FLYI INC - 10-Q Quarterly Report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2004

Commission file number 0-21976

FLYi, INC.

(Exact name of registrant as specified in its charter)


Delaware		13-3621051

(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification No.)

45200 Business Court, Dulles, Virginia		20166

(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (703) 650-6000

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 Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes [X] No [ ]

As of November 5, 2004, there were 45,339,810 shares of common stock, par value $.02 per share, outstanding.

Part I. Financial Information
Item 1. Financial Statements

FLYi, Inc.
Condensed Consolidated Balance Sheets


				September 30, 2004
(In thousands except for share and per share data)	December 31, 2003			(Unaudited)
Assets
Current:
Cash and cash equivalents	$	95,879		$	39,677
Short term investments		202,055			158,322
Restricted cash		—			22,886
Accounts receivable, net		9,071			37,267
Expendable parts and fuel inventory, net		18,440			18,531
Prepaid expenses and other current assets		58,341			127,505
Deferred tax asset		14,592			15,845

Total current assets		398,378			420,033
Restricted cash		14,829			17,757
Property and equipment at cost, net of accumulated depreciation and amortization		314,800			317,645
Intangible assets		1,730			1,730
Debt issuance costs, net of accumulated amortization		2,804			5,440
Aircraft deposits		46,990			105,337
Other assets		3,713			2,041

Total assets	$	783,244		$	869,983

Liabilities and Stockholders’ Equity
Current:
Current portion of long-term debt	$	8,927		$	47,898
Current portion of capital lease obligations		159			570
Accounts payable		24,842			34,499
Air traffic liability		2,569			31,247
Accrued liabilities		88,366			89,320
Accrued aircraft early retirement charge		2,666			13,472

Total current liabilities		127,529			217,006
Long-term debt, less current portion		133,971			240,724
Capital lease obligations, less current portion		356			1,178
Deferred tax liability		42,267			15,845
Deferred credits, net		102,115			94,446
Accrued aircraft early retirement charge, less current portion		15,313			44,704
Other long-term liabilities		2,279			2,847

Total liabilities		423,830			616,750

Stockholders’ equity:
Common stock: $.02 par value per share; shares authorized 130,000,000; shares issued 50,404,287 and 50,410,787 respectively; shares outstanding 45,333,310 and 45,339,810, respectively		1,008			1,008
Additional paid-in capital		152,485			152,513
Less: Common stock in treasury, at cost, 5,070,977 and 5,070,977 shares respectively		(35,718	)		(35,718	)
Accumulated other comprehensive income		(5	)		(88	)
Retained earnings		241,644			135,518

Total stockholders’ equity		359,414			253,233

Total liabilities and stockholders’ equity	$	783,244		$	869,983

See accompanying notes to the condensed consolidated financial statements.

FLYi, Inc.
Condensed Consolidated Statements of Operations
(Unaudited)


Three months ended September 30,
(In thousands, except for per share data)	2003			2004
Operating revenues:
Passenger	$	217,279		$	117,690
Other		3,757			1,944

Total operating revenues		221,036			119,634

Operating expenses:
Salaries and related costs		51,845			54,099
Aircraft fuel		35,119			44,192
Aircraft maintenance and materials		20,317			16,080
Aircraft rentals		32,406			29,832
Sales and marketing		5,682			13,633
Facility rents and landing fees		13,102			13,942
Depreciation and amortization		7,780			14,447
Other		17,411			22,000
Aircraft early retirement charge		—			19,894

Total operating expenses		183,662			228,119

Operating income (loss)		37,374			(108,485	)
Other income (expense):
Interest income		588			1,637
Interest expense		(1,797	)		(3,481	)
Other, net		(10	)		(559	)

Total other expense		(1,219	)		(2,403	)

Income (loss) before income tax provision		36,155			(110,888	)
Income tax provision (benefit)		14,823			(28,214	)

Net income (loss)	$	21,332		$	(82,674	)

Income (loss) per share:
Basic:
Net income (loss)	$	0.47		$	(1.82	)

Diluted:
Net income (loss)	$	0.47		$	(1.82	)

Weighted average shares outstanding:
-Basic		45,333			45,340
-Diluted		45,425			45,340

See accompanying notes to the condensed consolidated financial statements.

FLYi, Inc.
Condensed Consolidated Statements of Operations
(Unaudited)


Nine months ended September 30,
(In thousands, except for per share data)	2003			2004
Operating revenues:
Passenger	$	639,601		$	516,836
Other		12,774			5,335

Total operating revenues		652,375			522,171

Operating expenses:
Salaries and related costs		161,023			161,603
Aircraft fuel		107,428			122,184
Aircraft maintenance and materials		62,967			60,270
Aircraft rentals		96,501			92,793
Sales and marketing		17,949			38,717
Facility rents and landing fees		37,803			39,744
Depreciation and amortization		20,899			32,141
Other		63,960			67,434
Aircraft early retirement charge		(34,586	)		48,512

Total operating expenses		533,944			663,398

Operating income (loss)		118,431			(141,227	)
Other income (expense):
Interest income		1,791			3,775
Interest expense		(4,489	)		(10,480	)
Government compensation		1,520			—
Other, net		(199	)		(904	)

Total other expense		(1,377	)		(7,609	)

Income (loss) before income tax provision		117,054			(148,836	)
Income tax provision (benefit)		47,992			(42,710	)

Net income (loss)	$	69,062		$	(106,126	)

Income (loss) per share:
Basic:
Net income (loss)	$	1.53		$	(2.34	)

Diluted:
Net income (loss)	$	1.52		$	(2.34	)

Weighted average shares outstanding:
-Basic		45,269			45,336
-Diluted		45,365			45,336

See accompanying notes to the condensed consolidated financial statements.

FLYi, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)


Nine months ended September 30,
(In thousands)	2003			2004
Cash flows from operating activities:
Net income (loss)	$	69,062		$	(106,126	)
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization		21,455			32,845
Loss on disposal of fixed assets		1,672			1,563
Provision for inventory obsolescence		624			909
Amortization and write-off of deferred credits		(5,629	)		(8,234	)
Amortization of deferred financing costs		374			851
Capitalized interest (net)		984			(1,360	)
Other		33			—
Changes in operating assets and liabilities:
Accounts receivable		(12,276	)		(27,177	)
Expendable parts and fuel inventory		(3,516	)		(1,001	)
Prepaid expenses and other current assets		(50,520	)		(39,666	)
Accounts payable		1,585			9,705
Air traffic liability		(276	)		28,678
Accrued liabilities		(8,274	)		14,046

Net cash provided by (used in) operating activities		15,298			(94,967	)

Cash flows from investing activities:
Purchases of property and equipment		(74,671	)		(34,882	)
Proceeds from sales of assets		—			644
Purchases of short term investments		(316,440	)		(248,100	)
Sales of short term investments		318,095			291,750
Increase in restricted cash		(14,816	)		(25,814	)
Refunds of aircraft deposits		2,400			1,400
Payments of aircraft deposits and other		(1,845	)		(62,005	)

Net cash used in investing activities		(87,277	)		(77,007	)

Cash flows from financing activities:
Proceeds from issuance of long-term debt		60,078			125,000
Payments of long-term debt		(3,423	)		(5,777	)
Payments of capital lease obligations		(1,081	)		(342	)
Deferred financing costs and other		95			(3,487	)
Increase in deferred credits		—			350
Purchase of treasury stock		(132	)		—
Proceeds from exercise of stock options		1,106			28

Net cash provided by financing activities		56,643			115,772

Net decrease in cash and cash equivalents		(15,336	)		(56,202	)
Cash and cash equivalents, beginning of period		29,261			95,879

Cash and cash equivalents, end of period	$	13,925		$	39,677

See accompanying notes to the condensed consolidated financial statements.

FLYi, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements include the accounts of FLYi, Inc. (“FLYi”) and its wholly owned subsidiary, Independence Air, Inc. (“IAI”), (collectively, the “Company”), pursuant to the rules and regulations of the Securities and Exchange Commission. All significant intercompany accounts and transactions have been eliminated in consolidation. The information furnished in these condensed consolidated financial statements reflects all adjustments, which are, in the opinion of management, necessary for a fair presentation of such consolidated financial statements. Results of operations for the three and nine months periods presented are not necessarily indicative of the results to be expected for the full year ending December 31, 2004. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements, and the notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. Certain prior period amounts have been reclassified to conform to the current period presentation.

2. OPERATING ENVIRONMENT

The Company has experienced and continues to experience a fierce competitive response to its low fare marketing strategy from both the legacy carriers and other low fare carriers. United not only replaced the capacity that the Company provided as a United Express carrier, but also increased service from Washington Dulles while matching fares and offering special frequent flyer incentives in markets where it competes with Independence Air. In other markets where the Company competes, USAirways, Delta, and Northwest have matched fares, added frequency to existing markets, and/or started service to markets they previously did not serve. During the third quarter 2004, industry yields as a whole fell as a result of the weak revenue environment and the inability to raise fares. The fierce competition and weak revenue environment have resulted in Independence Air’s revenue falling significantly below anticipated levels.

This revenue shortfall combined with the unprecedented high jet fuel prices has caused the Company to expend more cash than it anticipated when it embarked on its strategy of becoming an independent airline. Although the Company has implemented cost savings measures and reduced capital spending, it cannot sustain the losses it currently projects for the fourth quarter 2004 and full year 2005 without additional liquidity. In order to increase available cash, the Company has engaged in a series of actions designed to reduce or eliminate certain of its obligations and to raise cash in the near term. The Company has entered discussions with its CRJ aircraft lessors and lenders to negotiate payment deferrals of amounts due or coming due for the next two years, with its J41 lessors to terminate the leases, and with its 328Jet lessors to assign the aircraft to Delta and be released from future obligations. The Company is also negotiating for the potential sale or financing of unemcumbered assets including four owned CRJs, one owned 328Jet, and aircraft spare parts. The Company is also evaluating the possible early termination of some of its leased CRJ aircraft.

The acquisition of Airbus aircraft is critical to the Company’s business plan, which assumes that CRJ passengers will be able to connect to longer haul and larger markets served by narrowbody aircraft. The Company is in discussions with Airbus and operating lessors regarding the terms for securing future aircraft deliveries in order to address the Company’s liquidity constraints and the operating lessors’ interest in assuring the Company’s ability to perform its obligations. These discussions may affect terms and aircraft delivery schedules.

We expect to have substantial cash needs as we continue to establish ourselves under the “Independence Air” brand as a low-fare carrier, including cash required to fund increases in accounts payable, prepaid expenses, prepaid maintenance, aircraft security deposits on new aircraft to be leased, pre-delivery payments on new aircraft to be purchased, as well as anticipated operating losses. The Company believes that it has sufficient liquidity to fulfill all of its obligations arising prior to the lease payments that are due in January 2005. The Company is in negotiations with various parties to provide sufficient liquidity to make these payments and to meet its subsequent obligations as they come due. If the Company is unsuccessful in those negotiations in a satisfactory or timely manner, it will be forced to consider commencing a bankruptcy case under Chapter 11 of the U.S. Bankruptcy Code or may be the subject of an involuntary Chapter 11 case commenced against it by creditors.

3. STOCKHOLDERS’ EQUITY

The Company applies the provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation”, to account for its stock options. Currently, SFAS No. 123 allows companies to continue to apply the provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations and provide pro forma net income and pro forma earnings per share disclosures for employee stock options granted as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosures of SFAS No. 123. Beginning after June 30, 2005, the Company will be required to adopt the fair-value-based method and expense the unvested portion of outstanding employee stock options over the remaining vesting periods and to expense over the vesting period any employee stock options granted after June 30, 2005. The Company accounts for non-employee stock option awards in accordance with SFAS No. 123.

As a result of applying APB Opinion No. 25, and related interpretations to the current period, no stock-based employee compensation cost is reflected in net income, as all options granted to employees had an exercise price equal to or greater than the fair market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.


Three months ended September 30,
(in thousands except for per share data)	2003			2004
Net income (loss), as reported	$	21,332		$	(82,674	)
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		—			—
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(1,717	)		(1,207	)

Pro forma net income (loss)	$	19,615		$	(83,881	)

Income (loss) per share:
Basic — as reported	$	.47		$	(1.82	)

Basic — pro forma	$	.43		$	(1.85	)

Diluted — as reported	$	.47		$	(1.82	)

Diluted — pro forma	$	.43		$	(1.85	)


Nine months ended September 30,
(in thousands except for per share data)	2003			2004
Net income (loss), as reported	$	69,062		$	(106,126	)
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		14			—
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(3,836	)		(4,010	)

Pro forma net income (loss)	$	65,240		$	(110,136	)

Income (loss) per share:
Basic — as reported	$	1.53		$	(2.34	)

Basic — pro forma	$	1.44		$	(2.43	)

Diluted – as reported	$	1.52		$	(2.34	)

Diluted — pro forma	$	1.44		$	(2.43	)

4. DEBT

Long-term debt consists of the following at December 31, 2003 and September 30, 2004, respectively:

(in thousands)

December 31, 2003

September 30, 2004

Equipment Notes associated with Pass Through Trust Certificates, due January 1, 2008 and January 1, 2010, principal payable annually through January 1, 2006 and semi-annually thereafter through maturity, interest payable semi-annually at 7.49% throughout term of notes, collateralized by four J-41 aircraft.

10,008

8,869

Notes payable to institutional lenders, due between October 23, 2010 and May 15, 2015, principal payable semiannually with interest ranging from 5.65% to 7.63% through maturity, collateralized by four CRJ aircraft.

41,794

39,761

Note payable to institutional lender, due October 2, 2006, principal payable semiannually with interest at 6.56%, collateralized by one J-41 aircraft.

1,738

1,335

Notes payable to institutional lender, due November 2019, principal payable semiannually with interest at 5.11%, collateralized by four CRJ aircraft.

58,897

57,686

Notes payable, due October 2005, principal payable monthly with variable rate based on 1-month LIBOR rate plus 2.25% through maturity, collateralized by two CRJ aircraft.

30,461

29,471

Notes payable to Airbus for deferrable predelivery payments, due upon delivery of aircraft with interest at 6.5%

—

26,500

6% Convertible Senior notes – due 2034

—

125,000

Total

142,898

288,622

Less: Current Portion

8,927

47,898

133,971

240,724

In February 2004, the Company sold $125 million of Convertible Senior Notes (“Notes”). The Notes have an interest rate of 6% and are convertible into FLYi, Inc. common stock at a conversion rate of 90.2690 shares per $1,000 principal amount of the Notes (a conversion price of approximately $11.08) once the Company’s common stock share price reaches 120% of the conversion price or $13.30. The Notes mature in 2034 and interest is payable semi-annually beginning August 15, 2004. The Company may redeem the Notes either in whole or in part beginning 2007 at the redemption price, plus accrued and unpaid interest and liquidated damages, if any. The holders may require the Company to repurchase the Notes on February 15 of 2009, 2014, 2019, 2024 and 2029 at a repurchase price equal to 100% of their principal amount, plus accrued and unpaid interest and liquidated damages, if any. The Company filed a registration statement with the U.S. Securities and Exchange Commission on May 24, 2004 to register the resale of the Notes and the sale of the shares of the Company’s Common Stock issuable upon conversion of the Notes. This registration statement, as amended, was declared effective on July 2, 2004.

The Company’s purchase agreement with Airbus allows the Company to defer a portion of the predelivery payments for each aircraft as part of a financing arrangement with the manufacturer. The portion of the deferred predelivery payment is payable upon delivery of the aircraft plus accrued interest at an interest rate of 6.5%. Delivery of the purchased aircraft is scheduled to begin in July 2005.

5. INCOME TAXES

The Company’s net loss for the third quarter 2004 and the nine months ended September 30, 2004 reflect a benefit from income taxes of approximately 25.4% and 28.7% respectively, as compared to income tax expense of 41.0% for the three and nine months ended September 30, 2003. The Company will realize this tax benefit as a reduction in deferred tax liabilities and as a carry back of net operating losses against taxes paid for the 2002 and 2003 tax years. The Company estimates that the total amount of its two year tax carry-back will be exhausted by the projected losses to be incurred during the fourth quarter of 2004. The ability to record a tax benefit from future losses once the carry-back amount is exhausted will depend on the Company being able to generate income in the future periods.

6. INCOME PER SHARE

Basic income per share is computed by dividing net income by the weighted average number of common shares outstanding. Diluted income per share is computed by dividing net income by the weighted average number of common shares outstanding and common stock equivalents, which consist of shares subject to stock options computed using the treasury stock method. A reconciliation of the numerator and denominator used in computing basic and diluted income per share is as follows:


Three months ended September 30,
(in thousands)	2003		2004
Net income (loss) (basic and diluted)	$	21,332	$	(82,674	)

Weighted average shares outstanding (basic)		45,333		45,340
Incremental shares related to stock options		92		—

Weighted average shares outstanding (diluted)		45,425		45,340

Number of antidilutive options outstanding		5,403		5,969


Nine months ended September 30,
(in thousands)	2003		2004
Net income (loss) (basic and diluted)	$	69,062	$	(106,126	)

Weighted average shares outstanding (basic)		45,269		45,336
Incremental shares related to stock options		96		—

Weighted average shares outstanding (diluted)		45,365		45,336

Number of antidilutive options outstanding		4,574		5,903

7. COMPREHENSIVE INCOME

Comprehensive income includes changes in the unrealized gains and losses on available-for-sale securities. The following statements present comprehensive income for:


Three months ended September 30,
(in thousands)	2003		2004
Net income (loss)	$	21,332	$	(82,674	)
Other comprehensive income - net change in unrealized gain(loss) on available-for-sale securities		12		70

Comprehensive income (loss)	$	21,344	$	(82,604	)


Nine months ended September 30,
(in thousands)	2003		2004
Net income (loss)	$	69,062	$	(106,126	)
Other comprehensive income - net change in unrealized gain(loss) on available-for-sale securities		15		(83	)

Comprehensive income (loss)	$	69,077	$	(106,209	)

8. SUPPLEMENTAL CASH FLOW INFORMATION


Nine months ended September 30,
(in thousands)	2003		2004
Cash paid during the period for:
Interest	$	2,796	$	8,348
Income taxes		21,243		5,289
Non-cash transactions
Purchase of aircraft		52,577		—
Financed aircraft deposits		—		26,500

9. AIRCRAFT EARLY RETIREMENT CHARGE

The Company is utilizing an all jet fleet with its operations as an independent low-fare carrier. Therefore, the British Aerospace Jetstream (“J-41s”) turboprops operated by the Company in its United Express operations have been retired upon their exit from the United Express program and placed in long term storage. As the aircraft exited the United Express program, the Company recorded charges for the retirement of leased aircraft.

During the third quarter 2004, the Company retired the nine remaining J-41s, eight of which were leased. The Company recorded an aircraft early retirement charge of $19.9 million (pre-tax) and $48.5 million (pre-tax) for the three months and nine months ended September 30, 2004, respectively. The estimated charge relates to the retirement of eight leased J-41s in the third quarter for a total of twenty-one retired leased J-41s (includes three leased J-41s retired in first quarter and ten leased J-41s in the second quarter) for the nine months ended September 30, 2004. The estimated early retirement charge in the third quarter assumes remarketing income of $1.5 million (pre-tax) over the remaining terms of the leases based on current market conditions for subleasing transactions of J-41s. The Company is in discussions with the lessors of these aircraft for the early termination of these leases. If acceptable arrangements cannot be agreed upon, the Company expects to seek other ways of mitigating its exposure, including the sale or sublease of aircraft. As of September 30, 2004, the Company has written down the book value of its five owned J-41s to current estimated fair market value. The overall debt balance on these aircraft exceeds this estimated fair market value and the Company is considering its alternatives regarding these aircraft and the associated indebtedness.

As of September 30, 2004, the Company had net liabilities of $58.2 million accrued for the twenty-five leased J-41 aircraft that have been early retired. The Company will make adjustments to the estimated accrued liabilities as deemed necessary based on its ability to terminate the leases or to remarket the aircraft. Any sales arrangements involving leased aircraft may result in the Company providing compensation to the lessor to cover shortfalls between sale prices and lease stipulated loss values. Under the Equipment Notes associated with Pass Through Trust Certificates, due January 1, 2008 and January 1, 2010, the Company is required make payments to cover the unpaid principal balance and accrued interest, if any, plus a make-whole premium as stipulated in the agreements in connection with any sale of owned aircraft that were financed through such Equipment Notes.

During the second quarter of 2003, the Company reversed a portion of the J-41 charge previously taken by recording a $34.6 million (pre-tax) credit to income due to delays in the Company’s retirement schedule for its J-41 turboprop fleet as a result of uncertainty over the Company’s contractual relationship