next twelve months.

The effect of fuel derivative instruments designated as cash flow hedges and the underlying hedged items on the condensed consolidated statements of operations for the three and six months ended June 30, 2015 and 2014, respectively, is summarized as follows (in thousands):

 

Derivatives designated as cash flow hedges

   Amount of gain (loss)
recognized in AOCI
on derivatives
(Effective portion)
    Gain (loss) reclassified
from AOCI into
income (Fuel expense or
Interest expense)
(Effective portion)
    Amount of gain (loss)
recognized into
income (Ineffective
portion)
 
     Three Months Ended,     Three Months Ended,     Three Months Ended,  
     June 30,
2015
     June 30,
2014
    June 30,
2015
    June 30,
2014
    June 30,
2015
    June 30,
2014
 
     (unaudited)      (unaudited)     (unaudited)     (unaudited)     (unaudited)     (unaudited)  

Fuel derivative instruments

   $ 4,527       $ 1,518      $ (9,080   $ (484   $ (139   $ (65

Interest rate swaps

     42         —          —          —          —          —     

Derivatives designated as cash flow hedges

   Amount of gain (loss)
recognized in AOCI
on derivatives
(Effective portion)
    Gain (loss) reclassified
from AOCI into
income (Fuel expense or
Interest expense)
(Effective portion)
    Amount of gain (loss)
recognized into
income (Ineffective
portion)
 
     Six Months Ended,     Six Months Ended,     Six Months Ended,  
     June 30,
2015
     June 30,
2014
    June 30,
2015
    June 30,
2014
    June 30,
2015
    June 30,
2014
 
     (unaudited)      (unaudited)     (unaudited)     (unaudited)     (unaudited)     (unaudited)  

Fuel derivative instruments

   $ 1,509       $ (1,227   $ (24,315   $ (501   $ (119   $ (176

Interest rate swaps

     42         —          —          —          —          —     

 

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The notional amounts of the Company’s outstanding fuel and debt payment related derivatives are summarized as follows (in millions):

 

     June 30, 2015      December 31, 2014  
     (unaudited)         

Derivatives designated as hedging instruments:

     

Fuel derivative instruments—Heating oil collars (gallons)

     0         36   

Fuel derivative instruments—Brent calls (gallons)

     0         16   

Fuel derivative instruments—Heating oil swaps (gallons)

     9         0   

Fuel derivative instruments—Jet fuel swaps (gallons)

     28         0   

Interest rate swaps (dollars)

   $ 39       $ 0   

Derivatives not designated as hedging instruments:

     

Fuel derivative instruments—Heating oil collars (gallons)

     0         3   

Fuel derivative instruments—Brent calls (gallons)

     11         13   

Fuel derivative instruments—Heating oil swaps (gallons)

     2         0   

Fuel derivative instruments—Jet fuel swaps (gallons)

     0         0   

Interest rate swaps (dollars)

   $ 0       $ 0   

As of June 30, 2015, the Company had entered into fuel derivative contracts for approximately 30% of its forecasted aircraft fuel requirements for the next nine months at a weighted-average cost per gallon of $1.86 (excluding related fuel taxes).

The Company presents its fuel derivative instruments at net fair value in the accompanying condensed consolidated balance sheets. The Company’s master netting arrangements with counterparties allow for net settlement under certain conditions. As of June 30, 2015 and December 31, 2014, information related to these offsetting arrangements was as follows (in thousands):

 

     June 30, 2015 (unaudited)  
     Derivatives offset in consolidated balance sheet     Derivatives eligible for offsetting  
     Gross derivative
amounts
    Gross derivative
amounts offset in
consolidated
balance sheet
    Net amount     Gross derivative
amounts
    Gross derivative
amounts eligible
for offsetting
    Net amount  

Fair value of assets

   $ 2,176      $ (2,176   $ —        $ 2,176      $ (2,176   $ —     

Fair value of liabilities

     (2,233     2,176        (57     (2,233     2,176        (57

Margin call deposits

         —              —     
      

 

 

       

 

 

 

Total

       $ (57       $ (57
      

 

 

       

 

 

 
     December 31, 2014  
     Derivatives offset in consolidated balance sheet     Derivatives eligible for offsetting  
     Gross derivative
amounts
    Gross derivative
amounts offset in
consolidated
balance sheet
    Net amount     Gross derivative
amounts
    Gross derivative
amounts eligible
for offsetting
    Net amount  

Fair value of assets

   $ 256      $ (256   $ 0      $ 256      $ (256   $ 0   

Fair value of liabilities

     (27,376     256        (27,120     (27,376     256        (27,120

Margin call deposits

         14,390            14,390   
      

 

 

       

 

 

 

Total

         (12,730         (12,730
      

 

 

       

 

 

 

 

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The fuel derivative agreements the Company has with its counterparties may require the Company to pay all, or a portion of, the outstanding loss positions related to these contracts in the form of a margin call prior to their scheduled maturities. The amount of collateral posted, if any, is adjusted based on the fair value of the fuel hedge derivatives. The Company did not have any collateral posted related to outstanding fuel hedge contracts at June 30, 2015 and had $14.4 million of collateral posted related to outstanding fuel hedge contracts at December 31, 2014, which is reflected in the table above.

 

(4) Contingencies and Commitments

 

(a) Contingencies

The Company is subject to legal proceedings, claims and investigations arising in the ordinary course of business. While the outcome of these matters is currently not determinable, the Company does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its condensed consolidated financial position, results of operations or cash flows.

The Company is party to routine contracts under which it indemnifies third parties for various risks. The Company has not accrued any liability for these indemnities, as the amounts are neither determinable nor estimable.

In its aircraft related agreements, as is typical of commercial arrangements made in order to purchase, finance and operate commercial aircraft, the Company indemnifies the manufacturer, the financing parties 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. The Company believes that it will be covered by insurance subject to deductibles for most tort liabilities and related indemnities as described above with respect to the aircraft the Company will operate. Additionally, if there is a change in the law that 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, the Company will pay the lender the additional amount necessary to compensate the lender for the actual cost increase. The Company cannot estimate the potential amount of future payments under the foregoing indemnities.

 

(b) Commitments

Pre-Delivery Payments and Financing for Flight Equipment

In December 2010, the Company entered into a purchase agreement with Airbus for 60 A320 aircraft, including 30 A320neo aircraft, the first commercial order for the new eco-efficient engine option. Under the terms of the Company’s aircraft purchase agreement, the Company is committed to making pre-delivery payments at varying dates prior to delivery.

In December 2012, the Company amended its 2010 aircraft purchase agreement with Airbus reducing its order of 60 A320 aircraft to 40 aircraft and deferring delivery dates to begin in 2015. Under the amended agreement, the Company also obtained cancellation rights for the last 30 of the 40 aircraft, which cancellation rights are exercisable in groups of five aircraft two years prior to the stated delivery periods in 2020 to 2022, subject to loss of deposits and credits as a cancellation fee. All of the deposits have been reapplied according to the new delivery schedule except for $11.0 million which was converted into a credit earned upon delivery of the last 10 of the 40 aircraft. The Company has evaluated the recoverability of the deposits, credits and related capitalized interest in connection with the anticipated purchase of aircraft in future periods and determined them to be recoverable. If the Company ultimately exercises its cancellation rights for up to 30 aircraft, it would incur a loss of deposits and credits of up to $26.0 million held by Airbus as a cancellation fee, but would not be required to pay any additional funds. Because the Company concluded that the deposits and credits are recoverable and that it is not likely to incur cancellation fees, the Company did not record such fees. The Company maintains $117.5 million of pre-delivery payments, of which $91.5 million relates to the first 10 and $26.0 million to the last 30 aircraft, in its accompanying condensed consolidated balance sheets as of June 30, 2015, $68.7 million of which was financed by a third party and all of which is payable in 2015 and 2016.

 

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Committed expenditures not subject to cancellation rights for these aircraft and separately sourced spare engines, including estimated amounts for contractual price escalations and pre-delivery payment deposits, will total approximately $213.9 million in the remainder of 2015 and $209.6 million in 2016. The Company believes that its cash resources and commercially available aircraft financing will be sufficient to satisfy these purchase commitments. In April 2015, the Company executed debt facility agreements to finance the Company’s 2015 aircraft deliveries for $195.0 million with three financing parties. These financings will represent approximately 80% of the net purchase price of the five A320 CEO aircraft. Each of the loans will be closed and funded on the date of each aircraft delivery from July through December 2015. The Company will finance an aggregate of $168.6 million through the senior debt facilities, subject to 12-year repayment terms, and $26.4 million through the subordinated debt facility, subject to six-year repayment terms. All of the debt will accrue interest which, if fixed at the applicable LIBOR swap rate for the weighted average life of the loan, would average approximately 5.0%. As of June 30, 2015, senior debt in the amount of $102.6 million has been fixed under these agreements at an aggregate interest rate of 4.77% and is not subject to further changes in interest rates. Principal and interest will be payable quarterly in arrears. Loans related to two of the aircraft are pre-payable with a premium prior to the third anniversary of such advance date and at par thereafter, subject to payment of early termination charges, if applicable. Loans related to three of the aircraft are not pre-payable prior to the third anniversary of the issuance date and are pre-payable at par thereafter, subject to payment of early termination charges, if applicable. The debt facility agreements have no financial covenants. The Company entered into interest rate swaps on the underlying base indexed interest rates for $33 million notional of aircraft financing with a 12-year term at 2.36% and for $6 million of the subordinated aircraft financing at 1.70% with a six-year term. See Note 3, Financial Derivative Instruments and Risk Management for more information.

In July 2015, the Company took delivery of the first of five aircraft scheduled to be delivered in 2015.

Letter of Credit Facility

In connection with the 2014 Recapitalization, the Virgin Group arranged for a $100.0 million Letter of Credit Facility issued on behalf of the Company to certain companies that process substantially all of the Company’s credit card transactions. The Letter of Credit Facility would have only become an obligation of the Company if one or both of its credit card processors had drawn on the Letter of Credit Facility. The Letter of Credit Facility was canceled in June 2015 upon the elimination of the credit card holdback requirement by the Company’s primary credit card processors.

The note purchase agreement for the Post-IPO Note provides that the term of the Post-IPO Note will reduce from eight to six years in the event that the Letter of Credit Facility is terminated within the first six years of issuance. As a result of the cancellation of the Letter of Credit Facility, the Post-IPO Note and the related accrued interest will become payable in November 2020.

Summary of Future Payment Obligations

As of June 30, 2015, the Company has the following contractual payment commitments (in thousands):

 

Year

   Long-term debt
including related-
party (1)
     Aircraft and
engine
purchases (2)
     Aircraft and
engine leases (3)
     Maintenance
deposits (4)
     Other leases (5)      Total  

2015

   $ 33,824       $ 213,918       $ 112,277       $ 5,645       $ 13,373       $ 379,037   

2016

     34,832         209,583         217,457         8,968         26,547         497,387   

2017

     —           —           204,303         9,367         26,712         240,382   

2018

     40,000         —           188,903         10,186         23,541         262,630   

2019

     51,534         —           172,562         10,814         16,888         251,798   

Thereafter

     —           —           487,888         36,900         34,265         559,053   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 160,190       $ 423,501       $ 1,383,390       $ 81,880       $ 141,326       $ 2,190,287   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
(1) Includes accrued interest; excludes future interest of $15.5 million to be accrued through and payable in November 2020 on the Post-IPO Note.
(2) Represents non-cancelable contractual payment commitments for aircraft and engines; includes $195.0 million of aircraft financing obtained for 2015 deliveries.
(3) Represents future minimum lease payments under non-cancelable operating leases with initial terms in excess of one year, including renewal payments for signed lease extensions and excluding lease rebates.
(4) Represents the fixed portion of supplemental rent under lessor contracts for maintenance reserve payment commitments; excludes variable future amounts that will be based on actual flight hours.
(5) Represents future minimum lease payments under non-cancelable building, airport station and equipment leases.

The table above excludes the Company’s commitment to pay royalties in 2015 of 0.5% of the Company’s operating revenue for the use of the Company’s brand name to a related party. This license fee will increase to 0.7% starting in the first quarter of 2016 until the Company’s total annual revenue exceeds $4.5 billion, at which time the annual license fee would resume to 0.5%. For additional information, see the consolidated financial statements included in the 2014 Form 10-K.

 

(5) Income Taxes

The Company’s effective tax rates are lower than the federal statutory rate of 35% primarily because of the impact of changes to existing valuation allowances. The Company continues to provide a valuation allowance for its deferred tax assets in excess of deferred tax liabilities because the Company concluded that it is more likely than not that such deferred tax assets will ultimately not be realized.

 

(6) Related-Party Transactions

The Company licenses the use of its brand name from certain entities affiliated with Virgin Enterprises Limited, a company incorporated in England and Wales (“VEL”). VEL is an affiliate of one of the Company’s largest stockholders, the Virgin Group, which has one designee on the Company’s board of directors. The Company paid license fees of $2.0 million during each of the three months ended June 30, 2015 and 2014 and $3.7 million and $3.6 million for the six months ended June 30, 2015 and 2014. The Company had accrued unpaid royalty fees of $2.0 million and $1.8 million at June 30, 2015 and December 31, 2014.

As of June 30, 2015 the Virgin Group, through its affiliates including VX Holdings L.P., owned approximately 18.9% of the Company’s issued and outstanding voting stock and all of the outstanding related-party debt. In order to comply with requirements under U.S. law governing the ownership and control of U.S. airlines, at least 75% of the voting stock of the Company must be held by U.S. citizens and at least two-thirds of the Company’s board of directors must be U.S. citizens. U.S. citizen investors owned over 75% of the voting stock of the Company, of which Cyrus Aviation Holdings, LLC, the largest single U.S. investor, owned approximately 28.8% as of June 30, 2015.

As of June 30, 2015, 27.1% of the Company’s $149.1 million debt was held by related-party investors. In connection with the 2014 Recapitalization, the Company reduced related-party debt with a carrying value of $728.3 million to $38.5 million. The Company incurred $0.8 million and $9.6 million of related-party interest expense for the three months ended June 30, 2015 and 2014 and $1.6 million and $18.9 million for the six months ended June 30, 2015 and 2014. Commencing in November 2014, the Company began to incur an annual commitment fee on the $100.0 million Letter of Credit Facility issued by the Virgin Group. The fee was equal to 5.0% per annum of the daily maximum amount available to be drawn, accruing on a daily basis from the date of issuance and was payable quarterly. For the three and six months ended June 30, 2015, the Company recorded $1.1 million and $2.5 million in commitment fees in the accompanying condensed consolidated statements of operations. In June 2015, the Company canceled the Letter of Credit Facility in conjunction with the elimination of the credit card holdback requirement and is no longer incurring related commitment fees. The Post-IPO Note provided for a reduction of the term of the Note from eight to six years in the event of early termination of the Letter of Credit Facility. In connection with the cancellation of the Letter of Credit Facility in June 2015, and as required by the related note purchase agreement, the term of the Post-IPO Note issued to Virgin Group was reduced from eight to six years.

 

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Table of Contents
(7) Net Income Per Share

Employee equity share options and unvested shares granted by the Company are treated as potential common shares outstanding in computing diluted earnings per share. Diluted shares outstanding include the dilutive effect of of in-the-money options, unvested restricted stock units, and shares to be issued under the Company’s ESPP. The dilutive effect of such equity awards is calculated based on the average share price for each fiscal period using the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized and the amount of tax benefits that would be recorded in additional paid-in capital when the award becomes deductible are collectively assumed to be used to repurchase shares.

Basic and diluted net income per share were computed using the two-class method for periods prior to the completion of the IPO, which is an allocation method that determines net income per share for common stock and participating securities.

The following table sets forth the computation of the Company’s basic and diluted net income per share attributable to common stock for the periods presented (in thousands, except per share data):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2015      2014     2015      2014  
     (unaudited)      (unaudited)     (unaudited)      (unaudited)  

BASIC:

          

Net income

   $ 64,989       $ 36,983        77,775       $ 14,629   

Less: net income allocated to participating securities

     —           (22,658     —           (8,962
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income attributable to common shareholders

   $ 64,989       $ 14,325      $ 77,775       $ 5,667   
  

 

 

    

 

 

   

 

 

    

 

 

 

Weighted-average common shares outstanding

     43,298         702        43,239         702   
  

 

 

    

 

 

   

 

 

    

 

 

 

Basic net income per share

   $ 1.50       $ 20.42      $ 1.80       $ 8.08   
  

 

 

    

 

 

   

 

 

    

 

 

 

DILUTED:

          

Net income

   $ 64,989       $ 36,983      $ 77,775       $ 14,629   

Less: net income allocated to participating securities

     —           (13,230     —           (5,233
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income attributable to common shareholders

   $ 64,989       $ 23,753      $ 77,775       $ 9,396   
  

 

 

    

 

 

   

 

 

    

 

 

 

Weighted-average common shares outstanding-basic

     43,298         702        43,239         702   

Effect of dilutive potential common shares

     785         1,290        1,299         1,290   
          

Weighted-average common shares outstanding-diluted

     44,083         1,992        44,538         1,992   
  

 

 

    

 

 

   

 

 

    

 

 

 

Diluted net income per share

   $ 1.47       $ 11.92      $ 1.75       $ 4.72   
  

 

 

    

 

 

   

 

 

    

 

 

 

The following warrants and director and employee stock awards were excluded from the calculation of diluted net earnings per share attributable to common stockholders because their effect would have been anti-dilutive for the periods presented (share data, in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2015      2014      2015      2014  
     (unaudited)      (unaudited)      (unaudited)      (unaudited)  

Warrants to purchase common stock

     —           42,243         —           42,243   

Stock option awards

     22         —           18         —     

 

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Table of Contents
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This report contains various “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. When used in this report, the words “expect,” “estimate,” “plan,” “anticipate,” “indicate,” “believe,” “forecast,” “guidance,” “outlook,” “may,” “will,” “would,” “should,” “seek,” “target” and similar expressions are intended to identify forward-looking statements. Forward-looking statements represent our expectations and beliefs concerning future events, based on information available to us on the date of the filing of this report, and are subject to various risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results and will not necessarily be accurate indications of the times at which or by which such performance or results will be achieved. Factors that could cause actual results to differ materially from those referenced in the forward-looking statements include those listed in Part I, Item 1A, “Risk Factors” and in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report. We disclaim any intent or obligation to update or revise any of the forward-looking statements, whether in response to new information, unforeseen events, changed circumstances or otherwise, except as required by applicable law.

Overview

Virgin America is a premium-branded, low-cost airline based in California that provides scheduled air travel in the continental United States and Mexico. We operate primarily from our focus cities of Los Angeles and San Francisco, with a smaller presence at Dallas Love Field, to other major business and leisure destinations in North America. We provide a distinctive offering for our passengers, whom we call guests, that is centered around our brand and our premium travel experience, while at the same time maintaining a low-cost structure through our point-to-point network and high utilization of our efficient A320 fleet. As of June 30, 2015, we provided service to 21 airports in the United States and Mexico with a fleet of 53 narrow-body aircraft.

Second Quarter 2015 Highlights

Our pre-tax income for the second quarter of 2015 was $65.4 million, an increase of $28.1 million as compared to the second quarter of 2014. Several factors contributed to our significant improvement in earnings:

 

    Operating Revenue: Total revenue increased $2.0 million, or 0.5%, from an increase in revenue per available seat mile (RASM) of 0.6%, on a slight decrease in capacity. Our passenger revenue per available seat mile (PRASM) was positively impacted by a $3.2 million adjustment related to Elevate loyalty revenue which increased PRASM by 0.9%. The majority of our markets within our network showed improved revenue performance in the second quarter of 2015 as compared to the second quarter of 2014. Our transcontinental flights from New York to Los Angeles and to San Francisco experienced high demand with lower average fares as a result of the introduction of additional capacity into the market by competitors, resulting in a year-over-year PRASM reduction in these markets. Our operations at Dallas Love Field (“DAL”), which began in the third quarter of 2014, are still developing. The markets we serve from DAL are experiencing large increases in capacity by us and other airlines, growing levels of traffic and low average fares. These routes produce PRASM well below our average PRASM but are showing signs of improvement as the markets mature.

 

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    Operating Cost: Our total operating expenses declined $18.5 million, or 5.3%, primarily from sharply lower fuel costs. Our average cost per gallon of jet fuel declined 29.9% from the second quarter of 2014, resulting in a decrease in aircraft fuel expense of $37.9 million. In addition, our aircraft maintenance expense declined $3.8 million due to decreased scheduled heavy airframe maintenance checks. Salaries, wages and benefits expense increased $15.4 million from the second quarter of 2014, primarily from an increase in accrued profit-sharing and profit-sharing-related payroll taxes of $4.0 million, increases in equity related compensation of $1.3 million and increases for teammate compensation, 401K contributions and benefits related to our 2015 compensation and benefits initiatives implemented earlier in 2015. We expect salaries, wages and benefits to increase throughout 2015 compared to 2014 as we align compensation across most work groups with industry average pay rates. However, we expect the salaries, wages and benefits rate increases that we are experiencing in 2015 will moderate in 2016 and beyond and be more aligned with long-term domestic inflation trends.

 

    Net Other Expense: Our net interest and other expense decreased $7.6 million as a result of the decrease in related-party debt from the restructuring of our balance sheet in connection with our initial public offering in November 2014.

We operated a total fleet of 53 aircraft in both the second quarters of 2015 and 2014. Our capacity remained consistent year-over-year.

In July 2015, subsequent to second quarter end, we took delivery of the first of five A320 aircraft scheduled to be delivered in the second half of 2015. We also are scheduled to take delivery of five A320 aircraft in the first half of 2016. We expect to add new markets from this expansion as well as increase frequency in some of our existing markets. We currently expect to purchase these aircraft and finance the majority of the purchase price with long-term debt obtained from commercial banks. The operating lease on one of existing 53 aircraft is scheduled to terminate in the first quarter of 2016. We are in discussions with this lessor and expect to extend this operating lease.

In connection with our aircraft deliveries, in April 2015, we announced service from San Francisco to Honolulu and Maui, to begin in the fourth quarter of 2015. Hawaii markets from the west coast have many of the characteristics of markets where we have historically been successful, including very high demand with a large number of flights already operated by multiple competitors, average fares similar to those of long-haul markets where we currently have profitable operations and higher than those of other leisure markets in our network and a high level of origin passengers in California, where we have an established presence.

Results of Operations

Three Months Ended June 30, 2015 Compared to Three Months Ended June 30, 2014

For the three months ended June 30, 2015, our net income was $65.0 million, an increase of $28.0 million as compared to $37.0 million for the same period in 2014. Our operating income of $67.7 million for the three months ended June 30, 2015 increased by $20.5 million from the prior year period. Our operating margin increased by 5.1 points to 16.9% in the three months ended June 30, 2015 as compared to 11.8% for the three months ended June 30, 2014.

Our operating capacity, as measured by available seat miles (ASMs), remained relatively consistent for the three months ended June 30, 2015 as compared to the same period in 2014. Our number of passengers increased by 4.4% in the three months ended June 30, 2015 year-over-year due to reduction in stage length from changes in our route network, and our yield increased by 0.3%.

Our cost per available seat mile (CASM) decreased by 5.3% to 10.41 cents for the three months ended June 30, 2015 as compared to 10.99 cents for the same period in 2014. This was primarily a result of lower fuel costs, partially offset by increased salaries, wages and benefits.

In addition, interest expense for the three months ended June 30, 2015 decreased by $8.1 million from the prior year period, primarily as a result of a recapitalization agreement (our 2014 Recapitalization) with security holders to exchange or extinguish the majority of our then outstanding related-party debt and accrued interest.

 

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Operating Revenues

 

     Three Months Ended June 30,     Change  
     2015     2014     Amount     %  

Operating revenues (in thousands):

        

Passenger

   $ 359,709      $ 358,108      $ 1,601        0.4   

Other

     41,177        40,737        440        1.1   
  

 

 

   

 

 

   

 

 

   

Total operating revenues

   $ 400,886      $ 398,845      $ 2,041        0.5   
  

 

 

   

 

 

   

 

 

   

Operating statistics:

        

Available seat miles (millions)

     3,200        3,202        (2     (0.1

Revenue passenger miles (millions)

     2,722        2,719        3        0.1   

Average stage length (statute miles)

     1,421        1,482        (61     (4.1

Load factor

     85.1     84.9     0.2        pts   

Total passenger revenue per available seat mile—PRASM (cents)

     11.24        11.18        0.06        0.5   

Total revenue per available seat mile—RASM (cents)

     12.53        12.46        0.07        0.6   

Yield (cents)

     13.21        13.17        0.04        0.3   

Average fare

   $ 199.30      $ 207.09      $ (7.79     (3.8

Passengers (thousands)

     1,805        1,729        76        4.4   

Passenger revenue for the three months ended June 30, 2015 increased 0.4% from the three months ended June 30, 2014 on flat capacity as measured by our ASMs. Second quarter 2015 PRASM increased 0.5% year-over-year. PRASM was positively impacted by a $3.2 million adjustment related to Elevate loyalty revenue which increased PRASM by 0.9%. Total RASM for the three months ended June 30, 2015 increased 0.6% from the three months ended June 30, 2014, primarily from the increase in PRASM and 1.1% increase in other revenue.

Other revenue for the three months ended June 30, 2015 increased 1.1% from the three months ended June 30, 2014 primarily due to higher ancillary fee revenue from reserved seat assignments and priority boarding in our main cabin.

 

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Operating Expenses

 

     Three Months Ended
June 30,
     Change     Cost per ASM      Change  
     2015      2014      Amount     %     2015      2014      %  
                               (in cents)  

Operating expenses (in thousands):

                  

Aircraft fuel

   $ 93,743       $ 131,664       $ (37,921     (28.8     2.93         4.12         (28.9

Salaries, wages and benefits

     74,758         59,318         15,440        26.0        2.34         1.85         26.5   

Aircraft rent

     45,708         45,861         (153     (0.3     1.43         1.43         —     

Landing fees and other rents

     34,071         33,286         785        2.4        1.06         1.03         2.9   

Sales and marketing

     30,704         28,615         2,089        7.3        0.96         0.89         7.9   

Aircraft maintenance

     12,656         16,409         (3,753     (22.9     0.40         0.52         (23.1

Depreciation and amortization

     4,225         3,484         741        21.3        0.13         0.11         18.2   

Other operating expenses

     37,363         33,082         4,281        12.9        1.16         1.04         11.5   
  

 

 

    

 

 

    

 

 

     

 

 

    

 

 

    

Total operating expenses

   $ 333,228       $ 351,719       $ (18,491     (5.3     10.41         10.99         (5.3
  

 

 

    

 

 

    

 

 

     

 

 

    

 

 

    

Operating statistics:

                  

Available seat miles (millions)

     3,200         3,202         (2     (0.1        

Average stage length (statute miles)

     1,421         1,482         (61     (4.1        

Departures

     15,722         15,137         585        3.9           

CASM (excluding fuel)

     7.48         6.87         0.61        8.9           

CASM (excluding fuel and profit sharing)

     7.27         6.79         0.48        7.1           

Fuel cost per gallon

   $ 2.18       $ 3.11         (0.93     (29.9        

Fuel gallons consumed (thousands)

     42,915         42,281         634        1.5           

Teammates (FTE)

     2,565         2,500         65        2.6           

Aircraft fuel

Aircraft fuel expense for the three months ended June 30, 2015, which includes the effect of our fuel hedges, decreased by $37.9 million, or 28.8%, from the three months ended June 30, 2014. The decrease was primarily due to a decrease of $0.93, or 29.9%, in the average fuel cost per gallon offset in part by a 1.5% increase in fuel consumption, and $8.4 million of net fuel hedge losses.

We maintain an active hedging program to reduce the impact of sudden, sharp increases in fuel prices. We enter into a variety of hedging instruments, such as forward swaps, options and collar contracts on jet fuel and highly correlated commodities such as heating oil and crude oil. We also use fixed forward pricing agreements, or FFPs, which allow us to lock in the price of jet fuel for specified quantities and at specified locations in future periods. At June 30, 2015, we had entered into derivative hedging instruments and FFPs for approximately 46% of our then-expected nine-month fuel requirements, with all of our then existing hedge contracts expected to settle by the end of the first quarter of 2016. Due in part to the impact of declining fuel prices, we recorded $8.4 million in fuel hedge net losses in the three months ended June 30, 2015, which include the effect of $0.6 million offsetting unrealized gains associated with undesignated fuel hedges that will mature after June 30, 2015.

Salaries, wages and benefits

Salaries, wages and benefits expense for the three months ended June 30, 2015 increased by $15.4 million, or 26.0%, from the three months ended June 30, 2014. Salaries and wages for flight crews increased significantly as a result of our 2015 pay initiatives that were implemented earlier in 2015 due to the competitive marketplace for talent and the increasing average seniority of our teammates. In addition, profit sharing and related payroll tax expense for the three months ended June 30, 2015 increased by $4.0 million year-over-year. Under our annual profit sharing program, we accrued a pro rata portion of our expected total annual 2015 profit sharing amount during the quarter , which is based on current internal projections of 2015 pre-tax income. Our profit sharing plan provides for profit sharing on pre-tax income above a threshold based on $1.5 million times the weighted average number of aircraft in our fleet. For the full year 2015, we estimate the threshold to be approximately $81.0 million.

 

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Our overall benefit plan costs for the three months ended June 30, 2015 increased from the prior year period due to an increase in the amount of the 401(k) match benefits paid to our teammates and an increase in healthcare costs.

We expect salaries, wages and benefit expense in 2015 to grow at a faster rate than our capacity as market and tenure-related adjustments continue. In 2015, we implemented a new employee stock purchase program under which employees may purchase our stock at a 10% discount of the market value at the end of each offering period. Also, a new discretionary 401(k) company contribution called “401(k) Plus” went into effect, under which we make additional 401(k) contributions of 4.5% of salary for pilots and 1.5% for all other teammates, subject to approval by our Board of Directors annually.

Additionally, in 2015 we began incurring costs associated with hiring and training new teammates in connection with our new aircraft deliveries.

Aircraft rent

Aircraft rent expense remained relatively constant for the three months ended June 30, 2015 from the three months ended June 30, 2014.

Landing fees and other rents

Landing fees and other rents expense for the three months ended June 30, 2015 increased by $0.8 million, or 2.4%, from the three months ended June 30, 2014, primarily as a result of rate increases for facilities at our destination airports.

Sales and marketing

Sales and marketing expense for the three months ended June 30, 2015 increased $2.1 million, or 7.3%, from the three months ended June 30, 2014, in part due to higher spending on advertising associated with new markets and higher distribution costs.

Aircraft maintenance

Aircraft maintenance expense for the three months ended June 30, 2015 decreased by $3.8 million, or 22.9% from the three months ended June 30, 2014. There were no significant heavy airframe maintenance events scheduled for the second quarter of 2015 while multiple maintenance events were completed in the same period in 2014. We expect to incur additional maintenance costs during the third quarter related to an engine maintenance overhaul.

Depreciation and amortization

Depreciation and amortization expense increased by $0.7 million, or 21.3%, for the three months ended June 30, 2015 as compared to the three months ended June 30, 2014, primarily due to depreciation of additional aircraft leasehold improvements and amortization of our new software licenses.

Other operating expenses

Other operating expense increased by $4.3 million, or 12.9%, for the three months ended June 30, 2015 as compared to the three months ended June 30, 2014, primarily from increased legal and professional fees related to becoming a public company, higher catering costs and increased crew and teammate travel costs.

Other Income (Expense)

Other income (expense) for the three months ended June 30, 2015 decreased by $7.6 million, or 76.7%, from the three months ended June 30, 2014, primarily due to the $8.7 million reduction in related-party interest expense as a result of the 2014 Recapitalization. In November 2014 in connection with the 2014 Recapitalization, we reduced our remaining related-party debt and accrued interest to a recorded value of $38.5 million with an effective interest rate of 8.5%. See our consolidated financial statements included in our 2014 Form 10-K for further details and a discussion of the accounting for these transactions. The effective interest rate increased to 9.8% in June 2015 as a result of the change in the term of the Post-IPO Note in connection with the cancellation of the Letter of Credit Facility described in Note 1 - Basis of Presentation.

 

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Income Taxes

The income tax provision associated with our income in 2015 was largely offset by the release of a valuation allowance against net deferred tax assets. For the three months ended June 30, 2015, we recorded tax expense of $0.4 million resulting from the difference between the book and tax basis of indefinite-lived intangible assets that are not available to cover net deferred tax assets subject to a valuation allowance.

Six Months Ended June 30, 2015 Compared to Six Months Ended June 30, 2014

For the six months ended June 30, 2015, our net income was $77.8 million. This was an increase of $63.2 million as compared to $14.6 million for the same period in 2014. Our operating income of $83.0 million for the six months ended June 30, 2015 increased by $49.0 million compared to the six months ended June 30, 2014. Our operating margin increased by 6.6 points to 11.4% in the six months ended June 30, 2015 as compared to 4.8% in the six months ended June 30, 2014.

Our operating capacity, as measured by ASMs, increased by 0.7% for the six months ended June 30, 2015 from the same period in 2014. Our number of passengers increased by 3.7% in the six months ended June 30, 2015 year-over-year, and our yield increased by 0.8%.

Our CASM decreased by 5.6% to 10.70 cents for the six months ended June 30, 2015 as compared to 11.34 cents for the same period in 2014. This was primarily a result of lower fuel costs, partially offset by increased salaries, wages and benefits.

In addition, interest expense for the six months ended June 30, 2015 decreased by $16.0 million from the prior year period, primarily as a result of our 2014 Recapitalization.

Operating Revenues

 

     Six Months Ended
June 30, 2015
    Change  
     2015     2014     Amount     %  

Operating revenues (in thousands):

        

Passenger

   $ 649,073      $ 636,148      $ 12,925        2.0   

Other

     78,165        76,087        2,078        2.7   
  

 

 

   

 

 

   

 

 

   

Total operating revenues

   $ 727,238      $ 712,235      $ 15,003        2.1   
  

 

 

   

 

 

   

 

 

   

Operating statistics:

        

Available seat miles (millions)

     6,019        5,979        40        0.7   

Revenue passenger miles (millions)

     4,979        4,917        62        1.3   

Average stage length (statute miles)

     1,423        1,445        (22     (1.5

Load factor

     82.7     82.2     0.5        pts   

Total passenger revenue per available seat mile—PRASM (cents)

     10.78        10.64        0.14        1.3   

Total revenue per available seat mile—RASM (cents)

     12.08        11.91        0.17        1.4   

Yield per passenger mile (cents)

     13.04        12.94        0.1        0.8   

Average fare

   $ 195.06      $ 198.27      $ (3.21     (1.6

Passengers (thousands)

     3,328        3,208        120        3.7   

 

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Passenger revenue for the six months ended June 30, 2015 increased 2.0% from the six months ended June 30, 2014 on a 0.7% increase in capacity as measured by our ASMs. PRASM increased 1.3% year-over-year due to a 0.8% increase in passenger yield and a 0.5 point increase in load factor and was positively affected by a $2.8 million adjustment related to Elevate loyalty revenue which increased PRASM by 0.5%. Total RASM for the six months ended June 30, 2015 increased 1.4% from the six months ended June 30, 2014, primarily from the increase in PRASM and 2.7% increase in other revenue.

Other revenue for the six months ended June 30, 2015 increased 2.7% from the six months ended June 30, 2014 primarily due to increased advertising and brand revenues on our co-branded consumer credit card program and higher ancillary fee revenue from reserved seat assignments and priority boarding in our main cabin, partially offset by no charter revenue as compared to prior year.

Operating Expenses

 

     Six Months Ended
June 30, 2015
     Change     Cost per ASM      Change  
     2015      2014      Amount     %     2015      2014      %  
                               (in cents)         

Operating expenses (in thousands):

                  

Aircraft fuel

   $ 182,301       $ 247,423       $ (65,122     (26.3     3.03         4.13         (26.6

Salaries, wages and benefits

     139,490         113,143         26,347        23.3        2.32         1.89         22.8   

Aircraft rent

     90,690         92,357         (1,667     (1.8     1.51         1.54         (1.9

Landing fees and other rents

     68,054         65,507         2,547        3.9        1.13         1.10         2.7   

Sales and marketing

     57,083         53,177         3,906        7.3        0.95         0.89         6.7   

Aircraft maintenance

     26,489         35,453         (8,964     (25.3     0.44         0.59         (25.4

Depreciation and amortization

     8,328         6,753         1,575        23.3        0.14         0.11         27.3   

Other operating expenses

     71,762         64,427         7,335        11.4        1.18         1.09         8.3   
  

 

 

    

 

 

    

 

 

     

 

 

    

 

 

    

Total operating expenses

   $ 644,197       $ 678,240       $ (34,043     (5.0     10.70         11.34         (5.6
  

 

 

    

 

 

    

 

 

     

 

 

    

 

 

    

Operating statistics:

                  

Available seat miles (millions)

     6,019         5,979         40        0.7           

Average stage length (statute miles)

     1,423         1,445         (22     (1.5        

Departures

     29,550         28,962         588        2.0           

CASM (excluding fuel)

     7.67         7.21         0.46        6.4           

CASM (excluding fuel and profit sharing)

     7.53         7.16         0.37        5.2           

Fuel cost per gallon

   $ 2.28       $ 3.14         (0.86     (27.4        

Fuel gallons consumed (thousands)

     79,941         78,828         1,113        1.4           

Teammates (FTE)

     2,565         2,500         65        2.6           

Aircraft fuel

Aircraft fuel expense for the six months ended June 30, 2015, which includes the effect of our fuel hedges, decreased by $65.1 million, or 26.3%, from the six months ended June 30, 2014. The decrease was primarily due to a decrease of $0.86, or 27.4%, in the average fuel cost per gallon offset in part by a 1.4% increase in fuel consumption, and $24.1 million of net fuel hedge losses.

Salaries, wages and benefits

Salaries, wages and benefits expense for the six months ended June 30, 2015 increased by $26.3 million, or 23.3%, from the six months ended June 30, 2014. Salaries and wages for flight crews increased significantly as a result of our 2015 pay and benefits initiatives implemented due to the competitive marketplace for talent and from the increasing average seniority of our teammates. Salaries, wages and benefits expense for the six months ended June 30, 2015 also included an increase of $6.1 million in profit sharing expense and related payroll tax expense. Under our annual profit sharing program, we accrued a pro rata portion of our estimated 2015 total profit sharing expense, which is based on current internal projections of 2015 pre-tax income. Our profit sharing plan provides for profit sharing on pre-tax income above a threshold which is based on $1.5 million times the weighted average number of aircraft in our fleet. For the full year 2015, we estimate the threshold to be approximately $81.0 million.

 

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Our overall benefit plan costs for the six months ended June 30, 2015 increased from the prior year period due to an increase in the amount of the 401(k) match benefits paid to our teammates and an increase in healthcare costs.

Aircraft rent

Aircraft rent expense remained relatively constant for the six months ended June 30, 2015 from the six months ended June 30, 2014.

Landing fees and other rents

Landing fees and other rent expense for the six months ended June 30, 2015 increased by $2.5 million, or 3.9%, from the six months ended June 30, 2014, primarily as a result of rate increases for facilities at our destination airports.

Sales and marketing

Sales and marketing expense for the six months ended June 30, 2015 increased $3.9 million, or 7.3%, from the six months ended June 30, 2014, in part due to higher spending on advertising associated with new markets and higher distribution costs.

Aircraft maintenance

Aircraft maintenance expense for the six months ended June 30, 2015 decreased by $9.0 million, or 25.3% from the six months ended June 30, 2014. There were no significant heavy airframe maintenance events scheduled for the six months ended June 30, 2015 while multiple maintenance events were completed in the same period in 2014.

Depreciation and amortization

Depreciation and amortization expense increased by $1.6 million, or 23.3%, for the six months ended June 30, 2015 as compared to the six months ended June 30, 2014, primarily due to depreciation of our new software licenses and additional aircraft leasehold improvements.

Other operating expenses

Other operating expense increased by $7.3 million, or 11.4%, for the six months ended June 30, 2015 as compared to the six months ended June 30, 2014, primarily related to higher legal and professional fees primarily associated with becoming a public company and higher guest services and supplies and teammate travel costs.

Other Income (Expense)

Other income (expense) for the six months ended June 30, 2015 decreased by $14.5 million, or 76.0%, from the six months ended June 30, 2014, primarily due to the $17.3 million reduction in related-party interest expense as a result of the 2014 Recapitalization. In November 2014, in connection with the 2014 Recapitalization, we reduced our remaining related-party debt and accrued interest to a recorded value of $38.5 million with an effective interest rate of 8.5%.

Income Taxes

The income tax provision associated with our income in 2015 was largely offset by the release of a valuation allowance against net deferred tax assets. For the six months ended June 30, 2015, we recorded tax expense of $0.7 million resulting from the difference between the book and tax basis of indefinite-lived intangible assets that are not available to cover net deferred tax assets subject to a valuation allowance.

 

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The following table sets forth our operating statistics for the three months and six months ended June 30, 2015 and 2014:

 

     Three Months
Ended June 30,
    Six Months Ended
June 30,
 
     2015     2014     %
Change
     2015     2014     %
Change
 

Operating Statistics (unaudited):

                 

Available seat miles—ASMs (millions)

     3,200        3,202        (0.1        6,019        5,979        0.7     

Departures

     15,722        15,137        3.9           29,550        28,962        2.0     

Average stage length (statute miles)

     1,421        1,482        (4.1        1,423        1,445        (1.5  

Aircraft in service—end of period

     53        53        —             53        53        —       

Fleet utilization

     11.2        11.3        (0.9        10.7        10.7        —       

Passengers (thousands)

     1,805        1,729        4.4           3,328        3,208        3.7     

Average fare

   $ 199.30      $ 207.09        (3.8      $ 195.06      $ 198.27        (1.6  

Yield per passenger mile (cents)

     13.21        13.17        0.3           13.04        12.94        0.8     

Revenue passenger miles—RPMs (millions)

     2,722        2,719        0.1           4,979        4,917        1.3     

Load factor

     85.1     84.9     0.2        pts         82.7     82.2     0.5        pts   

Passenger revenue per available seat mile—PRASM (cents)

     11.24        11.18        0.5           10.78        10.64        1.3     

Total revenue per available seat mile—RASM (cents)

     12.53        12.46        0.6           12.08        11.91        1.4     

Cost per available seat mile—CASM (cents)

     10.41        10.99        (5.3        10.70        11.34        (5.6  

CASM, excluding fuel (cents) (1)

     7.48        6.87        8.9           7.67        7.21        6.4     

CASM, excluding fuel and profit sharing (cents) (1)

     7.27        6.79        7.1           7.53        7.16        5.2     

Fuel cost per gallon

   $ 2.18      $ 3.11        (29.9      $ 2.28      $ 3.14        (27.4  

Fuel gallons consumed (thousands)

     42,915        42,281        1.5           79,941        78,828        1.4     

Teammates (FTE)

     2,565        2,500        2.6           2,565        2,500        2.6     

(1) Refer to our “Reconciliation of GAAP to Non-GAAP Financial Measures” note for more information on these non-GAAP measures.

Liquidity and Capital Resources

As of June 30, 2015, our principal sources of liquidity were cash and cash equivalents of $500.5 million. We also had restricted cash of $19.7 million as of June 30, 2015. Restricted cash primarily represents cash collateral securing our letters of credit for airport facility leases.

As of June 30, 2015, we had $68.7 million of short-term debt and $80.5 million of long-term debt, of which $40.5 million was related-party debt. Included in our long-term debt balance is a five-year term loan credit facility we entered into in April 2014 for $40.0 million to finance airport slot purchases. This loan was funded in two tranches in April and May 2014. Principal is repayable in full at the end of five years. We accrue interest on this loan at a variable rate based on LIBOR and pay quarterly in arrears.

 

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Currently our single largest capital expense is the acquisition cost of our aircraft. We operate 53 of our 54 existing aircraft under operating leases, which required a smaller up-front investment than if we had financed these aircraft with debt. Pre-delivery payments, or PDPs, relating to future deliveries under our agreement with Airbus, are required at various times prior to each aircraft’s delivery date. As of June 30, 2015, we had paid $117.5 million of PDPs to Airbus, $68.7 million of which were financed by a third-party payable upon delivery of aircraft. Subsequent to quarter end, we took delivery of our first of 10 aircraft scheduled to be received in 2015 and 2016. We expect that committed expenditures for the remaining nine future aircraft deliveries between August 2015 and June 2016, including separately sourced spare engines and related aircraft equipment, estimated amounts for contractual price escalations and PDPs, will total approximately $213.9 million in 2015 and $209.6 million in 2016. In April 2015, we entered into long-term debt financing agreements with three financing parties with respect to the first five aircraft deliveries in 2015 for a total of $195.0 million. We expect to finance approximately 80% of the net purchase price of these aircraft through these financing arrangements. We have entered into nonbinding term sheets for similar financing commitments with third-party lenders for the five A320 aircraft to be delivered to us in 2016, and expect to complete these financing agreements during the third quarter of 2015. We do not have financing commitments in place for the remaining 30 Airbus aircraft orders scheduled for delivery between 2020 and 2022. We have the right to cancel the remaining 30 aircraft, and as a result, these are not considered firm commitments. If we ultimately exercise our cancellation rights for up to 30 aircraft, we would incur a loss of deposits and credits of up to $26.0 million previously paid to Airbus as a cancellation fee.

In June 2015, we entered into agreements with our credit card processors to reduce our holdback requirements to 0%, and in connection with this, our $100.0 million Letter of Credit Facility was terminated. The credit card processors have the right to increase the credit card holdback amount depending on our future financial performance. If our credit card processors were to implement a holdback requirement, it would be funded through withholding proceeds from future ticket sales made through credit card transactions.

We expect to meet our obligations as they become due through available cash, internally generated funds from our operating cash flows, supplemented by financing activities as necessary and as they may become available to us, although we cannot assure that adequate financing will be available on acceptable terms, or at all. We cannot predict what the effect on our business and financial position might be from the extremely competitive environment in which we operate or from events beyond our control, such as volatile fuel prices, economic conditions, weather-related disruptions, the impact of airline bankruptcies, restructurings or consolidations, U.S. military actions or acts of terrorism. We believe the working capital available to us will be sufficient to meet our cash requirements for at least the next 12 months.

Cash Flows

The following table presents information regarding our cash flows in the six months ended June 30, 2015 and 2014:

 

     Six Months Ended June 30,  
     2015      2014  

Net cash provided by operating activities

   $ 130,920       $ 25,059   

Net cash used in investing activities

     (22,078      (40,252

Net cash provided by (used in) financing activities

     (3,028      39,514   

Net increase in cash and cash equivalents

     105,814         24,321   

Cash and cash equivalents, end of period

     500,457         179,980   

Net Cash Flow Provided By Operating Activities

During the six months ended June 30, 2015, net cash flow provided by operating activities was $130.9 million. We had net income of $77.8 million adjusted for the following non-cash items: depreciation and amortization of $8.3 million, share-based compensation expense of $2.8 million, $2.8 million of unrealized fuel hedge gains, and paid in-kind interest expense of $1.6 million. Air traffic liability, net of credit card holdbacks, contributed $63.7 million of operating cash flow, primarily due to an annual $33.0 million advance payment from our co-branded credit card partner and due to the elimination of holdback requirements by our credit card processors. We increased our maintenance deposits by $21.5 million, primarily due to our reserve payments for future maintenance events. Other non-current assets increased by $13.9 million primarily due to expensing rent on a straight-line basis at a rate that is lower than our cash payments during the period.

 

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During the six months ended June 30, 2014, net cash flow provided by operating activities was $25.1 million. We had net income of $14.6 million adjusted for the following non-cash items: paid in-kind interest expense of $11.5 million and depreciation and amortization of $6.8 million. We increased our maintenance deposits by $20.1 million, primarily due to our reserve payments for future maintenance events. Air traffic liability, net of credit card holdbacks, contributed $17.3 million of cash flow, primarily due to a $23.0 million additional advance payment from our new co-branded credit card partner in January 2014, offset in part by the timing of credit card settlements. Other non-current assets increased by $14.3 million primarily due to expense exceeding cash payments. Our accounts payable increased by $10.0 million primarily due to the timing of our payments.

Net Cash Flows Used In Investing Activities

During the six months ended June 30, 2015, net cash flow used in investing activities was $22.1 million. We invested $16.3 million in flight equipment and software and made $5.8 million in net pre-delivery payments for our aircraft scheduled to be delivered in 2015 and 2016.

During the six months ended June 30, 2014, net cash flow used in investing activities was $40.3 million. We invested $31.1 million in domestic airport operating rights, flight equipment and software and made $9.2 million in net pre-delivery payments for our aircraft scheduled to be delivered in 2015 and 2016.

Net Cash Flows Provided By (Used In) Financing Activities

Cash flow used in financing was $3.0 million in the six months ended June 30, 2015 primarily as a result of a stock repurchase of $3.7 million to satisfy minimum tax withholding requirements for the vesting of restricted stock.

Cash flow provided by financing activities was $39.5 million in the six months ended June 30, 2014 primarily as a result of our April 2014 credit facility to purchase domestic airport operating rights. We expect to take delivery of five aircraft in the last half of 2015. We plan to fund the purchase of these aircraft through a mix of debt financing and operating cash. We finalized the debt financing arrangements totaling $195.0 million for the 2015 aircraft deliveries in April 2015.

Commitments and Contractual Obligations

The following table presents aggregate information about our contractual payment commitments as of June 30, 2015 and the periods in which payments are due (in thousands):

 

     Total      Less than 1
Year
     1 to 3
Years
     3 to 5
Years
     More than
5 Years
 

Long-term debt including related-party (1)

   $ 160,190       $ 33,824       $ 34,832       $ 91,534       $ —     

Aircraft and engine purchases (2)

     423,501         213,918         209,583         —           —     

Aircraft and engine leases (3)

     1,383,390         112,277         421,760         361,465         487,888   

Maintenance deposits (4)

     81,880         5,645         18,335         21,000         36,900   

Other leases (5)

     141,326         13,373         53,259         40,429         34,265   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,190,287       $ 379,037       $ 737,769       $ 514,428       $ 559,053   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes accrued interest; excludes future interest of $15.5 million to be accrued through and payable in November 2020 on the Post-IPO Note.
(2) Represents non-cancelable contractual payment commitments for aircraft and engines, includes $195.0 million of aircraft financing obtained for 2015 deliveries.
(3) Represents future minimum lease payments under non-cancelable operating leases with initial terms in excess of one year, including renewal payments for signed lease extensions and excluding lease rebates.

 

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(4) Represents the fixed portion of supplemental rent under lessor contracts for maintenance reserve payment commitments; excludes variable future amounts that will be based on actual flight hours.
(5) Represents future minimum lease payments under non-cancelable building, airport station and equipment leases.

The table above does not include our commitment to pay royalties to the Virgin Group pursuant to amended and restated license agreements related to our use of the Virgin name and brand.

Certain of our aircraft operating leases and debt instruments include certain financial covenants and cross-default provisions. As of June 30, 2015, we were in compliance with all covenants under these agreements.

Critical Accounting Estimates

There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Estimates” included in our 2014 Form 10-K.

Reconciliation of GAAP to Non-GAAP Financial Measures

Consolidated operating cost per available seat mile, excluding fuel and profit sharing is a non-GAAP financial measure that we use as a measure of our performance. CASM is a common metric used in the airline industry. We exclude aircraft fuel and profit sharing from operating cost per available seat mile to determine CASM ex-fuel and profit sharing. We believe that CASM excluding fuel and profit sharing provides investors the ability to measure financial performance excluding items beyond our control, such as (i) fuel costs, which are subject to many economic and political factors beyond our control, and (ii) profit sharing, which is sensitive to volatility in earnings. We believe this measure is more indicative of our ability to manage costs and is more comparable to measures reported by other major airlines.

We believe this non-GAAP measure provides a more meaningful comparison of our results to others in the airline industry and our prior year results. Investors should consider this non-GAAP financial measure in addition to, and not as a substitute for, our financial performance measures prepared in accordance with GAAP. Further, our non-GAAP information may be different from the non-GAAP information provided by other companies.

The following table provides the reconciliation of operating expense per ASM excluding fuel and profit sharing for the three months ended June 30, 2015 and 2014:

 

     Three Months Ended June 30,  
     2015      2014  
     $      per ASM      $      per ASM  
     (in thousands)      (in cents)      (in thousands)      (in cents)  

Total operating expenses

   $ 333,228         10.41       $ 351,719         10.99   

Less: Aircraft fuel

     93,743         2.93         131,664         4.12   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating expenses, excluding fuel

     239,485         7.48         220,055         6.87   

Less: Profit sharing and payroll taxes related to profit sharing

     6,743         0.21         2,755         0.08   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating expense, excluding fuel and profit sharing

   $ 232,742         7.27       $ 217,300         6.79   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table provides the reconciliation of operating expense per ASM excluding fuel and profit sharing for the six months ended June 30, 2015 and 2014:

 

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     Six Months Ended June 30,  
     2015      2014  
     $      per ASM      $      per ASM  
     (in thousands)      (in cents)      (in thousands)      (in cents)  

Total operating expenses

   $ 644,197         10.70       $ 678,240         11.34   

Less: Aircraft fuel

     182,301         3.03         247,423         4.13   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating expenses, excluding fuel

     461,896         7.67         430,817         7.21   

Less: 2015 profit sharing and payroll taxes related to 2014 profit sharing

     8,839         0.14         2,740         0.05   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating expense, excluding fuel and profit sharing

   $ 453,057         7.53       $ 428,077         7.16   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are subject to market risks in the ordinary course of our business. These risks include commodity price risk, specifically with respect to aircraft fuel, as well as interest rate risk. The adverse effects of changes in these markets could pose a potential loss as discussed below. The sensitivity analysis provided does not consider the effects that such adverse changes may have on overall economic activity, nor does it consider additional actions we may take to mitigate our exposure to such changes. Actual results may differ.

Aircraft Fuel. Our results of operations can vary materially, due to changes in the price and availability of aircraft fuel and are also impacted by the number of aircraft in use and the number of flights we operate. Aircraft fuel expense for the six months ended June 30, 2015 and 2014 represented approximately 28.3% and 36.5% of our operating expenses, respectively. Increases in aircraft fuel prices or a shortage of supply could have a material adverse effect on our operations and results of operations. Based on June 30, 2015 aircraft fuel market prices and our projected 2015 fuel consumption, a 10% increase in the average price per gallon would increase our current year aircraft fuel expense, including the impact of our outstanding hedged positions, by approximately $10.3 million. To manage economic risks associated with the fluctuations of aircraft fuel prices, we periodically enter into FFPs, forward swaps, call options for crude oil and collar contracts for heating oil. As of June 30, 2015, we had entered into fuel derivative contracts and FFPs that fixed or established a floor on the price associated with 46% of our forecasted aircraft fuel requirements for the next nine months at an approximate cost per gallon of $1.86 (excluding related fuel taxes), which is in excess of current market prices. All of our currently existing fuel hedge contracts are expected to settle by the end of the first quarter of 2016.

The fair value of our fuel derivative contracts as of June 30, 2015 was a net asset of $0.1 million. The fair value of our fuel derivative contracts as of December 31, 2014 was a net liability of $27.1 million offset by margin call deposits of $14.4 million, resulting in an overall net liability of $12.7 million. We measure our fuel derivative instruments at fair value, which is determined using standard option valuation models that use observable market inputs including contractual terms, market prices, yield curves, fuel price curves and measures of volatility. Changes in the related commodity derivative instrument cash flows may change by more or less than the fair value based on further fluctuations in futures prices. Outstanding financial derivative instruments expose us to credit loss in the event of non-performance by the counterparties to the agreements. As of June 30, 2015, we believed the credit exposure related to these fuel forward contracts was minimal and do not expect the counterparties to fail to meet their obligations.

Interest Rates. We are subject to market risk associated with changing interest rates, due to LIBOR-based interest rates on an applicable portion of our aircraft pre-delivery payments loan and airport slot financing. A hypothetical 10% change in LIBOR for the six months ended June 30, 2015 would have had an immaterial effect on total interest expense for the six months ended June 30, 2015.

Our remaining long-term debt consists of a fixed rate note payable. A hypothetical 10% change in market interest rates as of June 30, 2015 would have no effect on our interest expense but would reduce the fair value of our fixed-rate related-party debt instrument by $1.7 million.

 

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of June 30, 2015. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of June 30, 2015, our disclosure controls and procedures were effective at the reasonable assurance level in ensuring that information required to be disclosed in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (the “SEC”) and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

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Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during our fiscal quarter ended June 30, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART 2. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

We are subject to litigation claims and to administrative and regulatory proceedings and reviews that may be asserted or maintained from time to time. We currently believe that the ultimate outcome of such lawsuits, proceedings and reviews will not, individually or in the aggregate, have a material adverse effect on our financial position, liquidity or results of operations.

 

ITEM 1A. RISK FACTORS

Our business involves significant risks, some of which are described below. You should carefully consider these risks, as well as the other information in this report, including our financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The occurrence of any of the events or developments described below, as well as additional risks and uncertainties not presently known to us or that we currently deem immaterial, could materially adversely affect our business, results of operations, financial condition and growth prospects.

Our business has been and in the future may be materially adversely affected by the price and availability of aircraft fuel. High fuel costs and increases in fuel prices or a shortage or disruption in the supply of aircraft fuel would have a material adverse effect on our business.

The price of aircraft fuel may be high or volatile. The cost of aircraft fuel is highly volatile and is our largest individual operating expense, accounting for 39.4%, 37.7% and 35.8% of our operating expenses for 2012, 2013, 2014, respectively. High fuel costs or increases in fuel costs (or in the price of crude oil) could materially adversely affect our business. Since August 2014, the price of jet fuel has fallen substantially, which benefits us by lowering our expenses. However, because fuel prices are highly volatile, the price of jet fuel may increase significantly at any time. We may be more susceptible to fuel-price volatility than most of our competitors since fuel represents a larger proportion of our total costs due to the longer average stage length of our flights.

Availability of aircraft fuel may be low. Our business is also dependent on the availability of aircraft fuel (or crude oil), which is not predictable. Weather-related events, natural disasters, terrorism, wars, political disruption or instability involving oil-producing countries, changes in governmental or cartel policy concerning crude oil or aircraft fuel production, labor strikes or other events affecting refinery production, transportation, taxes or marketing, environmental concerns, market manipulation, price speculation and other unpredictable events may drive actual or perceived fuel supply shortages. Shortages in the availability of, or increases in demand for, crude oil in general, other crude-oil-based fuel derivatives and aircraft fuel in particular could result in increased fuel prices and could materially adversely affect our business.

Fare increases may not cover increased fuel costs. We may not be able to increase ticket prices sufficiently to cover increased fuel costs, particularly when fuel prices rise quickly. We sell a significant number of tickets to passengers well in advance of travel, and, as a result, fares sold for future travel may not reflect increased fuel costs. In addition, our ability to increase ticket prices to offset an increase in fuel costs is limited by the competitive nature of the airline industry and the price sensitivity associated with air travel, particularly leisure travel, and any increases in fares may reduce the general demand for air travel.

 

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Our fuel hedging program may not be effective. We cannot assure you our fuel hedging program, including our FFP contracts, which we use as part of our hedging strategy, will be effective or that we will maintain a fuel hedging program. Even if we are able to hedge portions of our future fuel requirements, we cannot guarantee that our hedge contracts will provide an adequate level of protection against increased fuel costs or that the counterparties to our hedge contracts will be able to perform. Certain of our fuel hedge contracts may contain margin funding requirements that could require us to post collateral to counterparties in the event of a significant drop in fuel prices. Additionally, our ability to realize the benefit of declining fuel prices will be delayed by the impact of fuel hedges in place, and we may record significant losses on fuel hedges during periods of declining prices. A failure of our fuel hedging strategy, significant margin funding requirements, overpaying for fuel through the use of FFPs or our failure to maintain a fuel hedging program could prevent us from adequately mitigating the risk of fuel price increases and could materially adversely affect our business.

The airline industry is exceedingly competitive, and we compete against both legacy airlines and low-cost carriers; if we are not able to compete successfully in the domestic airline industry, our business will be materially adversely affected.

The domestic airline industry is characterized by significant competition from both large legacy airlines and low-cost carriers, or LCCs. Airlines compete for passengers with a variety of fares, discounts, route networks, flight schedules, flight frequencies, frequent flyer programs and other products and services, including seating, food, entertainment and other on-board amenities. Airlines also compete on the basis of customer-service performance statistics, such as on-time arrivals, customer complaints and mishandled baggage reports. We face significant competition from both large legacy airlines and LCCs on the routes we operate, and if we are unable to compete effectively, our business will be materially adversely affected.

Large legacy airlines have numerous competitive advantages in competing for airline passengers, particularly following the consolidation in the domestic airline industry that occurred between 2008 and 2013, which resulted in the creation of four dominant domestic airlines with significant breadth of network coverage and financial resources. We face competition from one or more of these legacy carriers with respect to nearly all of the routes we serve. The legacy carriers have a number of competitive advantages relative to us that may enable them to attain higher average fares, more passenger traffic and a greater percentage of business passengers than we attain. These advantages include a much larger route network with domestic and international connections, more flights and convenient flight schedules in routes that overlap with ours. These carriers also offer frequent flyer programs and lounge access benefits that reward and create loyalty with travelers, particularly business travelers. Moreover, several legacy carriers have corporate travel contracts that direct employees to fly with a preferred carrier. The enormous route networks operated by these airlines, combined with their marketing and partnership relationships with regional airlines and international alliance partner carriers, allow them to generate increased passenger traffic from domestic and international cities. Our smaller, point-to-point route network and lack of connecting traffic and marketing alliances puts us at a competitive disadvantage to legacy carriers, particularly with respect to our appeal to higher-fare business travelers.

Each of the legacy carriers operates a much larger fleet of aircraft and has greater financial resources than we do, which permits them to add service in response to our entry into new markets. For example, United Airlines operates a hub at San Francisco International Airport (SFO) and has engaged in aggressive competitive practices, such as increasing seat capacity by introducing larger-gauge aircraft or adding incremental flights in response to our entry into new markets served from SFO. Due to our relatively small size, we are more susceptible to a fare war or other competitive activities in one or more of the markets we serve, which could prevent us from attaining the level of passenger traffic or maintaining the level of ticket sales required to sustain profitable operations in new or existing markets.

 

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LCCs also have numerous competitive advantages in competing for airline passengers. LCCs generally offer a more basic service to travelers and therefore have lower cost structures than other airlines. The lower cost structure of LCCs permits them to offer flights to and from many of the same markets as most major airlines, which are defined by the U.S. Department of Transportation, or DOT, as U.S.-based air carriers with annual operating revenues in excess of one billion dollars during a fiscal year, but at lower prices. LCCs also typically fly direct, point-to-point flights, which tends to improve aircraft and crew scheduling efficiency. Many LCCs also provide only a single class of service, thereby avoiding the incremental cost of offering premium-class services like those that we offer.

In addition, some LCCs have a relentless focus on lowering costs and provide only a very basic level of service to passengers. These carriers configure their aircraft with high-density seating configurations and offer minimal amenities during the flight, and as a result, they incur lower unit costs than we do. Some LCCs also charge ancillary fees for basic services that we provide free of charge, such as making a reservation, printing boarding passes at the airport and carrying bags onboard the cabin for stowage in the overhead bins. In general, LCCs have lower unit costs and therefore are able to offer lower base fares.

If we fail to implement our business strategy successfully, our business will be materially adversely affected.

Our business strategy is to target business and leisure travelers who are willing to pay a premium for our newer aircraft, more comfortable seating, better customer service and the latest on-board amenities while maintaining a cost structure that is lower than that of the legacy airlines that these business and premium travelers have historically favored. We may not be successful in attracting enough passengers willing to pay a premium over the fares offered by the LCCs, which we require to offset the additional costs embedded within our premium service model. In addition, American Airlines, Delta Air Lines, United Airlines and JetBlue Airways are increasing the quality of their seating and on-board amenities in some of the routes where they compete with us, making it more challenging to attract passengers who are loyal to those airlines. Continuing to grow our business profitably is also critical to our business strategy. Growth poses various operational and financial challenges, including securing additional financing for aircraft acquisition, obtaining airport gates and facilities at congested airports that serve business and premium travelers and hiring qualified personnel while maintaining our culture, which we believe is vital to the continued success of our airline. We cannot assure you that we will be able to successfully and profitably expand our fleet, enter new markets or grow existing markets in order to achieve additional economies of scale and maintain or increase our profitability. If we are unsuccessful in deploying our strategy, or if our strategy is unsustainable, our business will be materially adversely affected.

Threatened or actual terrorist attacks or security concerns involving airlines could materially adversely affect our business.

Past terrorist attacks against airlines have caused substantial revenue losses and increased security costs. As a result, any actual or threatened terrorist attack or security breach, even if not directly against an airline, could materially adversely affect our business by weakening the demand for air travel and resulting in increased safety and security costs for us and the airline industry generally. Terrorist attacks made directly on a domestic airline, or the fear of such attacks or other hostilities (including elevated national threat warnings or selective cancellation or redirection of flights due to terror threats), would have a negative impact on the airline industry and materially adversely affect our business.

Unauthorized incursions of our information technology infrastructure could compromise the personally identifiable information of our guests, prospective guests or employees and expose us to liability, damage our reputation and materially adversely affect our business.

 

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In the processing of our customer transactions and as part of our ordinary business operations, we and certain of our third-party service providers collect, process, transmit and store a large volume of personally identifiable information, including email addresses and home addresses and financial data such as credit card information. The security of the systems and network where we and our service providers store this data is a critical element of our business, and these systems and our network may be vulnerable to computer viruses, hackers and other security issues. Recently, several high profile consumer-oriented companies have experienced significant data breaches, which have caused those companies to suffer substantial financial and reputational harm. While we believe that we have taken appropriate precautions to avoid an unauthorized incursion of our computer systems, we cannot assure you that our precautions are either adequate or implemented properly to prevent a data breach and its adverse financial and reputational consequences to our business. We are also subject to laws relating to privacy of personal data. The compromise of our technology systems resulting in the loss, disclosure, misappropriation of or access to the personally identifiable information of our guests, prospective guests or employees could result in governmental investigation, civil liability or regulatory penalties under laws protecting the privacy of personal information, any or all of which could disrupt our operations and materially adversely affect our business. Additionally, any material failure by us or our service providers to maintain compliance with the Payment Card Industry security requirements or to rectify a data security issue may result in fines and restrictions on our ability to accept credit cards as a form of payment.

We rely heavily on technology and automated systems to operate our business, and any failure of these technologies or systems could materially adversely affect our business.

We are highly dependent on technology and computer systems and networks to operate our business. These technologies and systems include our computerized airline reservation system, flight operations systems, telecommunications systems, airline website, maintenance systems and check-in kiosks.

In order for our operations to work efficiently, our website and reservation system must be able to accommodate a high volume of traffic, maintain secure information and deliver flight information. We depend on our reservation system, which is hosted and maintained under a long-term contract by a third-party service provider, to issue, track and accept electronic tickets, conduct check-in, board and manage our passengers through the airports we serve and provide us with access to global distribution systems, which enlarge our pool of potential passengers. In May 2011, we experienced significant reservations system outages, which resulted in lost ticket sales on our website which materially adversely affected our business and goodwill. If our reservation system fails or experiences interruptions again, and we are unable to book seats for a period of time, we could lose a significant amount of revenue as customers book seats on other airlines, and our reputation could be harmed.

We also rely on third-party service providers to maintain our flight operations systems, and if those systems are not functioning, we could experience service disruptions, which could result in the loss of important data, increase our expenses, decrease our operational performance and temporarily stall our operations. Replacement services may not be readily available on a timely basis, at competitive rates or at all, and any transition time to a new system may be significant. In the event that one or more of our primary technology or systems vendors fails to perform and a replacement system is not available, our business could be materially adversely affected.

Our business could be materially adversely affected from an accident or safety incident involving our aircraft.

An accident or safety incident involving one of our aircraft could expose us to significant liability and a public perception that our airline is unsafe or unreliable. In the event of a major accident, we could be subject to significant personal injury and property claims. While we maintain liability insurance in amounts and of the type generally consistent with industry practice, the amount of such coverage may not be adequate to cover fully all claims, and we may be forced to bear substantial losses from an accident. In addition, any accident or incident involving one of our aircraft (or an accident involving another Virgin-branded airline), even if fully insured, could harm our reputation and result in a loss of future passenger demand if it creates a public perception that our operation is unsafe or unreliable as compared to other airlines or means of transportation. As a result, any accident or safety incident involving our aircraft could materially adversely affect our business.

 

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The demand for airline services is sensitive to changes in economic conditions, and another recession would weaken demand for our services and materially adversely affect our business.

The demand for business and leisure travel is affected by U.S. and global economic conditions. Unfavorable economic conditions have historically reduced airline travel spending. For most leisure consumers, travel is a discretionary expense, and during unfavorable economic conditions, travelers have often replaced air travel with car travel or other forms of ground transportation or have opted not to travel at all. Likewise, during unfavorable economic conditions, businesses have foregone or deferred air travel. Travelers have also reduced spending by purchasing less expensive tickets, which can result in a decrease in average revenue per seat. Because we have relatively high fixed costs, much of which cannot be mitigated during periods of lower demand for air travel, our business is particularly sensitive to changes in U.S. economic conditions. A reduction in the demand for air travel due to unfavorable economic conditions also limits our ability to raise fares to counteract increased fuel, labor and other costs. If U.S. or global economic conditions are unfavorable or uncertain for an extended period of time, it would materially adversely affect our business.

We have a limited operating history and have only recorded two years of profit, and we may not sustain or increase profitability in the future.

We have a history of losses and only a limited operating history upon which you can evaluate our business and prospects. While we recorded an annual profit in 2013, 2014 and the first six months of 2015, we cannot assure you that we will be able to sustain or increase profitability on a quarterly or an annual basis. In turn, this may cause the trading price of our common stock to decline and may materially adversely affect our business.

Airlines are subject to extensive regulation and taxation by governmental authorities, and compliance with new regulations and any new or higher taxes will increase our operating costs and may materially adversely affect our business.

We are subject to extensive regulatory and legal compliance requirements. Congress regularly passes laws that affect the airline industry, and the DOT, the Federal Aviation Administration, or FAA, and the Transportation Security Administration, or TSA, continually issue regulations, orders, rulings and guidance relating to the operation, safety and security of airlines that require significant expenditures and investment by us. For example, the DOT has broad authority over airlines to prevent unfair and deceptive practices and has used this authority to impose numerous airline regulations, including rules and fines relating to airline advertising, pricing, baggage compensation, denied boarding compensation and tarmac delayed flights. The DOT frequently considers the adoption of new regulations, such as rules relating to congestion-based landing fees at airports and limits or disclosures concerning ancillary passenger fees. For example, in June 2014, the DOT issued a notice of proposed rulemaking to further enhance passenger protections that addresses several areas of regulation, including post-purchase ticket increases, ancillary fee disclosures and code-share data reporting and disclosure.

Compliance with existing requirements drives administrative, legal and operational costs and subjects us to potential fines, and any new regulatory requirements issued by the DOT may increase our compliance costs, reduce our revenues and materially adversely affect our business.

The FAA has broad authority to address airline safety issues, including inspection authority over our flight, technical and safety operations, and has the ability to issue mandatory orders relating to, among other things, the grounding of aircraft, installation of mandatory equipment and removal and replacement of aircraft parts that have failed or may fail in the future. Any decision by the FAA to require aircraft inspections, complete aircraft maintenance or ground aircraft types operated by us could materially adversely affect our business. For example, on January 4, 2014, the FAA’s new and more stringent pilot flight and duty time requirements under Part 117 of the Federal Aviation Regulations took effect, which has increased costs and could further increase our costs in the future.

The FAA also has extensive authority to address airspace/airport congestion issues and has imposed limitations on take-off and landing slots at four airports: Ronald Reagan Washington National Airport (DCA), LaGuardia Airport (LGA), John F. Kennedy International Airport (JFK) and Newark Liberty International Airport (EWR). The FAA could reduce the number of slots allocated at these airports or impose new slot restrictions at other airports.

 

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The Port Authority of New York & New Jersey maintains a so-called “perimeter rule” that prohibits, with certain exceptions, weekday non-stop flights longer than 1,500 statutory miles from LGA, a restriction that does not exist at JFK and EWR. We currently have a limited number of take-off and landing slots at LGA, compared to certain of our competitors. If the LGA perimeter rule were relaxed or eliminated, it could increase competition at LGA for high-revenue longer haul routes favored by business travelers and higher revenue passengers. If New York business travelers and higher revenue passengers elect to travel out of LGA rather than JFK and EWR, airports that are farther from Manhattan, the financial performance of our operations at JFK and EWR may be materially adversely affected. Additionally, we may not have sufficient slots at LGA to compete, which could materially adversely affect our business.

We are also subject to restrictions imposed by federal law that require that no more than 24.9% of our stock be voted, directly or indirectly, by persons who are not U.S. citizens, that no more than 49.9% of our outstanding stock be owned by persons who are not U.S. citizens and that our president and at least two-thirds of the members of our board of directors and senior management be U.S. citizens. For more information on these requirements, see “-Our corporate charter and bylaws include provisions limiting voting and ownership by non-citizens and specifying an exclusive forum for stockholder disputes.” We are currently in compliance with these ownership restrictions. Our high level of foreign ownership may limit our opportunity to participate in U.S. government travel contracts and the Civilian Reserve Air Fleet program, however, if we are unable to satisfy policies and procedures of the U.S. Department of Defense for the mitigation of foreign ownership, control or influence required of cleared U.S. contractors.

Domestic airlines are also subject to significant taxation, including taxes on jet fuel, passenger tickets and security fees to compensate the federal government for its role in regulating airlines, providing air traffic controls and implementing security measures related to airlines and airports. In July 2014, the TSA implemented an increased passenger security fee at a flat rate of $5.60 per passenger. Any significant increase in ticket taxes or security fees could weaken the demand for air travel, increase our costs and materially adversely affect our business.

Many aspects of airlines’ operations are also subject to increasingly stringent environmental regulations, and growing concerns about climate change may result in the imposition of additional regulation. Since the domestic airline industry is highly price sensitive, we may not be able to recover from our passengers the cost of compliance with new or more stringent environmental laws and regulations, which could materially adversely affect our business. Although we do not expect the costs of complying with current environmental regulations will have a material adverse effect on our business, we cannot assure you that the costs of complying with environmental regulations would not materially adversely affect us in the future.

Almost all commercial service airports are owned and/or operated by units of local or state governments. Airlines are largely dependent on these governmental entities to provide adequate airport facilities and capacity at an affordable cost. Many airports have increased their rates and charges to air carriers because of higher security costs, increased costs related to updated infrastructures and other costs. Additional laws, regulations, taxes and airport rates and charges have been proposed from time to time that could significantly increase the cost of airline operations or reduce the demand for air travel. Although lawmakers may impose these additional fees and consider them “pass-through” costs, we believe that a higher total ticket price will influence consumer purchase and travel decisions and may result in an overall decline in passenger traffic, which could materially adversely affect our business.

 

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Our ability to obtain financing or access capital markets may be limited.

We have significant obligations to purchase aircraft and spare engines that we have on order from Airbus and CFM International, or CFM, and we have historically relied solely on lessors to provide financing for our aircraft acquisition needs. In April 2015, we entered into financing transactions with three lenders to finance the purchase of five aircraft scheduled for delivery in 2015 under our existing purchase agreement with Airbus. As of June 30, 2015, committed expenditures for these aircraft and spare engines, including estimated amounts for contractual price escalations and $117.5 million of net pre-delivery payment commitments, were approximately $423.5 million in the aggregate. Because we may not have sufficient liquidity or creditworthiness to fund the purchase of additional aircraft and engines in 2016, we expect to seek external financing for these expenses. There are a number of factors that may affect our ability to raise financing or access the capital markets, including our liquidity and credit status, our operating cash flows, market conditions in the airline industry, U.S. and global economic conditions, the general state of the capital markets and the financial position of the major providers of commercial aircraft financing. We cannot assure you that we will be able to source external financing for our planned aircraft acquisitions or for other significant capital needs, and if we are unable to source financing on acceptable terms, or unable to source financing at all, our business could be materially adversely affected. To the extent we finance our activities with additional debt, we may become subject to financial and other covenants that may restrict our ability to pursue our strategy or otherwise constrain our growth and operations.

In addition, we may be unable to fully finance future aircraft acquisitions if the aircraft are perceived to be less valuable for any reason. We presently have nine Airbus A320-family, current engine option, or A320ceo, aircraft on order for delivery between August 2015 and June 2016. If Airbus’s newer A320neo-family aircraft provide expected improvements in the fuel consumption and an increase in nautical mile range, the Airbus A320ceo-family aircraft may be perceived to be less valuable. If we are unable to fully finance our acquisition of the aircraft on order for delivery in 2016, our business may be materially adversely affected.

The “Virgin” brand is not under our control, and negative publicity related to the Virgin brand name could materially adversely affect our business.

We believe the “Virgin” brand, which is integral to our corporate identity, represents quality, innovation, creativity, fun, a sense of competitive challenge and employee-friendliness. We license rights to the Virgin brand from certain entities affiliated with the Virgin Group on a non-exclusive basis. The Virgin brand is also licensed to and used by a number of other companies, including two airlines, Virgin Atlantic Airways and Virgin Australia Airlines, operating in other geographies. We rely on the general goodwill of consumers and our employees, whom we call teammates, towards the Virgin brand as part of our internal corporate culture and external marketing strategy. Consequently, any adverse publicity in relation to the Virgin brand name or its principals, particularly Sir Richard Branson who is closely associated with the brand, or in relation to another Virgin-branded company over which we have no control or influence, could have a material adverse effect on our business.

We obtain our rights to use the Virgin brand under agreements with certain entities affiliated with the Virgin Group, and we would lose those rights if these agreements are terminated or not renewed.

We are party to license agreements with certain entities affiliated with the Virgin Group pursuant to which we obtain rights to use the Virgin brand. The licensor may terminate the agreements upon the occurrence of a number of specified events including if we commit a material breach of our obligations under the agreements that is uncured for more than 10 business days or if we materially damage the Virgin brand. If we lose our rights to use the Virgin brand, we would lose the goodwill associated with our brand name and be forced to develop a new brand name, which would likely require substantial expenditures, and our business would likely be materially adversely affected.

We are subject to labor-related disruptions that could materially adversely affect our business.

On August 13, 2014, our inflight teammates (whom other airlines refer to as flight attendants), representing approximately 32% of our workforce at the time, voted for representation by the Transport Workers Union, or TWU. As a result, the TWU has been certified as the representative of our inflight teammates, and we are engaged with the TWU in a collective bargaining process for a first contract for those teammates in accordance with the requirements of the Railway Labor Act.

 

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On June 4, 2015, our pilots, representing approximately 22% of our workforce as of such date, voted for representation by the Air Line Pilots Association, or ALPA. As a result, ALPA has been certified as the representative of our pilots, and we are engaged with ALPA in a collective bargaining process for a first contract for those teammates in accordance with the requirements of the Railway Labor Act.

Although we currently have a direct relationship with our remaining teammates, airline workers are one of the most heavily unionized private-sector employee groups, and any of our other non-management teammates could also seek to unionize. If we are not able to reach agreement with the TWU or ALPA on the terms of the collective bargaining agreements for each of our inflight teammates, or pilots, respectively, or if one or more of our other teammate groups elects a union to represent them, it could create a risk of work stoppages, which could materially adversely affect our business.

We depend on the Los Angeles and San Francisco markets to be successful.

Most of our current flights operate from our two focus cities of Los Angeles and San Francisco. In 2014, passengers to and from Los Angeles International Airport (LAX) and to and from SFO accounted for 43.2% and 54.1% of our total passengers. We believe that concentrating our service offerings in this way allows us to maximize our investment in personnel, aircraft and ground facilities and to leverage sales and marketing efforts in those regions. As a result, we are highly dependent on the LAX and SFO markets.

At LAX, we operate out of Terminal Three under an airport lease agreement that runs through 2019, subject to earlier expiration depending on our completion of certain leasehold improvement projects. Under the LAX lease, we have the preferential use of six airport gates and shared access with other airlines to additional common-use gates. At SFO, we primarily operate out of recently renovated Terminal Two, under an operating lease that runs through June 2021, with the occasional use of a gate in the international terminal for flights from Mexico. Under the SFO lease, we have preferential access to seven Terminal Two gates, shared access with other airlines to one common-use Terminal Two gate and shared access to international terminal gates. In the past, we have used SFO international gates for domestic flights. As gate space is limited at both LAX and SFO, we cannot assure you that our gate access at each airport is capable of handling our planned growth in operations for at least the next several years.

However, both LAX and SFO are high-traffic airports with limited excess facilities and capacity, which may restrict our growth at these two bases or may even constrict our existing operations. If either LAX or SFO are fully utilized by other airlines, we may be unable to increase our operations at such airport. Additionally, under our LAX and SFO leases, each airport has reserved the right to reevaluate the airlines’ collective utilization of the airport facilities to re-allocate preferential gates among the airlines based on certain usage standards. If we are unable to meet current or future minimum usage standards, we may lose access to our preferential gates. If we are unable to increase flights in these and other key markets, if any events cause a reduction in demand for air transportation in these key markets, if increases in competition cause us to reduce fares in these key markets, or if we lose access to our preferential gates, our business may be materially adversely affected.

Our quarterly results of operations fluctuate due to a number of factors, including seasonality.

We expect our quarterly results of operations to continue to fluctuate due to a number of factors, including actions by our competitors, price changes in aircraft fuel and the timing and amount of maintenance expenses. As a result of these and other factors, quarter-to-quarter comparisons of our results of operations may not be reliable indicators of our future performance. In addition, seasonality may cause our quarterly results of operations to fluctuate since passengers tend to fly more during the summer months and less in the winter months. We cannot assure you that we will find profitable markets in which to operate during the winter season. Lower demand for air travel during the winter months may materially adversely affect our business.

 

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We have a significant amount of fixed obligations.

The airline business is capital intensive, and many airlines, including us, are highly leveraged. We currently lease 53 of our 54 aircraft, and these leases contain provisions requiring the payment of monthly rent regardless of usage. As of June 30, 2015, we had undiscounted future operating lease obligations of approximately $1.4 billion, as well as significant maintenance reserve requirements associated with these leases that are variable in nature. In addition, we have ordered aircraft and spare engines from Airbus and CFM for delivery over the next eight years. Under those agreements, we are obligated to make PDPs to Airbus and CFM on regular intervals in advance of the delivery of our ordered aircraft and spare engines. Moreover, we expect to incur additional fixed expenses as we take delivery of new aircraft, with nine aircraft scheduled for delivery between August 2015 and June 2016 that are non-cancelable and 30 aircraft scheduled for delivery in 2020 through 2022 that can be canceled by forfeiting amounts on deposit with Airbus.

The amount of our current and expected future fixed obligations could strain our cash flows from operations, reducing the availability of our cash flows to fund working capital, capital expenditures and other general corporate purposes and limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete. Our substantial fixed obligations could reduce our credit, which would negatively impact our ability to obtain additional financing and could place us at a competitive disadvantage compared to less leveraged competitors and competitors that have better access to capital resources or more favorable terms. We cannot assure you that we will be able to generate sufficient cash flows from our operations or from capital market activities to pay our debt and other fixed obligations as they become due or that we will be able to finance these obligations on favorable terms, or at all. If we are unable to generate sufficient cash flows for any reason, we may be unable to meet our fixed obligations, and our business may be materially adversely affected. In particular, if we are unable to make our required aircraft lease rental payments, we could lose access to one or more aircraft and forfeit our rent deposits, and our lessors could exercise their remedies under the lease agreements. Also, an event of default under any of our leases and our debt financing agreements could trigger cross-default provisions under other agreements.

Our credit card processors have the right to impose larger holdbacks which could have a material adverse effect on our business.

Most of our tickets are sold to customers using credit cards as the form of payment. Our credit card processors have rights in their agreements to hold back receivable monies related to tickets sold for future travel services (i.e., a “holdback”). Any related holdback is remitted to us shortly after the customer travels. Holdbacks are commonly imposed on newer or less creditworthy airlines. Until recently, we had significant holdback requirements with our two primary credit card processors, Elavon Inc. for Visa/MasterCard and American Express. On June 5, 2015, Elavon agreed to reduce the Company’s holdback to zero percent (0%), and on June 15, 2015, the Company entered into an amendment with American Express pursuant to which American Express agreed to remove the letter of credit requirement, effectively reducing the Company’s holdback to zero. However, Elavon and Amex each have the right to restore the holdback in the future depending on the Company’s financial performance. Any re-imposition of our holdbacks by Elavon or Amex will immediately and negatively impact our liquidity, which may materially adversely affect our business.

Significant flight delays, cancellations or aircraft unavailability may materially adversely affect our business.

Various factors, many of which are beyond our control, such as air traffic congestion at airports, other air traffic control problems, security requirements, unscheduled maintenance and adverse weather conditions, can cause flight delays or cancellations or cause certain of our aircraft to be unavailable for a period of time. SFO, one of our two primary focus airports, is particularly vulnerable to air traffic constraints and other delays due to fog and inclement weather. Factors that cause flight delays frustrate passengers, and reduced aircraft availability could lead to customer dissatisfaction that harms our reputation. Additionally, if we are forced to cancel a flight due to an event within our control, we will be liable to re-accommodate our guests, including by purchasing tickets for them on other airlines. If one or more of our aircraft is unavailable to fly revenue service for any amount of time, our capacity will be reduced. Significant flight delays, cancellations or aircraft unavailability for any reason could have a material adverse effect on our business.

 

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Our maintenance costs will increase as our fleet ages.

As of June 30, 2015, the average age of aircraft in our fleet of Airbus A320-family aircraft was 6.3 years. Our aircraft will require more scheduled and unscheduled maintenance as they age. We are beginning to incur substantial costs for major maintenance visits for our aircraft, and because of the pattern of our historical fleet growth, we expect to have several aircraft undergoing major maintenance at roughly the same time. These more significant maintenance activities result in out-of-service periods during which certain of our aircraft are unavailable to fly passengers. Any significant increase in maintenance and repair expenses, as well as resulting out-of-service periods, could have a material adverse effect on our business.

We expect that costs associated with the final qualifying major engine maintenance events for our aircraft will be amortized over the remaining lease term rather than until the next estimated major maintenance event, because we account for major maintenance under the deferral method. This could result in significantly higher depreciation and amortization expense related to major maintenance in the last few years of the leases as compared to the expenses in earlier periods.

In addition, the terms of our lease agreements for our 53 leased aircraft require us to pay supplemental rent, also known as maintenance reserves, to our lessor in advance of the performance of major maintenance, resulting in our recording significant aircraft maintenance deposits on our consolidated balance sheet. However, the payments made after the final qualifying major engine maintenance event during the lease term are generally fully expensed, as the majority of these amounts are not reimbursable from the lessor. As such, it will result in both additional rent expense and depreciation and amortization expense for previously capitalized maintenance being recorded in the period after the final qualifying major engine maintenance event and just prior to the termination of the lease.

We depend on sole-source suppliers for our aircraft and engines.

A critical cost-saving element of our business strategy is to operate a single-family aircraft fleet; however, our dependence on the Airbus A320-family aircraft and CFM engines for all of our flights makes us more vulnerable to any design defects or mechanical problems associated with this aircraft type or these engines. In the event of any actual or suspected design defects or mechanical problems with the Airbus A320-family aircraft or CFM engines, whether involving our aircraft or that of another airline, we may choose or be required to suspend or restrict the use of our aircraft. Our business could also be materially adversely affected if the public avoids flying on our aircraft due to an adverse perception of the Airbus A320-family aircraft or CFM engines, whether because of safety concerns or other problems, real or perceived, or in the event of an accident involving such aircraft or engines. Separately, if Airbus or CFM becomes unable to perform its contractual obligations and we must lease or purchase aircraft from another supplier, we would incur substantial transition costs, including expenses related to acquiring new aircraft, engines, spare parts, maintenance facilities and training activities, and we would lose the cost benefits from our current single-fleet composition, any of which could have a material adverse effect on our business.

We rely on third-party service providers to perform functions integral to our operations.

We depend on third-party service providers to provide the majority of the services required for our operations, including fueling, maintenance, catering, passenger handling, reservations and airport ground handling, as well as certain administrative and support services. We are likely to enter into similar service agreements for new markets we enter, and we cannot assure you that we will be able to obtain the necessary services at acceptable rates. Moreover, although we do enter into agreements with many of our third-party service providers that define expected service performance, we do not directly control these third-party service providers. Any of these third-party service providers may fail to meet their service performance commitments to us, suffer disruptions to their systems that could negatively impact their services or fail to perform their services reliably, professionally or at the high standard of quality that we expect. Any such failure of our third-party service providers may prevent us from operating one or more flights or providing other services to our customers and may materially adversely affect our business. In addition, our business could be materially adversely affected if our customers believe that our services are unreliable or unsatisfactory.

 

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Our business could be affected by severe weather conditions, natural disasters or the outbreak of contagious disease, any of which could materially adversely affect our business.

Our operations may be materially adversely affected by factors beyond our control, including severe weather conditions, natural disasters and the outbreak of disease. Severe weather conditions, such as winter snowstorms, hurricanes or other weather events, can cause flight cancellations, turbulence or significant delays that may result in increased costs and reduced revenue. Also, our two focus cities, Los Angeles and San Francisco, and our headquarters in Burlingame, California, are located on or near active seismic faults, and an earthquake could occur at any time, which could disrupt our operations at those locations. Similarly, outbreaks of pandemic or contagious diseases, such as avian flu, severe acute respiratory syndrome (SARS), H1N1 (swine) flu and the Ebola virus could significantly reduce demand for passenger traffic and result in travel restrictions. Any interruption in our ability to operate flights or reduction in airline passenger demand because of such events could have a material adverse effect on our business.

Increases in insurance costs or reductions in insurance coverage may materially adversely affect our business.

If any of our aircraft were to be involved in an accident or if our property or operations were to be affected by a significant natural catastrophe or other event, we could be exposed to significant liability or loss. If we are unable to obtain sufficient insurance (including aviation hull and liability insurance and property and business interruption coverage) to cover such liabilities or losses, whether due to insurance market conditions or otherwise, our business could be materially adversely affected.

We currently obtain third-party war risk (terrorism) insurance, which is a separate policy from our commercial aviation hull and liability policy, from private insurance companies. Our current war risk insurance from commercial underwriters excludes NBCR (nuclear, biological, chemical and radiological) events. If we are unable to obtain adequate third-party war risk (terrorism) insurance or if a NBCR attack were to take place, our business could be materially adversely affected.

Our business could be materially adversely affected if we lose the services of our key personnel.

Our success depends to a significant extent upon the efforts and abilities of our officers, senior management team and key operating personnel. Competition for highly qualified personnel is intense, and a substantial turnover in key employees without adequate replacement or the inability to attract new qualified personnel could have a material adverse effect on our business.

Concentrated ownership by our principal stockholders could materially adversely affect our other stockholders.

As of June 30, 2015, the Virgin Group and Cyrus Holdings owned approximately 18.9% and 28.8% of our outstanding voting common stock, respectively. This concentrated ownership may limit the ability of other stockholders to influence corporate matters; as a result, these stockholders may cause us to take actions that our other stockholders do not view as beneficial. For example, this concentration of ownership could delay or prevent a change in control or otherwise discourage a potential acquirer from attempting to obtain control of us, which in turn could cause the trading price of our common stock to decline or prevent our stockholders from realizing a premium over the market price for their common stock.

 

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The requirements of being a public company may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members or executive officers.

As a public company, we have incurred and will incur significant legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements. We also have incurred and will incur costs associated with the Sarbanes-Oxley Act of 2002, as amended, the Dodd-Frank Wall Street Reform and Consumer Protection Act, related rules implemented or to be implemented by the Securities and Exchange Commission, or the SEC, and the listing rules of the NASDAQ Global Select Market. The expenses incurred by public companies generally for reporting and corporate governance purposes have been increasing. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly, although we are currently unable to estimate these costs with any degree of certainty. These laws and regulations could also make it more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. These laws and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or our board committees or as our executive officers and may divert management’s attention. Furthermore, if we are unable to satisfy our obligations as a public company, our common stock could be delisted, and we could be subject to fines, sanctions and other regulatory action and potentially civil litigation.

We will be required to assess our internal control over financial reporting on an annual basis, and any future adverse findings from such assessment could result in a loss of investor confidence in our financial reports, result in significant expenses to remediate any internal control deficiencies and have a material adverse effect on our business.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, as amended, and beginning with our Annual Report on Form 10-K for the year ending December 31, 2015, our management will be required to report on, and our independent registered public accounting firm to attest to, the effectiveness of our internal control over financial reporting. The rules governing management’s assessment of our internal control over financial reporting are complex and require significant documentation, testing and possible remediation. We are currently in the process of reviewing, documenting and testing our internal control over financial reporting. We may encounter problems or delays in completing the implementation of any changes necessary to make a favorable assessment of our internal control over financial reporting. In connection with the attestation process by our independent registered public accounting firm, we may encounter problems or delays in implementing any requested improvements and receiving a favorable attestation. In addition, if we fail to maintain the adequacy of our internal control over financial reporting, we will not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404. If we fail to achieve and maintain an effective internal control environment, we could suffer material misstatements in our financial statements and fail to meet our reporting obligations, which would likely cause investors to lose confidence in our reported financial information. Additionally, ineffective internal control over financial reporting could expose us to increased risk of fraud or misuse of corporate assets and subject us to potential delisting from the NASDAQ Global Select Market, regulatory investigations, civil or criminal sanctions and litigation, any of which would materially adversely affect our business.

The market price of our common stock may be volatile, which could cause the value of an investment in our stock to decline.

We completed our initial public offering in November 2014. Prior to that offering, there was no public market for shares of our common stock, and an active public market for our shares may not be sustained. From November 14, 2014, the first date of trading of our common stock, through June 30, 2015, the last reported sale price of our common stock has fluctuated between $26.50 and $45.43 per share. The market price of our common stock may fluctuate substantially due to a variety of factors, many of which are beyond our control, including:

 

    changes in the price of aircraft fuel;

 

    announcements concerning our competitors, the airline industry or the economy in general;

 

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    strategic actions by us or our competitors, such as acquisitions or restructurings;

 

    media reports and publications about the safety of our aircraft or the aircraft type we operate;

 

    new regulatory pronouncements and changes in regulatory guidelines;

 

    announcements concerning the availability of the type of aircraft we use;

 

    general and industry-specific economic conditions;

 

    changes in financial estimates or recommendations by securities analysts or failure to meet analysts’ performance expectations;

 

    sales of our common stock or other actions by investors with significant shareholdings, including sales by our principal stockholders;

 

    trading strategies related to changes in fuel or oil prices; and

 

    general market, political and other economic conditions.

The stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of particular companies. Broad market fluctuations may materially adversely affect the trading price of our common stock.

In the past, stockholders have sometimes instituted securities class action litigation against companies following periods of volatility in the market price of their securities. Any similar litigation against us could result in substantial costs, divert management’s attention and resources and materially adversely affect our business.

If securities or industry analysts cease to publish research or reports about our business or publish negative reports about our business, our stock price and trading volume could decline.

The trading market for our common stock depends in part on the research and reports that securities and industry analysts may publish about us or our business. If one or more of the analysts who cover us downgrade our stock or publish inaccurate or unfavorable research about our business, the trading price of our common stock would likely decline. If one or more of these analysts ceases to cover our company or fails to publish reports on us regularly, demand for our stock could decrease, which may cause the trading price of our common stock and our trading volume to decline.

Our anti-takeover provisions may delay or prevent a change of control, which could materially adversely affect the price of our common stock.

Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that may make it difficult to remove our board of directors and management and may discourage or delay “change of control” transactions, which could materially adversely affect the price of our common stock. These provisions include, among others:

 

    our board of directors is divided into three staggered classes, with each class serving a three-year term, which prevents stockholders from electing an entirely new board of directors at a single annual meeting;

 

    actions to be taken by our stockholders may only be effected at an annual or special meeting of our stockholders and not by written consent;

 

    special meetings of our stockholders can be called only by our board of directors, the Chairman of the Board, our chief executive officer or our president;

 

    advance notice procedures that stockholders must comply with in order to nominate candidates to our board of directors and propose matters to be brought before an annual meeting of our stockholders may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer’s own slate of directors or otherwise attempting to obtain control of our company; and

 

    our board of directors may, without stockholder approval, issue series of preferred stock, or rights to acquire preferred stock, that could dilute the interest of, or impair the voting power of, holders of our common stock or could also be used as a method of discouraging, delaying or preventing a change of control.

 

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The value of our common stock may be materially adversely affected by additional issuances of common stock or preferred stock by us or sales by our principal stockholders.

Any future issuances or sales of our common stock by us will be dilutive to our existing common stockholders. Cyrus Holdings and the Virgin Group collectively held an aggregate of 17,411,888 shares of our voting common stock, or 47.6% of our voting common stock outstanding, and 55.9% of the total outstanding equity interests in our company as of June 30, 2015 (which includes 6,852,738 shares of non-voting common stock held by the Virgin Group). Cyrus Capital and the Virgin Group are entitled to rights with respect to registration of such shares under the Securities Act. Sales of substantial amounts of our common stock in the public or private market, a perception in the market that such sales could occur, or the issuance or exercise of securities exercisable or convertible into our common stock, including warrants to purchase our common stock, could materially adversely affect the prevailing price of our common stock.

Our corporate charter and bylaws include provisions limiting voting and ownership by non-U.S. citizens and specifying an exclusive forum for stockholder disputes.

To comply with restrictions imposed by federal law on foreign ownership of U.S. airlines, our amended and restated certificate of incorporation and amended and restated bylaws restrict voting of shares of our common stock by non-U.S. citizens. The restrictions imposed by federal law currently require that no more than 24.9% of our stock be voted, directly or indirectly, by persons who are not U.S. citizens, that no more than 49.9% of our outstanding stock be owned (beneficially or of record) by persons who are not U.S. citizens and that our president and at least two-thirds of the members of our board of directors and senior management be U.S. citizens. Our amended and restated bylaws provide that the failure of non-U.S. citizens to register their shares on a separate stock record, which we refer to as the “foreign stock record,” would result in a suspension of their voting rights in the event that the aggregate foreign ownership of the outstanding common stock exceeds the foreign ownership restrictions imposed by federal law. Our amended and restated bylaws also provide that any transfer or issuance of our stock that would cause the amount of our stock owned by persons who are not U.S. citizens to exceed foreign ownership restrictions imposed by federal law will be void and of no effect.

Our amended and restated bylaws further provide that no shares of our common stock will be registered on the foreign stock record if the amount so registered would exceed the foreign ownership restrictions imposed by federal law. If it is determined that the amount registered in the foreign stock record exceeds the foreign ownership restrictions imposed by federal law, shares will be removed from the foreign stock record in reverse chronological order based on the date of registration therein, until the number of shares registered therein does not exceed the foreign ownership restrictions imposed by federal law. We are currently in compliance with these ownership restrictions.

As of July 3, 2015, non-U.S. citizens owned, in the aggregate, 7,589,707 shares of voting common stock and 14,442,445 shares of outstanding common stock (representing approximately 20.8% of the total voting rights and approximately 33.3% of the total outstanding equity interests in our company, respectively).

Our amended and restated certificate of incorporation provides that, unless we consent in writing to an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by law, be the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of us; (ii) any action asserting a claim of breach of a fiduciary duty owed by, or otherwise wrongdoing by, any of our directors, officers or other employees to us or our stockholders; (iii) any action asserting a claim against us arising pursuant to any provision of the Delaware General Corporation Law or our amended and restated certificate of incorporation or amended and restated bylaws; (iv) any action to interpret, apply, enforce or determine the validity of our amended and restated certificate of incorporation or the bylaws; or (v) any action asserting a claim against us or any of our directors, officers or employees governed by the internal affairs doctrine. Accordingly, you may be limited in your ability to pursue legal actions.

 

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We do not intend to pay cash dividends for the foreseeable future.

We have never declared or paid cash dividends on our common stock. We currently intend to retain our future earnings, if any, to finance the further development and expansion of our business and do not intend to pay cash dividends in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will depend on our financial condition, results of operations, capital requirements, restrictions contained in current or future financing instruments, business prospects and such other factors as our board of directors deems relevant.

We may become involved in litigation that may materially adversely affect us.

From time to time, we may become involved in various legal proceedings relating to matters incidental to the ordinary course of our business, including patent, commercial, product liability, employment, class action, whistleblower and other litigation and claims, and governmental and other regulatory investigations and proceedings. In particular, in recent years, there has been significant litigation in the United States and abroad involving patents and other intellectual property rights. We have in the past faced, and may face in the future, claims by third parties that we infringe upon their intellectual property rights. Such matters can be time- consuming, divert management’s attention and resources, cause us to incur significant expenses or liability and/ or require us to change our business practices. Because of the potential risks, expenses and uncertainties of litigation, we may, from time to time, settle disputes, even where we believe that we have meritorious claims or defenses. Because litigation is inherently unpredictable, we cannot assure you that the results of any of these actions will not have a material adverse effect on our business.

Risks associated with our presence in international emerging markets, including political or economic instability, and failure to adequately comply with existing legal requirements, may materially adversely affect us.

Countries with less developed economies, legal systems, financial markets and business and political environments are vulnerable to economic and political problems, such as significant fluctuations in gross domestic product, interest and currency exchange rates, civil disturbances, government instability, nationalization and expropriation of private assets, trafficking and the imposition of taxes or other charges by governments. The occurrence of any of these events in markets served by us now or in the future and the resulting instability may materially adversely affect our business.

We emphasize legal compliance and have implemented and continue to implement and refresh policies, procedures and certain ongoing training of our teammates with regard to business ethics and many key legal requirements; however, we cannot assure you that our teammates will adhere to our code of business ethics, other policies or other legal requirements. If we fail to enforce our policies and procedures properly or maintain adequate record-keeping and internal accounting practices to record our transactions accurately, we may be subject to sanctions. In the event we believe or have reason to believe our teammates have or may have violated applicable laws or regulations, we may incur investigation costs, potential penalties and other related costs which in turn may materially adversely affect our reputation and business.

Our ability to utilize our net operating loss carryforwards and certain other tax attributes may be limited.

We incurred significant cumulative net taxable losses through 2014. Our unused losses generally carry forward to offset future taxable income, if any, until such unused losses expire. We may be unable to use these losses to offset income before such unused losses expire. In addition, if a corporation undergoes an “ownership change” (generally defined as a greater than 50-percentage-point cumulative change in the equity ownership of certain stockholders over a rolling three-year period) under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, the corporation’s ability to use its pre-change net operating loss carryforwards, or NOLs and other pre-change tax attributes to offset future taxable income or taxes may be limited. We have experienced ownership changes in the past, including in connection with our IPO and 2014 Recapitalization, that could limit our ability to use pre-change NOLs to offset future taxable income. In addition, we may experience ownership changes as a result of future changes in our stock ownership (some of which changes may not be within our control), including in connection with sales of our common stock by Cyrus Capital or the Virgin Group. This, in turn, could materially reduce or eliminate our ability to use our losses or tax attributes to offset future taxable income or tax and have an adverse effect on our future cash flows.

 

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

We have not sold any equity securities during the period covered by this Quarterly Report on Form 10-Q that were not registered under the Securities Act.

Use of Proceeds from Initial Public Offering of Common Stock

On November 13, 2014, the Securities and Exchange Commission declared effective our Registration Statement on Form S-1 (File No. 333-197660), as amended, filed in connection with the IPO. Pursuant to the Registration Statement, we registered, issued and sold an aggregate of 13,106,377 shares of our common stock at a price to the public of $23.00 per share for aggregate gross offering proceeds of $301.4 million. In addition, pursuant to the Registration Statement, VX Employee Holdings, LLC, a Virgin America employee stock ownership vehicle that we consolidate for financial reporting purposes, sold 231,210 outstanding shares held by it at a price to the public of $23.00 per share for aggregate gross offering proceeds of $5.3 million, which were then immediately disbursed to our teammates.

There has been no material change in the planned use of proceeds from the offering as described in the Registration Statement and in our 2014 Form 10-K.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

ITEM 5. OTHER INFORMATION

Not applicable.

 

ITEM 6. EXHIBITS

The exhibits filed as part of this Quarterly Report on Form 10-Q are set forth on the Exhibit Index and are incorporated herein by reference.

 

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SIGNATURES

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.

Dated: July 30, 2015

 

VIRGIN AMERICA INC.
By:   /s/ Peter D. Hunt

Peter D. Hunt

Chief Financial Officer

(Principal Financial Officer and Duly Authorized Signatory)

 

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EXHIBIT INDEX

 

          Incorporated by Reference  

Exhibit
Number

  

Exhibit Description

   Form      Exhibit
No.
     Filing
Date
     Provided
Herewith
 
    3.1    Amended and Restated Certificate of Incorporation of Virgin America Inc.      8-K         3.1         11/19/14      
    3.2    Amended and Restated Bylaws of Virgin America Inc.      8-K         3.2         11/19/14      
  10.1    Eighth Amendment, dated as of September 16, 2014, to that certain Office Lease Agreement, dated as of December 9, 2005, as amended, between CA-Bay Park Plaza Limited Partnership and Virgin America Inc.               X   
  10.2    Ninth Amendment, dated as of April 1, 2015, to that certain Office Lease Agreement, dated as of December 9, 2005, as amended, between CA-Bay Park Plaza Limited Partnership and Virgin America Inc.               X   
  10.3    Facility Agreement, dated as of April 29, 2015, among Virgin America Inc., each Loan Participant (defined therein), BNP Paribas, New York Branch, Investec Bank plc and Bank of Utah               X   
  10.4    Aircraft Lease Agreement, dated as of April 29, 2015, between VX 2015 LLC and Virgin America Inc.               X   
  10.5    Note Purchase Agreement, dated as of April 29, 2015, among VX 2015 LLC, the Purchasers (defined therein), New York Life Insurance Company, Investec Bank plc and Bank of Utah               X   
  10.6†    Second Amendment to the Terms and Conditions of Worldwide Acceptance of the American Express Card by Airlines, dated June 15, 2015, by and between Virgin America Inc. and American Express Travel Related Services Company, Inc.               X   
  31.1    Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002               X   
  31.2    Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.               X   
  32.1**    Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002               X   
101.INS    XBRL Instance Document               X   
101.SCH    XBRL Taxonomy Extension Schema Document               X   
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document               X   
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document               X   
101.LAB    XBRL Taxonomy Extension Labels Linkbase Document               X   
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document               X   

 

Confidential treatment has been requested for certain portions of this Exhibit pursuant to Rule 24b-2 under the Exchange Act, which portions are omitted and filed separately with the Securities and Exchange Commission.

 

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** The certification attached as Exhibit 32.1 that accompanies this Quarterly Report on Form 10-Q is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Virgin America Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Form 10-Q, irrespective of any general incorporation language contained in such filing.

 

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