10-Q 1 q31610q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2016
 
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________ to ________

Commission file number 001-36718
______________________

VIRGIN AMERICA INC.
(Exact name of registrant as specified in its charter)
______________________
Delaware
 
20-1585173
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
 
555 Airport Boulevard
Burlingame, CA 94010
(Address of Principal Executive Offices) (Zip Code)

(650) 762-7000
(Registrant's telephone number, including area code)
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
As of October 24, 2016, the registrant had 44,741,386 shares of common stock outstanding.






Virgin America Inc.
FORM 10-Q
INDEX
PART I
FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II
OTHER INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

i


PART I. FINANCIAL INFORMATION
ITEM 1.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Virgin America Inc.
Condensed Consolidated Balance Sheets
(In thousands)

 
September 30, 2016
 
December 31, 2015
 
(Unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
614,278

 
$
496,349

Receivables, net
37,218

 
19,556

Prepaid expenses and other assets
17,940

 
10,675

Total current assets
669,436

 
526,580

Property and equipment:
 
 

Flight equipment
645,345

 
373,199

Ground and other equipment
99,474

 
85,471

Less accumulated depreciation and amortization
(118,586
)
 
(92,173
)
 
626,233

 
366,497

Pre-delivery payments for flight equipment
25,960

 
72,402

Total property and equipment, net
652,193

 
438,899

Aircraft maintenance deposits
235,376

 
216,207

Aircraft lease deposits
57,287

 
58,330

Restricted cash
21,559

 
19,800

Deferred income taxes
91,776

 
171,443

Other non-current assets
166,639

 
137,272

 
572,637

 
603,052

Total assets
$
1,894,266

 
$
1,568,531





See accompanying notes to the condensed consolidated financial statements.

3



Virgin America Inc.
Condensed Consolidated Balance Sheets
(In thousands)

 
September 30, 2016
 
December 31, 2015
 
(Unaudited)
 
 
Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
52,762

 
$
76,603

Air traffic liability
230,623

 
174,853

Other current liabilities
117,972

 
117,135

Long-term debt-current portion
30,581

 
48,843

Total current liabilities
431,938

 
417,434

Long-term debt
395,881

 
216,477

Long-term debt-related parties
45,505

 
42,421

Other long-term liabilities
81,733

 
84,052

Total liabilities
955,057

 
760,384

Contingencies and commitments (Note 5)

 

Stockholders’ equity
 
 

Preferred stock

 

Common stock
444

 
442

Treasury stock
(6,856
)
 
(5,038
)
Additional paid-in capital
1,260,223

 
1,251,524

Accumulated deficit
(305,123
)
 
(412,479
)
Accumulated other comprehensive loss
(9,479
)
 
(26,302
)
Total stockholders’ equity
939,209

 
808,147

Total liabilities and stockholders’ equity
$
1,894,266

 
$
1,568,531





See accompanying notes to the condensed consolidated financial statements.

4



Virgin America Inc.
Consolidated Statements of Operations
(In thousands, except per share data) (Unaudited)


 
Three months ended September 30,
 
Nine months ended September 30,
 
2016
 
2015
 
2016
 
2015
Operating revenues:
 
 
 
 
 
 
 
Passenger
$
395,817

 
$
366,089

 
$
1,095,953

 
$
1,015,162

Other
49,368

 
44,792

 
138,967

 
122,957

Total operating revenues
445,185

 
410,881

 
1,234,920

 
1,138,119

Operating expenses:
 
 
 
 
 
 
 
Salaries, wages and benefits
82,759

 
74,995

 
244,772

 
214,485

Aircraft fuel
76,566

 
86,480

 
218,237

 
268,781

Aircraft rent
47,901

 
47,088

 
143,008

 
137,779

Landing fees and other rents
41,389

 
38,128

 
121,286

 
106,181

Sales and marketing
35,845

 
32,632

 
103,663

 
89,715

Aircraft maintenance
17,112

 
15,838

 
50,844

 
42,327

Depreciation and amortization
10,582

 
4,465

 
27,860

 
12,792

Other operating expenses
42,377

 
37,387

 
133,497

 
109,150

Total operating expenses
354,531

 
337,013

 
1,043,167

 
981,210

Operating income:
90,654

 
73,868

 
191,753

 
156,909

Other expense:
 
 
 
 
 
 
 
Interest expense
(5,028
)
 
(1,672
)
 
(12,816
)
 
(4,503
)
Interest expense-related-party
(1,036
)
 
(953
)
 
(3,085
)
 
(2,581
)
Capitalized interest

 
1,100

 
635

 
3,409

Other income (expense), net
134

 
(95
)
 
425

 
(2,523
)
Total other expense
(5,930
)
 
(1,620
)
 
(14,841
)
 
(6,198
)
Income before income tax
84,724

 
72,248

 
176,912

 
150,711

Income tax expense
32,926

 
392

 
69,556

 
1,081

Net income
$
51,798

 
$
71,856

 
$
107,356

 
$
149,630

Net income per share:
 
 
 
 
 
 
 
Basic
$
1.17

 
$
1.65

 
$
2.42

 
$
3.45

Diluted
$
1.15

 
$
1.61

 
$
2.39

 
$
3.36

Shares used for computation:
 
 
 
 
 
 
 
Basic
44,407

 
43,642

 
44,319

 
43,375

Diluted
45,018

 
44,588

 
44,855

 
44,554




See accompanying notes to the condensed consolidated financial statements

5


Virgin America Inc.
Consolidated Statements of Comprehensive Income
(In thousands) (Unaudited)

 
Three months ended September 30,
 
Nine months ended September 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
51,798

 
$
71,856

 
$
107,356

 
$
149,630

Fuel derivative financial instruments:
 
 
 
 
 
 
 
Change in unrealized gains (losses) on fuel derivative instruments, net of tax benefit (expense) of $1,001 and $0 for the three months ended September 30, 2016 and 2015, and ($4,363) and $0 for the nine months ended September 30, 2016 and 2015
(1,646
)
 
(17,359
)
 
7,185

 
(15,808
)
Net fuel derivative losses reclassified into earnings, net of tax benefit (expense) of ($174) and $0 for the three months ended September 30, 2016 and 2015, and ($6,370) and $0 for the nine months ended September 30, 2016 and 2015
287

 
4,921

 
10,491

 
29,236

Interest rate swap derivative financial instruments:
 
 
 
 
 
 
 
Change in unrealized losses on interest rate swaps, net of tax benefit of $572 for the nine months ended September 30, 2016

 

 
(973
)
 

Net interest rate swap losses reclassified into earnings, net of tax expense of $30 and of $54 for the three and nine months ended September 30, 2016
48

 

 
120

 

Other comprehensive income (loss)
(1,311
)
 
(12,438
)
 
16,823

 
13,428

Total comprehensive income
$
50,487

 
$
59,418

 
$
124,179

 
$
163,058




See accompanying notes to the condensed consolidated financial statements

6


Virgin America Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands) (Unaudited)

 
Nine months ended September 30,
 
2016
 
2015
Cash flows from operating activities
$
204,858

 
$
173,745

Cash flows from investing activities:
 
 
 
Acquisition of property and equipment
(249,264
)
 
(115,135
)
Pre-delivery payments for flight equipment

 
(5,805
)
Net cash used in investing activities
(249,264
)
 
(120,940
)
Cash flows from financing activities:
 
 
 
Net proceeds of equity issuance
2,621

 
5,155

Proceeds of debt issuance
214,750

 
78,000

Debt issuance costs
(2,448
)
 
(1,621
)
Payment of long-term debt
(50,770
)
 
(13,539
)
Shares repurchased for tax withholdings
(1,818
)

(3,736
)
Net cash provided by financing activities
162,335

 
64,259

Net increase in cash and cash equivalents
117,929

 
117,064

Cash and cash equivalents, beginning of period
496,349

 
394,643

Cash and cash equivalents, end of period
$
614,278

 
$
511,707

 
 
 

Non-cash transactions:
 
 
 
Fixed assets in accounts payable
$
13,968

 
$
1,939

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

 
17,416



See accompanying notes to the condensed consolidated financial statements

7

Virgin America Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)


(1) Basis of Presentation
The condensed consolidated financial statements of Virgin America Inc. (the “Company”) for the three and nine months ended September 30, 2016 include the accounts of the Company and its variable interest entities, for which it was the primary beneficiary. These unaudited condensed consolidated financial statements and related notes should be read in conjunction with the Company's 2015 audited financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2015 (“2015 Form 10-K”).
These unaudited condensed consolidated financial statements have been prepared as required by the U.S. Securities Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) have been condensed or omitted as permitted by the SEC. The financial statements include all adjustments, including normal recurring adjustments and other adjustments, which are considered necessary for a fair presentation of the Company’s financial position and results of operations. Operating results for the periods presented herein are not necessarily indicative of the results that may be expected for the entire year. Certain prior year amounts have been reclassified to conform to current year presentation. These amounts were not material to any of the periods presented.
On April 1, 2016, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Alaska Air Group, Inc. (“Alaska Air Group” or “Parent”) and Alpine Acquisition Corp. ("Merger Sub"), its wholly-owned subsidiary. The Merger Agreement provides that Merger Sub will merge with and into the Company, with the Company surviving as a subsidiary of Parent (the “Merger”).
At the closing of the acquisition, the Company’s stockholders will receive the right to receive $57.00 in cash, without interest and less any applicable withholding taxes, for each share of Virgin America’s stock that they own. Immediately prior to the closing of the acquisition, each unexpired and unexercised option to purchase shares of the Company's common stock will vest and be canceled in exchange for the right to receive $57.00 in cash per share less the option exercise price for such option, each outstanding restricted stock unit will vest and be canceled in exchange for the right to receive $57.00 in cash, and each outstanding award of shares that is subject to restrictions based on performance or continuing service will vest and be converted into the right to receive $57.00 in cash per share. All consideration is payable without interest and subject to deduction for any required withholding tax.
The closing of the acquisition is subject to the approval by the Company's stockholders, performance by the parties of all their obligations under the Merger Agreement, regulatory approvals and the satisfaction of other customary closing conditions, as set forth in further detail in the Merger Agreement. The Company obtained stockholder approval on July 26, 2016 and anticipates that it will complete the transaction in the fourth quarter of 2016, however, the Company cannot predict with certainty whether and when any of the remaining required closing conditions will be satisfied or if the Merger will close.
For the three months and nine months ended September 30, 2016, the Company incurred $1.6 million and $7.7 million of costs related to the Merger Agreement.
New and Recently Adopted Accounting Standards
In August 2016, the Financial Accounting Standards Board (the “FASB”) issued an accounting standards update to address how certain cash receipts and cash payments are presented and classified in the statement of cash flows with the objective of reducing the existing diversity in practice. The update is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect this accounting standards update to have a material impact on its consolidated financial statements.
In March 2016, the FASB issued an accounting standards update to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The amendments in this update are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods with early adoption permitted. The Company is in the process of evaluating the new guidance on its consolidated financial statements.
In February 2016, the FASB issued a comprehensive new leases standard that amends various aspects of existing accounting guidance for leases. It will require recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The main difference between current U.S. GAAP

8

Virgin America Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

and the amended standard is the recognition of lease assets and lease liabilities by lessees on the balance sheet for those leases classified as operating leases under previous U.S. GAAP. The accounting applied by a lessor is largely unchanged from that applied under current U.S. GAAP. As a result, the Company will have to recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term on the balance sheet. The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is in the process of evaluating the new guidance on its consolidated financial statements.
In August 2014, the FASB issued an accounting standards update to require evaluation of whether there are conditions and events that raise substantial doubt about an entity’s ability to continue as a going concern within one year after its financial statements are issued (or available to be issued when applicable) and, if so, disclosure of that fact. The standard requires the Company to make this evaluation for both annual and interim reporting periods, if applicable, and disclose whether its plans alleviate that doubt. The standard is effective for annual periods ending after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016. The Company does not expect this accounting standards update to have an impact on its consolidated financial statements.
In May 2014, the FASB and the International Accounting Standards Board (“IASB”) jointly issued a comprehensive new revenue recognition standard that will replace most existing revenue recognition standards under U.S. GAAP and International Financial Reporting Standards (“IFRS”). The new standard will require the Company to recognize revenue when goods or services are transferred to customers in an amount that reflects the consideration to which it expects to be entitled in exchange for those goods or services. As a result, the Company will need to use more judgments and estimates to determine when and how revenue is recognized than U.S. GAAP currently requires. In August 2015, the FASB issued an accounting standards update that provides a one-year deferral of the effective date for the new revenue standard for public and non-public entities, resulting in an effective date for the Company of January 1, 2018. In March 2016, the FASB issued an accounting standards update to improve the operability and understandability of the implementation guidance on principal versus agent considerations in the new revenue recognition standard. In April 2016, the FASB issued an accounting standards update to improve the guidance and reduce the cost and complexity of applying the guidance on identifying performance obligations in a contract and to improve the operability and understandability of the licensing implementation guidance in the new revenue recognition standard. In May 2016, the FASB issued an accounting standards update to make several narrow scope improvements and to provide a practical expedient for contract modifications at transition. The Company believes the most significant effect of the accounting standards update will be the elimination of the incremental cost method for frequent flyer accounting, which would require the Company to re-value its liability earned by customers associated with flights points with a relative fair value approach. The Company is in the process of evaluating the new guidance on its consolidated financial statements.
(2)
Fair Value
The accounting guidance establishes a fair value hierarchy as follows:
Level 1
Observable inputs such as quoted prices in active markets for identical assets or liabilities.
 
 
Level 2
Observable inputs other than Level 1 prices such as quoted prices in active markets for similar assets and liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term for the assets or liabilities.
 
 
Level 3
Unobservable inputs in which there is little or no market data and that are significant to the fair value of the assets or liabilities.

9

Virgin America Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The following is a listing of the Company’s assets and liabilities required to be measured at fair value on a recurring basis and where they are classified within the fair value hierarchy as of September 30, 2016 and December 31, 2015 respectively (in thousands):
 
September 30, 2016
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets (Liability)
 
 
 
 
 
 
 
Cash equivalents
$
511,827

 
$

 
$

 
$
511,827

Restricted cash
21,559

 

 

 
21,559

Heating oil swaps - fuel derivative instruments

 
441

 

 
441

Jet fuel swaps - fuel derivative instruments

 
2,313

 

 
2,313

 
$
533,386

 
$
2,754

 
$

 
$
536,140

 
December 31, 2015
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets (Liability)
 
 
 
 
 
 
 
Cash equivalents
$
419,176

 
$

 
$

 
$
419,176

Restricted cash
19,800

 

 

 
19,800

Heating oil swaps - fuel derivative instruments

 
(17,895
)
 

 
(17,895
)
Jet fuel swaps - fuel derivative instruments

 
(9,655
)
 

 
(9,655
)
     Interest rate swaps

 
155

 

 
155

 
$
438,976

 
$
(27,395
)
 
$

 
$
411,581

The following are estimated fair values of the Company's debt at September 30, 2016 (in thousands):
 
Carrying value
 
Estimated fair value
Third-party debt:
 
 
 
Aircraft-related term loans
$
392,430

 
$
386,718

Term loan credit facility
40,000

 
40,000

Related-party debt:
 
 
 
Virgin Group
45,505

 
52,277

The estimated fair values of the Company’s related-party debt and aircraft-related term loans were based on rates currently offered for debt with similar maturities and terms. The carrying value of the airport slots term loan credit facility approximated fair value because it has a variable interest rate that approximates rates that would currently be available to the Company on borrowings for similar assets. The Company uses significant unobservable inputs in determining discounted cash flows to estimate the fair value, and therefore, such amounts are categorized as Level 3 in the fair value hierarchy.
(3)
Financial Derivative Instruments and Risk Management
(a)    Fuel Derivatives
To manage economic risks associated with the fluctuations of aircraft fuel prices, since 2012, the Company has hedged a targeted percentage of its forecasted fuel requirements over the following 12 months with a rolling strategy of entering into call options for crude oil and collar contracts for heating oil in the longer term, three to 12 months before the expected fuel purchase date; then prior to maturity of these contracts, within three months of the fuel purchase, the Company exited these contracts by entering into offsetting trades and locking in the price of a percentage of its fuel requirements through the purchase of fixed forward pricing (“FFP”) contracts in jet fuel. In 2015, the Company changed its fuel hedging program strategy by discontinuing the purchase of call options and collars, and began utilizing forward swaps on jet fuel, heating oil and crude oil to lock in future fuel purchase prices.

10

Virgin America Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The Company’s remaining heating oil collars matured by the end of the second quarter 2015 and the remaining Brent call options matured by the end of the third quarter 2015.
The Company utilizes FFP contracts with its fuel service provider as part of its risk management strategy, wherein fixed prices are negotiated for set volumes of future purchases of fuel. The Company takes physical delivery of the future purchases. The Company has applied the normal purchase and normal sales exception for these commitments. The Company did not have any commitments related to FFP contracts outstanding at September 30, 2016.
The Company designates the majority of its fuel hedge derivatives contracts as cash flow hedges under the applicable accounting standard, if they qualify for hedge accounting. Under hedge accounting, all periodic changes in the fair value of the derivatives designated as effective hedges are recorded in accumulated other comprehensive income (loss) (AOCI) until the underlying fuel is purchased, at which point the deferred gain or loss will be recorded as fuel expense. In the event that the Company’s fuel hedge derivatives do not qualify as effective hedges, the periodic changes in fair value of the derivatives are included in fuel expense in the period they occur. If the Company terminates a fuel hedge derivative contract prior to its settlement date, the cumulative gain or loss recognized in AOCI at the termination date will remain in AOCI until the terminated intended transaction occurs. In the event it becomes improbable that such event will occur, the cumulative gain or loss is immediately reclassified into earnings. All cash flows associated with purchasing and settling of fuel hedge derivatives are classified as operating cash flows in the accompanying condensed consolidated statements of cash flows.
(b)    Interest Rate Swaps
The Company enters into interest rate swaps to protect against adverse fluctuations in interest rates associated with variable rate debt financing by reducing its exposure to variability in cash flows related to the future interest payments on the financing for committed aircraft. The interest rate swaps are designated cash flow hedges. The Company has no active swaps as of September 30, 2016. The AOCI loss balance of $2.0 million at September 30, 2016 relates to interest rate swaps that matured in 2015 and 2016, which is being amortized to interest expense over the term of the debt in the accompanying consolidated statements of operations.
(c)    Summary of Derivative Instruments    
All of the Company's derivatives were designated as cash flow hedges at September 30, 2016 and December 31, 2015. The following tables present the fair value of derivative assets and liabilities that are designated as hedging instruments, as well as the location of the asset and liability balances within the condensed consolidated balance sheets as of September 30, 2016 and December 31, 2015 (in thousands):
Derivatives designated as cash flow hedges
 
Consolidated
balance sheet location
 
Fair value of derivatives as of
 
September 30, 2016
 
December 31, 2015
Fuel derivative instruments—Heating oil swaps
 
Current liabilities
 
$

 
$
(17,895
)
Fuel derivative instruments—Jet fuel swaps
 
Current liabilities
 

 
(9,655
)
Total current liabilities
 
 
 
$

 
$
(27,550
)
 
 
 
 
 
 
 
Fuel derivative instruments—Heating oil swaps
 
Current assets
 
$
441

 
$

Fuel derivative instruments—Jet fuel swaps
 
Current assets
 
2,313

 

Interest rate swaps
 
Current assets
 

 
155

Total current assets
 
 
 
$
2,754

 
$
155

As of September 30, 2016, the Company had no collateral deposited to comply with margin call requirements. As of December 31, 2015, the Company had deposited $9.7 million as collateral with two of its counterparties to comply with margin call requirements related to derivative losses that exceeded the portfolio’s credit limit. The Company recorded margin call deposits in other current liabilities in the accompanying condensed consolidated balance sheet as an offset to fuel hedge liability. Total fuel hedge net current assets was $2.8 million at September 30, 2016, and at December 31, 2015, the total current liability was $17.9 million.

11

Virgin America Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The following table summarizes the effect of derivative instruments in the condensed consolidated statements of operations for the three and nine months ended September 30, 2016 and 2015 (in thousands):
Derivatives accounted for as hedging instruments under ASC 815
 
Consolidated financial 
statement location
 
Gains (losses) on derivative
contracts for the three months ended
 
Gains (losses) on derivative
contracts for the nine months ended
 
September 30, 2016
 
September 30, 2015
 
September 30, 2016
 
September 30, 2015
Fuel derivative instruments
 
Aircraft fuel expense
 
$
(379
)
 
$
(5,340
)
 
$
(18,125
)
 
$
(29,774
)
Interest rate swaps
 
Interest expense
 
78

 

 
174

 

Total impact to the consolidated statements of operations
 
 
 
$
(301
)
 
$
(5,340
)
 
$
(17,951
)
 
$
(29,774
)
Derivatives not accounted for as hedging instruments under ASC 815
 
Consolidated financial 
statement location  
 
Gains (losses) on derivative
contracts for the three months ended
 
Gains (losses) on derivative
contracts for the nine months ended
 
 
September 30, 2016
 
September 30, 2015
 
September 30, 2016
 
September 30, 2015
Fuel derivative instruments
 
Aircraft fuel expense
 
$

 
$
(1,242
)
 
$

 
$
(889
)
Total impact to the consolidated statements of operations
 
 
 
$

 
$
(1,242
)
 
$

 
$
(889
)
At September 30, 2016, the Company estimates that approximately $2.7 million of net fuel derivative gains related to its cash flow fuel hedges included in accumulated other comprehensive income will be reclassified into earnings within the next 12 months.
At September 30, 2016, the Company estimates that approximately $0.3 million of net derivative losses related to its interest rate swaps included in accumulated other comprehensive income will be reclassified into earnings within the next 12 months.
The effect of derivative instruments designated as cash flow hedges and the underlying hedged items on the condensed consolidated statements of operations for three and nine months ended September 30, 2016 and 2015, respectively, is summarized as follows (in thousands):
Derivatives designated as cash flow hedges
 
Amount of gain (loss)
recognized in AOCI
on derivatives
(Effective portion)
 
Gain (loss) reclassified
from AOCI into
income (Fuel expense or interest expense)
(Effective portion)
 
Amount of gain (loss)
recognized into
income (Ineffective
portion)
 
Three months ended
 
Three months ended
 
Three months ended
 
September 30, 2016
 
September 30, 2015
 
September 30, 2016
 
September 30, 2015
 
September 30, 2016
 
September 30, 2015
Fuel derivative instruments
 
$
(2,647
)
 
$
(16,221
)
 
$
(461
)
 
$
(4,921
)
 
$
82

 
$
(419
)
Interest rate swaps
 

 
(1,138
)
 
(78
)
 

 

 


12

Virgin America Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Derivatives designated as cash flow hedges
 
Amount of gain (loss)
recognized in AOCI
on derivatives
(Effective portion)
 
Gain (loss) reclassified
from AOCI into
income (Fuel expense or interest expense)
(Effective portion)
 
Amount of gain (loss)
recognized into
income (Ineffective
portion)
 
 
Nine months ended
 
Nine months ended
 
Nine months ended
 
 
September 30, 2016
 
September 30, 2015
 
September 30, 2016
 
September 30, 2015
 
September 30, 2016
 
September 30, 2015
Fuel derivative instruments
 
$
11,548

 
$
(14,712
)
 
$
(16,861
)
 
$
(29,236
)
 
$
(1,264
)
 
$
(538
)
Interest rate swaps
 
(1,545
)
 
(1,096
)
 
(174
)
 

 

 

The notional amounts of the Company’s outstanding derivatives are summarized as follows (gallons in millions):
 
 
September 30, 2016
 
December 31, 2015
Derivatives designated as hedging instruments:
 
 
 
 
Fuel derivative instruments—Heating oil swaps (gallons)
 
1

 
38

Fuel derivative instruments—Jet fuel swaps (gallons)
 
8

 
25

Interest rate swaps (dollars)
 
$

 
$
34

As of September 30, 2016, the Company had entered into fuel derivative contracts for approximately 17% of its forecasted aircraft fuel requirements for the fourth quarter of 2016 at a weighted-average cost per gallon of $1.16, excluding related fuel taxes.
The Company presents its derivative instruments at net fair value in the accompanying condensed consolidated balance sheets. The Company’s master netting arrangements with counterparties allow for net settlement under certain conditions. As of September 30, 2016 and December 31, 2015, no fuel derivative or interest rate swap amounts were available for offset.

(4)
Long-Term Debt
During the first half of 2016, the Company took delivery of five aircraft as scheduled. Simultaneously, the Company executed financing agreements totaling $168.2 million with senior debt facilities subject to 12-year repayment terms with an average interest rate of 3.9% and $31.1 million with subordinated debt facilities subject to seven-year repayment terms with an average interest rate of 6.5%. Principal and interest are payable quarterly in arrears. Loans related to two aircraft are pre-payable any time. Loans related to the other three aircraft are not pre-payable prior to the third anniversary of the delivery date (for two aircraft) or issuance date (for one aircraft) and are pre-payable at par thereafter, subject to payment of early termination charges, if applicable. The debt agreements have no financial covenants.
In 2016, the Company financed $15.5 million of the purchase price of two spare engines acquired in the past year with debt facilities subject to 7-year repayment terms and at a 90-day floating rate based on LIBOR. Principal and interest are payable quarterly in arrears. The loans related to the engines are not pre-payable prior to the third anniversary of the delivery date and are pre-payable at par thereafter. The debt agreements have no financial covenants.
Long-term debt including accrued paid-in-kind interest consisted of the following as of September 30, 2016 and December 31, 2015 (in thousands):

13

Virgin America Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 
September 30, 2016
 
December 31, 2015
Third-party debt:
 
 
 
Aircraft-related term loans
$
392,430

 
$
193,618

Pre–delivery payment loans

 
34,823

Term loan credit facility
40,000

 
40,000

     Total third-party debt
432,430

 
268,441

Related-party debt:
 
 
 
Virgin Group
54,774

 
52,808

Total debt
487,204

 
321,249

Less: current maturities
(30,581
)
 
(48,843
)
Less: unamortized debt issuance costs
(5,968
)
 
(3,121
)
Less: discount on Virgin Group debt
(9,269
)
 
(10,387
)
     Long–term debt
$
441,386

 
$
258,898

In connection with three of the 2015 aircraft-related term loans and three of the 2016 aircraft-related term loans, special purpose entities were formed to authorize and issue senior and junior secured notes and to acquire, finance, own and lease to the Company certain aircraft. Under variable interest entity accounting guidelines, the Company consolidated these entities because the Company is the primary beneficiary. As of September 30, 2016, the entities' assets consisted of six aircraft leased to the Company and its only liabilities consisted of notes payable in relation to the financing of such aircraft.
(5)
Contingencies and Commitments
(a)
Contingencies
The Company is subject to legal proceedings, claims and investigations arising in the ordinary course of business. While the outcome of these matters is currently not determinable, the Company does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its condensed consolidated financial position, results of operations or cash flows.
The Company is party to routine contracts under which it indemnifies third parties for various risks. The Company has not accrued any liability for these indemnities, as the amounts are not determinable nor estimable.
In its aircraft-related agreements, as is typical of commercial arrangements made in order to purchase, finance and operate commercial aircraft, the Company indemnifies the manufacturer, the financing parties and other related parties against liabilities that arise from the manufacture, design, ownership, financing, use, operation and maintenance of the aircraft for tort liability, whether or not these liabilities arise out of or relate to the negligence of these indemnified parties, except for their gross negligence or willful misconduct. The Company believes that it will be covered by insurance subject to deductibles for most tort liabilities and related indemnities as described above with respect to the aircraft the Company will operate. Additionally, if there is a change in the law that results in the imposition of any reserve, capital adequacy, special deposit or similar requirement the result of which is to increase the cost to the lender, the Company will pay the lender the additional amount necessary to compensate the lender for the actual cost increase. The Company cannot estimate the potential amount of future payments under the foregoing indemnities.
(b)
Commitments
In December 2010, the Company entered into a purchase agreement with Airbus for 60 A320 aircraft, including 30 A320neo aircraft, the first commercial order for the new eco-efficient engine option. Under the terms of the Company’s aircraft purchase agreement, the Company is committed to making pre-delivery payments at varying dates prior to delivery.
In December 2012, the Company amended its 2010 aircraft purchase agreement with Airbus reducing its order of 60 A320 aircraft to 40 aircraft and deferring delivery dates to begin in 2015. Under the amended agreement, the Company also obtained cancellation rights for the last 30 of the 40 aircraft, which cancellation rights are exercisable in groups of five aircraft three years prior to the stated delivery periods in 2020 to 2022, subject to loss of deposits

14

Virgin America Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

and credits as a cancellation fee. All of the deposits have been reapplied according to the new delivery schedule except for $11.0 million which was converted into a credit earned upon delivery of the last 10 of the 40 aircraft.
The Company evaluated the recoverability of the deposits, credits and related capitalized interest in connection with the anticipated purchase of aircraft in future periods and determined them to be recoverable. If the Company ultimately exercises its cancellation rights for up to 30 aircraft, it would incur a loss of deposits and credits of up to $26.0 million as a cancellation fee. Because the Company concluded that the deposits and credits are recoverable and that it is not likely to incur cancellation fees, the Company did not record such fees and maintained such deposits as pre-delivery payments in its accompanying condensed consolidated balance sheet as of September 30, 2016.
The Company had six spare engines on hand as of September 30, 2016, four of which were leased under operating lease contracts and two of which were purchased in the past twelve months. During 2016, the Company financed $15.5 million of the purchase price of the two engines with debt facilities in each case subject to a 7-year repayment term and a 90 day floating interest rate based on three month LIBOR.
(6)
Related-Party Transactions
The Company licenses the use of its brand name from certain entities affiliated with Virgin Enterprises Limited, a company incorporated in England and Wales (“VEL”). VEL is an affiliate of one of the Company’s largest stockholders, the Virgin Group, which has an employee who sits on the Company's board of directors. In connection with the recapitalization agreement the Company entered into in November 2014, the annual license fee to the Virgin Group increased from 0.5% to 0.7% of total revenue starting January 1, 2016. The annual license fee increase will resume at 0.5% once the Company’s total revenue for four consecutive quarters exceeds $4.5 billion. The Company paid license fees of $3.1 million and $2.1 million for the three months ended September 30, 2016 and 2015 and $8.1 million and $5.7 million for the nine months ended September 30, 2016 and 2015. The Company has accrued unpaid royalty fees of $3.1 million and $2.0 million at September 30, 2016 and December 31, 2015.
As of September 30, 2016, the Virgin Group, through its affiliates including Virgin Group Holdings Limited, owned approximately 18.2% of the Company’s issued and outstanding voting stock and all of the outstanding related-party debt. In order to comply with requirements under U.S. law governing the ownership and control of U.S. airlines, at least 75% of the voting stock of the Company must be held by U.S. citizens and at least two-thirds of the Company's board of directors must be U.S. citizens. U.S. citizen investors own over 75% of the voting stock of the Company, of which Cyrus Aviation Holdings, LLC, the largest single U.S. investor, owned approximately 27.7% as of September 30, 2016.
As of September 30, 2016, 9.6% of the Company’s $472.0 million debt was held by related-party investors. The Company incurred $1.0 million of related-party interest expense for both the three months ended September 30, 2016 and 2015 and $3.1 million and $2.6 million for the nine months ended September 30, 2016 and 2015. Commencing in November 2014, the Company began to incur an annual commitment fee on the $100.0 million Letter of Credit Facility issued by the Virgin Group. The fee was equal to 5.0% per annum of the daily maximum amount available to be drawn, accruing on a daily basis from the date of issuance and was payable quarterly. In June 2015, the Company canceled the Letter of Credit Facility in conjunction with the elimination of its credit card holdback requirement and stopped incurring related commitment fees. For the nine months ended September 30, 2015, the Company recorded $2.5 million in commitment fees related to this Letter of Credit Facility in other income (expense) in the accompanying condensed consolidated statement of operations.
(7)
Income Taxes
The provision for income taxes for the three and nine months ended September 30, 2016 was $32.9 million and $69.6 million as compared to $0.4 million and $1.1 million for the three and nine months ended September 30, 2015. The Company’s effective tax rate was approximately 38.9% and 39.3% for the three and nine months ended September 30, 2016 compared to 0.5% and 0.7% for the three and nine months ended September 30, 2015. The differences were primarily related to the effects of the valuation allowance the Company had on its deferred tax assets through the first three quarters of 2015 that was fully released as of December 31, 2015. The effective tax rates for the three and nine months ended September 30, 2016 differ from the statutory rate of 35% primarily as a result of state taxes, nondeductible meals and entertainment expenses, and nondeductible merger-related costs.

15

Virgin America Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

(8)
Net Income Per Share
Employee equity share options and unvested stock and stock units granted by the Company are treated as potential common shares outstanding in computing diluted earnings per share. Diluted shares outstanding include the dilutive effect of in-the-money options, unvested restricted stock and stock units, and shares to be issued under the Company's ESPP. The dilutive effect of such equity awards is calculated based on the average share price for each fiscal period using the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefits that would be recorded in additional paid-in capital when the award becomes deductible are collectively assumed to be used to repurchase shares.
The following table sets forth the computation of the Company’s basic and diluted net income for the periods presented (in thousands, except per share data):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2016
 
2015
 
2016
 
2015
BASIC:
 
 
 
 
 
 
 
Net income
$
51,798

 
$
71,856

 
$
107,356

 
$
149,630

Weighted-average common shares outstanding
44,407

 
43,642

 
44,319

 
43,375

Basic net income per share
$
1.17

 
$
1.65

 
$
2.42

 
$
3.45

DILUTED:
 
 
 
 
 
 
 
Net income
$
51,798

 
$
71,856

 
$
107,356

 
$
149,630

Weighted-average common shares outstanding-basic
44,407

 
43,642

 
44,319

 
43,375

Effect of dilutive potential common shares
611

 
946

 
536

 
1,179

Weighted-average common shares outstanding-diluted
45,018

 
44,588

 
44,855

 
44,554

Diluted net income per share
$
1.15

 
$
1.61

 
$
2.39

 
$
3.36

The following director and employee stock awards were excluded from the calculation of diluted net income per share because their effect would have been anti-dilutive for the periods presented (share data, in thousands):
 
Three months ended September 30,
 
Nine months ended September 30,
 
2016
 
2015
 
2016
 
2015
Stock option awards

 
1

 

 
9

Restricted stock units

 
1

 

 
1

ESPP

 

 
34

 


16


ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
This report contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. When used in this report, the words “expect,” “estimate,” “plan,” “anticipate,” “indicate,” “believe,” “forecast,” “guidance,” “outlook,” “may,” “will,” “would,” “should,” “seek,” “target,” or the negatives thereof, and similar expressions are intended to identify forward-looking statements. Forward-looking statements represent our expectations and beliefs concerning future events, based on information available to us on the date of the filing of this report, and are subject to various risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results and will not necessarily be accurate indications of the times at which or by which such performance or results will be achieved. Factors that could cause actual results to differ materially from those referenced in the forward-looking statements include those listed in Part II, Item 1A of this report. We disclaim any intent or obligation to update or revise any of the forward-looking statements, whether in response to new information, unforeseen events, changed circumstances or otherwise, except as required by applicable law.
Reconciliation of Reported Amounts to Non-GAAP Financial Measures
We evaluate our financial performance using various financial measures, some of which are measures calculated under U.S. GAAP, and some of which use alternative methods of calculation (non-GAAP). These measures include operating income/loss, operating margin, net income/loss, net earnings/loss per share and CASM, among others. Pursuant to SEC Regulation G, we have included the following reconciliations of reported non-GAAP financial measures to comparable financial measures reported on a U.S. GAAP basis. CASM is a common metric used in the airline industry to measure an airline’s cost structure and efficiency. We believe that adjusting CASM for certain special items is useful to investors because the items are not expected to be incurred on a regular basis in future periods. We also believe that excluding fuel costs from CASM is useful to investors because it provides an additional measure of management’s performance excluding the effects of a significant cost item over which management has limited influence. We also believe that reporting economic fuel cost per gallon excluding gains or losses on hedges that related to future periods is useful to investors because such gain or loss is not indicative of the actual future value of the underlying hedge contract, and we believe that excluding such gain or loss helps investors to understand the core operating performance in the current period. In addition, we believe that excluding profit sharing costs from CASM better allows investors to understand the core operating cost performance for the period and provides for a more meaningful comparison of the costs of our operations to those of the rest of the industry.
Special items, or Special Items, consist of costs related to the Merger Agreement with Alaska Air Group and out-of-period fuel related adjustments for the three and nine months ended September 30, 2016 and of out-of-period fuel related adjustments for the three and nine months ended September 30, 2015. Net income and fully diluted earnings per share, excluding Special Items for the three and nine months ended September 30, 2016 include the statutory tax effect of Special Items. For the three and nine months ended September 30, 2015, there was no tax effect on Special Items due to the full valuation allowance.
The following table provides the reconciliation of statements of operations and excluding fuel and profit sharing for the three and nine months ended September 30, 2016 and 2015 (dollar amounts in thousands, except per share data):

17


 
Three months ended September 30,
 
%
 
Nine months ended September 30,
 
%
 
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
 
Operating income, as reported
$
90,654

 
$
73,868

 
22.7

 
$
191,753

 
$
156,909

 
22.2

 
Add: merger-related costs
1,609

 

 
 
 
7,658

 

 
 
 
Add (deduct): out-of-period fuel costs
32

 
1,098

 
 
 
(1,015
)
 
$
(1,717
)
 
 
 
Operating income, non-GAAP
$
92,295

 
$
74,966

 
23.1

 
$
198,396

 
$
155,192

 
27.8

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating margin, as reported
20.4
%
 
18.0
%
 
2.4

pts
15.5
 %
 
13.8
 %
 
1.7

pts
Add: merger-related costs
0.3

 

 
 
 
0.7

 

 
 
 
Add (deduct): out-of-period fuel costs

 
0.2

 
 
 
(0.1
)
 
(0.2
)
 
 
 
Operating margin, non-GAAP
20.7
%
 
18.2
%
 
2.5

pts
16.1
 %
 
13.6
 %
 
2.5

pts
 
 
 
 
 
 
 
 
 
 
 
 
 
Income before taxes, as reported
$
84,724

 
$
72,248

 
17.3

 
$
176,912

 
$
150,711

 
17.4

 
Add: merger-related costs
1,609

 

 
 
 
7,658

 

 
 
 
Add (deduct): out-of-period fuel costs
32

 
1,098

 
 
 
(1,015
)
 
(1,717
)
 
 
 
Income before taxes, non-GAAP
$
86,365

 
$
73,346

 
17.8

 
$
183,555

 
$
148,994

 
23.2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income, as reported
$
51,798

 
$
71,856

 
(27.9
)
 
$
107,356

 
$
149,630

 
(28.3
)
 
Add: merger-related costs
1,609

 

 
 
 
7,658

 

 
 
 
Add (deduct): out-of-period fuel costs
32

 
1,098

 
 
 
(1,015
)
 
(1,717
)
 
 
 
Add (deduct): income tax effect of special items
(12
)
 

 
 
 
(377
)
 

 
 
 
Net income, non-GAAP
$
53,427

 
$
72,954

 
(26.8
)
 
$
113,622

 
$
147,913

 
(23.2
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fully diluted earnings per share, as reported
$
1.15

 
$
1.61

 
(28.6
)
 
$
2.39

 
$
3.36

 
(28.9
)
 
Add: merger-related costs
0.04

 

 
 
 
0.17

 

 
 
 
Add (deduct): out-of-period fuel costs

 
0.03

 
 
 
(0.02
)
 
(0.04
)
 
 
 
Add (deduct): income tax effect of special items

 

 
 
 
(0.01
)
 

 
 
 
Fully diluted earnings per share, non-GAAP
$
1.19

 
$
1.64

 
(27.4
)
 
$
2.53

 
$
3.32

 
(23.8
)
 


18


The following table provides the reconciliation of CASM, excluding Special Items, fuel and profit sharing and CASM excluding fuel and fuel and profit sharing for the three and nine months ended September 30, 2016 and 2015 (in cents):
 
Three months ended September 30,
 
%
 
Nine months ended September 30,
 
%
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
CASM, as reported
9.17

 
10.17

 
(9.8
)
 
9.64

 
10.51

 
(8.3
)
Deduct: merger-related costs
(0.04
)
 

 
 
 
(0.07
)
 

 
 
Add (deduct): out-of-period fuel costs

 
(0.04
)
 
 
 
0.01

 
0.02

 
 
CASM, non-GAAP, excluding special items
9.13

 
10.13

 
(9.9
)
 
9.58

 
10.53

 
(9.0
)
Deduct: aircraft fuel, net of out-of-period fuel costs
(1.98
)
 
(2.57
)
 
 
 
(2.03
)
 
(2.90
)
 
 
Deduct: profit sharing
(0.22
)
 
(0.22
)
 
 
 
(0.17
)
 
(0.17
)
 
 
CASM, non-GAAP, excluding special items, aircraft fuel and profit sharing
6.93

 
7.34

 
(5.6
)
 
7.38

 
7.46

 
(1.1
)
 
 
 
 
 
 
 
 
 
 
 
 
CASM, as reported
9.17

 
10.17

 
(9.8
)
 
9.64

 
10.51

 
(8.3
)
Deduct: aircraft fuel
(1.98
)
 
(2.61
)
 
 
 
(2.02
)
 
(2.88
)
 
 
CASM, non-GAAP, excluding aircraft fuel
7.19

 
7.56

 
 
 
7.62

 
7.63

 
 
Deduct: profit sharing
(0.22
)
 
(0.22
)
 
 
 
(0.17
)
 
(0.17
)
 
 
CASM, non-GAAP, excluding aircraft fuel and profit sharing
6.97

 
7.34

 
(5.0
)
 
7.45

 
7.46

 
(0.1
)

The following table provides the reconciliation of fuel cost per gallon, excluding Special Items, for the three and nine months ended September 30, 2016 and 2015:
 
Three months ended September 30,
 
%
 
Nine months ended September 30,
 
%
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
GAAP fuel cost per gallon
$
1.48

 
$
1.95

 
(24.1
)
 
$
1.51

 
$
2.16

 
(30.1
)
Add: out-of-period fuel adjustments
(0.01
)
 
(0.03
)
 
 
 
0.01

 
0.02

 
 
Non-GAAP fuel cost per gallon excluding special item
$
1.47

 
$
1.92

 
(23.4
)
 
$
1.52

 
$
2.18

 
(30.3
)
Overview
Virgin America is a premium-branded, low-cost airline based in California that provides scheduled air travel in the United States and Mexico. We operate primarily from our focus cities of Los Angeles and San Francisco, with a smaller presence at Dallas Love Field, to other major business and leisure destinations in North America. We provide a distinctive offering for our passengers, whom we call guests, that is centered around our brand and our premium travel experience, while at the same time maintaining a low-cost structure through our point-to-point network and high utilization of our efficient, single fleet type. As of September 30, 2016, we provided service to 24 airports in the United States and Mexico with a fleet of 63 narrow-body aircraft.
Third Quarter 2016 Highlights
Our pre-tax income for the third quarter of 2016 was $84.7 million, an improvement of $12.5 million over pre-tax income of $72.2 million for the third quarter of 2015 and resulted in the highest pre-tax income and margin in our history. We recorded $1.6 million of legal and professional costs associated with the proposed acquisition of Virgin America by Alaska Air Group (as more fully described below) as well as an immaterial amount related to out-of-period fuel costs that we consider Special Items for the period. Excluding these Special Items, our pre-tax income was $86.4 million for the third quarter of 2016 (a non-GAAP financial measure). This represents an improvement of 17.8% as compared to pre-tax income excluding Special Items (a non-GAAP financial measure) for the third quarter of 2015. Highlights of our financial results, both with and without Special Items are as follows:

19


Capacity: Available Seat Miles (ASMs) for the third quarter of 2016 increased by 16.7% compared with the third quarter of 2015. We had a total of 63 total Airbus A320-family aircraft in service as of September 30, 2016 as compared to 55 aircraft as of September 30, 2015.
Operating Revenue: Total operating revenue was $445.2 million, an increase of 8.3% over the third quarter of 2015.
Revenue per Available Seat Mile (RASM): Passenger revenue per available seat mile (PRASM) decreased 7.3% compared to the third quarter of 2015, to 10.24 cents. Our average yield per revenue passenger mile declined by 10.9% due to a reduced domestic industry fare environment. This was partially offset by 3.4 point increase in our load factor, to 85.9%. Total RASM decreased 7.2% year-over-year.
Cost per Available Seat Mile (CASM): Total CASM for the third quarter of 2016 decreased 9.8%, to 9.17 cents. Total CASM excluding Special Items decreased 9.9%, to 9.13 cents. A decrease in fuel costs was the primary factor in the decline in total CASM. CASM excluding Special Items, fuel costs and profit sharing decreased 5.6% year-over-year, to 6.93 cents. We achieved economies of scale from the growth in our operating fleet and our capacity over the past 12 months, resulting in this reduction in our CASM excluding Special Items, fuel costs and profit sharing. Our recorded salaries, wages and benefits in the third quarter of 2016 includes a $8.5 million accrual for teammate profit sharing and related payroll taxes.
Fuel Expense: Our fuel cost per gallon was $1.48 for the third quarter of 2016. Excluding Special Items, our fuel cost per gallon for the third quarter of 2016 was $1.47, a decrease of 23.4% from the third quarter of 2015.
Operating Income: Third quarter operating income and operating margin were $90.7 million and 20.4%, respectively. Excluding Special Items, third quarter operating income (a non-GAAP financial measure) was $92.3 million, an increase of 23.1% compared to the third quarter of 2015. Our operating margin excluding Special Items (a non-GAAP financial measure) was 20.7%, an increase of 2.5 points from the third quarter of 2015. Our growth in operations and our 9.8% decrease in CASM were the primary drivers behind our increased operating income and operating margin. These factors were partially offset by our decline in PRASM.
Total Other Expense: Total other expense was $5.9 million, an increase of $4.3 million as compared to the third quarter of 2015. The increase is due to higher interest expense associated with the financing of ten new A320 aircraft that we have acquired since the third quarter of 2015.
Net Income: Net income for the third quarter of 2016 was $51.8 million and for the third quarter of 2015 was $71.9 million. Excluding Special Items, net income for the third quarter of 2016 (a non-GAAP financial measure) was $53.4 million, a decrease of 26.8% compared to the third quarter of 2015. We recorded a provision for income taxes excluding special items of $32.9 million in the third quarter of 2016. We did not record a material provision for income taxes in the third quarter of 2015 due to a valuation allowance recorded against our deferred income tax assets. We released substantially all of this valuation allowance in the fourth quarter of 2015.
Fully Diluted Earnings per Share (EPS): Our fully diluted earnings per share for the third quarter of 2016 was $1.15. Excluding Special Items, fully diluted earnings per share (a non-GAAP financial measure) was $1.19 for the third quarter of 2016.
Proposed Acquisition by Alaska Air Group
On April 1, 2016, we entered into that certain Agreement and Plan of Merger, or the Merger Agreement, with Alaska Air Group, Inc., or Alaska Air Group, and Alpine Acquisition Corp., or Merger Sub. The Merger Agreement provides that Merger Sub will merge with and into Virgin America, with Virgin America surviving as a subsidiary of Alaska Air Group, or the Merger.
At the closing of the acquisition, our stockholders will receive the right to receive $57.00 in cash for each share of Virgin America’s stock that they own. Immediately prior to the closing of the acquisition, each unexpired and unexercised option to purchase shares of our common stock will vest and be canceled in exchange for the right to receive $57.00 in cash per share less the option exercise price per share for such option, each outstanding restricted stock unit will vest and be canceled in exchange for the right to receive $57.00 in cash per share, and each outstanding award of shares that is subject to restrictions based on performance or continuing service will vest and be converted into the right to receive $57.00 in cash per share. All consideration is payable without interest and subject to deduction for any required withholding tax.


20


Results of Operations
Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015
For the three months ended September 30, 2016, we had net income of $51.8 million compared to net income of $71.9 million for the same period in 2015. Our operating income of $90.7 million for the three months ended September 30, 2016 increased by $16.8 million, or 22.7%, from the three months ended September 30, 2015. Our operating margin increased by 2.4 points to 20.4% in the three months ended September 30, 2016 as compared to 18.0% in the three months ended September 30, 2015.
Our operating capacity, as measured by available seat miles, or ASMs, increased by 16.7% for the three months ended September 30, 2016 from the same period in 2015. Our number of passengers increased by 17.6% in the three months ended September 30, 2016 year-over-year, and our yield decreased by 10.9%.
Our CASM decreased by 9.8% to 9.17 cents for the three months ended September 30, 2016 as compared to 10.17 cents for the same period in 2015. This was primarily a result of lower per ASM costs, in particular for aircraft rent, partially offset by increased depreciation expense per ASM, as well as $1.6 million of costs associated with the negotiation of the proposed acquisition of Virgin America by Alaska Air Group.
In addition, net other expense for the three months ended September 30, 2016 increased by $4.3 million from the prior year period as a result of financing we entered into for ten aircraft that we acquired and placed into service from July 2015 through July 2016.
Operating Revenues
 
Three months ended September 30,
 
Change
 
2016
 
2015
 
Amount
 
 %
Operating revenues (in thousands):
 
 
 
 
 
 
 
Passenger
$
395,817

 
$
366,089

 
$
29,728

 
8.1

Other
49,368

 
44,792

 
4,576

 
10.2

Total operating revenues
$
445,185

 
$
410,881

 
$
34,304

 
8.3

 
 
 
 
 
 
 
 
Operating statistics:
 
 
 
 
 
 
 
Available seat miles (millions)
3,867

 
3,315

 
552

 
16.7

Revenue passenger miles (millions)
3,321

 
2,736

 
585

 
21.4

Average stage length (statute miles)
1,472

 
1,397

 
75

 
5.4

Load factor
85.9
%
 
82.5
%
 
3.4

 
pts
Total passenger revenue per available seat mile—PRASM (cents)
10.24

 
11.05

 
(0.81
)
 
(7.3
)
Total revenue per available seat mile—RASM (cents)
11.51

 
12.40

 
(0.89
)
 
(7.2
)
Yield (cents)
11.92

 
13.38

 
(1.46
)
 
(10.9
)
Average fare
$
181.98

 
$
197.98

 
$
(16.00
)
 
(8.1
)
Passengers (thousands)
2,175

 
1,849

 
326

 
17.6

Passenger revenue for the three months ended September 30, 2016 increased 8.1% from the three months ended September 30, 2015 on a 16.7% increase in capacity as measured by our ASMs. Third quarter 2016 PRASM decreased 7.3% year-over-year due to a 10.9% decrease in passenger yield. Total RASM for the three months ended September 30, 2016 decreased 7.2% from the three months ended September 30, 2015, primarily from the decrease in PRASM, slightly offset by an 10.2% increase in other revenue.
Other revenue for the three months ended September 30, 2016 increased 10.2% from the three months ended September 30, 2015 primarily due to higher ancillary fee revenue from new ancillary products introduced in February 2016, priority boarding in our main cabin, and higher bag revenue primarily driven by higher capacity.

21


Operating Expenses
 
Three months ended September 30,
 
Change 
 
Cost per ASM 
 
Change
 
2016
 
2015
 
Amount 
 
 
2016
 
2015
 
%  
 
 
 
 
 
 
 
 
 
(In cents)
 
 
Operating expenses (in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
 
Salaries, wages and benefits
$
82,759

 
$
74,995

 
$
7,764

 
10.4

 
2.14

 
2.26

 
(5.3
)
Aircraft fuel
76,566

 
86,480

 
(9,914
)
 
(11.5
)
 
1.98

 
2.61

 
(24.1
)
Aircraft rent
47,901

 
47,088

 
813

 
1.7

 
1.24

 
1.42

 
(12.7
)
Landing fees and other rents
41,389

 
38,128

 
3,261

 
8.6

 
1.07

 
1.15

 
(7.0
)
Sales and marketing
35,845

 
32,632

 
3,213

 
9.8

 
0.93

 
0.98

 
(5.1
)
Aircraft maintenance
17,112

 
15,838

 
1,274

 
8.0

 
0.44

 
0.48

 
(8.3
)
Depreciation and
amortization
10,582

 
4,465

 
6,117

 
137.0

 
0.27

 
0.13

 
107.7

Other operating expenses
42,377

 
37,387

 
4,990

 
13.3

 
1.10

 
1.14

 
(3.5
)
Total operating expenses
$
354,531

 
$
337,013

 
$
17,518

 
5.2

 
9.17

 
10.17

 
(9.8
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating statistics:
 
 
 
 
 
 
 
 
 
 
 
 
 
Available seat miles (millions)
3,867

 
3,315

 
552

 
16.7

 
 
 
 
 

Average stage length (statute miles)
1,472

 
1,397

 
75

 
5.4

 
 
 
 
 
 
Departures
18,216

 
16,554

 
1,662

 
10.0

 
 
 
 
 
 
CASM, excluding fuel (cents)
7.19

 
7.56

 
(0.37
)
 
(4.9
)
 
 
 
 
 
 
CASM, excluding fuel and profit sharing (cents)
6.97

 
7.34

 
(0.37
)
 
(5.0
)
 
 
 
 
 
 
Fuel cost per gallon
$
1.48

 
$
1.95

 
$
(0.47
)
 
(24.1
)
 
 
 
 
 
 
Fuel gallons consumed (thousands)
51,893

 
44,365

 
7,528

 
17.0

 
 
 
 
 
 
Teammates (FTE)
2,888

 
2,626

 
262

 
10.0

 
 
 
 
 
 
Salaries, wages and benefits
Salaries, wages and benefits expense for the three months ended September 30, 2016 increased by $7.8 million, or 10.4%, from the three months ended September 30, 2015, primarily driven by a 10.0% increase in teammate FTE headcount as we continued hiring new teammates in connection with our 2015 and 2016 aircraft deliveries. Salaries and wages for flight crews also increased as a result of pay initiatives we implemented during 2015 due to the competitive marketplace for talent and increasing seniority of our pilots and inflight teammates. Profit sharing expense for the three months ended September 30, 2016 remained relatively constant. Under our annual profit sharing program, we accrued a pro rata portion of our estimated annual total profit sharing, which is based on current internal projections of pre-tax income for the year. Our profit sharing plan provides for profit sharing on pre-tax income above a threshold which is based on $1.5 million times the weighted average number of aircraft in our fleet. For the full year 2016, we estimate the threshold to be approximately $92.7 million.
Our overall benefit plan costs for the three months ended September 30, 2016 increased from the prior year period due to an increase in the amount of the 401(k) match benefits paid to our teammates primarily driven by higher headcount.
Aircraft fuel
Aircraft fuel expense for the three months ended September 30, 2016, which includes the effect of our fuel hedges, decreased by $9.9 million, or 11.5%, from the three months ended September 30, 2015. The decrease was primarily due to a decrease of $0.47, or 24.1%, in the average fuel cost per gallon offset in part by a 17.0% increase in fuel consumption, and $0.4 million net fuel hedge losses. The increased fuel consumption was substantially consistent with the increase in available seat miles.
We maintain a fixed forward pricing, or FFP, and derivative hedging program, primarily jet fuel and heating oil swaps, to reduce the impact of sudden, sharp increases in fuel prices. We use FFPs and jet fuel swaps to lock in the price of jet fuel for specified quantities and at specified locations in future periods. At September 30, 2016, we had entered into derivative hedging instruments for approximately 17% of our then expected three-month fuel requirements, with all of our then existing hedge contracts expected to settle by the end of the fourth quarter of 2016.

22


Aircraft rent
Aircraft rent expense remained relatively constant for the three months ended September 30, 2016 compared with the three months ended September 30, 2015.
Landing fees and other rents
Landing fees and other rents expense for the three months ended September 30, 2016 increased by $3.3 million, or 8.6%, compared with the three months ended September 30, 2015, primarily as a result of our increase in departures of 10.0% from the addition of frequencies throughout our network and the opening of two Hawaii stations at the end of 2015 and our Denver station in March 2016.
Sales and marketing
Sales and marketing expense for the three months ended September 30, 2016 did not change significantly as compared to the three months ended September 30, 2015.
Aircraft maintenance
Aircraft maintenance expense for the three months ended September 30, 2016 did not change significantly as compared to the three months ended September 30, 2015.
Depreciation and amortization
Depreciation and amortization expense increased by $6.1 million, or 137.0%, for the three months ended September 30, 2016 as compared to the three months ended September 30, 2015, primarily due to depreciation associated with the ten aircraft that were delivered and placed in service beginning July 2015 through July 2016.
Other operating expenses
Other operating expense increased by $5.0 million, or 13.3%, for the three months ended September 30, 2016 as compared to the three months ended September 30, 2015, primarily related to catering and crew travel costs commensurate with capacity growth, higher airport taxes, and $1.6 million of costs associated with the negotiation of our proposed acquisition by Alaska Air Group.
Other Income (Expense)
Other income (expense) for the three months ended September 30, 2016 increased by $4.3 million, or 266.0%, from the three months ended September 30, 2015, as a result of interest expense associated with financings we entered into in relation to the ten aircraft we acquired and placed into service from July 2015 through July 2016.
Income Taxes
Our effective tax rate was approximately 38.9% in the three months ended September 30, 2016, compared with 0.5% in the three months ended September 30, 2015. The difference was primarily related to the effect of the valuation allowance we had on our deferred tax assets through the first three quarters of 2015 that was fully released as of December 31, 2015. The effective tax rate for the three months ended September 30, 2016 differed from the federal statutory rate of 35.0% primarily as a result of state taxes, nondeductible meals and entertainment expenses, and nondeductible merger-related costs.

Nine Months Ended September 30, 2016 Compared to Nine Months Ended September 30, 2015
For the nine months ended September 30, 2016, we had net income of $107.4 million compared to net income of $149.6 million for the same period in 2015. Our operating income of $191.8 million for the nine months ended September 30, 2016 increased by $34.8 million, or 22.2%, from the nine months ended September 30, 2015. Our operating margin increased by 1.7 points to 15.5% in the nine months ended September 30, 2016 as compared to 13.8% in the nine months ended September 30, 2015.
Our operating capacity, as measured by available seat miles, or ASMs, increased by 15.9% for the nine months ended September 30, 2016 from the same period in 2015. Our number of passengers increased by 16.4% in the nine months ended September 30, 2016 year-over-year, while our yield decreased by 8.5%.
Our CASM decreased by 8.3% to 9.64 cents for the nine months ended September 30, 2016 as compared to 10.51 cents for the same period in 2015. This was primarily a result of lower fuel and aircraft rent costs per ASM, partially offset by higher depreciation per ASM tied to our ten aircraft acquisition, as well $7.7 million of costs associated with the negotiation of our proposed acquisition by Alaska Air Group.

23


In addition, net other expense for the nine months ended September 30, 2016 increased by $8.6 million from the prior year period as a result of financings we entered into for ten aircraft that we acquired and placed into service from July 2015 through July 2016, partially offset by a decrease in fees associated with a letter of credit facility that we terminated in the second quarter of 2015.
Operating Revenues
 
Nine months ended September 30,
 
Change
 
2016
 
2015
 
Amount
 
 %
Operating revenues (in thousands):
 
 
 
 
 
 
 
Passenger
$
1,095,953

 
$
1,015,162

 
$
80,791

 
8.0

Other
138,967

 
122,957

 
16,010

 
13.0

Total operating revenues
$
1,234,920

 
$
1,138,119

 
$
96,801

 
8.5

 
 
 
 
 
 
 
 
Operating statistics:
 
 
 
 
 
 
 
Available seat miles (millions)
10,820

 
9,333

 
1,487

 
15.9

Revenue passenger miles (millions)
9,101

 
7,715

 
1,386

 
18.0

Average stage length (statute miles)
1,450

 
1,413

 
37

 
2.6

Load factor
84.1
%
 
82.7
%
 
1.4

 
pts
Total passenger revenue per available seat mile—PRASM (cents)
10.13

 
10.88

 
(0.75
)
 
(6.9
)
Total revenue per available seat mile—RASM (cents)
11.41

 
12.19

 
(0.78
)
 
(6.4
)
Yield (cents)
12.04

 
13.16

 
(1.12
)
 
(8.5
)
Average fare
$
181.82

 
$
196.10

 
$
(14.28
)
 
(7.3
)
Passengers (thousands)
6,028

 
5,177

 
851

 
16.4

Passenger revenue for the nine months ended September 30, 2016 increased 8.0% from the nine months ended September 30, 2015 on a 15.9% increase in capacity as measured by our ASMs. 2016 nine months year-to-date PRASM decreased 6.9% year-over-year due to a 8.5% decrease in passenger yield. Total RASM for the nine months ended September 30, 2016 decreased 6.4% from the nine months ended September 30, 2015, primarily from the decrease in PRASM, slightly offset by an 13.0% increase in other revenue.
Other revenue for the nine months ended September 30, 2016 increased 13.0% from the nine months ended September 30, 2015 primarily due to higher ancillary fee revenue from new ancillary products introduced in February 2016, priority boarding in our main cabin and higher bag revenue primarily driven by higher capacity.

24


Operating Expenses
 
Nine months ended September 30,
 
Change 
 
Cost per ASM 
 
Change
 
2016
 
2015
 
Amount 
 
 
2016
 
2015
 
%  
 
 
 
 
 
 
 
 
 
(In cents)
 
 
Operating expenses (in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
 
Salaries, wages and benefits
$
244,772

 
$
214,485

 
30,287

 
14.1

 
2.26

 
2.30

 
(1.7
)
Aircraft fuel
218,237

 
268,781

 
(50,544
)
 
(18.8
)
 
2.02

 
2.88

 
(29.9
)
Aircraft rent
143,008

 
137,779

 
5,229

 
3.8

 
1.32

 
1.48

 
(10.8
)
Landing fees and other rents
121,286

 
106,181

 
15,105

 
14.2

 
1.12

 
1.14

 
(1.8
)
Sales and marketing
103,663

 
89,715

 
13,948

 
15.5

 
0.96

 
0.96

 

Aircraft maintenance
50,844

 
42,327

 
8,517

 
20.1

 
0.47

 
0.45

 
4.4

Depreciation and
amortization
27,860

 
12,792

 
15,068

 
117.8

 
0.26

 
0.14

 
85.7

Other operating expenses
133,497

 
109,150

 
24,347

 
22.3

 
1.23

 
1.16

 
6.0

Total operating expenses
$
1,043,167

 
$
981,210

 
$
61,957

 
6.3

 
9.64

 
10.51

 
(8.3
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating statistics:
 
 
 
 
 
 
 
 
 
 
 
 
 
Available seat miles (millions)
10,820

 
9,333

 
1,487

 
15.9

 
 
 
 
 
 
Average stage length (statute miles)
1,450

 
1,413

 
37

 
2.6

 
 
 
 
 
 
Departures
51,898

 
46,104

 
5,794

 
12.6

 
 
 
 
 
 
CASM, excluding fuel (cents)
7.62

 
7.63

 
(0.01
)
 
(0.1
)
 
 
 
 
 
 
CASM, excluding fuel and profit sharing (cents)
7.45