Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File No. 0-23224
GREAT LAKES AVIATION, LTD.
(Exact name of registrant as specified in its charter)
Iowa 42-1135319
-------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1022 Airport Parkway, Cheyenne, WY 82001
----------------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (307) 432-7000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
par value $.01
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [_] No [X]
The aggregate market value of voting stock held by non-affiliates of the
registrant as of March 31, 2003 was approximately $2,896,667.
As of March 31, 2003 there were 14,052,166 shares of Common Stock of the
registrant issued and outstanding.
Documents Incorporated By Reference
None.
FORM 10-K INDEX
PART I ..................................................................... 1
Item 1. BUSINESS ...................................................... 1
Item 2. PROPERTIES .................................................... 12
Item 3. LEGAL PROCEEDINGS ............................................. 12
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ........... 13
PART II .................................................................... 14
Item 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS ........................................... 14
Item 6. SELECTED FINANCIAL AND OPERATING DATA ......................... 14
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ........................... 16
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .... 28
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ................... 30
PART III ................................................................... 58
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE ...................................... 58
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ............ 58
Item 11 EXECUTIVE COMPENSATION ........................................ 59
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT .................................................... 62
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ................ 63
Item 14. CONTROLS AND PROCEDURES ....................................... 64
PART IV .................................................................... 65
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K ...................................................... 65
SIGNATURES ................................................................. 67
i
Forward-Looking Statements
In accordance with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, Great Lakes Aviation, Ltd. ("Great Lakes" or the
"Company") notes that certain statements in this Form 10-K and elsewhere are
forward-looking and provide other than historical information. The Company's
management may also make oral, forward-looking statements from time-to-time.
These forward-looking statements include, among others, statements concerning
the Company's general business strategies, financing decisions and expectations
for funding expenditures and operations in the future. The words, "believe,"
"plan," "continue," "hope," "estimate," "project," "intend," "expect" and
similar expressions reflected in such forward-looking statements are based on
reasonable assumptions, and no statements contained in this Form 10-K and
elsewhere should be relied upon as predictions of future events. Such statements
are necessarily dependent on assumptions, data or methods that may be incorrect
or imprecise and may be incapable of being realized. The risks and uncertainties
inherent in these forward-looking statements could cause actual results to
differ materially from those expressed in or implied by these statements.
As more fully described in this report, important factors that could cause
results to differ materially from the expectations reflected in any
forward-looking statements include: (1) the Company's dependence on its
code-sharing relationships with United Airlines, Inc., which is undergoing
reorganization under the United States Bankruptcy Code, and Frontier Airlines,
Inc.; (2) the outcome of United's bankruptcy proceedings, including whether
United amends or rejects its code sharing agreement with the Company; (3) the
Company's ability to pay the restructured current maturities of indebtedness and
operating lease payments, which have been scheduled based on, among other
things, the Company's forecasted revenues; (4) the effect of general economic
conditions on business and leisure travel; (5) domestic and international
terrorism and military actions; (6) passenger confidence in the safety of air
travel; (7) fuel costs; (8) seasonality; (9) continued receipt of Essential Air
Service subsidies at currently contemplated rates; and (10) increased insurance
and security expenses. Additional information about the factors and events that
could cause actual results to differ materially from those implied by
forward-looking statements is contained in "Risk Factors Relating to the Company
and the Airline Industry" below.
Readers are cautioned not to place undue reliance on the forward-looking
statements contained herein, which speak only as of the date hereof. Changes may
occur after that date, and the Company does not undertake to update any
forward-looking statements except as required by law in the normal course of its
public disclosure practices.
PART I
Item 1. BUSINESS
General
Great Lakes is a regional airline that began providing scheduled passenger
service under its own marketing identity on October 12, 1981. On April 26, 1992
the Company began operating a large portion of its route network as a United
Express carrier. The United Express marketing program included painting of
aircraft with a United Express paint scheme, branding of station facilities and
outfitting Great Lakes customer service employees with United designated
uniforms. On May 1, 2001, the program with United was terminated and the Company
implemented a new three-year code share agreement with United that included
returning aircraft, station signage and customer service personnel to the Great
Lakes market identity. Subsequently, the Company negotiated a code share
agreement with Frontier Airlines, Inc. which was implemented in phases beginning
on July 7, 2001. Under the terms of the Company's code share agreements,
schedules are published to enable customers of Great Lakes and its code sharing
partners to conveniently book well timed connecting flights. Customers that only
travel to and from the hubs (Denver, Minneapolis and Phoenix) purchase tickets
directly from Great Lakes or travel agents.
As of March 31, 2003, the Company served 32 destinations in nine states to and
from Denver as code sharing partners with both United and Frontier. It also
served four destinations in two states to and from Minneapolis and two
destinations in two states to and from Phoenix. On February 28, 2003, the
Company discontinued its service to the
1
Chicago hub after the United States Department of Transportation ("DOT") elected
to reduce its subsidy funding for service from Chicago.
As of December 31, 2002, the Company's fleet consisted of 37 Beechcraft Model
1900D 19-passenger aircraft and seven Embraer Model 120 30-passenger aircraft.
The Company also has two Beechcraft Model 1900C aircraft that are used
exclusively for freight operations. As more fully explained below, on December
31, 2002, the Company entered into a restructuring agreement (the "Restructuring
Agreement") with Raytheon Aircraft Credit Corporation ("Raytheon") which, among
other provisions, permits the Company to return to Raytheon seven Model 1900D
aircraft during 2003 that are surplus to the needs of the Company.
Liquidity and Financing
Beginning in 2001, the airline industry suffered substantial declines in revenue
as demand for air service fell due to a variety of factors, including terrorism
and general economic trends. It is unclear when and to what extent demand for
air travel will return. Airlines have also incurred increased expenses,
including insurance and security. As a consequence, most air carriers, including
the Company, have incurred substantial losses.
Due to significant losses in 2001 and 2002, the Company has exhausted its
available sources of working capital and has no financing agreements in place
under which it can secure additional funds. At the end of 2001, the Company was
in arrears in its payments to some institutions providing financing for the
Company's aircraft, which resulted in most of the Company's long-term debt
obligation being reclassified into current liabilities as of December 31, 2001.
On December 31, 2002 and during the first quarter of 2003, the Company
restructured its financing arrangements with Raytheon and certain other
institutions providing financing for the Company's aircraft. The effect of this
restructuring was to reduce the Company's payments to these creditors. It also
provided for the return of surplus aircraft. However, the debt and lease rental
payments to be made under the restructuring agreements are closely aligned with
expected cash flows, and any shortfall from expected cash flows may result in
the Company's inability to make the scheduled payments. There are significant
uncertainties regarding the Company's ability to achieve the required cash flows
because of a variety of factors beyond the Company's control, including the
outcome of United's reorganization in bankruptcy, volatility of fuel prices,
reduced passenger demand, effects of the Iraq conflict and general economic
conditions. See "-- Restructuring Agreement with Raytheon" and "-- Other
Financing" below.
As a result of continued declines in traffic and fare levels as well as slower
receipt of essential air service payments, the Company did not make its February
and March payments under the Restructuring Agreement to Raytheon and will not
make the payments due Raytheon in April 2003. In addition the Company is not in
compliance with certain financial covenants contained in that Agreement. On
April 14, 2003, Raytheon waived the foregoing requirements until June 15, 2003.
At December 31, 2002, the Company was in compliance with its debt agreements or
had obtained amendments or short-term waivers from its lenders with respect to
any nonpayment of scheduled debt installments or noncompliance with financial
covenants. However, the Company cannot determine with a high degree of
confidence that it will be able to make the required payments or remain in
compliance with the agreements during the year 2003. Therefore the amount of
debt that by its terms would otherwise be due after one year is shown as
long-term obligations classified as current. In addition to the contractual
amounts due the lenders, the balance includes $22.3 million of additional
carrying amounts under FAS 15.
The Company plans to continue to seek additional sources of permanent capital;
however, it is unlikely that such capital will be available until the Company
and the airline industry appear capable of returning to a continuing level of
profitability. If the Company is unable to generate adequate funding through
improved financial performance or a combination of additional financing and
further settlements with creditors, the Company may be required to make further
reductions in operating levels and develop other alternatives to provide
sufficient operating funds. No assurances can be made that the Company will be
successful in finding financing alternatives to allow it to continue as a going
concern or that its creditors will not impose conditions that result in a
corporate restructuring or ceasing operations.
The Company's financial statements have been prepared assuming that the Company
will continue as a going concern. The financial statements do not include any
adjustments that might result if the Company were forced to discontinue
operations. As discussed in note 1 to the financial statements, the Company has
suffered significant losses in the years ended December 31, 2002 and 2001, and
had liabilities in excess of assets at December 31, 2002.
2
The auditor's report dated March 17, 2003 on the Company's financial statements
states that these matters raise substantial doubt about the Company's ability to
continue as a going concern.
Air Transportation Safety and System Stabilization Act
The terrorist attacks of September 11, 2001 had a significant impact on the
business of the Company. Following the attacks, the Company took immediate
action to reduce its level of operations to better match the reduced level of
passenger demand. However, as was the case with most of the airline industry,
these actions were not sufficient to avoid large economic losses from the
initial grounding of all flights, increased expenses and substantially reduced
passenger revenues.
In response to the terrorist acts, Congress passed the Air Transportation Safety
and System Stabilization Act ("Stabilization Act"). The Stabilization Act
included for all U.S. airlines and air cargo carriers provisions for cash
compensation of $5 billion, of which $1.9 million was allocated to Great Lakes
and received during 2001 and 2002. In addition to benefits for the entire
airline industry, the Stabilization Act also took notice of the unique
requirements of providing service to small communities by increasing funding for
Essential Air Service. See "Essential Air Service Program" below.
Management
On December 31, 2002, the Company appointed Charles R. Howell IV as Chief
Executive Officer. Mr. Howell joined the Company in August 2002 as Chief
Operating Officer. He served most recently as President and Chief Executive
Officer of Corporate Airlines, Inc., a Nashville-based airline that he
co-founded in 1996. The Company plans to further strengthen management by hiring
a new senior financial officer and additional marketing personnel.
United and Frontier Code Sharing Relationships
Prior to May 1, 2001, the Company had been operating scheduled passenger service
exclusively as United Express under a cooperative marketing agreement with
United Airlines, Inc. ("United"). On February 1, 2001, the Company and United
entered into a three-year code sharing agreement, which became effective May 1,
2001. Under this agreement, the Company no longer operates under the name
"United Express"; rather, it operates under its own name but continues to use
the UA code for connecting service to United points beyond the Company's hubs.
The United code sharing agreement provides for use of United's flight designator
for Great Lakes flights connecting with United flights in Denver, Minneapolis,
Phoenix and Chicago, and permits the Company to enter into code sharing
agreements with certain other carriers.
On December 9, 2002, UAL, Inc. and its subsidiaries, including United, filed for
protection under Chapter 11 of the United States Bankruptcy Code. United has
obtained an order from the bankruptcy court that allows United to perform under
its code sharing agreement with the Company. United has assumed but has the
right to reject the code sharing agreement until October 6, 2003, which is the
deadline to file a plan of reorganization. The deadline for acceptance of the
plan is December 5, 2003. Creditors must file proofs of claim against United by
May 12, 2003. The deadline does not apply to executory contracts such as the
Company's code sharing agreement, unless such contracts are rejected by United.
The deadlines may be extended by the bankruptcy court.
On May 3, 2001, the Company entered into a code sharing agreement with Frontier
Airlines, Inc. ("Frontier"), which was implemented July 9, 2001. The Frontier
agreement provides for the use of Frontier's flight designator on Great Lakes'
flights connecting with Frontier's flights in Denver. Accordingly, certain
flights to and from Denver carry both the United and Frontier designator as well
as the Great Lakes designator.
Markets
As of December 31, 2002, the Company operated 84 departures daily from Denver,
five departures daily from Minneapolis/St. Paul, three departures daily from
Phoenix and five departures daily from Chicago. Chicago service was discontinued
on February 28, 2003. The Company currently serves 41 airports in 11 states.
3
Essential Air Service Program
The Airline Deregulation Act of 1978 (the "Deregulation Act") allowed airlines
great freedom to introduce, increase and generally reduce or eliminate service
to existing markets. Under the Essential Air Service program ("EAS"), which is
administered by the DOT, certain communities that received scheduled air service
prior to the passage of the Deregulation Act are guaranteed specified levels of
"essential air service." The DOT may authorize federal subsidies to compensate a
carrier providing essential air service in otherwise unprofitable or minimally
profitable markets. An airline serving a community that qualifies for essential
air services is required to give the DOT advance notice before it may terminate,
suspend or reduce service. Depending on the circumstances, the DOT may require
the continuation of existing service until a replacement carrier is found. EAS
rates are normally set for two-year contract periods for each city. Significant
fluctuations in passenger revenues as well as in fuel and other costs cause EAS
routes to become unprofitable during these two-year terms.
The DOT may request competitive proposals from other airlines at the end of the
contract period for EAS service to a particular city. Proposals, when requested,
are evaluated on, among other things, level of service provided, subsidy
requested, fitness of the applicant and comments from the communities served.
For the federal fiscal year ended September 30, 2001, the EAS budgeted subsidy
funding level for the entire program was $50 million. In recognition of the
impact of the terrorist attacks of September 11, and the contractual obligation
to provide a fixed level of service to EAS communities by carriers receiving
subsidies, Congress authorized the DOT to increase subsidy rates to compensate
for reduced passenger revenues and higher level of expenses. Congress set the
EAS funding level at $113 million for the fiscal year ended September 30, 2002
and at $113 million for the fiscal year ending September 30, 2003.
As a result of these funding increases and the reduction of non-EAS service, the
Company's EAS revenues were approximately 36% of total revenue ($30.6 million)
in 2002, up from approximately 19% ($19.3 million) in 2001 and 11% ($14.9
million) in 2000. For 2003, total subsidy revenues are expected to be
approximately the same as the prior year due to the Company's filing for subsidy
support at additional cities, which are expected to replace subsidies lost with
the termination of service to and from Chicago. At March 31, 2003, the Company
served 25 essential air service communities on a subsidized basis. Of these, 12
were being served under closed rate orders and the remainder were in the process
of negotiation.
Aircraft
At December 31, 2002, the Company's fleet consisted of 39 Beechcraft 1900
aircraft and seven Embraer Brasilia passenger aircraft. Thirty-seven Beechcraft
1900D aircraft were available for use in passenger service, and two Beechcraft
1900C aircraft were being utilized exclusively for scheduled mail and freight
operations. The Beechcraft 1900D aircraft are pressurized, radar equipped and
offer a 300-mile per hour cruising speed for 19 passengers, plus cargo, with a
range of 850 miles. The Beechcraft 1900D aircraft is widely regarded by airlines
as an efficient and reliable aircraft for regional service. At December 31,
2002, the Company owned 36 and leased one of the passenger-configured Beechcraft
1900D aircraft.
On May 14, 2002, one owned Beechcraft 1900D and one leased Beechcraft 1900D,
along with spare parts inventory, were destroyed by fire in a maintenance hangar
owned by the Hall County Airport Authority and located in Grand Island,
Nebraska. The fire started during hangar door modification performed by an
outside contractor at the request of the Hall County Airport Authority. Of the
total insurance proceeds of $10.0 million received by the Company, $7.8 million
was applied to payment of the value of the leased aircraft and current and past
due debt and lease obligations due Raytheon. The balance was used by the Company
to replace spare parts inventory and tooling or was added to general corporate
funds.
Because of the reduction in demand for air service following the events of
September 11, the Company decided to retire seven of its Beechcraft 1900D
aircraft. In conjunction with the Restructuring Agreement, as more fully
described below, the Company will return the seven 1900D aircraft during 2003.
Also in conjunction with the Restructuring Agreement, the Company purchased nine
of the formerly leased 1900D aircraft which it elected to
4
retain in its fleet. The aggregate purchase price for the nine aircraft was
$22.5 million. Two 1900C aircraft were returned during 2002.
At December 31, 2002, two of the Company's seven Brasilia aircraft were in
scheduled service and the remainder were being used as spares and for limited
charter service. Four of the Brasilia aircraft are owned and three are leased
under terms ranging from nine months to 10 years. The 30 passenger Embraer
Brasilia aircraft are equipped with advanced avionics, have restrooms, are
staffed with a flight attendant and offer a 330-mile per hour cruising speed
with a range of 750 miles. The Company intends to increase the number of
Brasilia aircraft in scheduled service beginning in July 2003, as warranted by
passenger demand. The Company will return one Brasilia at the end of its lease
term in September 2003. Thereafter, the Company believes that there will be
greater opportunities to deploy these aircraft as the larger airlines reduce
service to small cities that are unprofitable for their regional jet aircraft.
The table below shows the number and type of aircraft operated by the Company on
January 1, 2002 and December 31, 2002.
December 31, 2002
January 1, December 31, ------------------
2002 2002 Owned Leased
----------- ------------- -------- --------
Beechcraft 1900C 4 2 -- 2
Beechcraft 1900D 40 37 36 1
Embraer 120 8 7 4 3
----------- ------------- -------- --------
Total 52 46 40 6
=========== ============= ======== ========
As of December 31, 2002, the average age of the Company's aircraft was
approximately eight years and as of December 31, 2001, the average age of the
Company's aircraft was approximately seven years.
Restructuring Agreement with Raytheon
Following the terrorist attacks of September 11 and due to continuing
unfavorable economic conditions, the Company suffered substantial losses during
the fourth quarter of 2001 and the year 2002. These losses produced a
significant reduction in liquidity and rendered several aircraft surplus to the
Company's reduced level of operations. Because of these financial difficulties,
the Company missed contractual debt and lease payments during these periods and
made only minor payments on its debt and lease obligations. As a result, debt of
$111.0 million was in default and the Company was in arrears on lease payment
obligations which totaled $11.3 million at December 31, 2002, immediately prior
to the restructuring discussed below. Of these amounts, $106.0 million and $6.8
million, respectively, were owed to Raytheon.
On December 31, 2002, the Company finalized an agreement (the "Restructuring
Agreement") with Raytheon regarding lease and debt financing provided by
Raytheon for the Company's Beechcraft 1900C and 1900D aircraft fleet. The
Restructuring Agreement included provisions for:
o the issuance of 5,371,980 shares of the Company's Common Stock to
Raytheon,
o the termination and modification of aircraft operating leases,
o the return of aircraft in satisfaction of indebtedness obligations,
o the modification of principal and interest rates for various aircraft
financing promissory notes and
o a restructuring of certain non-aircraft indebtedness.
5
Return of Aircraft. The Company has agreed to return seven Beechcraft 1900D
aircraft to Raytheon during 2003 in exchange for the cancellation and
extinguishment of one operating lease and six promissory notes. Because the
Company will incur repair and refurbishment expenses during 2003 in order to
return the aircraft to Raytheon in good working order, the Company has
recognized a liability of $4 million for such expenditures. In addition, and in
accordance with the provisions of SFAS 15 regarding the satisfaction of debt by
a transfer of assets, the Company has adjusted the net book value of the six
owned aircraft down to the aircrafts' total fair market value of $15 million,
and has recognized an impairment loss of $5.5 million. Upon return of the
aircraft to Raytheon in 2003, the Company expects to reduce its outstanding
aircraft debt and lease liabilities for these seven aircraft by $20.9 million
and record a gain from extinguishment of debt of $5.4 million.
Termination of Aircraft Operating Leases/Financed Purchase of Aircraft.
Operating leases for nine Beechcraft 1900D aircraft have been converted to
aircraft ownership with purchase money financing. The Company has recorded the
purchase of the nine aircraft at a total fair market value of $22.5 million with
a corresponding increase in long-term aircraft debt. Interest will accrue on the
unpaid principal balance of the new debt at the rate of LIBOR plus 375 basis
points per annum. Payments of principal and accrued interest are to be made in
120 monthly installments, with the amount of the monthly payment to be adjusted
quarterly to reflect any change in the LIBOR rate.
Restructured Financing Terms for Aircraft Promissory Notes. The Company obtained
amended debt financing for 21 Beechcraft 1900D aircraft promissory notes (the
"Restructured Aircraft Notes") in the amount of $52.5 million. Each of the
Restructured Aircraft Notes reflects an initial principal balance in the amount
of $2.5 million with interest to accrue on the unpaid principal balance at the
rate of LIBOR plus 375 basis points per annum. Payments of principal and accrued
interest are to be made in 120 monthly installments, with the amount of monthly
payment to be adjusted quarterly to reflect any change in the LIBOR rate. Total
cash payments for all of the Restructured Aircraft Notes is estimated to be
$68.1 million over the term of the notes.
Accounting for Refinancing of Aircraft Debt and Lease Obligations under SFAS 15.
Consistent with SFAS 15, the restructured financing terms for all 30 of the
Beechcraft 1900D aircraft debt and lease obligations discussed above (the "Old
Aircraft Debt") has been accounted for as a troubled debt restructuring. SFAS 15
states that in a troubled debt restructuring, the debtor shall account for the
effects of the restructuring prospectively from the time of restructuring and
shall not reduce the carrying amount of the existing debt unless the carrying
amount of the existing debt exceeds the total future cash payments of the new
debt under the restructured terms. Included in the carrying value of
restructured debt and lease obligations were $3.7 million of deferred gains and
other deferred credits. The effects of any changes in the face amount or
interest rate are to be amortized in future periods by reducing interest expense
to an effective interest rate which equates the net present value of the future
cash payments under the modified terms to the carrying value on the debtor's
books.
After increasing the Company's liabilities by $22.5 million for financing of the
Purchased Aircraft, the carrying value on the Company's books for the Old
Aircraft Debt was $101.3 million, while total future cash flows for the 30 new
and amended aircraft promissory notes (the "New Aircraft Debt") was estimated to
be $95.7 million. In accordance with the provisions of SFAS 15, the amount of
the Company's long-term liabilities has been reduced by $5.6 million in order to
reflect the carrying value of the Old Aircraft Debt to an amount not more than
the estimated future cash flows of the New Aircraft Debt. The $20.7 million
difference between the $95.7 million restructured value of the Old Aircraft Debt
and the $75 million principal amount of the New Aircraft Debt will be amortized
as a reduction to the Company's interest expense over the next ten years.
Modification of Terms for Aircraft Operating Leases. Pursuant to the terms of
the Restructuring Agreement, $384,000 of pre-December 31, 2002 unpaid lease
payments on two Beechcraft 1900C aircraft operating leases has been
contractually extinguished and the Company negotiated a reduction in the monthly
lease payments for the two leases, which is anticipated to yield net cash flow
savings of $1.2 million over the next ten years. The $384,000 liability will
remain on the Company's books and be amortized over a period of 120 months.
Other Debt Restructuring Involving Partial Settlement Through Issuance of
Equity. $14.9 million of outstanding principal and accrued interest on various
non-aircraft debt was restructured into three new promissory notes (the
6
"Non-Aircraft Debt") with a total principal amount of $11.2 million and
estimated future cash payments of $15.2 million. In addition, the Company issued
5,371,980 shares of the Company's Common Stock to Raytheon, representing a 38.2%
interest in the Company's outstanding post-restructuring shares of Common Stock.
The restructuring of the Non-Aircraft Debt through the issuance of equity and
new debt obligations was accounted for in compliance with SFAS 15. The new debt
obligations were recorded at the carrying amount of the prior debt obligations,
less the fair value of the equity granted to Raytheon. The Company has
determined that, on the effective date of the Restructuring Agreement, the fair
market value of the equity interest granted to Raytheon was $2.1 million.
Accordingly, the Company has reduced $14.9 million of the Non-Aircraft Debt by
$2.1 million to a net carrying amount of $12.8 million, and has recorded an
increase of $2.1 million in shareholders' equity.
Board of Director Observer Rights. As further consideration for the concessions
granted by Raytheon in the Restructuring Agreement, the Company has granted
Raytheon observer rights for the Company's Board of Directors, but without any
right to vote or enter into any discussions at any Board of Directors meetings.
Registration Rights. The Company agreed to file a shelf registration statement
to permit Raytheon to resell the shares of Company Common Stock issued to it
under the Restructuring Agreement. The registration statement was to have been
filed by the date of this annual report, but has not yet been filed.
Independent Directors. The Restructuring Agreement provides that the Company
will appoint two new directors unaffiliated with the Company or Raytheon by
March 31, 2003. Mr. John Reardon has been appointed as a director under this
provision. The second director has not yet been appointed.
Mandatory Prepayments. Not later than the earlier of 90 days after the end of
the Company's fiscal year or the filing of the Company's Form 10-K for such
fiscal year, the Company is required to prepay amounts outstanding under the
Company's notes held by Raytheon in an amount equal to 50% of the "excess cash
flow" for that fiscal year. "Excess cash flow" means cash flow from the
Company's operations, less (a) capital expenditures, (b) payments of funded
indebtedness for or made during such fiscal year and (c) $250,000.
Anti-Dilution. The Restructuring Agreement gives Raytheon anti-dilution rights
with respect to certain issuances of Common Stock, rights to purchase Common
Stock or securities convertible into Common Stock.
As a result of continued declines in traffic and fare levels as well as slower
receipt of essential air service payments, the Company did not make its February
and March payments under the Restructuring Agreement to Raytheon and will not
make the payments due Raytheon in April 2003. In addition the Company is not in
compliance with certain financial covenants contained in that Agreement. On
April 14, 2003, Raytheon waived the foregoing requirements until June 15, 2003.
At December 31, 2002, the Company was in compliance with its debt agreements or
had obtained amendments or short-term waivers from its lenders with respect to
any nonpayment of scheduled debt installments or noncompliance with financial
covenants. However, the Company cannot determine with a high degree of
confidence that it will be able to make the required payments or remain in
compliance with the agreements during the year 2003. Therefore the amount of
debt that by its terms would otherwise be due after one year is shown as
long-term obligations classified as current. In addition to the contractual
amounts due the lenders, the balance includes $22.3 million of additional
carrying amounts under FAS 15.
Other Financing
The Company is renegotiating agreements with three other creditors who provide
the financing for six of the Company's seven Brasilia aircraft. In August 2002,
the Company entered into a settlement with Finova Capital Corporation ("Finova")
with respect to an aircraft returned to Finova. As a part of that agreement, the
Company agreed to pay Finova a total of $727,589 with interest at 10% over a
period of 48 months. The Company retained the second aircraft leased from Finova
and agreed to pay Finova $10,000 per month from October 2002 through March 2003
and $15,000 per month from April 2003 until the end of the lease term on
September 30, 2003. For the period prior to September 30, 2003 the parties have
agreed to negotiate a settlement of amounts due under the lease agreement and
for unpaid rentals and return condition of the remaining aircraft.
At December 31, 2002, Great Lakes had three notes payable to the CIT
Group/Equipment Financing, Inc. ("CIT") with interest at 8.7% to 9.08%, totaling
$5.0 million for financing of three of its Brasilia aircraft, of which $214,000
was in arrears. In April 2003, the Company combined and modified the notes to
provide for reduced monthly payments through March 2008 at an interest rate of
LIBOR plus 275 basis points.
7
At December 31, 2002, the Company was in arrears on rental payments to Boeing
Capital Corporation ("Boeing") for lease of two Brasilia aircraft in the amount
of $3.4 million. Subsequent to year-end, the Company entered into a letter
agreement with Boeing, effective as of December 31, 2002, cancelling the unpaid
lease installments, reducing the monthly rental payments through the end of the
lease terms in 2013, requiring the Company to fund major overhauls in advance
and giving Boeing the right to terminate the leases at its option with six
months notice. Boeing will receive shares of redeemable preferred stock valued
at $4.5 million. The Company intends to file a Certificate of Designation
setting forth the terms of the redeemable preferred stock by April 30, 2003. The
parties will further document the terms and conditions of the lease
restructuring by that date.
Maintenance
The Federal Aviation Administration ("FAA") mandates periodic inspection and
maintenance of commercial aircraft. The Company performs most maintenance and
inspection of its aircraft and engines (except engine overhaul) using its own
personnel. Heavy maintenance bases are located at Cheyenne, Wyoming; Huron,
South Dakota; and Grand Island, Nebraska. Line maintenance is also performed in
Denver, Colorado. Parts and supplies inventories are also maintained at these
locations to promote the mechanical dispatch reliability of the fleet. The
Company also maintains an inventory of spare engines and propellers for its
fleet to allow for minimal downtime during major overhauls. The Company
internally performs overhaul of selected aircraft components for its fleet.
In October 2001, Great Lakes became the first operator of Beechcraft 1900D
aircraft with Pratt & Whitney PT6A-67D engines to be authorized by the FAA to
maintain its engines on an "on-condition" basis. As part of the Restructuring
Agreement with Raytheon, the Company agreed that by April 30, 2003, it will
enter into an engine reserve funding plan with a third party vendor that covers
the next complete overhaul performed on each 1900D engine after the engine
completes the current refurbishment cycle.
Yield Management
The Company closely monitors its inventory and pricing of available seats with
yield management systems. These systems enable the Company's revenue control
analysts to examine the Company's past traffic and pricing trends and to
estimate the optimal number of seats made available for sale at various fares.
The analysts then monitor each flight to adjust seat allocations and booking
levels, with the objective of maximizing the total revenue for each flight.
Marketing
The Company's services are marketed primarily by means of listings in
computerized reservation systems and the Official Airline Guide, and through
direct contact with travel agencies and corporate travel departments. The
Company's promotional programs emphasize the Company's close affiliation with
its code sharing partners and the opportunity for the Company's passengers to
participate in United's "Mileage Plus" frequent flyer program.
Competition
The Company competes for passenger traffic primarily with regional and major air
carriers and ground transportation. It may also compete with other regional
carriers and smaller carriers to provide Essential Air Service and receive
subsidies for providing service to small communities. The Company's competition
from other air carriers varies from location to location and, in certain areas,
comes from regional and major carriers who serve the same destinations as the
Company but through different hub and spoke systems. The domestic airline
industry has undergone major structural changes since the enactment of the
Deregulation Act. Deregulation has made possible the rapid entry of competitors
into the Company's markets, and competitors are able to adjust fares rapidly to
improve their competitive position. The Company could experience increased
competition from existing competitors or from new entrants on one or more of the
Company's routes.
Almost all markets are subject to a high degree of price competition both from
established carriers and low fare jet carriers. The Company believes, however,
that its ability to compete in its market areas is strengthened by its code
sharing relationships with United and Frontier at Denver. The Company competes
with other airlines by offering
8
frequent flights, flexible schedules and competitive fares. In addition, the
Company's competitive position benefits from the large number of participants in
United's "Mileage Plus" frequent flyer program. These participants receive
mileage credits on flights operated by Great Lakes under its own identity and on
connecting flights with United. They may also use their awards to travel on
United or Great Lakes flights.
Fuel
The Company has not experienced difficulty with fuel availability and expects to
continue to be able to obtain fuel in quantities sufficient to meet its future
requirements. The Company contracts directly with refiners for the purchase of
portions of its fuel. Standard industry contracts generally do not provide
protection against fuel price increases and do not ensure availability of
supply. Accordingly, an increase in the cost of fuel, if not accompanied by an
equivalent increase in passenger revenues, could have a material adverse impact
on the Company's future operating results. During 2002, the Company's average
price of fuel including taxes and into plane service fees was $1.11 per gallon
as compared to $1.25 in 2001 and $1.26 in 2000. At current rates of consumption,
a one cent increase or decrease in the per gallon price of fuel will increase or
decrease expense by approximately $115,000 annually.
Employees
At March 31, 2003, the Company had 674 full-time and 222 part-time active
employees as compared to 762 full-time and 174 part-time active employees at
December 31, 2001, as follows:
March 31, December 31,
2003 2001
---------- -------------
Classification:
Pilots 233 219
Station personnel 417 484
Maintenance personnel 152 161
Administrative and clerical personnel 66 43
Flight attendants 8 2
Management 20 27
--------- ------------
Total employees 896 936
========= ============
The Company's pilots are represented by the International Brotherhood of
Teamsters. The Company's agreement with the pilots became amendable October 30,
2000, and the Company and the union are negotiating to achieve an agreement. The
members of the union have authorized a strike at some future date if an
agreement is not reached. However, before any work stoppage can occur, the
Federal Mediation Board must release the participants to self help, followed by
a 30-day cooling off period. The Company's flight attendants are also
represented by the International Brotherhood of Teamsters, and the Company's
agreement with the flight attendants became amendable April 1, 2002.
Negotiations with the flight attendants are inactive at the present time.
The Company's mechanics and maintenance clerks are represented by the
International Association of Machinists. The Company's agreement with the
mechanics becomes amendable November 1, 2005, and the Company's agreement with
the maintenance clerks became amendable March 1, 2002. Negotiations with the
maintenance clerks are inactive at the present time.
Charter and Freight Service
The Company uses its Beechcraft and Brasilia aircraft to provide charter
services to private individuals, corporations and athletic teams. The Company
also carries freight, mail and small packages on most of its scheduled flights
and has two Beechcraft 1900C aircraft devoted to providing service under a
subcontract for carriage of mail for the U.S. Postal Service. Revenues from the
Company's charter flights and freight and mail
9
deliveries were 3.8%, 4.1% and 3.8% of the Company's total revenues for the
years ended December 31, 2002, 2001 and 2000, respectively.
Regulation
In accordance with the provisions of the Federal Aviation Act of 1958, as
amended (the "1958 Act"), the Company is an air carrier subject to regulation by
the DOT, primarily with respect to economic matters, and is also subject to
regulation by the FAA with respect to certain safety related matters.
The Company holds an air carrier operating certificate issued by the FAA
pursuant to Part 121 of the FAA's regulations. The Company, as a commuter air
carrier, is licensed under Part 298 of the Economic Regulations of the DOT. The
Company is subject to the jurisdiction of the FAA with respect to its aircraft
maintenance and operations, including equipment, ground facilities, dispatch,
communications, training, weather observation, flight personnel and other
matters affecting air safety. To ensure compliance with its regulations, the FAA
requires airlines to obtain an operating certificate and operations
specifications for the particular aircraft and types of operations conducted by
the carrier, all of which are subject to suspension or revocation for cause.
The Deregulation Act eliminated many regulatory constraints so that airlines
became free to set fares and, with limited exceptions, to establish domestic
routes without the necessity of seeking government approval. The DOT is still
authorized to establish consumer protection regulations; to prohibit certain
pricing practices; to mandate conditions of carriage; and to make ongoing
determinations of a carrier's fitness, willingness and ability to properly and
lawfully provide air transportation. The DOT also has the power to bring
proceedings to enforce its regulations under the 1958 Act and seek penalties,
including the assessment of civil penalties, the revocation of operating
authority and criminal sanctions.
The Aviation and Transportation Security Act requires the adoption of certain
security measures by airlines and airports, including screening of passengers
and baggage. The new security measures are being partially funded by a $2.50 per
flight segment tax on tickets. The Company is responsible for certain security
costs above this level.
The Company is subject to the jurisdiction of the Federal Communications
Commission regarding the use of its radio facilities. Local governments and
authorities in certain markets have adopted regulations governing various
aspects of aircraft operations, including noise abatement, curfews and use of
airport facilities. The Company believes that it is in compliance with all such
regulations.
Insurance
The Company carries the types and amounts of insurance required by the DOT and
customary in the regional airline industry, including coverage for public
liability, property damage, aircraft loss or damage, baggage and cargo liability
and workers' compensation.
As a result of the September 11 terrorist attacks, aviation insurers have
significantly increased premiums for all aviation coverage while dramatically
reducing the amount of coverage available for war-risk occurrences. In response
to the reduction in coverage, the Stabilization Act provided U.S. air carriers
with the option to purchase certain war-risk liability insurance from the U.S.
government on an interim basis at rates that are more favorable than those
available in the private market. The Company has purchased this coverage and
anticipates renewing it for as long as the coverage is available from the U.S.
government. The airlines and insurance industries, together with the U.S. and
other governments, are continuing to evaluate both the cost and options for
providing coverage of aviation insurance. The Company anticipates that it will
follow industry practices with respect to sources of insurance. The Company
believes that its insurance is adequate as to amounts and risks covered. There
can be no assurance, however, that the limits of the Company's insurance will be
sufficient to cover any catastrophic loss.
10
Risk Factors Relating to the Company and the Airline Industry
Dependence on Relationship with United
The Company believes approximately 70% of Great Lakes passenger traffic
currently connects with United flights. As a result of the Company's
relationship with United, the Company's business is sensitive to events and
risks affecting United. If adverse events affect United's business, the
Company's business is also adversely affected. Such events include the outcome
of United's bankruptcy reorganization, changes in United's business plan or
model, employee strikes or job actions, significant curtailment of services or
terrorist events. However, to the extent that the Company is successful in
developing its own identity on its operating system and is successful in
developing its code sharing relationship with Frontier, it will reduce its
dependence on United and mitigate the effects of such adverse events if they
relate to United only.
Terrorist Events
The Company is sensitive to items related to the September 11, 2001 terrorist
attacks, such as the impact of additional airline and security charges on
Company costs, customer demand for travel, cost and availability of war risk and
other aviation insurance, including the federal government's provision of third
party war-risk coverage and the possibility of additional terrorist events which
could cause further customer aversion to air travel.
War
War or other military action by the United States or others could have a
significant effect on passenger traffic.
Dependence on Essential Air Service Revenues
In 2002, 36.2% of the Company's revenues were received as EAS subsidies. EAS
subsidies are expected to remain a significant portion of the Company's revenues
in 2003 and future years. Changes in DOT policies with regard to payment of
subsidies and reduction or loss of subsidies as a result of competitive bidding
may have a substantial impact on the Company.
Effect of General Economic Conditions
The airline industry is significantly affected by general economic conditions.
During recent recessions, most airlines reduced fares in an effort to increase
traffic. The Company does not hedge its fuel purchasing costs. Economic and
competitive conditions in the airline industry have contributed to a number of
bankruptcies and liquidations among airlines. A worsening of current economic
conditions, or an extended period of recession nationally or regionally, would
have a materially adverse effect on the Company's operations.
Fuel Costs
Fuel is a major component of operating expense for all airlines. The Company's
cost of fuel varies directly with market conditions, and the Company has no
guaranteed long-term sources of supply. The Company intends generally to follow
industry trends by raising fares in response to significant fuel price
increases. However, the Company's ability to pass on increased fuel costs
through fare increases may be limited by economic and competitive conditions.
Accordingly, a reduction in the availability or an increase in the price of fuel
could have a material adverse effect on the Company's cash flow from operations
and profitability.
Weather
The Company passenger traffic and costs can be directly impacted by adverse
weather conditions and air traffic control related constraints.
11
Restructuring Agreement
Payments under the Restructuring Agreement signed on December 31, 2002 with
Raytheon are closely aligned with future forecasted cash flows. If the Company
fails to achieve those cash flows, it will be unable to meet its obligations
under that and other agreements. This could result in the demand for immediate
payment of all obligations by the Company's creditors.
Control by Principal Stockholders
Raytheon, the Company's principal creditor, owns approximately 38.2% of the
outstanding shares of the Company's common stock. Raytheon and the Company are
parties to a Restructuring Agreement. See "Business-Restructuring Agreement with
Raytheon."
Mr. Douglas G. Voss, Chairman of the Board of the Company beneficially owns or
controls approximately 38.3% of the outstanding shares of the Company's common
stock. On October 22, 1996, Mr. Voss transferred approximately one-half of the
shares of the Company's common stock owned by him to his ex-spouse, Ms. Gayle R.
Brandt, pursuant to a Marital Dissolution Stipulation and Property Settlement.
Ms. Brandt has granted Mr. Voss an Irrevocable Proxy to vote such securities
until June 28, 2010. Accordingly, Mr. Voss and Raytheon are in a position to
control the management and affairs of the Company.
Noncompliance with the Nasdaq Continued Listing Requirements
The Company's Common Stock was de-listed from The Nasdaq SmallCap Market on
August 14, 2002. As a result of the delisting, the Company's Common Stock has
become subject to certain rules of the SEC relating to "penny stocks." These
rules require broker-dealers to make a suitability determination for purchasers
and to receive the purchaser's prior written consent for a purchase transaction,
thus restricting the ability to purchase or sell the securities in the open
market. Trading of the Company's Common Stock is conducted on the OTC Bulletin
Board, which was established for securities that do not meet Nasdaq listing
requirements. Consequently, trading the Company's Common Stock may be more
difficult, because of lower trading volumes, transaction delays and reduced
security analyst and news media coverage of the Company. These factors could
also contribute to lower prices and larger spreads in the bid and ask prices for
the Company's Common Stock.
Item 2. PROPERTIES
At December 31, 2002, the Company leased gate and ramp facilities at 40 airports
where ticketing, passenger loading and unloading are handled by Company
personnel. Payments to airport authorities for ground facilities are based on a
number of factors, including the amount of space used and flight volume. The
Company also leases aircraft hangar space for maintenance operations at three of
the locations it serves.
Effective January 1, 2000, the Company entered into a lease in Cheyenne,
Wyoming, for approximately 42,000 square feet of space for administration and
maintenance needs. In 2000, the Company constructed an additional leased
facility in Cheyenne. This facility is approximately 54,000 square feet and is
used for administrative, flight operations, maintenance offices, maintenance and
hangar space.
The Company believes that it has adequate facilities for the conduct of its
current and planned operations.
Item 3. LEGAL PROCEEDINGS
On February 27, 2002, Finova Capital Corporation ("Finova") filed suit against
the Company in the United States District Court for the District of Arizona. No.
Civ. 02-0362 PHX SMM. Finova alleged that the Company breached two airplane
lease agreements and sought damages, costs and attorney's fees. On August 1,
2002, Finova and the Company entered into a Settlement Agreement and Covenant
Not to Execute on one of the aircraft. On November 1, 2002, Finova and the
Company entered into a Deferral Agreement which provides for the withdrawal of
the suit and payment of $10,000 per month from October 2002 through March 2003
and $15,000 per month from
12
April 2003 until the end of the lease term on September 30, 2003 for the second
aircraft. Finova and the Company have agreed that prior to the end of the lease
term they will negotiate the other outstanding issues regarding the second
aircraft. The Company has recognized in its accounts the expected cost
associated with these aircraft and these agreements.
The Company is a also a defendant in a lawsuit arising from the collision of a
small aircraft with one of the Company's Beechcraft 1900 aircraft in Quincy,
Illinois on November 19, 1996. The collision occurred at the intersection of two
runways as the Company's aircraft was landing, and resulted in the death of all
10 passengers and the two crewmembers. The Company's insurance carrier is
providing for the Company's defense in the lawsuit and the Company believes that
all claims arising from the accident will be adequately covered by insurance.
The Company is a party to several routine pending legal proceedings, none of
which management believes are material to the Company.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the Company's shareholders during
the three-month period ended December 31, 2002.
Executive Officers of the Registrant
The following table provides information with respect to the Company's executive
officers as of March 15, 2003. Each executive officer has been appointed to
serve until his successor is duly appointed by the Board of Directors or his
earlier removal or resignation from office.
Name Age Title
- ---- --- -----
Douglas G. Voss 48 Chairman of the Board of Directors
Charles R. Howell IV 45 Chief Executive Officer
Michael L. Tuinstra 49 Treasurer
Christopher C. Wilken 32 Controller
James A. Frazier 44 Vice President-Customer Service
Douglas G. Voss. Mr. Voss co-founded the Company in 1979 and served in the
position of Chief Executive Officer from the Company's inception until December
31, 2002. Mr. Voss has served as a director of the Company since the Company's
inception. Mr. Voss became a pilot in 1974 and holds both an Airline Transport
Pilot Certificate and an Airframe and Powerplant Mechanic Certificate. Mr. Voss
is a graduate of Colorado Aero Tech. In 1977 and 1978, Mr. Voss was employed as
a mechanic for a subsidiary of Executive Beechcraft, Inc. Mr. Voss has also
served the Company in a number of operational positions, including Director of
Maintenance and Director of Operations.
Charles R. Howell IV. Mr. Howell became the Chief Executive Officer of the
Company on December 31, 2002. Mr. Howell served as Chief Operating Officer from
August 2002 until December 31, 2002. Prior to joining the Company, Mr. Howell
was the President and Chief Executive Officer of Corporate Airlines, Inc., a
Nashville-based airline that he co-founded in 1996.
Michael L. Tuinstra. Mr. Tuinstra became the Company's Treasurer in January
2002. From August 1998 to January 2002 Mr. Tuinstra served as the Company's
Director of Purchasing and Inventory Control, and prior to this, from August
1998 until April 1999, he was the Company's budget and financial analyst. From
June 1995 until August 1998 Mr. Tuinstra was self employed and was a financial
consultant.
Christopher C. Wilken. Mr. Wilken became the Company's Controller in
January 2002. Mr. Wilken has served the Company in various positions since
November 1987. From March 1999 until January 2002 Mr. Wilken was the Company's
Director of Planning and Financial Analysis, and from August 1996 to March 1999,
he was the Company's Manager of Market Planning. Mr. Wilken is also a commercial
pilot with instructor's ratings and holds airframe and powerplant mechanic's
ratings with inspection authorization.
James A. Frazier. Mr. Frazier joined Great Lakes in March 1990 as Director
of Stations and was promoted to his present position of Vice President of
Customer Service in March 1992.
13
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded under the symbol "GLUX" on the
Over-the-Counter Bulletin Board (the "OTCBB"). The Company's Common Stock began
trading on January 19, 1994, the date of its initial public offering. The
initial public offering price of the Company's Common Stock was $11.00 per
share. On August 14, 2002, the Company's common stock was delisted from the
NASDAQ SmallCap Market as a result of the failure to maintain an average stock
price of at least $1 per share.
The following table sets forth the range of high and low sale prices for the
Company's Common Stock for each of the fiscal quarters for the past two years as
reported by Nasdaq and the OTCBB. These prices represent inter-dealer prices
without adjustments for mark-up, mark-down or commission and do not necessarily
reflect actual transactions.
Stock Quotations High Low
----------------------- ----------- -----------
2002:
First quarter $ 0.64 $ 0.36
Second quarter 0.87 0.35
Third quarter 0.46 0.16
Fourth quarter 0.46 0.12
2001:
First quarter 2.50 0.875
Second quarter 1.75 1.01
Third quarter 1.25 0.40
Fourth quarter 0.75 0.25
As of March 31, 2003, the Company had approximately 375 record holders of its
Common Stock.
The transfer agent for the Company's Common Stock is Wells Fargo Bank Minnesota,
N.A., 161 North Concord Exchange, South St. Paul, Minnesota, 55075-0738,
telephone: (651) 450-4064.
The Company has not paid any dividends on its Common Stock since its initial
public offering in January 1994 and expects that for the foreseeable future it
will follow a policy of retaining earnings in order to finance the continued
development of its business. Payment of dividends is within the discretion of
the Company's Board of Directors and will depend upon the earnings, capital
requirements and operating and financial condition of the Company, and any
applicable restrictive debt and lease covenants, among other factors. Under the
Restructuring Agreement, the Company is prohibited from paying dividends until
after December 31, 2005.
Recent Sales of Unregistered Securities
On December 31, 2002, the Company issued to Raytheon Aircraft Credit Corporation
5,371,980 shares of Common Stock of the Company. The Company issued the shares
to Raytheon as partial consideration for a series of transactions that included
restructured finance terms for aircraft promissory notes, termination of
aircraft operating leases, aircraft purchases, aircraft returns, modified
aircraft operating leases and other debt restructuring. See "Business--
Restructuring Agreement with Raytheon" for a description of the Restructuring
Agreement, including certain continuing rights and obligations of the parties.
The issuance of common stock to Raytheon is exempt from registration pursuant to
Section 4(2) of the Securities Act.
Item 6. SELECTED FINANCIAL AND OPERATING DATA
The following statement of operations and balance sheet data as of and for each
of the years in the five-year period ended December 31, 2002 are derived from
the Company's financial statements. The financial statements for the year ended
December 31, 2002, 2001, 2000, 1999 and 1998 have been audited by KPMG LLP. The
financial statements as of December 31, 2002 and 2001 and for each of the years
in the three-year period ended December 31, 2002 and the report thereon are
included elsewhere in this Form 10-K. The following selected financial data
should be read in conjunction with and are qualified in their entirety by the
financial statements and the notes thereto included elsewhere in this Form 10-K.
The financial statements and selected data do not include any adjustments that
might result from the outcome of the uncertainty over the Company's ability to
continue as a going concern.
14
Year ended December 31,
----------------------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
(In thousands, except per share and selected operating data)
Statement of Operations Data:
Passenger and public service revenues $ 81,330 $ 97,030 $ 126,914 $ 122,890 $ 108,467
Other revenues 3,399 4,410 6,676 8,480 5,565
---------- ---------- ---------- ---------- ----------
Total operating revenues 84,729 101,440 133,590 131,370 114,032
---------- ---------- ---------- ---------- ----------
Operating expenses:
Salaries, wages and benefits 25,856 31,124 35,162 33,037 29,106
Aircraft fuel 12,616 17,514 21,503 16,557 13,974
Aircraft repairs 12,740 15,122 17,491 17,478 9,426
Commissions 871 2,512 4,248 5,796 5,560
Depreciation and amortization 7,012 7,063 7,103 4,779 3,499
Aircraft rental 7,462 8,682 9,226 13,194 16,511
Other rentals and landing fees 5,780 6,363 7,808 6,504 6,375
Other operating expense 18,101 23,689 30,113 25,316 22,922
Impairment of assets and other property 5,470 -- -- -- --
Non-recurring expenses -- -- -- -- 146
---------- ---------- ---------- ---------- ----------
Total operating expenses 95,908 112,069 132,654 122,661 107,519
---------- ---------- ---------- ---------- ----------
Operating (loss) income (11,179) (10,629) 936 8,709 6,513
Interest expense, net (6,643) (9,961) (9,169) (5,974) (3,485)
Federal grant -- 1,927 -- -- --
Gain on insurance recovery 1,438 -- -- -- --
Loss on sale of assets -- -- -- (7) (191)
Gain on extinguishment of debt 5,573 -- -- -- --
---------- ---------- ---------- ---------- ----------
Income (loss) before
income tax expense (10,811) (18,634) (8,233) 2,728 2,837
----------
Income tax expense (benefit) -- 6 -- 115
---------- ---------- ---------- ---------- ----------
Net income (loss) $ (10,811) $ (18,634) $ (8,239) $ 2,728 $ 2,722
========== ========== ========== ========== ==========
Net income (loss) per share: Basic $ (1.24) $ (2.15) $ (0.95) $ 0.32 $ 0.34
========== ========== ========== ========== ==========
Net income (loss) per share: Diluted $ (1.24) $ (2.15) $ (0.95) $ 0.29 $ 0.34
========== ========== ========== ========== ==========
Average number of common shares
outstanding Basic 8,698 8,658 8,646 8,634 7,925
========== ========== ========== ========== ==========
Average number of common shares
outstanding Diluted 8,698 8,658 8,646 9,336 8,703
========== ========== ========== ========== ==========
Balance Sheet Data:
Working capital (deficit) $ (147,246) (121,820) (10,366) (3,112) (3,025)
Total assets 136,182 132,111 143,179 148,876 72,281
Long-term debt, net of current maturities 672 4,727 96,054 98,701 28,471
Stockholders' equity (deficit) (27,158) (18,496) 130 8,619 5,850
Selected Operating Data:
Available seat miles (000s) (1) 358,541 428,707 525,872 526,095 489,213
Revenue passenger miles (000s) (2) 134,236 200,536 265,589 265,733 250,098
Revenue passengers carried 505,176 811,217 1,117,576 1,057,798 873,186
Departures flown 84,933 102,379 126,770 133,423 122,278
Passenger load factor (3) 37.4% 46.8% 50.5% 50.5% 51.1%
Break-even passenger load factor (4) 45.3% 58.0% 52.9% 49.1% 49.3%
Average yield per revenue passenger mile (5) 37.8(cent) 38.8(cent) 42.2(cent) 40.1(cent) 37.4(cent)
Operating cost per available seat mile (6) 25.2(cent) 26.1(cent) 25.2(cent) 23.3(cent) 22.0(cent)
Average passenger fare (7) $ 100.39 95.87 100.25 100.83 107.26
Average passenger trip length (miles) (8) 266 247 238 251 286
Aircraft in service (end of period) 46 52 52 52 53
Destinations served (end of period) 40 48 57 67 71
15
(1) "Available seat miles" or "ASMs" represent the number of seats available
for passengers in scheduled flights multiplied by the number of scheduled
miles those seats are flown.
(2) "Revenue passenger miles" or "RPMs" represent the number of miles flown by
revenue passengers.
(3) "Passenger load factor" represents the percentage of seats filled by
revenue passengers and is calculated by dividing revenue passenger miles by
available seat miles.
(4) "Break-even passenger load factor" represents the percentage of available
seat miles which must be flown by revenue passengers at the average yield
(net of commissions and fees) for airline operations to break even.
(5) "Average yield per revenue passenger mile" represents the average passenger
revenue received for each mile a revenue passenger is carried.
(6) "Operating cost per available seat mile" represents operating expenses
divided by available seat miles.
(7) "Average passenger fare" represents passenger revenue divided by the number
of revenue passengers carried.
(8) "Average passenger trip length" represents revenue passenger miles divided
by the number of revenue passengers carried.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
The discussion and analysis throughout this filing contains certain
forward-looking terminology such as "believes," "anticipates," "will" and
"intends," or comparable terminology. Such statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from those projected. Potential purchasers of the Company's securities are
cautioned not to place undue reliance on such forward-looking statements which
are qualified in their entirety by the cautions and risks described herein and
in other reports filed by the Company with the Securities and Exchange
Commission. See Liquidity and Capital Resources for discussion of the Company's
financial condition.
The Company began providing air charter service in 1979, and has provided
scheduled passenger service in the Upper Midwest since 1981. Beginning in April
1992, the Company operated as a United Express carrier under a cooperative
marketing agreement with United, which terminated on April 30, 2001. The Company
now operates under its own name and as a code sharing partner with United and
Frontier. As of March 1, 2003 the Company provided passenger service to 41
airports in 11 states with 1,433 scheduled departures each week.
16
Results of Operations
For the years ended December 31
-----------------------------------------------------------------------------------------
(Dollars in thousands)
2002 2001 2000
---------------------------------- --------------------------------- --------------------
Cents % Increase Cents % Increase Cents
Per (decrease) Per (decrease) Per
Amount ASM from 2001 Amount ASM from 2000 Amount ASM
-------- ------- ----------- -------- -------- ------------ -------- ----------
Operating revenues
Passenger $ 50,716 (34.8)% 77,753 (30.6)% 112,037
Public service 30,614 58.8 19,276 29.6 14,877
Other 3,399 (22.9) 4,410 (33.9) 6,676
-------- ----- -------- ----- --------
Total operating revenues 84,729 (16.5) 101,439 (24.1) 133,590
-------- ----- -------- ----- --------
Salaries, wages and benefits 25,856 7.2(cent) (16.9) 31,124 7.3(cent) (11.5) 35,162 6.7(cent)
Aircraft fuel 12,616 3.5 (28.0) 17,514 4.1 (18.6) 21,503 4.1
Aircraft maintenance materials
and component repairs 12,740 3.6 (15.8) 15,122 3.6 (13.5) 17,491 3.3
Commissions 871 0.2 (65.3) 2,512 0.6 (40.9) 4,248 0.8
Depreciation and amortization 7,012 2.0 (0.7) 7,063 1.6 (0.6) 7,103 1.4
Aircraft rental 7,462 2.1 (14.1) 8,682 2.0 (5.9) 9,226 1.8
Other rentals and landing fees 5,780 1.6 (9.2) 6,363 1.5 (18.5) 7,808 1.5
Other operating expense 18,101 5.0 (23.6) 23,689 5.5 (21.3) 30,113 5.7
Impairment of assets and other
property (5,470) -- -- -- -- -- -- --
-------- ---- ----- ------- ---- ----- ------- ----
Total operating expenses 95,908 25.2(cent) (19.3)% 112,069 26.1(cent) (15.5)% 132,654 25.2(cent)
-------- ---- ----- ------- ---- ----- ------- ----
Operating income (loss) $(11,179) -- -- (10,630) -- -- 936 --
======== ==== ===== ======= ==== ===== ======= ====
Interest expense, net (6,643) (1.9)(cent) (33.1)% (9,931) 2.4(cent) 8.3% (9,169) (1.7)(cent)
======== ==== ===== ======= ==== ===== ======= ====
Gain on insurance recovery 1,438 -- --
======== ======= ======
Gain on extinguishment of debt 5,573 -- --
======== ======= ======
Increase (decrease) Increase (decrease)
2002 from 2001 2001 from 2000 2000
----------- ------------------ -------- ------------------- ---------
Available Seat Miles (000s) 358,541 (16.4)% 428,707 (18.5)% 525,872
Revenue Passenger Miles (000s) 134,236 (33.1)% 200,536 (24.5)% 265,589
Passenger Load Factor 37.4% (20.0)% 46.8% (7.4)% 50.5%
Average Yield per Revenue Passenger Mile 37.8(cent) (2.6)% 38.8(cent) (8.1)% 42.2(cent)
Cost per ASM 25.2(cent) (3.5)% 26.1(cent) 3.7% 25.2(cent)
17
Comparison of 2002 to 2001
Passenger Revenues: Passenger revenues and revenue passenger miles decreased
34.8% and 33.1% respectively, from 2001. Although the Company discontinued
service to four cities during the year the decrease was largely due to the
continued industry wide decline in passenger traffic following the September 11
terrorist attacks.
Public Service Revenues: Public service revenues collected through the Essential
Air Service program increased 58.8% in 2002 compared to 2001. As a result of the
September 11 terrorist attacks, the Department of Transportation, in Order
number 2002-2-13, entitled "Order Authorizing Emergency Essential Air Service
Payments," provided for an immediate increase in all subsidized rates effective
retroactively to October 1, 2001. This order also began the process of
renegotiating all of the Company's subsidy contracts as of October 1, 2001 to
recognize the effects of the September 11 attacks on airline operations,
specifically higher insurance costs and lower passenger revenues.
Other Revenues: Other revenues declined 23.0% to $3.4 million in 2002. Freight
revenue decreased as a result of reduced capacity and increased security
requirements governing the acceptance of air freight following the September 11
terrorist acts. Charter revenues were down as a result of the non-renewal of
various university charter contracts.
Operating Expenses: Total operating expenses decreased 19.3%, or $21.7 million,
in 2002 compared to 2001. Cost per ASM decreased 3.5% from 2001 to 25.2 cents
per ASM. The suspension of service following the September 11 terrorist attacks
and the ensuing reduced schedule had a significant impact upon direct operating
costs.
Salaries, wages, and benefits decreased 16.9% to $25.9 million from 2001 as a
result of reductions in staffing levels, pay rates, hours worked and the closing
of service to and from some cities.
Aircraft fuel expense was down 28.0% in 2002. The decrease is attributed to the
continued flight schedule reductions following the September 11 terrorist
attacks. The Company benefited from flat average fuel costs through the first
three quarters. Rising fuel costs in the fourth quarter were offset by the usual
seasonal reduction in scheduled operations. The average per gallon rate
decreased 11.2% to $1.11 for the year.
Aircraft maintenance, materials and component repair expense was 3.6 cents per
ASM for both 2002 and 2001. The reduction in expense to $12.7 million
corresponds with the reduction of ASMs.
Commissions decreased 65.3% to $0.9 million in 2002 from $2.5 million in 2001 as
a result of lower travel agency commission rates, decreased gross revenues and
increasing direct sales. Following a majority of the airline industry, the
Company discontinued paying commissions to travel agents on tickets sold after
June 12, 2002.
Depreciation expenses were largely flat due to the Company's owned aircraft
fleet remaining substantially unchanged during the year from 2001.
Aircraft lease expense decreased 14.1% in 2002 to $7.5 million from $8.7 million
in 2001 as a result of the termination of a lease of one EMB-120 and two Beech
1900D aircraft. As of March 31, 2002, one of two EMB-120 aircraft leased from
Finova Corporation was returned to the lessor, and the lease was terminated. At
January 1, 2002, the Company was leasing one aircraft, a Beech 1900D, from an
affiliated company. Effective March 31, 2002, the aircraft was returned to the
lessor. On May 14, 2002, a leased Beech 1900D was one of two aircraft destroyed
in a hangar fire, and lease rentals ceased May 31, 2002. The second aircraft
destroyed in the fire was a Company-owned Beech 1900D aircraft.
Other rentals and landing fees decreased 9.2% in 2002. Landing fees were reduced
in conjunction with a corresponding decrease in total landings.
18
Other operating expenses decreased 23.6% in 2002 to $18.1 million from $23.7
million in 2001, representing a 0.5 cent per ASM reduction in cost. The decrease
is primarily due to the elimination of certain fees associated with the former
United Express agreement, lower levels of operations and other actions that were
taken to reduce costs.
The decrease in interest expense from $9.9 million in 2001 to $6.6 million in
2002 was primarily due to reduced interest rates as the majority of the
Company's fleet is financed at variable interest rates. Also, one Company-owned
Beech 1900D with debt of $3.2 million was destroyed in a hangar fire. In
addition, on April 30, 2002 the Company fully paid and terminated its line of
credit with Coast Business Credit.
Income Tax Expense (benefit): The realization of any benefits remains
substantially in doubt as the Company continues in its loss carry forward
position.
Gain on Insurance Recovery: The Company recorded a gain of $1.4 million in
connection with receipt of insurance proceeds for two aircraft destroyed in a
hangar fire. See "Busines--Aircraft" above.
Impairment of Assets and Gain on Extinguishment of Debt: The Company recognized
an impairment loss of $5.5 million and recognized a gain on extinguishment of
debt of $5.6 million in connection with the recording of the Restructuring
Agreement with Raytheon. See "--Restructuring Agreement with Raytheon Aircraft
Credit Corporation."
Comparison of 2001 to 2000
Passenger Revenues: Passenger revenues and revenue passenger miles decreased
30.6% and 24.5%, respectively, from 2000. As the Company continued to shift its
operational focus to the Denver hub, service was discontinued at a total of 10
cities serving Chicago O'Hare Airport by the end of the second quarter of 2001.
Service was also discontinued at Meigs Lakefront Airport in Chicago during
August 2001. These closings resulted in a 47% reduction in total departures for
the Chicago market. The closing of service to and from these cities contributed
to a reduction in yield as the traffic mix was primarily business oriented. The
suspension of air service following the terrorist attacks of September 11 and a
subsequent 39% decrease in passengers flown during the fourth quarter of 2001 as
compared to the first and second quarters further contributed to the decline in
revenue for 2001.
Public Service Revenues: Public service revenues collected through the EAS
program increased 29.6% in 2001 compared to 2000. While EAS service was
discontinued at Mattoon, Illinois; Ottumwa, Iowa; and Yankton, South Dakota;
service was added at Page, Arizona and Moab and Vernal, Utah. The Company
further negotiated and became eligible to collect subsidy for service to Pierre,
South Dakota.
As a result of the September 11 terrorist attacks, the Department of
Transportation, in Order number 2002-2-13, entitled "Order Authorizing Emergency
Essential Air Service Payments," provided for an immediate increase in all
subsidized rates effective retroactively to October 1, 2001. This order also
began the process of renegotiating all of the Company's subsidy contracts as of
October 1, 2001 to recognize the effects of the September 11 attacks on airline
operations, specifically higher insurance costs and lower passenger revenues.
These renegotiated rates superseded the interim rates through the normal end of
the contract period.
Other Revenues: Other revenues declined 33.9% in 2001. Freight revenue decreased
as a result of reduced capacity and increased security requirements governing
the acceptance of air freight following the September 11 terrorist attacks.
Charter revenues were down as a result of the cancellation of various university
charters following the highly publicized fatal accident in January 2001,
involving another charter operator and the Oklahoma State University basketball
team. These revenue losses were partially offset by an increase in December
2001, of the per pound rate paid by the U.S. Postal Service for mail carried on
the Company's air mail routes.
Operating Expenses: Total operating expenses decreased 15.5%, or $20.6 million
in 2001 compared to 2000. Cost per ASM increased 3.5% over 2000 to 26.1 cents
per ASM. The suspension of service following the September 11 terrorist attacks
and the ensuing reduced schedule had a significant impact upon direct operating
costs.
Salaries, wages, and benefits decreased $4.0 million from 2000 as a result of
employee furloughs, pay reductions, and pay freezes following the September 11
terrorist attacks.
Aircraft fuel expense was down 18.6% in 2001 on flat average fuel costs of $1.25
per gallon. Overall consumption was down 18.2% in 2001 as a result of reduced
flying.
Aircraft maintenance, materials and repairs showed a 13.5% decrease in 2001 from
an overall reduction in flights year over year and the reduction of utilization
of the Company's aircraft.
19
Commissions were down 40.9% in 2001 because of a corresponding decrease in
passenger revenue, further reductions in the number of tickets purchased through
travel agencies and continuing decreases in commission rates.
Depreciation and amortization and aircraft rental expenses were largely flat due
to the Company's aircraft fleet composition remaining unchanged from 2000.
Other rentals and landing fees decreased 18.5% in 2001 with no net change in
cost per ASM. Other rentals including terminal facilities expense at various
airports decreased as a result of the discontinuation of service in 15 markets.
Landing fees were reduced in conjunction with a corresponding decrease in total
landings.
Other operating expenses decreased 21.3% from 2000, representing a 0.2 cent per
ASM reduction in cost. The reduction was largely the result of the termination
of the United Airlines / United Express marketing agreement and its associated
franchise and marketing fees. Ongoing cost cutting efforts further contributed
to the reduction in expenses.
The Company recognized a grant of $1.9 million from the Air Transportation
Safety and System Stabilization Act, passed by Congress and signed into law by
President Bush on September 22, 2001.
Income Tax Expense (benefit): The realization of any benefits from the Company's
net operating loss carry forward is substantially in doubt.
Liquidity and Capital Resources
The Company's cash and cash equivalents balance at December 31, 2002 was
$358,000, down from $1.5 million at December 31, 2001. The Company had negative
working capital of $147.2 million at December 31, 2002.
While the Company experienced a net loss of $10.8 million for the year 2002,
cash of $6.1 million was provided by operating activities primarily as a result
of non cash depreciation and amortization charges of $7.0 million and increases
in accounts payable and accrued liabilities which includes the non-payment of
interest and the deferral of lease payments totaling $8.3 million. Recording of
the Restructuring Agreement as of December 31, 2002, included a charge for
impairment of assets and other property of $5.5 million that was offset by a
non-cash gain on extinguishment of debt of $5.6 million.
The $6.1 million of cash provided from operations and the $2.2 million proceeds
from the hangar fire insurance recovery were the primary sources of funds used
to retire a working capital line of credit balance of $4.6 million and reduce
notes payable and long-term debt by $4.4 million.
Following the terrorist attacks of September 11 and due to the continued
downturn in the economy, the Company suffered substantial losses during the
fourth quarter of 2001 and the year 2002. These losses produced a significant
reduction in liquidity as well as rendering a number of aircraft surplus to the
Company's reduced level of operations. Because of these financial difficulties,
the Company missed contractual debt and lease payments during these periods and
made only minor payments on its debt and lease obligations. As a result, debt of
$111.0 million was in default and the Company was in arrears on lease payment
obligations which totaled $11.3 million at December 31, 2002, immediately prior
to the restructuring discussed below. Of these amounts, $106.0 million and $6.8
million, respectively, were owed to Raytheon.
Restructuring Agreement with Raytheon Aircraft Credit Corporation. On December
31, 2002, the Company finalized an agreement (the Restructuring Agreement) with
Raytheon Aircraft Credit Corporation (Raytheon) regarding lease and debt
financing provided by Raytheon for the Company's Beechcraft 1900C and 1900D
aircraft fleet. The complex nature of the Restructuring Agreement included
separate provisions for i) the termination and/or modification of aircraft
operating leases, ii) the return of aircraft in satisfaction of indebtedness
obligations, iii) the modification of principal and interest rates for various
20
aircraft financing promissory notes, and iv) a restructuring of other
indebtedness by means of an issuance of new debt instruments and equity. For
purposes of accounting for the Restructuring Agreement, the Company has
identified the major types of transactions contained within the Restructuring
Agreement in order to more accurately apply the appropriate accounting treatment
to each type of transaction. Transactions involving the termination and/or
modification of aircraft operating leases have been accounted for pursuant to
the provisions of Statement of Financial Accounting Standards No. 13, Accounting
for Leases (SFAS 13), while the restructuring of indebtedness owed by the
Company to Raytheon has been accounted for in accordance with the provisions of
Statement of Financial Accounting Standards No. 15, Accounting for Debtors and
Creditors for Troubled Debt Restructurings (SFAS 15). Accordingly, the major
elements of the Restructuring Agreement and the Company's accounting treatment
of those transactions are as follows:
(a) Return of Aircraft
The Company has agreed to return seven Beechcraft 1900D aircraft to Raytheon
during 2003 in exchange for the cancellation and extinguishment of one operating
lease and six promissory notes. Because the Company will incur repair and
refurbishment expenses during 2003 in order to return the aircraft to Raytheon
in good working order, the Company has recognized a liability of $4 million for
such expenditures. In addition, and in accordance with the provisions of SFAS 15
regarding the satisfaction of debt by a transfer of assets, the Company has
adjusted the net book value of the six owned aircraft down to the aircrafts'
fair market value of $15 million, and has recognized an impairment loss of $5.5
million. Upon return of the aircraft to Raytheon in 2003, the Company expects to
reduce its outstanding aircraft debt and lease liabilities for these seven
aircraft by $20.9 million and record a gain from exinguishment of debt of $5.4
million.
(b) Termination of Aircraft Operating Leases/Financed Purchase of Aircraft
Pursuant to the terms of the Restructuring Agreement, operating leases for nine
Beechcraft 1900D aircraft (the "Purchased Aircraft") have been converted to
aircraft ownership with purchase money financing. The Company has recorded the
purchase of the nine aircraft at a total fair market value of $22.5 million with
a corresponding increase in long-term aircraft debt. Interest will accrue on the
unpaid principal balance of the new debt at the rate of LIBOR plus 375 basis
points per annum. Payments of principal and accrued interest are to be made in
120 monthly installments, with the amount of the monthly payment to be adjusted
quarterly to reflect any change in the LIBOR rate.
(c) Restructured Financing Terms for Aircraft Promissory Notes
The Company obtained amended debt financing for 21 Beechcraft 1900D aircraft
promissory notes (the "Restructured Aircraft Notes") in the amount of $52.5
million. Each of the Restructured Aircraft Notes reflects an initial principal
balance in the amount of $2.5 million with interest to accrue on the unpaid
principal balance at the rate of LIBOR plus 375 basis points per annum. Payments
of principal and accrued interest are to be made in 120 monthly installments,
with the amount of monthly payment to be adjusted quarterly to reflect any
change in the LIBOR rate. Total cash payments for all of the Restructured
Aircraft Notes is estimated to be $68.1 million over the term of the notes.
(d) Accounting for Refinancing of Aircraft Debt and Lease Obligations under
SFAS 15
Consistent with SFAS 15, the restructured financing terms for all 30 of the
Beechcraft 1900D aircraft debt and lease obligations discussed in (b) and (c)
above (the "Old Aircraft Debt") has been accounted for as a troubled debt
restructuring. SFAS 15 states that in a troubled debt restructuring, the debtor
shall account for the effects of the restructuring prospectively from the time
of restructuring and shall not reduce the carrying amount of the existing debt
unless the carrying amount of the existing debt exceeds the total future cash
payments of the new debt under the restructured terms. Included in the carrying
value of restructured debt and lease obligations were $3.7 million of deferred
gains and other deferred credits. The effects of any changes in the face amount
or interest rate are to be amortized in future periods by reducing interest
expense to an effective interest rate which equates the net present value of the
future cash payments under the modified terms to the carrying value on the
debtor's books.
21
After increasing the Company's liabilities by $22.5 million for financing of the
Purchased Aircraft, the carrying value on the Company's books for the Old
Aircraft Debt was $101.3 million, while total future cash flows for the thirty
(30) new and amended aircraft promissory notes (the "New Aircraft Debt") was
estimated to be $95.7 million. In accordance with the provisions of SFAS 15, the
amount of the Company's long-term liabilities has been reduced by $5.6 million
in order to reflect the carrying value of the Old Aircraft Debt to an amount not
more than the estimated future cash flows of the New Aircraft Debt. The $20.7
million difference between the $95.7 million restructured value of the Old
Aircraft Debt and the $75 million principal amount of the New Aircraft Debt will
be amortized as a reduction to the Company's interest expense over the next ten
years.
(e) Modification of Terms for Aircraft Operating Leases
Pursuant to the terms of the Restructuring Agreement, $384,000 of pre-12/31/02
unpaid lease payments on two Beechcraft 1900C aircraft operating leases has been
contractually extinguished and the Company negotiated a reduction in the monthly
lease payments for the two leases, which is anticipated to yield net cash flow
savings of $1.2 million over the next ten years. The $384,000 liability will
remain on the Company's books and be amortized over a period of 120 months.
(f) Other Debt Restructuring Involving Partial Settlement Through Issuance
of Equity
$14.9 million of outstanding principal and accrued interest on various
non-aircraft debt was restructured into three new promissory notes (the
"Non-Aircraft Debt") with a total principal amount of $11.2 million and
estimated future cash payments of $15.2 million. In addition, the Company issued
5,371,980 shares of the Company's common stock to Raytheon, representing a 38.2%
interest in the Company's outstanding post-restructuring shares of common stock.
The restructuring of the Non-Aircraft Debt through the issuance of equity and
new debt obligation(s) was accounted for in compliance with SFAS 15. The new
debt obligations were recorded at the carrying amount of the prior debt
obligation(s), less the fair value of the equity granted to Raytheon. The
Company has determined that, on the effective date of the Restructuring
Agreement, the fair market value of the equity interest granted to Raytheon was
$2.1 million. Accordingly, the Company has reduced $14.9 million of Non-Aircraft
Debt by $2.1 million to a net carrying amount of $12.8 million, and has recorded
an increase of $2.1 million in shareholders' equity.
(g) Board of Director Observer Rights
As further consideration for the concessions granted by Raytheon in the
Restructuring Agreement, the Company has granted Raytheon observer rights for
the Company's Board of Directors, but without any right to vote or enter into
any discussions at any Board of Directors meetings.
As a result of continued declines in traffic and fare levels as well as slower
receipt of essential air service payments, the Company did not make its February
and March payments under the Restructuring Agreement to Raytheon and will not
make the payments due Raytheon in April 2003. In addition the Company is not in
compliance with certain financial covenants contained in that Agreement. On
April 14, 2003, Raytheon waived the foregoing requirements until June 15, 2003.
22
A summary of the obligations immediately preceding the restructuring, the
contractual obligations after the restructuring and the recording of the
restructuring in accordance with SFAS 13 and 15 is set forth below.
RESTRUCTURING OF RAYTHEON AIRCRAFT CREDIT CORPORATION OBLIGATIONS
at December 31, 2002
Prior to Restructured Contractual Recorded in Accordance
Restructuring Obligation with SFAS 15
Interest Interest
Amount Amount Rate Amount Rate
- -----------------------------------------------------------------------------------------------------------------------------------
21 Aircraft owned and retained by $ 71,166,954 $ 52,500,000 LIBOR + 375 $ 66,514,494 0.0%
Great Lakes - notes payable, unpaid basis points initially
interest and other accrued credits 5.13%
initially
- -----------------------------------------------------------------------------------------------------------------------------------
9 Aircraft under operating leases 7,609,117 22,500,000 LIBOR + 375 29,188,957 0.0%
purchased by Great Lakes - unpaid basis points initially
lease installments, accrued credits 5.13%
and purchase price initially
- -----------------------------------------------------------------------------------------------------------------------------------
6 Aircraft owned by Great Lakes to 20,331,001 20,331,001 None 20,331,001 None
be returned to Raytheon and unpaid
obligations cancelled - notes
payable, unpaid interest and other
accrued credits
- -----------------------------------------------------------------------------------------------------------------------------------
1 Aircraft to be returned to 577,276 577,276 None 577,276 None
Raytheon and unpaid lease
installments cancelled in 2003 and
other accrued credits
- -----------------------------------------------------------------------------------------------------------------------------------
2 1900C Aircraft under operating 384,000 -- None 384,000 None
leases to be retained by Great
Lakes - unpaid lease installments
cancelled and are to be amortized
over remaining terms of the leases
- -----------------------------------------------------------------------------------------------------------------------------------
Other notes payable and unpaid 14,987,735
interest
Deferral Note 1,200,000 LIBOR + 375 1,200,000 LIBOR + 375
basis points basis points
Senior Note 5,000,000 8.25% 6,087,713 6.8%
Subordinated Note 5,000,000 6.00% 5,551,231 2.5%
Equity 5,371,980 shares of 2,148,792 2,148,792
common stock
- -----------------------------------------------------------------------------------------------------------------------------------
Other Financing
The Company has also renegotiated agreements with three other creditors who
provide the financing for six of the Company's seven Brasilia aircraft. In
August 2002, the Company entered into a settlement with Finova Capital
Corporation ("Finova") with respect to an aircraft returned to Finova. As a part
of that agreement, the Company agreed to pay Finova a total of $727,589 with
interest at 10% over a period of 48 months. The Company retained
23
the second aircraft leased from Finova and agreed to pay Finova $10,000 per
month from October 2002 through March 2003 and $15,000 per month from April 2003
until the end of the lease term on September 30, 2003. For the period prior to
September 30, 2003 the parties have agreed to negotiate a settlement of amounts
due under the lease agreement and for unpaid rentals and return condition of the
remaining aircraft.
At December 31, 2002, the Company was in arrears on rental payments to Boeing
Capital Corporation ("Boeing") for lease of two Brasilia aircraft in the amount
of $3.4 million. Subsequent to year-end, the Company entered into a letter
agreement with Boeing, effective as of December 31, 2002, to cancel the unpaid
lease installments, to reduce the monthly rental payments through the end of the
lease terms in 2013, requiring the Company to fund major overhauls in advance
and giving Boeing the right to terminate the leases at its option with six
months notice. Boeing will receive shares of redeemable preferred stock valued
at $4.5 million. The Company intends to file a Certificate of Designation
setting forth the terms of the redeemable preferred stock by April 30, 2003. The
parties will further document the terms and conditions of the lease
restructuring by that date.
At December 31, 2002, Great Lakes had three notes payable to The CIT
Group/Equipment Financing, Inc. ("CIT") Corporation with interest at 8.7% to
9.08%, totaling $5.0 million for financing of three of its Brasilia aircraft, of
which $214,000 was in arrears. In April 2003, the notes were combined and
modified to provide for reduced monthly payments through March 2008 at an
interest rate of LIBOR plus 275 basis points.
Debt Service
The restructured financing agreements with creditors are based in part on a
financial model that contains forecasts of expected revenues, expenses and cash
flows. Payments to creditors are closely aligned with expected cash flows, and
any shortfall in these cash flows would have an immediate effect on the
Company's ability to meet its payment obligations under its debt restructuring
agreements. There are significant uncertainties regarding the Company's ability
to achieve the required cash flows because of the unknown outcome of United's
attempt to reorganize under its bankruptcy filing, volatility of fuel prices,
unknown effects of the Iraq conflict and general economic conditions. The
foregoing uncertainties are outside the control of the Company, and the Company
has no alternative source of funding or financing to provide sufficient cash to
continue operations if the Company does not achieve its forecasted cash flows.
If the Company is unable to make the payments required under the restructuring
agreements, it will be required to attempt to renegotiate its payment schedule
with its current creditors. There can be no assurance that creditors will be
willing or able to renegotiate such payments.
At December 31, 2002, the Company was in compliance with its debt agreements or
had obtained amendments or short-term waivers from its lenders with respect to
any nonpayment of scheduled debt installments or noncompliance with financial
covenants. However, the Company cannot determine with a high degree of
confidence that it will be able to make the required payments or remain in
compliance with the agreements during the year 2003. Therefore the amount of
debt that by its terms would otherwise be due after one year is shown as
long-term obligations classified as current.
As a result of the significant uncertainties concerning the Company's ability to
achieve the results contained in its financial model and to pay its obligations
as they become due, there is substantial doubt as to the Company's ability to
continue as a going concern. The accompanying financial statements have been
prepared on a going concern basis which assumes continuity of operations and
realization of assets and liabilities in the ordinary course of business. The
financial statements do not include any adjustments that might result if the
Company were forced to discontinue operations.
The Company's financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in note 1 to the financial
statements, the Company has suffered significant losses in the years ended
December 31, 2002 and 2001, and had liabilities in excess of assets at December
31, 2002. The auditor's report dated March 17, 2003 on the Company's financial
statements states that these matters raise substantial doubt about the Company's
ability to continue as a going concern.
The terrorist attacks of September 11, brought about an immediate reduction of
passenger traffic as well as additional costs. The Company adjusted its level of
operations to better match the available traffic along with retiming its
schedules to align them with United's reduced capacity at Denver.
Since September 11, 2001, the Company has aggressively reduced its operations to
match as closely as possible its service to available traffic and the reduced
level of capacity by United and has instituted an aggressive cost control
24
program. It has also concentrated on maintaining and expanding its service in
markets eligible for government subsidy. At the end of 2002, approximately 54%
of its operations were in markets eligible for subsidy support.
Essential Air Service: The DOT also recognized the change in economics as a
result of September 11 for carriers providing service to Essential Air Service
cities and ordered the renegotiation of all subsidy contracts retroactive to
October 1, 2001. DOT Order 2002-2-13 provided for the adjustment of subsidy
payments to recognize lower levels of passenger revenues and compensate carriers
for higher levels of costs such as insurance and security.
Contracts with the DOT for providing Essential Air Service, while nominally
permitting a 5% margin on costs, have usually been negotiated against an overall
program funding limitation by Congress, which has resulted in carriers accepting
a subsidy rate that historically was not fully compensatory. With the enactment
of the Air Transportation Safety and System Stabilization Act and associated
increased funding, Congress appropriated a total of $113 million to compensate
EAS carriers for their total increased costs, including costs resulting from
September 11. This compares to an EAS subsidy level of $50 million for the
federal fiscal year ended September 30, 2001. The Company received approximately
$30.6 million of EAS subsidies in 2002 to compensate it for service it provides
to small cities as compared to $19.3 million in 2001. The total amount of
subsidy ultimately received over an extended period is determined by, among
other things, overall funding levels to the DOT by Congress, competitive bids by
other carriers, schedule modifications at the request of the DOT and the
Company's optimization of its schedules.
Relationship with United: Great Lakes may be impacted in the future by the
outcome of United's reorganization or liquidation in bankruptcy. Successful
reorganization by United may include changes in code sharing relationships under
a new business plan and changes in scope clauses contained in United's contract
with its pilots. As is the case with many of the major carriers, in the past,
United has agreed with its pilots to specific limits on the number of turboprop
and regional jet aircraft that may be operated by its affiliates, either as a
United Express or a code-sharing partner, in relation to the number of jet
aircraft that are flown by United pilots. The Company cannot predict what
limitations, if any, may be included in a United agreement with its pilots
negotiated as part of its reorganization. A liquidation would have a significant
impact on the Company's connecting traffic at Denver until Frontier increases
its service or a replacement carrier increases its operations and the Company is
able to enter into a marketing agreement with that carrier. There could also be
an increase in demand for the Company's services as service to smaller cities
currently receiving uneconomical jet service is discontinued.
Contractual Obligations
The following table summarizes our major contractual obligations as of December
31, 2002:
2003 2004, 2005 2006, 2007 After 2007 Total
---------------- ---------------- ---------------- ---------------- -----------------
Long-term debt $ 8,922,045 17,477,719 24,319,137 59,822,556 110,541,457
SFAS 15 amortization 3,431,059 6,263,545 6,312,842 6,334,949 22,342,395
---------------- ---------------- ---------------- ---------------- -----------------
Total debt $ 12,353,104 23,741,264 30,631,979 66,157,505 132,883,852
Operating leases 1,436,000 2,232,000 2,328,000 6,862,000 12,858,000
---------------- ---------------- ---------------- ---------------- -----------------
Total Obligations $ 13,789,104 25,973,264 32,959,979 73,019,505 145,741,852
================ ================ ================ ================ =================
See notes 3 and 4 to the financial statements.
Critical Accounting Policies and Estimates
The preparation of the Company's financial statements in conformity with
accounting principles generally accepted in the United States of America
requires the use of estimates, judgments and assumptions that affect the
reported
25
amounts of assets and liabilities as of the date of the financial statements,
revenues and expenses during the reporting period and related disclosures of
contingent assets and liabilities in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
The U.S. Securities and Exchange Commission ("SEC") has defined a company's most
critical accounting policies as the ones that are most important to the
portrayal of the Company's financial condition and results, and that require the
company to make its most difficult and subjective judgments, often as a result
of the need to make estimates of matters that are inherently uncertain. Based on
this definition, the Company has identified its critical accounting policies as
including those addressed below. The Company also has other key accounting
policies, which involve the use of estimates, judgments and assumptions. See
Note 3 "Summary of Significant Accounting Policies and Procedures" in the Notes
to the Financial Statements for additional discussion of these items. Management
believes that its estimates and assumptions are reasonable, based on information
presently available; however, changes in these estimates, judgments and
assumptions will occur as a result of future events. Accordingly, actual results
could differ from amounts estimated.
Passenger revenues. The Company recognizes revenues from ticket sales when the
service is provided and records as a liability amounts received for service to
be provided in the future. To the extent that a passenger travels using a joint
fare that provides for a portion of the service to be provided by another
airline, the amount of the ticket is apportioned to the carrying airline based
upon contractual formulas which approximate usual industry standard formulas for
sharing of ticket revenues.
Essential Air Service Subsidy Rates. EAS revenues are recorded based on
completed contracts for providing service to individual cities and estimated
revenues based upon contract negotiations that are in process and could change
once the agreements are finalized.
Estimated lives used to record depreciation on aircraft and obsolescence
reserves for aircraft parts inventories. The estimated lives used to record
depreciation may be affected by passenger traffic and fare levels, technology,
policies regarding EAS subsidies promulgated by the DOT and changes in strategy
by the Company. The foregoing may impact depreciation rates, impair