| HAWAIIAN HOLDINGS INC ITEM 1A RISK FACTORS In addition to the risks identified elsewhere in this report, the following risk factors apply to our business, results of operations and financial conditions: Risks Relating to our Business Our business is adversely affected by increases in fuel prices |
| Aircraft fuel costs constitute a significant portion of Hawaiian’s operating expenses |
| Fuel costs represented 25dtta2prca and 19dtta6prca of Hawaiian’s operating expenses for the years ended December 31, 2005 and 2004, respectively |
| Based on gallons expected to be consumed in 2006, for every one cent change in the cost per gallon of jet fuel, Hawaiian’s annual fuel expense increases or decreases by approximately dlra1dtta2 million |
| Fuel prices and supplies are influenced significantly by international political and economic circumstances, such as the war and post-war unrest in Iraq, as well as OPEC production curtailments, a disruption of oil imports, other conflicts in the Middle East, increasing demand from China, India and other developing countries, environmental concerns, weather and other unpredictable events |
| During the third quarter of 2005, Hurricanes Katrina and Rita caused widespread disruption to oil production, refinery operations and pipeline capacity along the US Gulf Coast |
| As a result of these disruptions, the price of jet fuel increased significantly and the availability of jet fuel supplies was diminished |
| Further increases in jet fuel prices or disruptions in fuel supplies, whether as a result of natural disasters or otherwise, could have a material adverse effect on our results of operations, financial position or liquidity |
| 12 ______________________________________________________________________ From time to time, Hawaiian enters into heating oil forward contracts, jet fuel forward contracts, or other derivative instruments to hedge our financial exposure to fluctuations in the cost of jet fuel |
| ” Our business is highly dependent on tourism, and our financial results could suffer if there is a downturn in tourism levels |
| Our principal base of operations is in Hawaii and our revenue is linked primarily to the number of travelers (mostly tourists) to, from and among the Hawaiian Islands |
| Hawaii tourism levels are affected by, among other things, the political and economic climate in Hawaii’s main tourism markets, the availability of hotel accommodations, promotional spending by competing destinations, the popularity of Hawaii as a tourist destination relative to other vacation options, and other global factors, including natural disasters, safety and security |
| From time to time, various events and industry specific problems such as strikes have had a negative impact on tourism in Hawaii |
| In addition, the potential or actual occurrence of terrorist attacks, the wars in Afghanistan and Iraq, and the threat of other negative world events has had and may in the future again have a material adverse effect on Hawaii tourism |
| No assurance can be given that the level of passenger traffic to Hawaii will not decline in the future |
| A decline in the level of Hawaii passenger traffic could have a material adverse effect on our results of operations and financial condition |
| Our business is subject to substantial seasonal and cyclical volatility |
| Our profitability and liquidity are sensitive to seasonal volatility primarily due to leisure and holiday travel patterns |
| Hawaii is a popular vacation destination |
| Traffic levels are typically stronger during June, July, August and December and considerably weaker at other times of the year |
| During weaker travel periods, we may utilize discounted fare pricing strategies to increase our traffic volume |
| Our results of operations generally reflect this seasonality, but are also impacted by numerous other factors that are not necessarily seasonal |
| These factors include the extent and nature of fare changes and competition from other airlines, changing levels of operations, national and international events, fuel prices and general economic conditions, including inflation |
| Because a substantial portion of both personal and business airline travel is discretionary, the industry tends to experience adverse financial results in general economic downturns |
| As a result, our operating results for a quarterly period are not necessarily indicative of operating results for an entire year, and historical operating results are not necessarily indicative of future operating results |
| Additionally, airlines generally require substantial liquidity to sustain continued operations under most conditions |
| Our business is impacted by the competitive advantages held by full service airlines in the transpacific market |
| In the transpacific market, most of our competition comes from full service legacy airlines such as United Airlines, American Airlines, Continental Airlines, Delta Air Lines, and Northwest Airlines |
| Legacy airlines have a number of competitive advantages relative to Hawaiian that historically have enabled them to obtain higher fares than Hawaiian: · Legacy airlines generate passenger traffic from throughout the US mainland |
| In contrast, Hawaiian lacks a comparable network to feed passengers to its transpacific flights and is therefore more reliant on passenger demand in the cities we serve |
| · Most legacy airlines operate from hubs, which can provide a built-in market of passengers, depending on the economic strength of the hub city and the size of the customer group that frequent the airline |
| For example, United flows sufficient passenger traffic throughout the US mainland to schedule approximately 11 flights a day, depending on seasonality, between San Francisco and the Hawaiian islands, which gives San Francisco residents wishing to travel to Hawaii a large number of United non-stop flight choices to Oahu, Maui, Kauai and the Big Island, while 13 ______________________________________________________________________ Hawaiian, without feed traffic, can offer only one flight per day |
| In contrast, Honolulu, the hub of our operations, does not originate much transpacific travel, nor does it have the city strength or potential customer franchise of a city such as Chicago or Dallas necessary to provide Hawaiian with a built-in market |
| Tickets to Hawaii are for the most part not sold in Honolulu, but rather on the mainland, making Honolulu primarily a destination rather than origin of passenger traffic |
| Most LCCs have lacked the fleet and infrastructure necessary to provide long-haul trans-oceanic service |
| The Hawaii market has, however, in recent years, seen growing LCC competition from Aloha and ATA, which increased service to Hawaii from San Francisco and other cities in 2003, and US Airways which commenced service to Hawaii at the end of 2005 |
| We also face the threat of more LCC competition in the future |
| Furthermore, a more fundamental and immediate consequence for us of the proliferation of LCCs is the response from full service legacy airlines, who are meeting the competition from LCCs by significantly reducing costs and adjusting their route networks to divert resources to long-haul markets such as Hawaii, where LCC competition is less severe |
| The result is that the legacy airlines have at the same time reduced their costs of operation and increased capacity in the Hawaii market |
| Additional capacity to Hawaii, whether from legacy airlines or LCCs, could result in a decrease in our share of the transpacific market, a decline in our transpacific yields, or both, which could have a material adverse effect on our results of operations and financial condition |
| Additional potential competitors have announced their intentions to launch interisland air service |
| In the interisland market, we face competition principally from two other airlines, Aloha Airlines and Island Air |
| In addition, Mesa Airlines, a regional carrier based in Phoenix, Arizona, has announced its intention to begin flying an interisland schedule with up to six 50-seat regional jets in the second quarter of 2006 |
| If the additional capacity described by Mesa Airlines is added to existing interisland capacity, it could have a significant negative impact on interisland yields and/or passenger traffic to Hawaiian and ultimately our financial condition |
| The demand for interisland service has been steadily declining, as other airlines have increased direct service from the mainland to Oahu’s neighbor islands, obviating the need for interisland transfers, and as the infrastructure, particularly the availability of goods and services, in the neighbor islands improves |
| The total size of the interisland market is, therefore, expected to continue to shrink for the foreseeable future |
| A decline in the level of interisland passenger traffic could have a material adverse effect on our results of operations and financial condition |
| The airline industry operates on low gross profit margins and revenue that varies substantially in relation to fixed operating costs |
| Due to high fixed costs, the expenses of each flight do not vary proportionately with the number of passengers carried, but the revenue generated from a particular flight is directly related to the number of passengers carried |
| Accordingly, while a decrease in the number of passengers carried would cause a corresponding decrease in revenue (if not offset by higher fares), it may result in a disproportionately greater decrease in profits |
| An increase in the number of passengers carried would have the opposite effect |
| 14 ______________________________________________________________________ We are dependent on satisfactory labor relations |
| Labor costs are a significant component of airline expenses and can substantially impact an airline’s results |
| Labor and related benefit costs represented approximately 28dtta5prca and 32dtta8prca, respectively, of Hawaiian’s operating expenses for the years ended December 31, 2005 and 2004 |
| We may make strategic and operational decisions that require the consent of one or more of our labor unions |
| We cannot assure you that these labor unions will not require additional wages or benefits in return for their consent |
| In addition, we have entered into collective bargaining agreements with our pilots, mechanical group employees, clerical group employees, flight attendants, dispatchers and network engineers which are amendable in less than three years |
| We cannot assure you that future agreements with our employees’ unions will be on terms in line with our expectations or comparable to agreements entered into by our competitors, and any future agreements may increase our labor costs or otherwise adversely affect us |
| If we are unable to reach an agreement with any unionized work group, we may be subject to future work interruptions and/or stoppages, which may hamper or halt operations |
| Our operations may be adversely affected if we are unable to attract and retain key executives, including our Chief Executive Officer |
| We are dependent on our ability to attract and retain key executives, particularly Mark B Dunkerley, our Chief Executive Officer, with whom we have entered into a three-year employment agreement |
| Competition for such personnel in the airline industry is highly competitive, and we cannot be certain that we will be able to retain our Chief Executive Officer or other key executives or that we can attract other qualified personnel in the future |
| Any inability to retain our Chief Executive Officer and other key executives, or attract and retain additional qualified executives, could have a negative impact on our operations |
| We are increasingly dependent on technology to operate our business |
| Any substantial or repeated failures of our computer or communications systems could impact our customer service, result in the loss of important data, loss of revenue, and increased costs, and generally harm our business |
| Like all companies, our computer and communication systems may be vulnerable to disruptions due to events beyond our control, including natural disasters, power or equipment failures and computer viruses and hackers |
| We have implemented various technology security initiatives, but there can be no assurance that these measures are adequate to prevent disruptions of our systems |
| We are highly reliant on third-party contractors to provide certain facilities and services for our operations, and termination of our third-party agreements could have a potentially adverse effect on our financial results |
| We have agreements with Alaska Airlines, US Airways, American Airlines, Continental Airlines, Delta Air Lines, Northwest Airlines, Island Air, and certain other contractors, to provide certain facilities and services required for our operations |
| These facilities and services include aircraft maintenance, code sharing, reservations, computer services, frequent flyer programs, passenger processing, ground facilities, baggage and cargo handling and personnel training |
| Our reliance on these third parties to continue to provide these important aspects of our business impact our ability to conduct our business effectively |
| · Maintenance agreements |
| If one or more of our maintenance providers terminate their respective agreements, we would have to seek alternative sources of maintenance service or undertake the 15 ______________________________________________________________________ maintenance of these aircraft or components ourselves |
| We cannot assure you that we would be able to do so on a basis that is as cost-effective as our current maintenance arrangements |
| · Code sharing agreements |
| We have code sharing agreements with Alaska Airlines, US Airways, American Airlines, American Eagle, Continental Airlines, Island Air, and Northwest Airlines |
| We also participate in the frequent flyer programs of Alaska Airlines, US Airways, American Airlines, Continental Airlines, Northwest Airlines and Virgin Atlantic Airways |
| Although these agreements increase our ability to be more competitive, they also increase our reliance on third parties |
| · Fuel agreements |
| We have entered into a jet fuel sale and purchase contract to provide us with a substantial amount of jet fuel, which we anticipate will be sufficient to meet all of our jet fuel needs for flights originating in Honolulu during 2006 |
| If the fuel provider terminates its agreement with us, we would have to seek an alternative source of jet fuel |
| We cannot assure you that we would be able to do so on a basis that is as cost-effective as our current arrangement |
| We have agreements with vendors at all airports we serve to provide us with fuel |
| Should any of these vendors cease to provide service to Hawaiian for whatever reason, our operations could be adversely affected |
| · Travel agency and wholesale agreements |
| In 2005, passenger ticket sales from travel agencies and wholesalers constituted approximately 27prca of our total operating revenue |
| Travel agents and wholesalers generally have a choice between one or more airlines when booking a customer’s flight |
| Accordingly, any effort by travel agencies or wholesalers to favor another airline or to disfavor us could adversely affect our revenue |
| Although we intend to maintain favorable relations with travel agencies and wholesalers, there can be no assurance that they will continue to do business with us |
| The loss of any one or several travel agencies and or wholesalers may have a material adverse affect on our operations |
| We are subject to various risks as a result of our fleet concentration in Boeing 717s |
| Our interisland fleet consists of 717 aircraft |
| In January 2005, Boeing Commercial Airplanes (Boeing) announced it would discontinue the production of that aircraft model in 2006 |
| As a result, the availability of parts and maintenance support for 717 aircraft may become limited in future years |
| Additionally, we may experience increased costs in later years associated with parts acquisition for and/or maintenance support of this aircraft |
| Our business may be adversely impacted by the existence of a provision in Hawaiian’s aircraft leases with one of its lessors which could lead to the termination of up to seven 767-300ER leases beginning in 2007 |
| We currently lease seven Boeing 767-300ER aircraft from AWMS I, an affiliate of AWAS, formerly Ansett Worldwide Aviation Services, Inc |
| AWAS can terminate those leases early, after not less than 180 days prior notice to Hawaiian, beginning in March 2007 |
| AWAS can terminate up to two of the leases between March 21, 2007 and September 20, 2007, up to three of the leases between September 21, 2007 and March 20, 2008 and up to two of the leases between March 21, 2008 and September 20, 2009 |
| After September 20, 2009, AWAS can terminate any or all seven of the leases on not less than 180 days prior notice |
| If AWAS successfully exercises any or all of its early termination options, Hawaiian is responsible for the rents due under the leases until the aircraft are returned to AWAS (or its designees) and for the aircraft return provisions prescribed in the lease agreements |
| Accordingly, if AWAS terminates one or more of its leases early, and we are unable to obtain additional replacement aircraft, our operations could be adversely affected |
| See “Business—Properties—Aircraft |
| ” Morgan Stanley, the owner of AWAS, has announced that AWAS will be sold to Terra Firma, a London-based private equity firm |
| Hawaiian has advised AWAS, Morgan Stanley and Terra Firma that Hawaiian believes it may have the ability to successfully challenge AWAS’s exercise of the termination 16 ______________________________________________________________________ rights, and the parties are engaged in discussions to attempt to reach a consensual resolution of the issue |
| There can be no assurance that these discussions will resolve the matter in our favor, or that any challenges would succeed if litigated |
| Our substantial debt could adversely affect our financial condition |
| As of December 31, 2005, we had substantial indebtedness, including the remaining balance of dlra20dtta8 million of the dlra25dtta0 million term loan portion of a dlra50dtta0 million senior secured credit facility which was scheduled to mature on June 2, 2008, a dlra25dtta0 million junior term loan which was scheduled to mature on June 2, 2008, dlra27dtta5 million of notes payable to the Internal Revenue Service (IRS) that mature in June 2011, and dlra52dtta3 million of subordinated convertible notes which mature on June 1, 2010 and are convertible into common stock at a conversion price of dlra4dtta35 per share commencing on June 1, 2006 |
| On March 14, 2006, the term loan portion of our senior secured credit facility was increased from dlra25dtta0 million to dlra62dtta5 million, and our junior term loan was increased from dlra25dtta0 million to dlra72dtta5 million |
| We intend to use a portion of the increased borrowings under the senior and junior credit facilities to redeem our Series A Subordinated Convertible Notes (the Series A Notes) and Series B Subordinated Convertible Notes (the Series B Notes and, together with the Series A Notes, the Notes) at 105prca of the aggregate principal amount, plus all accrued and unpaid interest due and payable thereunder, late in the first quarter or early in the second quarter of 2006 |
| See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources |
| ” The requirement to service our debt makes us more vulnerable to general adverse economic conditions, requires us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing the availability of our cash flow for operations and other purposes, limits our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate, and places us at a competitive disadvantage compared to any other competitor that has less debt than we do |
| Certain of our financing agreements include financial covenants that impose substantial restrictions on our financial and business operations |
| The terms of our senior secured credit facility and junior term loan agreements with Wells Fargo Foothill, Inc |
| and Canyon Capital Advisors, LLC, respectively, restrict our ability to, among other things, incur additional indebtedness, pay dividends or make other payments on investments, consummate asset sales or similar transactions, create liens, merge or consolidate with any other person, or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of our assets |
| The terms of the agreements contain covenants that require us to meet certain financial tests to avoid a default that might lead to early termination of the facilities |
| Moreover, these agreements contain covenants that require us to meet certain financial tests |
| If we were not able to comply with these covenants, our outstanding obligations under these facilities could be accelerated and become due and payable immediately |
| We have identified a material weakness in our internal control over financial reporting, which, if not remedied effectively, could have an adverse effect on our business |
| Management, through documentation, testing and assessment of our internal control over financial reporting pursuant to the rules promulgated by the |