10-K: AMERICA WEST AIRLINES INC
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Last Update: 6:10 AM ET Feb 28, 2007
(EDGAR Online via COMTEX) -- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Background
US Airways Group is a holding company whose primary business activity is the operation of a major network air carrier, through its ownership of the common stock of America West Holdings and its wholly owned subsidiary AWA, US Airways, Piedmont, PSA, MSC and Airways Assurance Limited. On September 12, 2004, US Airways Group and its domestic subsidiaries, US Airways, Piedmont, PSA and MSC (collectively, the "Reorganized Debtors"), which at the time accounted for substantially all of the operations of US Airways Group, filed voluntary petitions for relief under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the Eastern District of Virginia, Alexandria Division. On May 19, 2005, US Airways Group signed a merger agreement, subsequently amended on July 7, 2005, with America West Holdings pursuant to which America West Holdings merged with a wholly owned subsidiary of US Airways Group. The plan of reorganization of US Airways Group and its domestic subsidiaries was confirmed by the Bankruptcy Court on September 16, 2005. The merger became effective upon US Airways Group's emergence from bankruptcy on September 27, 2005. Following the merger, America West Holdings continued as a wholly owned subsidiary of US Airways Group.
Following the merger, US Airways Group has been moving toward operating under the single brand name of "US Airways" through its two principal subsidiaries:
The merger has been accounted for as a reverse acquisition using the purchase method of accounting. As a result, although the merger was structured such that America West Holdings became a wholly owned subsidiary of US Airways Group, America West Holdings was treated as the acquiring company for accounting purposes due to the following factors: (1) America West Holdings' stockholders received the largest share of US Airways Group's common stock in the merger in comparison to unsecured creditors of US Airways Group; (2) America West Holdings received a larger number of designees to the board of directors; and (3) America West Holdings' Chairman and Chief Executive Officer prior to the merger became the Chairman and Chief Executive Officer of the combined company. As a result of the reverse acquisition, the 2005 consolidated statement of operations for the new US Airways Group presented in this report is comprised of the results of America West Holdings for the 269 days through September 27, 2005 and consolidated results of US Airways Group for the 96 days from September 27, 2005 through December 31, 2005. The results of operations for fiscal years 2004 and 2003 are those of America West Holdings.
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2006 Overview
Merger Integration Update
Since the effective date of the merger on September 27, 2005, our operational accomplishments include the following:
Optimized our fleet mix to better match aircraft size with passenger demand. As a result, we expect to end 2007 with 359 mainline aircraft (supported by approximately 229 regional jets and approximately 104 turboprops that provide passenger feed into the mainline system);
Completed the consolidation of operations at 37 of 38 overlap cities by the end of 2006. The last remaining overlap city was completed in January 2007;
Completed over 60% of the transition plan to move to one FAA operating certificate, which we anticipate completing during 2007;
Painted over 90 aircraft (69%) of the former America West mainline fleet in the new US Airways livery;
Restructured and increased our Airbus order to 15 A321 aircraft, which includes seven additional A321 aircraft and converts prior commitments for seven A319 and one A320 aircraft to eight A321 aircraft;
Amended an agreement with Republic, which will result in adding 30 86-seat EMB 175 aircraft to the US Airways Express fleet in 2007 and 2008 that will be operated by Republic. These aircraft will offset a reduction of 50-seat EMB 145 aircraft operated by Chautauqua Airlines;
Deployed over 6,000 new desktops throughout our airport network and the reservation centers in preparation for the cutover to one reservations system, which is scheduled to be completed by the end of the first quarter of 2007;
Added $6.5 million of new ground equipment, 57 new managers and over 200 new full-time ramp employees at our Philadelphia hub to enhance the operational performance of this hub;
Launched new international service to Lisbon, Stockholm and Milan and announced new international service to Zurich, Athens and Brussels to begin during June 2007;
Achieved ETOPS (extended-range twin-engine operations) certification for Boeing 757 aircraft in long-range over-water service, which allowed us to begin new service to Hawaii; and
Ranked second in 2006 among the major US airlines in on-time performance.
In the area of finance, we have:
Completed a $1.25 billion refinancing, which was used to replace approximately $1.1 billion of outstanding debt at lower interest rates and with an extended amortization period;
Redeemed approximately $112 million in principal amount of America West Holding Corporation's 7.5 percent convertible senior notes due 2009 for approximately 3.9 million shares of common stock, which lowered our annual interest expense by $8.4 million;
Redeemed approximately $70 million in principal amount of our 7 percent senior convertible notes due in 2020 for approximately 2.9 million shares of common stock and a $17 million premium payment;
Ended 2006 with unrestricted and restricted cash, cash equivalents and short-term investments totaling $3 billion, of which $2.4 billion was unrestricted;
Completed the migration of myriad of back office systems including general ledger, accounts payable and revenue accounting, among others; and
Migrated all employees to one healthcare provider, which is expected to result in annual savings of over $5 million.
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In the marketing area, we have:
Launched the combined airline's new website, usairways.com. The new site integrated the former americawest.com and increases overall functionality. Bookings on the new website have exceeded the combined revenues from the two standalone sites;
Merged the former AWA frequent flyer program, FlightFund, into US Airways' frequent flyer program, Dividend Miles, to create one consolidated program that allows customers to more easily earn and redeem miles across our network and Star Alliance;
Realigned the combined airline's fare class structure to simplify and establish an identical fare hierarchy across all US Airways and AWA operated flights;
Released the new US Airways Vacation web site with improved functionality and eliminated the America West Vacations brand; and
Developed and launched the new airline brand "Fly with US" and the new employee brand "I make US fly".
US Airways Group's labor integration team has achieved the following since the merger closed:
Reached transition agreements with US Airways' and AWA's pilots, flight attendants and fleet service personnel;
Received single carrier certification by the National Mediation Board, which will further the process of getting to single representation for US Airways' and AWA's mechanics and fleet service workers;
Reached a final agreement with the Airline Customer Service Employee Association, an alliance between the Communication Workers of America (CWA) and the International Brotherhood of Teamsters (IBT), the two unions that represent the airline's 7,700 passenger service employees and reservations agents;
Reached a final agreement with the Transport Workers Union (TWU), the union that represents flight dispatchers, on a single contract that transitions former AWA dispatchers to the labor agreement covering pre-merger US Airways dispatchers;
Recalled 100 furloughed US Airways pilots and 200 furloughed US Airways flight attendants, due to increased operations since the merger; and
Increased hiring in the Winston-Salem, North Carolina and Reno, Nevada reservation centers to bring some of the currently outsourced reservations work back in-house.
We are fast approaching several significant milestones as we near completion of our integration efforts. Our next steps include:
Migration to a single reservation system by the end of the first quarter of 2007; and
Completion of the transition plan to merge the airlines into one FAA operating certificate during 2007.
Additionally, we are continuing to negotiate with the pilot, flight attendant, fleet service and mechanic labor groups in hopes of reaching final agreements with these unions. After final agreements are reached, we will make necessary changes to payroll and other labor-related systems.
Cost Control
We remain committed to maintaining a low cost structure, which we believe is necessary to compete effectively in the airline industry. Low cost carriers, some of which have cost structures lower than ours, continue to enter and grow in the markets in which we operate. In addition, the traditional legacy carriers, which have competitive advantages including vast route networks, alliances and generous frequent flyer programs, remain focused on lowering their respective costs. This includes using the bankruptcy process to restructure with lower cost structures. In light of this environment, we continue to focus on minimizing unnecessary capital expenditures and prudent spending for discretionary expenses. We believe our combined mainline cost per available seat mile ("CASM") will remain competitive with the low cost carriers and among the lowest of the traditional legacy
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carriers, particularly as the benefits of our cost synergies are realized. See the US Airways Group, AWA and US Airways Results of Operations sections within Item 7 of this report for analysis related to CASM.
Revenue Pricing Environment
The revenue environment improved dramatically during 2006 as our mainline passenger revenue per available seat mile ("PRASM") was 10.35 cents in 2006. For the fourth quarter of 2006, the first full quarter where US Airways Group's results were comparable on a year-over-year basis, US Airways Group's mainline PRASM increased to 10.12 cents compared to PRASM in the 2005 period of 9.32 cents. For the full year 2006, AWA's mainline PRASM increased 12.9% to 9.34 cents in 2006 from 8.27 cents in 2005. US Airways' mainline PRASM increased 16.3% to 10.97 cents in 2006 from 9.44 cents in 2005. The improvement in mainline PRASM during 2006 was driven by: (1) rational industry capacity growth, which led to pricing power and yield growth for the entire industry; (2) strong leisure demand; and (3) realization of some of the synergy benefits from the merger, including our fare restructuring, the implementation of a code share agreement between AWA and US Airways that helped each airline sell more tickets, an improved and combined frequent flyer program and a rationalized route network that eliminated capacity on our weakest routes.
Customer Service
We are committed to building a successful combined airline by taking care of our customers. We believe that our focus on excellent customer service in every aspect of our operations including personnel, flight equipment, inflight and ancillary amenities, on-time performance, flight completion ratios and baggage handling, will strengthen customer loyalty and attract new customers. Combined DOT measures as reported by AWA and US Airways for the years ended December 31, 2006, 2005 and 2004 were as follows:
Full Year
2006 2005 2004
On-time performance(a) 76.9 77.8 78.1
Completion factor(B) 98.9 98.2 98.4
Mishandled baggage© 7.82 7.68 4.85
Customer complaints(d) 1.35 1.55 1.14
(a) Percentage of reported flight operations arriving on time as defined by the DOT.
(B) Percentage of scheduled flight operations completed.
© Rate of mishandled baggage reports per 1,000 passengers.
(d) Rate of customer complaints filed with the DOT per 100,000 passengers.
Our on-time performance for 2006 ranked second among the ten largest U.S. carriers as measured by the DOT. During 2006 we achieved significant operational improvements at our Philadelphia hub. Specifically, customer complaints are down over 30 percent from 2005 levels. In addition, mishandled baggage per 1,000 enplanements is down nearly 15 percent year-over-year, with over 95 percent of all local in-bound baggage now delivered to the baggage carousel in 19.1 minutes on average.
US Airways Group's Results of Operations
The full year 2006 includes the consolidated results of the new US Airways Group and its subsidiaries, including US Airways, America West Holdings and AWA. As noted above, the 2005 statement of operations presented includes the consolidated results of America West Holdings for the 269 days through September 27, 2005, the effective date of the merger, and the consolidated results of the new US Airways Group for the 96 days from
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September 27, 2005 to December 31, 2005. For 2004, the consolidated statements of operations reflect only the consolidated results of America West Holdings. The table below shows the consolidated results (in millions):
2006 2005 2004
Consolidated Consolidated America America
US Airways US Airways 96 Days West West
Group Group US Airways(1) Holdings Holdings
Operating revenues $ 11,557 $ 5,069 $ 1,805 $ 3,264 $ 2,757
Operating expenses 10,999 5,286 1,897 3,389 2,777
Operating income (loss) 558 (217 ) (92 ) (125 ) (20 )
Nonoperating expense, net (154 ) (118 ) (44 ) (74 ) (69 )
Income (loss) before cumulative
effect of a change in accounting
principle $ 303 $ (335 ) $ (136 ) $ (199 ) $ (89 )
Diluted earnings (loss) per
common share before cumulative
effect of a change in accounting
principle $ 3.32 $ (10.65 ) $ n/a $ n/a $ (5.99 )
(1) Includes US Airways and US Airways Group's wholly owned subsidiaries, PSA, Piedmont and MSC.
In 2006, we realized operating income of $558 million and income before cumulative effect of change in accounting principle of $303 million. These results include $79 million of net losses associated with AWA's fuel hedging transactions. This includes $9 million of net realized losses on settled hedge transactions and $70 million of unrealized losses resulting from the application of mark-to-market accounting for changes in the fair value of fuel hedging instruments. AWA is required to use mark-to-market accounting as its fuel hedging instruments do not meet the requirements for hedge accounting as established by SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." Given the market volatility of jet fuel, the fair value of these fuel hedging instruments is expected to change until settled. The 2006 results also include $27 million of net special charges, including $131 million of merger-related transition expenses, partially offset by a $90 million credit related to the Airbus restructuring and $14 million of credits related to the settlement of certain bankruptcy-related claims.
The 2006 results include nonoperating expenses of $6 million for prepayment penalties and $5 million write-off of debt issuance costs in connection with our refinancing of the ATSB and GECC loans (discussed below under "Liquidity and Capital Resources - Commitments"), $17 million in payments in connection with the inducement to convert $70 million of the 7% Senior Convertible Notes to common stock and a $2 million write off of debt issuance costs associated with those converted notes.
As a result of the merger timing, the fourth quarter of 2006 is the first full quarter where our results are comparable on a year-over-year basis. In the fourth quarter of 2006, our CASM was 10.98 cents compared to 11.12 cents for the fourth quarter of 2005. The significant components of the quarter-over-quarter net decrease in CASM are as follows:
A $28 million decrease in fuel expense as the average cost per gallon of fuel decreased 7.2%, representing a decrease in CASM of 0.17 cents, and
A $26 million decrease in net special items, due to a decrease in the merger and transition related expenses, representing a decrease in CASM of 0.14 cents, partially offset by
A $20 million increase in expense related to our profit sharing and other employee bonus programs, which are included in salaries and related costs on our consolidated statements of operations, representing an increase in CASM of 0.10 cents.
As of December 31, 2006, US Airways and AWA had a total of $980 million of net operating loss carryforwards (NOL) to reduce future taxable income, which includes $69 million of NOL related to stock-based
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compensation deduction. Of this amount $795 million is available to reduce federal taxable income in 2007. Deferred tax assets, which include the $795 million of NOL discussed above, have been subject to a valuation allowance. As of December 31, 2006, that valuation allowance was $263 million. We utilized NOL in 2006, a portion of which was reserved by a valuation allowance. The use of the NOL permitted the reversal of the valuation allowance which reduced income tax expenses. In 2007, we expect to utilize additional NOL and as a result, the remaining valuation allowance will be reduced.
For the full year 2006, US Airways recognized $85 million of non-cash income tax expense, as NOL that was generated by US Airways prior to the merger was utilized. In accordance with SFAS No. 109, "Accounting for Income Taxes," as this was acquired NOL, the decrease in the valuation allowance associated with this NOL reduced goodwill instead of the provision for income taxes. As of December 31, 2006, the remaining valuation allowance associated with acquired NOL was $29 million.
We were subject to Alternative Minimum Tax liability ("AMT") in 2006. In most cases the recognition of AMT does not result in tax expense. However, since our NOL was subject to a full valuation allowance, any liability for AMT is recorded as tax expense. We recorded AMT tax expense of $10 million for the full year 2006. We also recorded $2 million of state income tax provision in 2006 related to certain states where NOL was not available to be used.
In 2005, we realized operating losses of $217 million and a loss before cumulative effect of change in accounting principle of $335 million. In 2005, America West Holdings changed its accounting policy for certain maintenance costs from the deferral method to the direct expense method as if that change occurred January 1, 2005. This resulted in a $202 million loss from the cumulative effect of a change in accounting principle, or $6.41 per common share. See note 3, "Change in Accounting Policy for Maintenance Costs," to the consolidated financial statements in Item 8A of this report.
The 2005 results include $75 million of net gains associated with AWA's fuel hedging transactions. This includes $71 million of net realized gains on settled hedge transactions and $4 million of unrealized gains resulting from the application of mark-to-market accounting for changes in the fair value of fuel hedging instruments.
The 2005 results include $121 million of special charges, including $28 million of merger related transition expenses, a $27 million loss on the sale and leaseback of six 737-300 aircraft and two 757 aircraft, $7 million of power by the hour program penalties associated with the return of certain leased aircraft and a restructuring fee of $50 million related to the amended Airbus purchase agreement, along with $7 million in capitalized interest. The restructuring fee was paid by means of set-off against existing equipment purchase deposits held by Airbus. The 2005 results also include nonoperating expenses of $8 million related to the write-off of the unamortized value of the ATSB warrants upon their repurchase in October 2005 and an aggregate $2 million write-off of debt issuance costs associated with the exchange of the 7.25% Senior Exchangeable Notes due 2023 and retirement of a portion of the loan formerly guaranteed by the ATSB.
In 2004, we realized operating losses of $20 million and a loss before cumulative effect of change in accounting principle of $89 million. These results include a $16 million net credit associated with the termination of the rate per engine hour agreement with General Electric Engine Services for overhaul maintenance services on V2500-A1 engines. This credit was partially offset by $2 million of net charges related to the return of certain Boeing 737-200 aircraft, which includes termination payments of $2 million, the write-down of leasehold improvements and deferred rent of $3 million, offset by the net reversal of maintenance reserves of $3 million related to the returned aircraft.
The 2004 results also include a $24 million net gain on derivative instruments associated with AWA's fuel hedging program. This amount includes $26 million of realized gains on settled hedge transactions and $2 million of unrealized losses resulting from mark-to-market accounting for changes in the fair value of AWA's fuel hedging instruments. A $6 million charge arising from the resolution of pending litigation, a $5 million loss on the sale and leaseback of two new Airbus aircraft and a $1 million charge for the write-off of debt issuance costs in connection with the refinancing of the Mizuho Corporate Bank term loan were also recognized in 2004.
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US Airways Group did not record an income tax benefit for the years ended December 31, 2005 and 2004 and recorded a full valuation allowance on any future tax benefits generated in those periods as we had yet to achieve several consecutive quarters of profitable results coupled with an expectation of continued profitability.
AWA's Results of Operations
In 2006, AWA realized operating losses of $35 million and a loss before income taxes and cumulative effect of change in accounting principle of $33 million. Included in these results is $79 million of net losses associated with its fuel hedging transactions. This includes $9 million of net realized losses on settled hedge transactions and $70 million of unrealized losses resulting from the application of mark-to-market accounting for changes in the fair value of fuel hedging instruments.
The 2006 results include $17 million of net special charges, including $68 million of merger related transition expenses offset in part by a credit of $51 million related to the Airbus restructuring. The 2006 results also include nonoperating expenses of $11 million related to $6 million for prepayment penalties and an aggregate $5 million write off of debt issuance costs in connection with our refinancing of the ATSB and GECC loans.
In 2005, AWA realized operating losses of $120 million and a loss before income taxes and cumulative effect of change in accounting principle of $195 million. In 2005, AWA changed its accounting policy for certain maintenance costs from the deferral method to the direct expense method as if that change occurred January 1, 2005. This resulted in a $202 million loss from the cumulative effect of a change in accounting principle. See Note 2, "Change in Accounting Policy for Maintenance Costs," to AWA's consolidated financial statements in Item 8B of this report.
AWA's 2005 results include $75 million of net gains associated with its fuel hedging transactions. This includes $71 million of net realized gains on settled hedge transactions and $4 million of unrealized gains resulting from the application of mark-to-market accounting for changes in the fair value of fuel hedging instruments.
The 2005 results include $106 million of special charges, including $13 million of merger related transition expenses, a $27 million loss on the sale and leaseback of six 737-300 aircraft and two 757 aircraft, $7 million of power by the hour program penalties associated with the return of certain leased aircraft and a $50 million charge related to an amended Airbus purchase agreement, along with $7 million in capitalized interest. The Airbus restructuring fee was paid by means of setoff against existing equipment purchase deposits held by Airbus. The 2005 results also include nonoperating expenses of $8 million related to the write-off of the unamortized value of the ATSB warrants upon their repurchase in October 2005 and an aggregate $2 million write-off of debt issuance costs associated with the exchange of the 7.25% Senior Exchangeable Notes due 2023 and retirement of a portion of the loan formerly guaranteed by the ATSB.
In 2004, AWA realized operating losses of $16 million and a loss before income taxes and cumulative effect of change in accounting principle of $85 million. Included in these results was a $16 million net credit associated with the termination of the rate per engine hour agreement with General Electric Engine . . .
Feb 28, 2007
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