assurance that our hedging strategy will successfully mitigate our fuel cost exposure. We are reviewing but have not implemented any hedging strategies with respect to our 2007 exposure. Based on market conditions, we may or may not hedge 2007 fuel exposure.
The term "disclosure controls and procedures" is defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. This term refers to the controls and procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC. An evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of our disclosure controls and procedures as of September 30, 2006. Based on that evaluation, our management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective as of September 30, 2006.
We have continued to make significant progress to remediate identified internal control deficiencies and to establish adequate internal controls over financial reporting during the quarter ended September 30, 2006. As we continue to evaluate the operating effectiveness of internal controls during 2006, it is possible that management will identify additional deficiencies that meet the definition of a material weakness and there can be no assurance that all material weaknesses will be remediated by December 31, 2006.
Other than as expressly noted above in this Item 4, there were no changes in our internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f), identified in connection with the evaluation of our controls performed during the fiscal quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
With respect to the fiscal quarter ended September 30, 2006, the information required in response to this Item is set forth in Note 6 to our Financial Statements contained in this report, and such information is incorporated herein by reference. Such description contains all of the information required with respect hereto.
ITEM 1A. RISK FACTORS
You should carefully consider each of the following Risk Factors and all other information in this report. These Risk Factors are not the only ones facing us. Our operations could also be impaired by additional risks and uncertainties. If any of the following risks and uncertainties develop into actual events, our business, financial condition and results of operations could be materially and adversely affected.
RISKS RELATED TO OUR BUSINESS
Risks Related to Our ACMI Business
We depend on a limited number of significant customers for our ACMI business, and the loss of one or more of such customers could materially adversely affect our business, results of operation and financial condition.
During the nine months ended September 30, 2006 and 2005, and the years ended December 31, 2005 and 2004, our ACMI business accounted for approximately 27.8%, 30.3%,28.8% and 26.6%, respectively, of our operating revenues. We depend on a limited number of significant customers for our ACMI business. In the years ended December 31, 2003, 2004 and 2005, the number of our ACMI customers ranged from 7 to 12. In addition, Emirates accounted for 12.3%, 9.8%, 9.7% and 9.1% of our operating revenues for the nine months ended September 30, 2006 and 2005 and for the years ended December 31, 2005 and 2004, respectively. We typically enter into ACMI contracts with terms of one year up to five years with our customers and the terms of these contracts expire on a staggered basis over the next 4.5 years. There is a risk that our customers, including Emirates, may not renew their ACMI contracts with us on favorable terms or at all. Entering into ACMI contracts with new customers generally requires a long sales cycle, and as a result, if our ACMI contracts are not renewed, our business, results of operations and financial condition could be materially adversely affected.
Our ACMI growth strategy could be adversely affected by a significant delay in the delivery of our new Boeing 747-8 freighter aircraft, or if such aircraft do not meet their performance specifications.
In September 2006, we placed an order for 12 new Boeing 747-8 freighter aircraft that are scheduled to be delivered in 2010 and 2011. As part of this transaction, we also hold rights to purchase up to an additional 14 747-8 aircraft at fixed prices, of which one is being held under option. The addition of these new aircraft is a material component of our ACMI growth strategy. Although the 747-8 aircraft shares many of the same components used in other Boeing 747 models, it is a new aircraft model and has not yet received the necessary regulatory approvals and certifications. Any significant delay in Boeing’s production or delivery schedule, including because of delay in receiving the necessary approvals and certifications, could delay the delivery and deployment of these aircraft. Although Boeing has provided us with performance guarantees, there is a risk that the new aircraft may not meet the performance specifications that are important to our customers, which could adversely affect our ability to deploy these aircraft in a timely manner or at favorable rates.
Risks Related to Our AMC Charter Business
We derive a significant portion of our revenues from our AMC charter business, and a substantial portion of these revenues were generated pursuant to ad hoc flying, as opposed to fixed contract arrangements with the AMC. In the longer term, we expect that the revenues from our AMC charter business may decline from 2006 levels, which could have a material adverse effect on our business, results of operations and financial condition.
During the nine months ended September 30, 2006 and 2005 and the years ended December 31, 2005 and 2004, approximately 21.7%, 26.9%, 27.2% and 20.0%, respectively, of our operating revenues were derived from our AMC charter business. In each of these years, the revenues derived from expansion flights for the Air Mobility Command significantly exceeded the value of the fixed flight component of our AMC contract.
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We expect that our AMC charter business, especially expansion flights, will be a significant source of our revenue for the foreseeable future, however over the long-term, revenues derived from the AMC charter business may decline from fiscal year 2006 levels as a result of reduced military heavy lift requirements. Revenues from our AMC charter business are derived from one-year contracts that the Air Mobility Command is not required to renew. Changes in national and international political priorities can significantly affect the volume of our AMC charter business, especially the volume of expansion flying. Any decrease in U.S. military activity could reduce our AMC charter business. In addition, our share of the total AMC charter business depends on several factors, including the total fleet size we commit to the CRAF program and the total number of aircraft deployed by our partners and competitors in the program. The Air Mobility Command holds all carriers to certain on-time performance requirements. To the extent that we fail to meet those performance requirements, or if we fail to perform or to pass semi-annual inspections, our revenues from our AMC charter business could decline through a suspension or termination of our AMC contract. Our revenues could also decline due to a reduction in the revenue rate we are paid by the Air Mobility Command, a greater reliance by the AMC on its own freighter fleet or a reduction in our allocation of expansion flying. If our AMC charter business declines significantly, it could have a material adverse effect on our business, results of operations and financial condition.
Our AMC charter business is dependent on our participation in a team accredited to participate in the CRAF program. If one of our team members withdraws from the program, or if our competitors commit additional aircraft to this program, our share of AMC flying may decline, which could have a material adverse effect on our results of operations and financial condition.
Each year, the Air Mobility Command grants a certain portion of its AMC charter business to different airlines based on a point system that is determined by the amount and type of aircraft pledged to the CRAF program. We participate in the CRAF program through a teaming arrangement with other airlines, led by FedEx Corporation. Our team is one of three major teams participating in the CRAF program. The formation of competing teaming arrangements, an increase by other air carriers in their commitment of aircraft to the program, the withdrawal of our team’s current partners, especially FedEx, or a reduction of the number of planes pledged to the CRAF program by our team could adversely affect the volume of and our revenues from our AMC charter business which could have a material adverse effect on our business, results of operations and financial condition.
Risks Related to Our Scheduled Service Business
Operating results in our scheduled service business may vary significantly from period to period, which could cause us to fail to meet operating targets and result in a decline in our stock price.
During the nine months ended September 30, 2006 and 2005 and the years ended December 31, 2005 and 2004, approximately 41.5%, 34.9% 34.4% and 45.3%of our operating revenues were derived from our scheduled service business. Our scheduled service business operates according to fixed flight schedules regardless of the amount of cargo transported. Consequently, a significant portion of our scheduled services costs are fixed, such as crew, fuel, capital costs, maintenance, and facilities expenses. The revenues generated from our scheduled services business vary significantly from period to period depending on a number of factors outside our control, including global airfreight demand, competition, global economic conditions and increases in fuel costs. As a result, if revenue for a particular period is below expectations, we will be unable to proportionately reduce our operating expenses for that period. Any revenue shortfall during a quarterly or annual period may thus cause our profitability for that period to fall below the expectations of public market analysts or investors, which could cause the price of our common stock to fall. Accordingly, you should not rely on period-to-period comparisons of operating results in our scheduled service business as an indicator of future performance.
Under the proposed terms of our blocked space agreement with DHL, DHL has committed to certain guaranteed capacity utilization, which we expect will account for a material portion of our scheduled service capacity. While we expect that our proposed venture with DHL will provide increased revenue stability in our scheduled service business, we cannot assure you that we will achieve the level of expected revenue from this transaction in accordance with our timetable, or at all.
We could lose our rights to fly into limited-entry markets primarily in Asia if we fail to fully utilize them which could materially adversely affect our scheduled service business. If additional route rights in the limited entry markets where we currently have a presence are awarded to other carriers, the value of our existing rights may be diminished.
A significant amount of our business, primarily in the scheduled service business, is conducted in limited-entry international markets with U.S.-negotiated rights that have been awarded in competitive carrier selection proceedings. This includes our Japan rights, China rights and our rights to carry local traffic between Hong Kong and other countries. Limited-
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entry rights are typically subject to loss for underutilization and there is a risk that some of our limited-entry rights may lapse if economic conditions and reduced demand from our customers preclude us from using them in full. The inability to obtain additional limited-entry routes might adversely affect our ability to quickly respond to any increased demand for scheduled service and thus limit our growth opportunities. If additional carriers are awarded route rights in the limited entry markets where we currently operate, we will face increased competition which could have an adverse effect on the rates we are able to charge for our service and the value of our limited entry rights may be diminished.
We may be unable to complete, or may be delayed in completing, our contemplated transaction with DHL. An inability to complete the transaction would impact our business strategy and may impact our stock price.
On October 12, 2006, one of our wholly owned subsidiaries, PACW entered into a letter of intent with DHL Network Operations (USA), Inc. for DHL to acquire a 49% equity interest and a 25% voting interest, in PACW. It is also contemplated that DHL will enter into a commercial arrangement whereby PACW will provide express network services to DHL through various commercial intercompany arrangements with one or more of its affiliates. These proposed transactions with DHL are an important part of enhancing the performance of our scheduled service business. While we are currently in the process of negotiating and finalizing definitive agreements with DHL, there can be no assurance that we will be able to enter into these definitive agreements on acceptable terms or at all. The completion of the contemplated transaction is subject to some closing conditions that are outside of our control, such as review and approval by regulatory authorities and third party consents. As a result, we can provide no assurance that this transaction will be completed. Our inability to complete this transaction, or delays in completing this transaction, may adversely impact our ability to execute our business strategy which could have a material adverse effect on our business, results of operations and financial condition.
Our proposed agreements with DHL will require us to meet certain performance targets in our scheduled service operations, including accelerated flying and processing schedules. Failure to meet these performance targets could lead to penalties under these agreements, or termination of the agreements.
Our ability to derive our desired economic benefits from our proposed transactions with DHL depends substantially on our ability to successfully meet strict performance standards and deadlines for processing cargo as part of an express cargo and freight network. These performance standards will impose more stringent time schedules on our scheduled service business than we currently operate under and we will be required to commence operating under these tighter time schedules by October 31, 2008 or an earlier date if requested by DHL. If we are not able to successfully transition our scheduled service to these accelerated schedules in a timely manner, we may not be able to achieve the projected revenues and profitability from this contract.
Our blocked space agreement with DHL will confer certain termination rights to DHL which, if exercised or triggered, may result in us being unable to realize the full benefits of this transaction.
The proposed terms of our blocked space agreement with DHL give DHL the option to terminate the agreement for convenience, on one year's notice to us, at the fifth, tenth or fifteenth anniversary of the commencement date. Further, DHL has a right to terminate for cause in the event that we default on our performance or we are unable to perform for reasons beyond our control. If DHL exercises its termination rights, we will not be able to achieve the projected revenues and profitability from this contract.
Risks Related to Our Business Generally
While our revenues may vary significantly from period to period, a substantial portion of our operating expenses are fixed. These fixed costs limit our ability to quickly change our cost structure to respond to any declines in our revenues, which could result in us failing to meet analyst and investor expectations.
To maintain our level of operations, a substantial portion of our costs are fixed, such as capital costs and debt service, crew, fuel, and maintenance and facility costs. Operating revenues from our business are directly affected by our ability to maintain high utilization of our aircraft and services at favorable rates. The utilization of our aircraft and our ability to obtain favorable rates are, in turn, affected by many factors, including global demand for airfreight, global economic conditions, fuel costs, and the deployment by our current and potential customers of their own aircraft, among others, causing our revenues to vary significantly over time. As a result, if our revenues for a particular period are below expectations, we will be unable to proportionately reduce our operating expenses for that period. Any revenue shortfall during a quarterly or annual period may cause our profitability for that period to fall below the expectations of public market analysts or investors.
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We have a limited number of revenue producing assets. The loss of one or more of our aircraft for an extended period of time could have a material adverse effect on our business, results of operations and financial condition.
Our operating revenues depend on our ability to effectively deploy all the aircraft in our fleet and maintain high utilization of these aircraft at favorable rates. In the event that one or more of our aircraft are out of service for an extended period of time, our operating revenues will significantly decrease and we may have difficulty fulfilling our obligations under one or more of our existing contracts. Many of our aircraft are deployed in potentially dangerous locations and carry hazardous cargo incidental to the services we provide in support of U.S. military activities, particularly in shipments to the Middle East. Other areas through which our flight routes pass are subject to geopolitical instability, which increases the risk of a loss of, or damage to, our aircraft, or death or injury to our personnel. While we maintain insurance to cover the loss of an aircraft, except for limited situations, we do not have insurance against the loss arising from business interruption. It is difficult to replace lost or substantially damaged aircraft due to the high capital requirements and long delivery lead times for new aircraft or to locate appropriate in-service aircraft for lease or sale. The loss of revenue resulting from any such business interruption, and the cost, long lead time and difficulties in sourcing a replacement aircraft, could have a material adverse effect on our business, results of operations and financial condition.
Should any of our aircraft become underutilized in our ACMI or AMC charter business, failure to redeploy these aircraft at favorable rates in our other lines of business or to successfully and timely dispose of such aircraft could have a material adverse effect on our business, results of operations and financial condition.
We provisionally allocate our aircraft among our business segments according to projected demand. If demand in our ACMI or AMC charter businesses weakens so that we have underutilized aircraft, we will seek to redeploy these aircraft in our other lines of business. If we are unable to successfully deploy these aircraft at favorable rates or achieve a timely disposal of such aircraft, our long term results of operations could be materially affected.
Our substantial obligations, including aircraft lease and other obligations, could impair our financial condition and adversely affect our ability to raise additional capital to fund our operations or capital requirements, all of which could limit our financial resources and ability to compete, and may make us more vulnerable to adverse economic events.
As of September 30, 2006, we had total obligations of approximately $2.9 billion, including our aircraft lease, debt and other obligations. Our outstanding financial obligations could have negative consequences, including:
making it more difficult to pay principal and interest with respect to our debt and lease obligations;
requiring us to dedicate a substantial portion of our cash flow from operations for interest, principal and leasepayments and reducing our ability to use our cash flow to fund working capital and other general corporaterequirements;
increasing our vulnerability to general adverse economic and industry conditions; and
limiting our flexibility in planning for, or reacting to, changes in business and in our industry.
Our ability to service our debt and meet our lease and other obligations as they come due is dependent on our future financial and operating performance. This performance is subject to various factors, including factors beyond our control, such as changes in global and regional economic conditions, changes in our industry, changes in interest or currency exchange rates, the price and availability of aviation fuel and other costs, including labor and insurance. Accordingly, we cannot assure you that we will be able to meet our debt service, lease and other obligations as they become due or otherwise.
Certain of our debt and lease obligations contain a number of restrictive covenants. In addition, many of our debt and lease obligations have certain cross default and cross acceleration provisions.
These restrictive covenants, under certain circumstances, could impact our ability to:
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In certain circumstances, a covenant default under one instrument could cause us to be in default of other obligations as well. Any such unremedied defaults could lead to an acceleration of repayment in full of any amounts owing, and in certain circumstances, potentially could cause us to lose possession or control of certain aircraft.
We have a number of contractual obligations, including progress payments, associated with our order of 12 Boeing 747-8 freighter aircraft. If we are unable to obtain financing for these aircraft and/or make the required progress payments, our growth strategy will be disrupted and our business, results of operations and financial condition could be materially adversely affected.
In September 2006, we placed an order for 12 new Boeing 747-8 freighter aircraft that are scheduled to be delivered in 2010 and 2011. As part of this transaction, we also hold options and rights to purchase up to an additional 14 747-8 aircraft at fixed prices. We are required to pay significant pre-delivery deposits to Boeing for these aircraft. We commenced making these pre-delivery payments in the third quarter of 2006. As of September 30, 2006, we had commitments of approximately $2.2 billion associated with this aircraft order. We typically finance our aircraft, including the required progress payments, through either mortgage debt or lease financing. Although we have received standby financing commitments to finance four of these aircraft, we cannot assure you that we will be able to meet the financing conditions contained in these commitments or to secure other financing at all or on terms attractive to us. If we are unable to secure such financing on acceptable terms, we may be required to incur financing costs that are substantially higher than what we currently anticipate.
Fuel price volatility could adversely affect our business and operations, especially in our scheduled service and commercial charter businesses.
The price of aircraft fuel is unpredictable and has been increasingly volatile over the past few years. Fuel is one of the most significant expenses in our scheduled service and commercial charter businesses. For the nine months ended September 30, 2006 and 2005 and the years ended December 31, 2005 and 2004, fuel costs were approximately 34.4%, 28.2%30.0% and 25.6%, respectively, of our total operating expenses. Although we attempt to pass on increases in the price of aircraft fuel to our scheduled service and commercial charter customers by imposing a surcharge, we end up bearing a portion of any price increases. There can be no assurance that we will be able to continue to impose such surcharges in the future. In 2005 and the first nine months of 2006 we did not enter into fuel hedging arrangements. With respect to the fourth quarter of 2006, we have hedged approximately 42% of our projected scheduled service fuel requirements through a combination of physical fixed fuel purchases and jet fuel swaps. However, there can be no assurance that our hedging strategy will successfully mitigate our fuel cost exposure. We are reviewing but have not implemented any fuel hedging strategies with respect to 2007 exposure.
In addition, while our ACMI contracts require our customers to pay for aviation fuel, if fuel costs increase significantly our customers may reduce the volume and frequency of cargo shipments or find less costly alternatives for cargo delivery, such as land and sea carriers.
Our insurance coverage may become more expensive and difficult to obtain.
Aviation insurance premiums historically have fluctuated based on factors that include the loss history of the industry in general, and the insured carrier in particular. Future terrorist attacks and other adverse events involving aircraft could result in increases in insurance costs and could affect the price and availability of such coverage. We have, as have most other U.S. airlines, purchased our war-risk coverage through a special program administered by the federal government. The Federal Aviation Administration is currently providing war-risk hull and cargo loss, crew and third-party liability insurance through December 31, 2006 as required by the Homeland Security Act of 2002, as amended by the Consolidated Appropriations Act of 2005 and by the Transportation Appropriations Act of 2006 and as further extended by the U.S. Secretary of Transportation. If the federal war-risk coverage program terminates or provides significantly less coverage in the future, we would likely face a material increase in the cost of war-risk coverage, and because of competitive pressures in the industry, our ability to pass this additional cost on to customers may be limited.
There can be no assurance that we will be able to maintain our existing coverage on terms favorable to us, that the premiums for such coverage will not increase substantially or that we will not bear substantial losses and lost revenues from accidents or other adverse events. Substantial claims resulting from an accident in excess of related insurance coverage or a significant increase in our current insurance expense could have a material adverse effect on our business, results of operations and financial condition. Additionally, while we carry insurance against the risks inherent to our operations, which we believe are consistent with the insurance arrangements of other participants in our industry, we cannot assure you that we are adequately insured against all risks. If our liability exceeds the amounts of our insurance coverage, we would be required to pay the excess amount, which could be material to our business and operations.
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As a U.S. government contractor, we are subject to a number of procurement and other rules and regulations that add costs to our business. A violation of these rules and regulations could lead to termination or suspension of our government contracts and could prevent us from entering into contracts with government agencies in the future.
In order to do business with government agencies, we must comply with, and are affected by, many laws and regulations, including those related to the formation, administration and performance of U.S. government contracts. These laws and regulations, among other things:
require, in some cases, certification and disclosure of all cost and pricing data in connection with contractnegotiations, and may give rise to U.S. government audit rights;
impose accounting rules that dictate how we define certain accounts, define allowable costs and otherwisegovern our right to reimbursement under certain cost-based U.S. government contracts;
establish specific health, safety and doing-business standards; and
restrict the use and dissemination of information classified for national security purposes and theexportation of certain products and technical data.
These laws and regulations affect how we do business with our customers and, in some instances, impose added costs on our business. A violation of these laws and regulations could result in the imposition of fines and penalties or the termination of our contracts. In addition, the violation of certain other generally applicable laws and regulations could result in our suspension or debarment as a government contractor.
Our financial condition could suffer if we experience unanticipated costs or enforcement action as a result of the SEC investigation, the Department of Justice fuel surcharge investigation and other lawsuits and claims.
On October 28, 2004, the SEC issued a Wells notice to us indicating that the SEC is considering bringing a civil action against us alleging that we violated certain financial reporting provisions of the federal securities laws from 1999 to 2002. In addition, on February 14, 2006, the Department of Justice served us with a subpoena in connection with its investigation into the fuel surcharge pricing practices of approximately 20 air cargo carriers. Other than the subpoena, there has been no complaint or demand of us by the Department of Justice, and we are fully cooperating with this investigation. As a result of the investigation, we and a number of other cargo carriers have been named co-defendants in approximately 80 class action suits filed in multiple jurisdictions of the U.S. Federal District Court, and have been named in a civil class action suit in Ontario, Canada, which is substantially similar to the U.S. class action suits. We have also received notification from Swiss authorities that they are investigating the freight pricing practices of several carriers, including us, on routes between Switzerland and the U.S. The Swiss authorities have not made any specific complaint or demand on us. We are also party to a number of other claims, lawsuits and pending actions, which we consider to be routine and incidental to our business (see Note 6 to our Financial Statements appearing elsewhere in this report).
While we are currently engaged in discussions with the SEC regarding the Wells notice and continue to cooperate fully with the SEC and the Department of Justice, we cannot assure you that we will be able to resolve these or the other matters discussed above on terms favorable to us or that they will not have a material adverse effect on our business, results of operations or financial condition.
We had significant deficiencies and a material weakness in our internal controls over financial reporting.
At the conclusion of the audit of our consolidated financial statements for the year ended December 31, 2005, our independent registered public accounting firm, Ernst & Young LLP, noted in a letter to management and the audit committee of our Board several significant deficiencies and one material weakness. However, Ernst & Young was not engaged to perform an audit or our internal controls over financial reporting. Accordingly, Ernst & Young has not expressed an opinion on the effectiveness of our internal controls over financial reporting. Through the nine months ended September 30, 2006, our management believes that we have taken appropriate steps that are intended to remediate the material weakness and significant deficiencies identified. However, we cannot confirm the effectiveness of our enhanced internal controls until we and our independent auditors have conducted sufficient testing. Such testing is to occur through the first quarter of 2007, with respect to the period through December 31, 2006. Accordingly, we will continue to monitor the effectiveness of these controls, and will make any further changes as management determines appropriate.
As we continue to evaluate the operating effectiveness of our internal controls during 2006, it is possible that management will identify additional deficiencies that meet the definition of a material weakness or significant deficiency and there can be no
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assurance that all such additional material weaknesses or significant deficiencies will be remediated by December 31, 2006 or thereafter in a timely manner. If we are unsuccessful in our efforts to permanently and effectively remediate these deficiencies and the material weakness, or otherwise fail to maintain adequate internal controls over financial reporting, our ability to accurately and timely report our financial condition may be adversely impacted, which could, among other things, limit our access to the capital markets. In addition, if we do not remediate any material weakness, we will not be able to conclude, pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and Item 308 of Regulation S-K of the Securities Act, that our internal controls over financial reporting are effective. We cannot assure you as to what conclusions our management or independent registered public accounting firm might reach with respect to their evaluation of the effectiveness of our internal controls over financial reporting as of December 31, 2006, the date at which we are first required to report such conclusions. In the event of non-compliance, we may lose credibility with our customers, suppliers and other our stakeholders, and our stock price may be adversely impacted, resulting in a material adverse effect on our business, results of operations and financial condition.
We are party to collective bargaining agreements with our U.S. crew members that could result in higher labor costs than faced by some of our non-unionized competitors putting us at a competitive disadvantage, and could result in a work interruption or stoppage, which could materially adversely affect our business, results of operations and financial condition.
All our U.S. crewmembers are represented by two unions. Collectively, these employees represented approximately 49.5%,49.0% and 54.0% of our workforce as of September 30, 2006 and years ended December 31, 2005 and 2004, respectively. We are subject to risks of increased labor costs associated with having a partially unionized workforce, as well as a greater risk of work interruption or stoppage. During 2005, a strike by our Polar crewmembers was resolved after a 20-day work stoppage. However, we cannot assure you that disputes, including disputes with certified collective bargaining representatives of our employees, will not arise in the future or will result in an agreement on terms satisfactory to us. Such disputes and the inherent costs associated with their resolution could have a material adverse effect on our business, results of operations and financial condition.
In November 2004, in order to increase efficiency and assist in controlling certain costs, we initiated steps to combine the U.S. crewmember bargaining units of Atlas and Polar. These actions are in accordance with the terms and conditions of Atlas and Polar’s collective bargaining agreements, which provide for a seniority integration process and the negotiation of a single collective bargaining agreement. In the event that we are unsuccessful in reaching agreement on a single collective bargaining agreement, any unresolved issues will be submitted to binding arbitration. While we cannot assure you as to the outcome of such arbitration, an adverse decision by the arbitrator could materially increase our crew costs. We may not be able to quickly or fully recover these increased costs in our rates which could have a material adverse effect on our business, results of operations and financial condition.
Our scheduled service and commercial charter businesses, and our revenue from those businesses are seasonal.
Our scheduled service and commercial charter businesses are seasonal in nature, with peak activity occurring during the retail holiday season, which traditionally begins in September and lasts through mid-December. This typically results in a significant decline in demand for these services in the first quarter of the fiscal year. Our ACMI contracts typically allow our customers to cancel a maximum of 5% of the guaranteed hours of aircraft utilization over the course of a year. Our customers often exercise those cancellation options early in the first quarter of the year, when the demand for air cargo capacity has been historically low following the seasonal holiday peak in the fourth quarter. While our scheduled service and commercial charter revenues fluctuate as described above, a significant proportion of the costs associated with these businesses, such as maintenance and facilities costs, are fixed and cannot easily be reduced to match the seasonal drop in demand. As a result, our net operating results are subject to a high degree of seasonality.
Volatility in international currency markets may adversely affect demand for our services.
Although we price the majority of our services and receive the majority of our payments in U.S. dollars, many of our customers’ revenues are denominated in foreign currencies. Any significant devaluation in such currencies relative to the U.S. dollar could have a material adverse effect on such customers’ ability to pay us or on their level of demand for our services, which could have a material adverse effect on our business, results of operations and financial condition. If there is a significant decline in the value of the U.S. dollar against foreign currencies, the demand for some of the products that we transport could decline. Such a decline could reduce demand for our services and thereby have a material adverse effect on our business, results of operations and financial condition.
We rely on third party service providers. If these service providers do not deliver the high level of service and support required in our business, we may lose customers and our revenue will suffer.
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We rely on third parties to provide certain essential services on our behalf, including maintenance and ground handling. In certain locations, there may be only one or a few sources of supply for these services. If we are unable to effectively manage these third parties, they may provide inadequate levels of support which could have an adverse impact on our operations resulting in an adverse impact on our results of operations. Any material problems with the efficiency and timeliness of our contract services, or an unexpected termination of those services, could have a material adverse effect on our business, results of operations and financial condition.
RISKS RELATED TO OUR INDUSTRY
We depend on certain levels of worldwide economic activity to operate our business successfully. Any significant decrease in demand for air cargo transport could adversely affect our business and operations.
Our success is highly dependent upon the level of business activity and overall economic conditions in the U.S. and abroad, including import and export demand in our key markets and levels of international U.S. military activity. Any economic downturn in the U.S. or in our key markets overseas, or any business shift towards using less time sensitive modes of freight transportation, such as land or sea based cargo services, is likely to adversely affect demand for the delivery services offered by our scheduled service business. Additionally, a prolonged economic slowdown may increase the likelihood that our ACMI customers would reduce the scope of services we provide to them which could adversely affect our business and operations.
The market for air cargo services is highly competitive and if we are unable to compete effectively, we may lose current customers or fail to attract new customers.
Each of the markets we participate in is highly competitive and fragmented. We offer a broad range of aviation services and our competitors vary by geographic market and type of service and include other international and domestic contract carriers, regional and national ground handling and logistics companies, internal cargo units of major airlines and third party cargo providers. Competition in the air cargo and transportation market is influenced by several key factors. Regulatory requirements to operate in the U.S. domestic air cargo market have been reduced, facilitating the entry into domestic markets by foreign air cargo companies. In addition, we expect that new freighter aircraft, including passenger aircraft that have been converted into freighter aircraft, that enter the market are likely to add to the supply of available cargo aircraft.
We are subject to extensive governmental regulations and our failure to comply with these regulations in the U.S. and abroad, or the adoption of any new laws, policies or regulations or changes to such regulations may have an adverse effect on our business.
Our operations are subject to complex aviation and transportation laws and regulations, including Title 49 of the U.S. Code (formerly the Federal Aviation Act 1958, as amended), under which the U.S. Department of Transportation and the U.S. Federal Aviation Administration exercise regulatory authority over air carriers. In addition, our business activities fall within the jurisdiction of various other federal, state, local and foreign authorities, including the U.S. Department of Defense, the U.S. Transportation Security Administration, U.S. Customs and Border Protection, the Treasury Department’s Office of Foreign Assets Control and the U.S. Environmental Protection Agency. In addition, other countries in which we operate have similar regulatory regimes to which we are subjected. These laws and regulations may require us to maintain and comply with the terms of a wide variety of certificates, permits, licenses, noise abatement standards and other requirements and our failure to do so could result in substantial fines or other sanctions. These U.S. and foreign aviation regulatory agencies have the authority to modify, amend, suspend or revoke the authority and licenses issued to us for failure to comply with provisions of law or applicable regulations and may impose civil or criminal penalties for violations of applicable rules and regulations. Such fines or sanctions, if imposed, could have a material adverse effect on our mode of conducting business, results of operations and financial condition. In addition, U.S. and foreign governmental authorities may adopt new regulations, directives or orders that could require us to take additional and potentially costly compliance steps or result in the grounding of some of our aircraft, which could increase our operating costs or result in a loss of revenues, which could have a material adverse effect on our business, results of operations and financial condition.
International aviation is increasingly subject to conflicting requirements imposed or proposed by the U.S. and foreign governments. This is especially true in the areas of transportation security, aircraft noise and emissions control. Recently, the European Commission proposed that the European Union adopt, through its legislative process, limitations on the ability of European Union carriers to wet lease (through ACMI arrangements) aircraft from non-European Union carriers. These and other similar regulatory developments could increase business uncertainty for commercial air-freight carriers.
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The airline industry, which encompasses both the travel and air freight industries, is subject to numerous security regulations and rules which increase costs. Imposition of more stringent regulations and rules than currently exist could materially increase our costs and have a material adverse effect on our results of operations.
The Transportation Security Administration has increased security requirements in response to increased levels of terrorist activity, and has adopted comprehensive new regulations governing air cargo transportation, including all-cargo services, in such areas as cargo screening and security clearances for individuals with access to cargo. Additional measures, including a requirement to screen cargo, have been proposed, which if adopted, may have an adverse impact on our ability to efficiently process cargo and would increase our costs. The cost of compliance with increasingly stringent regulations could have a material adverse effect on our business, results of operations and financial condition.
RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK
Our common stock share price has been, and is likely to continue to be, volatile.
The trading price of our common shares is subject to wide fluctuations in response to a variety of factors, including quarterly variations in our operating results, economic conditions of the airline industry generally or airline cargo carriers specifically, general economic conditions or other events and factors that are beyond our control.
In the past, following periods of significant volatility in the overall market and in the market price of a company's securities, securities class action litigation has been instituted against these companies in some circumstances. If this type of litigation were instituted against us following a period of volatility in the market price for our common stock, it could result in substantial costs and a diversion of our management's attention and resources, which could have a material adverse effect on our business, results of operations and financial condition.
We have not paid cash dividends and do not expect to pay dividends in the future, which means that our stockholders may not be able to realize the value of our common stock except through sale. In addition, certain of our financing arrangements contain financial covenants that limit our ability to pay dividends.
We have never declared or paid cash dividends. We expect to retain earnings for our business and do not anticipate paying dividends on our common stock at any time in the foreseeable future. Because we do not anticipate paying dividends in the future, a sale of shares likely is the only opportunity our stockholders will have to realize the value of our common stock. In addition, certain of our financing arrangements contain financial covenants that limit our ability to pay dividends.
Provisions in our restated certificate of incorporation and by-laws and Delaware law might discourage, delay or prevent a change in control of our company and, therefore, depress the trading price of our common stock.
Provisions of our restated certificate of incorporation and by-laws and Delaware law may discourage, delay or prevent a merger, acquisition or other change in control, which stockholders may consider favorable, including transactions in which you might otherwise receive a premium for your shares of common stock. These include the following:
the ability of our board of directors to designate the terms of, and issue new series of, preferred stock withoutstockholder approval;
the ability of our board of directors to make, alter or repeal our by-laws;
the inability of stockholders to act by written consent or to call special meetings of stockholders; and
advance notice requirements for stockholder proposals and director nominations.
Except for the provision dealing with the issuance of new series of preferred stock, the affirmative vote of at least two thirds of our shares of capital stock entitled to vote is necessary to amend or repeal the above provisions. In addition, absent approval of our board of directors, our by-laws may only be amended or repealed by the affirmative vote of at least two thirds of our shares entitled to vote.
In addition, Section 203 of the Delaware General Corporation Law prohibits a publicly-traded Delaware corporation from engaging in a business combination with an interested stockholder, generally a person which together with its affiliates owns, or within the last three years had owned, 15% of our voting stock, for a period of three years after the date of the
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transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner.
The existence of the above provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. They could also deter potential acquirers of us, thereby reducing the likelihood that you could receive a premium for your common stock in an acquisition.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
We made the following repurchases of shares of our common stock during the fiscal quarter ended September 30, 2006:
| | | | | | | | | Maximum Number (or |
| | | | | | | | Total Number of | Approximate Dollar |
| | | | | | | | Shares Purchased as | Value) of Shares that |
| | | | | | | | Part of Publicly | May Yet Be Purchased |
| | Total Number of | Average Price | Announced Plans or | Under the Plans or |
| Period | Shares Purchased (a) | Paid per Share | Programs (b) | Programs |
| |
| July 1, 2006 through July | | — | | | — | | — | — |
| 31, 2006 | | | | | | | | |
| |
| August 1, 2006 through | | 51,898 | | | $41.04 | | — | — |
| August 31, 2006 | | | | | | | | |
| |
| September 1, 2006 through | | — | | | — | | — | — |
| September 30, 2006 | | | | | | | | |
| |
| Total | | 51,898 | | | $41.04 | | — | — |
| | | | | | | | | |
(a) This column reflects the repurchase of 51,898 shares of common stock to satisfy individual tax liabilities of our employees relating to the vesting of restricted shares.
(b) There are no approved share repurchase programs.
ITEM 6. EXHIBITS
a. Exhibits
See accompanying Exhibit Index included after the signature page of this report for a list of exhibits filed or furnished with this report.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | Atlas Air Worldwide Holdings, Inc. |
| |
| Dated: November 9, 2006 | | /s/ William J. Flynn |
| | | William J. Flynn |
| | | President and Chief Executive Officer |
| |
| Dated: November 9, 2006 | | /s/ Michael L. Barna |
| | | Michael L. Barna |
| | | Senior Vice President and Chief Financial Officer |
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EXHIBIT INDEX
| Exhibit Number | Description |
| | | |
| | 10.1 | Purchase Agreement Number 3134, dated as of September 8, 2006, between The Boeing Company and Atlas Air, Inc. (Atlas has filed a request with the Commission for confidential treatment as to certain portions of this document) |
| |
| | 10.2 | Employment Agreement dated September 19, 2006, between Atlas Air, Inc. and John Dietrich. |
| |
| | 31.1 | Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer, furnished herewith. |
| |
| | 31.2 | Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer, furnished herewith. |
| |
| | 32.1 | Section 1350 Certifications, furnished herewith. |
| |
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