News Column

SPIRIT AIRLINES, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

February 20, 2014

You should read the following discussion of our financial condition and results of operations in conjunction with the financial statements and the notes thereto included elsewhere in this annual report. 2013 Year in Review The year 2013 marks the seventh consecutive year of profitability and one of the most successful years on record for us. We achieved earnings of $176.9 million ($2.42 per share, diluted), compared to net income of $108.5 million ($1.49 per share, diluted) in 2012. The increase in our 2013 net income is a result of our increased capacity, continued strong demand for our ultra-low fares and growth in our ancillary revenues. For the year ended December 31, 2013, we achieved record annual profits and a 17.1% operating profit margin, the highest in our history, on $1,654.4 million in operating revenues. Our traffic grew by 24.2% as we continued to stimulate demand with ultra-low fares. Total revenue per passenger flight segment increased by 5.4% from $126.50 to $133.27. Total RASM for 2013 was 11.94 cents, an increase of 2.8% compared to the prior year period, as a result of both higher average passenger yields and increased load factors. Strength in demand throughout 2013 allowed us to leverage our ability to revenue manage our inventory, resulting in increased profitability year over year. Our operating cost structure is a primary area of focus and is at the core of our ULCC business model in which we compete solely on the basis of price. Spirit's unit operating costs continue to be among the lowest of any airline in the Americas. During 2013, we increased our capacity by 22.2% as we grew our fleet of Airbus single-aisle aircraft from 45 to 54, added 25 new nonstop routes during the year, and launched service to two new destinations: New Orleans, Louisiana and Philadelphia, Pennsylvania. During 2013, we increased our average non-ticket revenue per passenger flight segment by 4.8%, or $2.45, to $53.84. Our total non-ticket revenue increased by 24.8%, or $132.8 million, to $668.4 million in 2013. The year-over-year increase in average non-ticket revenue per passenger flight segment was primarily driven by changes we made late in 2012 to our bag fee schedule to optimize revenue by channel, a change we made in July 2013 to align our foreign passenger usage fee with our domestic passenger usage fee, and an increase in service charges collected as a result of increased volume of third-party bookings. Growth in travel package sales including the offering of third-party travel-related options such as hotels and rental cars for sale through our website, subscriptions to our $9Fare Club and other options designed to enhance our customers' travel experience also contributed to the growth of our non-ticket revenue. During 2013, our adjusted CASM ex-fuel decreased by 1.5% to 5.91 cents. Better operational performance during 2013 as compared to 2012 helped drive lower wages and passenger re-accommodation expenses. In addition, during 2013, we entered into lease extensions covering 14 of our existing A319 aircraft resulting in reduced lease rates for the remaining term of the leases which contributed to the decrease in adjusted CASM ex-fuel as compared to 2012. These decreases were partially offset by higher heavy maintenance amortization expense for 2013 resulting from the increase in deferred heavy aircraft maintenance events as compared to the same period in 2012. During 2013, we reached a Company milestone with the introduction of the 50th aircraft into our operating fleet. As of December 31, 2013, our 54 Airbus A320-family aircraft fleet was comprised of 29 A319s, 23 A320s and 2 A321s. As of December 31, 2013, our aircraft orders consisted of 112 A320 family aircraft with Airbus and 5 direct operating leases for A320neos with a third party, scheduled for delivery from 2014 through 2021. Our plan calls for growing the fleet by 20.4% in 2014. 2011 IPO On June 1, 2011, we completed our initial public offering of common stock, or IPO, which raised net proceeds of $150.0 million after repayment of debt, payment of transaction expenses and other fees. In connection with the IPO, we effected a recapitalization, which we refer to as the 2011 Recapitalization, that resulted in the repayment or conversion of all of our notes and shares of preferred stock into shares of common stock. Our Operating Revenues Our operating revenues are comprised of passenger revenues and non-ticket revenues. Passenger Revenues. Passenger revenues consist of the base fares that customers pay for air travel. 36 -------------------------------------------------------------------------------- Non-ticket Revenues. Non-ticket revenues are generated from air travel-related charges for baggage, passenger usage fee (PUF) for bookings through our distribution channels, advance seat selection, itinerary changes, hotel travel packages and loyalty programs such as our FREE SPIRIT affinity credit card program and $9Fare Club. Non-ticket revenues also include revenues derived from services not directly related to providing transportation such as the sale of advertising to third parties on our website and on board our aircraft. Substantially all of our revenues are denominated in U.S. dollars. Passenger revenues are recognized once the related flight departs. Accordingly, the value of tickets sold in advance of travel is included under our current liabilities as "air traffic liability," or ATL, until the related air travel is provided. Non-ticket revenues are generally recognized at the time the ancillary products are purchased or ancillary services are provided. Non-ticket revenues also include revenues from our subscription-based $9Fare Club, which we recognize on a straight-line basis over 12 months. Revenue generated from the FREE SPIRIT credit card affinity program are recognized in accordance with the criteria as set forth in Accounting Standards Update ASU No. 2009-13. Please see "-Critical Accounting Policies and Estimates-Frequent Flier Program". We recognize revenues net of certain taxes and airport passenger fees, which are collected by us on behalf of airports and governmental agencies and remitted to the applicable governmental entity or airport on a periodic basis. These taxes and fees include U.S. federal transportation taxes, federal security charges, airport passenger facility charges and foreign arrival and departure taxes. These items are collected from customers at the time they purchase their tickets, but are not included in our revenues. We record a liability upon collection from the customer and relieve the liability when payments are remitted to the applicable governmental agency or airport. Our Operating Expenses Our operating expenses consist of the following line items. Aircraft Fuel. Aircraft fuel expense is our single largest operating expense. It includes the cost of jet fuel, related federal taxes, fueling into-plane fees and transportation fees. It also includes realized and unrealized gains and losses arising from any fuel price hedging activity. Salaries, Wages and Benefits. Salaries, wages and benefits expense includes the salaries, hourly wages, bonuses and equity compensation paid to employees for their services, as well as the related expenses associated with employee benefit plans and employer payroll taxes. Aircraft Rent. Aircraft rent expense consists of monthly lease rents for aircraft and spare engines under the terms of the related operating leases and is recognized on a straight-line basis. Aircraft rent expense also includes supplemental rent. Supplemental rent is made up of maintenance reserves paid or to be paid to aircraft lessors in advance of the performance of major maintenance activities that are not probable of being reimbursed and lease return condition obligations which we begin to accrue when they are probable. Aircraft rent expense is net of the amortization of gains and losses on sale and leaseback transactions on our flight equipment. Presently, all of our aircraft and spare engines are financed under operating leases. Landing Fees and Other Rents. Landing fees and other rents include both fixed and variable facilities expenses, such as the fees charged by airports for the use or lease of airport facilities, overfly fees paid to other countries and the monthly rent paid for our headquarters facility. Distribution. Distribution expense includes all of our direct costs including the cost of web support, our third-party call center, travel agent commissions and related GDS fees and credit card transaction fees, associated with the sale of our tickets and other products and services. Maintenance, Materials and Repairs. Maintenance, materials and repairs expense includes all parts, materials, repairs and fees for repairs performed by third-party vendors directly required to maintain our fleet. It excludes direct labor cost related to our own mechanics, which is included under salaries, wages and benefits. It also excludes the amortization of heavy maintenance expenses, which we defer under the deferral method of accounting and amortize as a component of depreciation and amortization expense. Depreciation and Amortization. Depreciation and amortization expense includes the depreciation of fixed assets we own and leasehold improvements. It also includes the amortization of heavy maintenance expenses we defer under the deferral method of accounting for heavy maintenance events and recognize into expense on a straight-line or usage basis until the earlier of the next estimated heavy maintenance event or the aircraft's return at the end of the lease term. Loss on Disposal of Assets. Loss on disposal of assets includes the net losses on the disposal of our fixed assets, including losses on sale and leaseback transactions. 37 -------------------------------------------------------------------------------- Other Operating Expenses. Other operating expenses include airport operations expense and fees charged by third-party vendors for ground handling services and food and liquor supply service expenses, passenger re-accommodation expense, the cost of passenger liability and aircraft hull insurance, all other insurance policies except for employee health insurance, travel and training expenses for crews and ground personnel, professional fees, personal property taxes and all other administrative and operational overhead expenses. No individual item included in this category represented more than 5% of our total operating expenses. Special Charges (Credits). Special charges (credits) include termination costs, secondary offering costs and the gain on the sale of take-off and landing slots. In 2012, we sold four permanent air carrier slots at Ronald Reagan National Airport (DCA) to another airline for $9.1 million. We recognized the $9.1 million gain within special charges (credits) in the third quarter of 2012, the period in which the FAA operating restriction lapsed and written confirmation of the slot transfer was received by the buyer from the FAA. During the third quarter of 2013, certain stockholders affiliated with Indigo Partners LLC (Indigo) sold an aggregate of 12,070,920 shares of common stock in an underwritten public offering. We incurred $0.3 million in costs related to this offering in 2013. Upon completion of this secondary offering, investment funds affiliated with Indigo owned no shares of our common stock. On July 31, 2012, certain stockholders affiliated with Oaktree Capital Management (Oaktree) sold an aggregate of 9,394,927 shares of common stock in an underwritten public offering. We incurred $0.7 million in costs related to this offering in 2012. Upon completion of this secondary offering, investment funds affiliated with Oaktree owned no shares of our common stock. On January 25, 2012, certain stockholders of the Company, including affiliates of Oaktree and Indigo and certain members of our executive team, sold an aggregate of 12,650,000 shares of common stock in an underwritten public offering. We incurred a total of $1.3 million in costs between 2011 and 2012 related to this secondary offering, offset by reimbursements from certain selling stockholders of $0.6 million in accordance with the Fourth Amendment to the Second Amended and Restated Investor Rights Agreement. We did not receive any proceeds from any of these secondary offerings. In the second quarter of 2011, we incurred $2.3 million of termination costs in connection with the IPO comprised of amounts paid to Indigo to terminate its professional services agreement with us and fees paid to three individual, unaffiliated holders of our subordinated notes. Our Other Expense (Income) Interest Expense. Paid-in-kind interest on notes due to related parties and preferred stock dividends due to related parties account, on average, for over 80% of interest expense incurred in 2011. Non-related party interest expense accounted for the remainder of interest expense in 2011. All of the notes and preferred stock were repaid or redeemed, or exchanged for common stock, in connection with the 2011 Recapitalization. Interest expense in 2012 primarily relates to interest on PDPs and interest related to the Tax Receivable Agreement, or TRA. Interest expense in 2013 primarily relates to interest on the TRA. Capitalized Interest. Capitalized interest represents interest cost incurred during the acquisition period of an aircraft which theoretically could have been avoided had we not made PDPs for that aircraft. These amounts are capitalized as part of the cost of the aircraft upon delivery. Capitalization of interest ceases when the asset is ready for service. Capitalized interest for 2011 primarily relates to the interest incurred on debt due to related parties. Capitalized interest for 2012 and 2013 primarily relates to interest incurred in connection with payments owed under the TRA. Our Income Taxes We account for income taxes using the liability method. We record a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred taxes are recorded based on differences between the financial statement basis and tax basis of assets and liabilities and available tax loss and credit carryforwards. In assessing the realizability of the deferred tax assets, we consider whether it is more likely than not that some or all of the deferred tax assets will be realized. In evaluating the ability to utilize our deferred tax assets, we consider all available evidence, both positive and negative, in determining future taxable income on a jurisdiction by jurisdiction basis. In connection with the IPO, we entered into the TRA and thereby distributed immediately prior to the completion of the IPO to the holders of common stock as of such time, or the Pre-IPO Stockholders, the right to receive an amount equal to 90% 38 -------------------------------------------------------------------------------- of the cash savings in federal income tax realized by it by virtue of the use of the federal net operating loss, deferred interest deductions and alternative minimum tax credits held by us as of March 31, 2011, which is defined as the Pre-IPO NOL. Cash tax savings generally will be computed by comparing actual federal income tax liability to the amount of such taxes that we would have been required to pay had such Pre-IPO NOLs (as defined in the TRA) not been available. Upon consummation of the IPO and execution of the TRA, we recorded a liability with an offsetting reduction to additional paid in capital. The amount and timing of payments under the TRA will depend upon a number of factors, including, but not limited to, the amount and timing of taxable income generated in the future and any future limitations that may be imposed on our ability to use the Pre-IPO NOLs. The term of the TRA will continue until the first to occur (a) the full payment of all amounts required under the agreement with respect to utilization or expiration of all of the Pre-IPO NOLs, (b) the end of the taxable year including the tenth anniversary of the IPO or (c) a change in control of the Company. In accordance with the TRA, we are required to submit a Tax Benefit Schedule showing the proposed TRA payout amount to the Stockholder Representatives within 45 calendar days after we file our tax return. Stockholder Representatives are defined as Indigo Pacific Partners, LLC and OCM FIE, LLC, representing the two largest ownership interest of pre-IPO shares. The Tax Benefit Schedule shall become final and binding on all parties unless a Stockholder Representative, within 45 calendar days after receiving such schedule, provides us with notice of a material objection to such schedule. If the parties, for any reason, are unable to successfully resolve the issues raised in any notice within 30 calendar days of receipt of such notice, we and the Stockholder Representatives have the right to employ the reconciliation procedures as set forth in the TRA. If the Tax Benefit Schedule is accepted, then we have five days after acceptance to make payments to the Pre-IPO stockholders. Pursuant to the TRA's reconciliation procedures, any disputes that cannot be settled amicably, are settled by arbitration conducted by a single arbitrator jointly selected by both parties. During the second quarter of 2012, we paid $27.2 million, or 90% of the 2011 tax savings realized from the utilization of NOLs, including $0.3 million of applicable interest. During 2012, management adjusted for an immaterial error in the original estimate of the liability. This adjustment reduced the liability with an offset to additional paid in capital. During 2013, we filed an amended 2009 income tax return in order to correct its NOL carry forward as of December 31, 2009. As a result, our NOL carry forward as of March 31, 2011 was consequently reduced by $7.8 million, which corresponds to a reduction in the estimated TRA benefit of $2.4 million with an offset to additional paid in capital. On September 13, 2013, we filed our 2012 federal income tax return, and on October 14, 2013, we submitted a Tax Benefit Schedule to the Stockholder Representatives. On November 27, 2013, pursuant to the TRA, we received an objection notice to the Tax Benefit Schedule from the Stockholder Representatives. As of December 31, 2013, we estimated the TRA liability to be $5.6 million. We are in discussions with the Stockholder Representatives attempting to resolve the objection related to the Tax Benefit Schedule and thus have not employed the TRA's reconciliation procedures. Trends and Uncertainties Affecting Our Business We believe our operating and business performance is driven by various factors that affect airlines and their markets, trends affecting the broader travel industry and trends affecting the specific markets and customer base that we target. The following key factors may affect our future performance. Competition. The airline industry is highly competitive. The principal competitive factors in the airline industry are fare pricing, total price, flight schedules, aircraft type, passenger amenities, number of routes served from a city, customer service, safety record and reputation, code-sharing relationships and frequent flier programs and redemption opportunities. Price competition occurs on a market-by-market basis through price discounts, changes in pricing structures, fare matching, target promotions and frequent flier initiatives. Airlines typically use discount fares and other promotions to stimulate traffic during normally slower travel periods to generate cash flow and to maximize unit revenue. The prevalence of discount fares can be particularly acute when a competitor has excess capacity that it is under financial pressure to sell. Seasonality and Volatility. Our results of operations for any interim period are not necessarily indicative of those for the entire year because the air transportation business is subject to significant seasonal fluctuations. We generally expect demand to be greater in the second and third quarters compared to the rest of the year. The air transportation business is also volatile and highly affected by economic cycles and trends. Consumer confidence and discretionary spending, fear of terrorism or war, weakening economic conditions, fare initiatives, fluctuations in fuel prices, labor actions, changed in governmental regulations on taxes and fees, weather and other factors have resulted in significant fluctuations in revenues and results of operations in the past. We believe demand for business travel historically has been more sensitive to economic pressures than demand for low-price travel. Finally, a significant portion of our operations are concentrated in markets such as South Florida, the Caribbean, Latin America and the Northeast and northern Midwest regions of the United States, which are particularly vulnerable to weather, airport traffic constraints and other delays. 39 -------------------------------------------------------------------------------- Aircraft Fuel. Fuel costs represent the single largest operating expense for most airlines, including ours. Fuel costs have been subject to wide price fluctuations in recent years. Fuel availability and pricing are also subject to refining capacity, periods of market surplus and shortage and demand for heating oil, gasoline and other petroleum products, as well as meteorological, economic and political factors and events occurring throughout the world, which we can neither control nor accurately predict. We source a significant portion of our fuel from refining resources located in the southeast United States, particularly facilities adjacent to the Gulf of Mexico. Gulf Coast fuel is subject to volatility and supply disruptions, particularly in hurricane season when refinery shutdowns have occurred in recent years, or when the threat of weather-related disruptions has caused Gulf Coast fuel prices to spike above other regional sources. Both jet fuel swaps and jet fuel options are used at times to protect the refining price risk between the price of crude oil and the price of refined jet fuel, and to manage the risk of increasing fuel prices. Historically, we have protected approximately 70% of our forecasted fuel requirements during peak hurricane season (August through October) using jet fuel swaps. Our fuel hedging practices are dependent upon many factors, including our assessment of market conditions for fuel, our access to the capital necessary to support margin requirements, the pricing of hedges and other derivative products in the market, our overall appetite for risk and applicable regulatory policies. As of December 31, 2013, we had no derivative contracts outstanding. As of December 31, 2013, we purchased all of our aircraft fuel under a single fuel service contract. The cost and future availability of jet fuel cannot be predicted with any degree of certainty. Labor. The airline industry is heavily unionized. The wages, benefits and work rules of unionized airline industry employees are determined by collective bargaining agreements, or CBAs. Relations between air carriers and labor unions in the United States are governed by the RLA. Under the RLA, CBAs generally contain "amendable dates" rather than expiration dates, and the RLA requires that a carrier maintain the existing terms and conditions of employment following the amendable date through a multi-stage and usually lengthy series of bargaining processes overseen by the NMB. This process continues until either the parties have reached agreement on a new CBA, or the parties have been released to "self-help" by the NMB. In most circumstances, the RLA prohibits strikes; however, after release by the NMB, carriers and unions are free to engage in self-help measures such as strikes and lockouts. We have three union-represented employee groups comprising approximately 59% of our employees at December 31, 2013. Our pilots are represented by the Airline Pilots Association, International or ALPA, our flight attendants are represented by the Association of Flight Attendants, or AFA-CWA, and our flight dispatchers are represented by the Transport Workers Union of America, or TWU. Conflicts between airlines and their unions can lead to work slowdowns or stoppages. In June 2010, we experienced a five-day strike by our pilots, which caused us to shut down our flight operations. The strike ended as a result of our reaching a tentative agreement under a Return to Work Agreement and a full flight schedule was resumed on June 18, 2010. On August 1, 2010, we entered into a five-year collective bargaining agreement with our pilots. In August 2013, we entered into a five-year agreement with our flight dispatchers. In December 2013, with the help of the NMB, we reached a tentative agreement for a five-year contract with our flight attendants. The tentative agreement was subject to ratification by the flight attendant membership. On February 7, 2014, we were notified that the flight attendants voted to not ratify the tentative agreement. We will continue to work together with the AFA and the NMB with a goal of reaching a mutually beneficial agreement. We believe the five-year term of our CBAs is valuable in providing stability to our labor costs and provide us with competitive labor costs compared to other U.S.-based low-cost carriers. If we are unable to reach agreement with any of our unionized work groups in current or future negotiations regarding the terms of their CBAs, we may be subject to work interruptions or stoppages, such as the strike by our pilots in June 2010. A strike or other significant labor dispute with our unionized employees is likely to adversely affect our ability to conduct business. Maintenance Expense. Maintenance expense grew through 2013, 2012 and 2011 mainly as a result of the increasing age (approximately 5.1 years on average at December 31, 2013) and size of our fleet. As the fleet ages, we expect that maintenance costs will increase in absolute terms. The amount of total maintenance costs and related amortization of heavy maintenance (included in depreciation and amortization expense) is subject to many variables such as future utilization rates, average stage length, the size and makeup of the fleet in future periods and the level of unscheduled maintenance events and their actual costs. Accordingly, we cannot reliably quantify future maintenance expenses for any significant period of time. However, we believe, based on our scheduled maintenance events, maintenance expense and maintenance-related amortization expense in 2014 will be approximately $113 million. In addition, we expect to capitalize $40 million of costs for heavy maintenance during 2014. As a result of a significant portion of our fleet being acquired over a relatively short period of time, significant maintenance scheduled on each of our planes will occur at roughly the same time, meaning we will incur our most expensive scheduled maintenance obligations across our current fleet around the same time. These more significant maintenance activities will result in out-of-service periods during which our aircraft will be dedicated to maintenance activities and unavailable to fly revenue service. In addition, management expects that the final heavy maintenance events will be amortized over the remaining lease term rather than until the next estimated heavy maintenance event, because we account for heavy maintenance under the deferral method. This will result in significantly higher depreciation and amortization expense related to heavy maintenance in 40 -------------------------------------------------------------------------------- the last few years of the leases as compared to the costs in earlier periods. Please see "-Critical Accounting Policies and Estimates-Aircraft Maintenance, Materials, Repair Costs and Related Heavy Maintenance Amortization." Maintenance Reserve Obligations. The terms of some of our aircraft lease agreements require us to post deposits for future maintenance, also known as maintenance reserves, to the lessor in advance of and as collateral for the performance of major maintenance events, resulting in our recording significant prepaid deposits on our balance sheet. As a result, the cash costs of scheduled major maintenance events are paid well in advance of the recognition of the maintenance event in our results of operations. Please see "-Critical Accounting Policies and Estimates-Aircraft Maintenance, Materials, Repair Costs and Related Heavy Maintenance Amortization" and "-Maintenance Reserves." Critical Accounting Policies and Estimates The following discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses and related disclosure of contingent assets and liabilities at the date of our financial statements. For a detailed discussion of our significant accounting policies, please see "Notes to Financial Statements-1. Summary of Significant Accounting Policies". Critical accounting policies are defined as those policies that reflect significant judgments or estimates about matters that are both inherently uncertain and material to our financial condition or results of operations. Revenue Recognition. Revenues from tickets sold are initially deferred as ATL. Passenger revenues are recognized when transportation is provided. An unused non-refundable ticket expires at the date of scheduled travel and is recognized as revenue for the expired ticket value at the date of scheduled travel. Our most significant non-ticket revenues include revenues generated from air travel-related services paid for baggage, bookings through our call center or third-party vendors, advance seat selection, itinerary changes and loyalty programs, and are recognized at the time products are purchased or ancillary services are provided. These revenues also include commissions from the sales of hotel rooms, trip insurance and rental cars recognized at the time the service is rendered. Non-ticket revenues also include revenues from our subscription-based $9Fare Club, recognized on a straight-line basis over 12 months. Customers may elect to change their itinerary prior to the date of departure. A service charge is assessed and recognized on the date the change is initiated and is deducted from the face value of the original purchase price of the ticket, and the original ticket becomes invalid. The amount remaining after deducting the service charge is called a credit shell which expires 60 days from the date the credit shell is created and can be used towards the purchase of a new ticket and our other service offerings. The amount of credits expected to expire is recognized as revenue upon issuance of the credit and is estimated based on historical experience. Estimating the amount of credits that will go unused involves some level of subjectivity and judgment. Frequent Flier Program. We accrue for mileage credits earned through travel, including mileage credits for members with an insufficient number of mileage credits to earn an award, under our FREE SPIRIT program based on the estimated incremental cost of providing free travel for credits that are expected to be redeemed. Incremental costs include fuel, insurance, security, ticketing and facility charges reduced by an estimate of amounts required to be paid by the passenger when redeeming the award. Under our affinity card program, funds received for the marketing of a co-branded Spirit credit card and delivery of award miles are accounted for as a mulitple-deliverable arrangement. At the inception of the arrangement, we evaluated all deliverables in the arrangement to determine whether they represent separate units of accounting. We determined the arrangement had three separate units of accounting: (i) travel miles to be awarded, (ii) licensing of brand and access to member lists and (iii) advertising and marketing efforts. At inception of the arrangement, we established the relative selling price for all deliverables that qualified for separation, as arrangement consideration should be allocated based on relative selling price. The manner in which the selling price was established was based on the applicable hierarchy of evidence. Total arrangement consideration was then allocated to each deliverable on the basis of the deliverable's relative selling price. In considering the hierarchy of evidence, we first determined whether vendor-specific objective evidence of selling price or third-party evidence of selling price existed. We determined that neither vendor-specific objective evidence of selling price nor third-party evidence existed due to the uniqueness of our program. As such, we developed our best estimate of the selling price for all deliverables. For the selling price of travel, we considered a number of entity-specific factors including the number of miles needed to redeem an award, average fare of comparable segments, breakage, restrictions and other charges. For licensing of brand and access to member lists, we considered both market-specific factors and entity-specific factors, including general profit margins realized in the marketplace/industry, brand power, market royalty rates and size of customer base. For the advertising and marketing element, we considered market-specific factors and entity-specific factors including, our internal costs (and 41 -------------------------------------------------------------------------------- fluctuations of costs) of providing services, volume of marketing efforts and overall advertising plan. Consideration allocated based on the relative selling price to both brand licensing and advertising elements is recognized as revenue when earned and recorded in non-ticket revenue. Consideration allocated to award miles is deferred and recognized ratably as passenger revenue over the estimated period the transportation is expected to be provided which is currently estimated at 16 months. We used entity-specific assumptions coupled with the various judgments necessary to determine the selling price of a deliverable in accordance with the required selling price hierarchy. Changes in these assumptions could result in changes in the estimated selling prices. Determining the frequency to reassess selling price for individual deliverables requires significant judgment. For additional information, please see "Notes to Financial Statements-1. Summary of Significant Accounting Policies-Frequent Flier Program". Aircraft Maintenance, Materials, Repair Costs and Related Heavy Maintenance Amortization. We account for heavy maintenance under the deferral method. Under the deferral method the cost of heavy maintenance is capitalized and amortized as a component of depreciation and amortization expense until the earlier of the next estimated heavy maintenance event or the aircraft's return at the end of the lease term. Amortization of engine and aircraft overhaul costs was $23.6 million, $9.1 million and $2.6 million for the years ended December 31, 2013, 2012 and 2011, respectively. If heavy maintenance costs were amortized within maintenance, material and repairs expense in the statement of operations, our maintenance, material and repairs expense would have been $83.8 million, $58.6 million and $36.6 million for the years ended December 31, 2013, 2012 and 2011, respectively. During the years ended December 31, 2013, 2012 and 2011, we capitalized $70.8 million, $61.6 million and $22.1 million of costs for heavy maintenance, respectively. The timing of the next heavy maintenance event is estimated based on assumptions including estimated usage, FAA-mandated maintenance intervals and average removal times as suggested by the manufacturer. These assumptions may change based on changes in our utilization of our aircraft, changes in government regulations and suggested manufacturer maintenance intervals. In addition, these assumptions can be affected by unplanned incidents that could damage an airframe, engine or major component to a level that would require a heavy maintenance event prior to a scheduled maintenance event. To the extent our planned usage increases, the estimated life would decrease before the next maintenance event, resulting in additional expense over a shorter period. Heavy maintenance events are our 6-year and 12-year airframe checks (HMV4 and HMV8, respectively), engine overhauls and overhauls to major components. Certain maintenance functions are outsourced under contracts that require payment based on a performance measure such as flight hours. Costs incurred for maintenance and repair under flight hour maintenance contracts, where labor and materials price risks have been transferred to the service provider, are accrued based on contractual payment terms. Routine cost for maintaining the airframes and engines and line maintenance are charged to maintenance, materials and repairs expense as performed. Maintenance Reserves. Some of our master lease agreements provide that we pay maintenance reserves to aircraft lessors to be held as collateral in advance of our performance of major maintenance activities. These lease agreements provide that maintenance reserves are reimbursable to us upon completion of the maintenance event in an amount equal to the lesser of (1) the amount of the maintenance reserve held by the lessor associated with the specific maintenance event or (2) the qualifying costs related to the specific maintenance event. Substantially all of these maintenance reserve payments are calculated based on a utilization measure, such as flight hours or cycles and are used solely to collateralize the lessor for maintenance time run off the aircraft until the completion of the maintenance of the aircraft. At lease inception and at each balance sheet date, we assess whether the maintenance reserve payments required by the master lease agreements are substantively and contractually related to the maintenance of the leased asset. Maintenance reserve payments that are substantively and contractually related to the maintenance of the leased asset are accounted for as maintenance deposits. Maintenance deposits expected to be recovered from lessors are reflected as prepaid maintenance deposits in the accompanying balance sheets. When it is not probable we will recover amounts currently on deposit with a lessor, such amounts are expensed as supplemental rent. Because we are required to pay maintenance reserves for our operating leased aircraft, and we choose to apply the deferral method for maintenance accounting, management expects that the final heavy maintenance events will be amortized over the remaining lease term rather than over the next estimated heavy maintenance event. As a result, our maintenance costs in the last few years of leases could be significantly in excess of the costs in earlier periods. In addition, these late periods could include additional costs from unrecoverable maintenance reserve payments required in the late years of the lease. We expensed $1.9 million, $2.0 million and $1.5 million of paid maintenance reserves as supplemental rent during 2013, 2012 and 2011, respectively. As of December 31, 2013 and 2012, we had prepaid maintenance deposits of $220.7 million and $198.5 million, respectively, on our balance sheets. We have concluded that these prepaid maintenance deposits are probable of recovery primarily due to the rate differential between the maintenance reserve payments and the expected cost for the related next maintenance event that the reserves serve to collateralize. These master lease agreements also provide that most maintenance reserves held by the lessor at the expiration of the lease are nonrefundable to us and will be retained by the lessor. Consequently, we have determined that any usage-based 42 -------------------------------------------------------------------------------- maintenance reserve payments after the last major maintenance event are not substantively related to the maintenance of the leased asset and therefore are accounted for as contingent rent. We accrue contingent rent beginning when it becomes probable and reasonably estimable we will incur such nonrefundable maintenance reserve payments. We make certain assumptions at the inception of the lease and at each balance sheet date to determine the recoverability of maintenance deposits. These assumptions are based on various factors such as the estimated time between the maintenance events, the cost of future maintenance events and the number of flight hours the aircraft is estimated to be utilized before it is returned to the lessor. Maintenance reserves held by lessors that are refundable to us at the expiration of the lease are accounted for as prepaid maintenance deposits on the balance sheet when they are paid. RESULTS OF OPERATIONS In 2013, we generated operating revenues of $1,654.4 million and operating income of $282.3 million resulting in a 17.1% operating margin and net earnings of $176.9 million. In 2012, we generated operating revenues of $1,318.4 million and operating income of $174.0 million resulting in a 13.2% operating margin and net earnings of $108.5 million. Operating revenues increased year-over-year as a result of a 24.2% increase in traffic and a 1.1% improvement in average yield. The increase in operating income in 2013 over 2012 of $108.3 million, is mainly due to a 25.5% increase in revenue partially offset by increased fuel and other expenses resulting from increase in operations. Fuel costs increased by $80.0 million during 2013 compared to 2012, primarily driven by an 20.2% increase in consumption resulting from our increase in operations. Operating expenses increased primarily due to our growth in capacity resulting from the addition of nine aircraft to our fleet and our route network expansion. The increase in operating margin year-over-year is due in part to the negative revenue impact in the fourth quarter of 2012 related to Hurricane Sandy, which we estimated to be $25 million, as well as lower fuel cost per gallon in 2013. As of December 31, 2013, our cash and cash equivalents grew to $530.6 million, an increase of $113.8 million compared to the prior year, mainly driven by cash from our operating activities offset by cash used to fund PDPs and capital expenditures. Operating Revenue % change 2013 % change 2012 Year Ended 2013 versus 2012 Year Ended 2012 versus 2011 Year Ended 2011 Passenger $ 986,018 26.0% $ 782,792 13.5% $ 689,650 Non-ticket 668,367 24.8% 535,596 40.4% 381,536 Total operating revenue $ 1,654,385 25.5% $ 1,318,388 23.1% $ 1,071,186 RASM (cents) 11.94 2.8% 11.62 1.5% 11.45 Average ticket revenue per passenger flight segment $ 79.43 5.8% $ 75.11 (7.2)% $ 80.97 Average non-ticket revenue per passenger flight segment $ 53.84 4.8% $ 51.39 14.7% 44.79 Total revenue per passenger flight segment $ 133.27 5.4% $ 126.50 0.6% $ 125.76 2013 compared to 2012 Operating revenue increased by $336.0 million, or 25.5%, to $1,654.4 million in 2013 compared to 2012 as we increased traffic by 24.2% and improved our average yield by 1.1% to 13.79 cents. Our results for 2013 were driven by a capacity increase of 22.2% compared to 2012 while maintaining a high load factor of 86.6% and an increase of 1.4 points compared to 2012. In addition, the year-over-year increase was partly attributable to the negative revenue impact in the fourth quarter 2012 related to Hurricane Sandy which we estimated to be $25 million. Total RASM for 2013 was 11.94 cents, an increase of 2.8% compared to 2012, as a result of higher average passenger yields and higher load factor. Total revenue per passenger flight segment increased 5.4% from $126.50 in 2012 to $133.27 in 2013. Non-ticket revenue increased 24.8% in 2013, as compared to 2012, mainly due to a 24.2% increase in traffic and an increase in baggage revenue per passenger flight segment. Non-ticket revenue as a percentage of total revenue remained relatively stable from 40.6% for 2012 to 40.4% for 2013. On a per passenger segment basis the increase is in non-ticket is attributed to changes to our bag fee schedule which better optimized revenue by channel. Additionally, during June 2012 and July 2013, we made adjustments to our passenger usage fee (PUF) helping to drive the increase in PUF fees year-over-year. Stronger demand throughout 2013, particularly in the second half of the year, as compared to 2012, allowed us to better leverage our ability to revenue manage our inventory, resulting in higher ticket revenue per passenger segment. Our average ticket fare per passenger flight segment increased 5.8% from $75.11 in 2012 to $79.43 in 2013. 43 -------------------------------------------------------------------------------- 2012 compared to 2011 Operating revenues increased by $247.2 million, or 23.1%, to $1,318.4 million in 2012 compared to 2011 as increased traffic by 20.7% and improved our average yield by 1.9% to 13.64 cents. Our results for 2012 were driven by growing capacity 21.3% compared to 2011 while maintaining a high load factor of 85.2% and a network reorientation in mid-2011 that added capacity in Dallas-Fort Worth, Chicago and Las Vegas. In October 2012, we canceled 136 flights, or 19.9 million available seat miles, as a result of adverse weather conditions and airport closures in connection with Hurricane Sandy. The negative impact of the storm on 2012 revenue was approximately $25 million. We generated greater demand in 2012 by lowering our average ticket revenue per passenger flight segment to $75.11, or by 7.2% compared to 2011, while increasing our non-ticket revenue per passenger flight segment from $44.79 to $51.39, a 14.7% increase compared to 2011. Total revenue per passenger flight segment increased 0.6% from $125.76 in 2011 to $126.50 in 2012. We experienced a 40.4% increase in non-ticket revenues in 2012 compared to 2011, reflecting the continued development and optimization of ancillary revenues and a 22.4% increase in passenger flight segments. During the fourth quarter of 2011 and continuing into 2012, we further standardized our passenger usage fee across all markets and fare classes, which drove much of the increases in non-ticket revenue in 2012 compared to 2011. Non-ticket revenue represented 40.6% of total revenue in 2012 compared to 35.6% in 2011. Operating Expenses Since adopting our ULCC model, we have continuously sought to reduce our unit operating costs and have created one of the industry's lowest cost structures in the Americas. The table below presents our operating expenses, as a percentage of operating revenue for the last three years, as well as unit operating costs (CASM). Year Ended December 31, 2013 2012 2011 % of % of % of Revenue CASM Revenue CASM Revenue CASM Operating revenue 100.0 % 100.0 % 100.0 % Operating expenses: Aircraft fuel (1) 33.4 % 3.98 35.8 % 4.16 36.2 % 4.15 Salaries, wages and benefits 15.8 1.89 16.6 1.93 17.0 1.94 Aircraft rent 10.3 1.22 10.9 1.27 10.9 1.25 Landing fees and other rentals 5.1 0.60 5.2 0.60 4.9 0.56 Distribution 4.1 0.49 4.3 0.50 4.8 0.55 Maintenance, materials and repairs 3.6 0.43 3.8 0.44 3.3 0.38 Depreciation and amortization 1.9 0.23 1.2 0.13 0.7 0.08 Other operating expenses 8.7 1.04 9.7 1.13 8.4 0.96 Loss on disposal of assets - - 0.1 0.01 - - Special charges (credits) (2) - - (0.6 ) (0.07 ) 0.3 0.03 Total operating expense 82.9 % 86.8 % 86.5 % CASM 9.90 10.09 9.91 MTM losses (gains)per ASM - - 0.03 Special charges (credits) per ASM - (0.07 ) 0.03 Adjusted CASM (excludes MTM gains or losses, loss on disposal of assets and special charges (credits)) 9.89 10.15 9.84 Adjusted CASM excluding fuel 5.91 6.00 5.72 (1) Aircraft fuel expense is the sum of (i) "into-plane fuel cost," which includes the cost of jet fuel and certain other charges such as fuel taxes and oil, (ii) settlement gains and losses and (iii) unrealized



mark-to-market gains and losses both associated with fuel hedge contracts.

The following table summarizes the components of aircraft fuel expense for the periods presented: 44

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Year Ended December 31, 2013 2012 2011 (in thousands) Into-plane fuel cost $ 542,523$ 471,542$ 392,278 Settlement losses (gains) 8,958 175 (7,436 ) Unrealized mark-to-market losses (gains) 265 46 3,204 Aircraft fuel $ 551,746$ 471,763$ 388,046 (2) Includes special charges (credits) of $(8.5) million ((0.07) cents per ASM) in 2012 and $3.2 million (0.03 cents per ASM) in 2011. Special



charges (credits) for 2012 primarily include a $9.1 million gain related

to the sale of four permanent air carrier slots at Ronald Reagan National

Airport (DCA), offset by $0.6 million in secondary offering costs. Special

charges for 2011 include $2.3 million of termination costs in connection

with the IPO comprised of amounts paid to Indigo Partners, LLC to terminate its professional services agreement with us and fees paid to three individual, unaffiliated holders of our subordinated notes and $0.8 million of legal, accounting, printing and filing fees in the fourth quarter related to the secondary offering completed on January 25, 2012. Please see "-Our Operating Expenses-Special Charges (Credits)." 2013 compared to 2012 Operating expense increased by $227.7 million, or 19.9%, in 2013 primarily due to our 22.2% growth in capacity as well as higher amortization of heavy maintenance events on our aircraft. Our adjusted CASM ex fuel for 2013 decreased by 1.5% as compared to 2012. Better operational performance during 2013 as compared to 2012 helped drive lower wages and passenger re-accommodation expenses. In addition, during 2013, we entered into lease extensions covering 14 of our existing A319 aircraft resulting in reduced lease rates for the remaining term of the leases which contributed to the decrease in adjusted CASM ex-fuel as compared to 2012. These decreases were partially offset by higher heavy maintenance amortization expense for 2013 resulting from the increase in deferred heavy aircraft maintenance events as compared to 2012. Aircraft fuel expenses includes both into-plane expense (as defined below) plus the effect of mark-to-market adjustments to our portfolio of derivative instruments, which is a component of aircraft fuel expenses. Into-plane fuel expense is defined as the price that we generally pay at the airport, or the "into-plane" price, including taxes and fees. Into-plane fuel prices are affected by world oil prices and refining costs, which can vary by region in the United States and the other countries where we operate. Into-plane fuel expense approximates cash paid to the supplier and does not reflect the effect of our fuel derivatives. Because our fuel derivative contracts do not qualify for hedge accounting, we recognize both realized and unrealized changes in the fair value of our derivatives when they occur as a component of aircraft fuel expense. We evaluate economic fuel expense, which we define as into-plane fuel expense including the cash we receive from or pay to counterparties for hedges that we settle during the relevant period, including hedges that we terminate early during the period. The key difference between aircraft fuel expense and economic fuel expense is the timing of gain or loss recognition on our hedge portfolio. When we refer to economic fuel expense, we include net settlement gains or losses only when they are realized through a cash payment from our derivative contract counterparties for those contracts that were settled during the period. We believe this is the best measure of the effect that fuel prices are currently having on our business because it most closely approximates the net cash outflow associated with purchasing fuel for our operations. Accordingly, many industry analysts also evaluate airline results using this measure, and it is frequently used in our internal management reporting. Aircraft fuel expense increased by 17% from $471.8 million in 2012 to $551.7 million in 2013. The increase was primarily due to an 20.2% increase in fuel gallons consumed partially offset by a 2.7% decrease in fuel prices per gallon. 45 --------------------------------------------------------------------------------



The difference between aircraft fuel expense and economic fuel expense and the elements of the changes are illustrated in the following table:

Year Ended December 31, 2013 2012 Percent Change (in thousands, except per gallon amounts) Into-plane fuel expense $ 542,523$ 471,542 15.1 % Cash paid (received) from settled derivatives, net 8,958 175 5,018.9 % Economic fuel expense 551,481 471,717 16.9 %



Impact on fuel expense from unrealized (gains) and losses arising from mark-to-market adjustments to our outstanding fuel derivatives

265 46 476.1 % Aircraft fuel expense (per Statement of Operations) $ 551,746$ 471,763 17.0 % Fuel gallons consumed 171,931 142,991 20.2 % Economic fuel cost per gallon $ 3.21$ 3.30 (2.7 )% Into-plane fuel cost per gallon $ 3.16$ 3.30 (4.2 )% Fuel gallons consumed increased 20.2% as a result of increased operations, as evidenced by a 20.1% increase in block hours. Total net loss recognized for hedges that settled during 2013 was $9.0 million, compared to a net loss of $0.2 million in 2012. These amounts represent the net cash paid (received) for the settlement of hedges. Labor costs in 2013 increased by $43.2 million, or 19.7%, compared to 2012, due mainly to a 30.9% increase in our pilot and flight attendant workforce required to operate the nine new aircraft deliveries in 2013. On a per-ASM basis, labor costs decreased as a result of better operational performance during 2013 as compared to 2012, which helped drive lower crew-related salary expenses during 2013. During 2013, aircraft rent increased $26.2 million, or 18.2%, compared to 2012. This increase was primarily driven by the delivery of nine new aircraft during 2013. On a per-ASM basis, aircraft rent expense decreased as a result of the modification and extension of 14 A319 aircraft leases. The modification resulted in reduced lease rates for the remaining term of these leases. This reduction was slightly offset by higher supplemental rent on three 40-month aircraft leases taken during late 2012 and early 2013. Landing fees and other rents for 2013 increased by $15.2 million, or 22.3%, compared to 2012 primarily due to a 14.9% increase in departures as well as increased volume at higher cost airports. On a per-ASM basis, landing fees and other rents remained flat as increased volume at higher-cost airports were offset by the increase in capacity which outpaced the increase of departures due to higher stage length year over year. The increase in distribution expense of $10.8 million, or 19.1%, in 2013 compared to 2012 was primarily due to increased sales volume driving up credit card fees as well as an increase of approximately 6.3 percentage points year-over-year in the percentage of sales from third-party travel agents, which are more expensive than sales directly through our website. This shift in distribution mix did not materially affect operating income because the revenues received from sales through third-party travel agents are designed to at least offset the associated incremental costs. On a per-ASM basis, distribution expense was relatively flat as credit card fee rates remained stable period over period. The following table shows our distribution channel usage: Year Ended December 31, 2013 2012 Change Website 61.0 % 64.2 % (3.2 ) Third-party travel agents 33.5 27.2 6.3 Call center 5.5 8.6 (3.1 ) 46

-------------------------------------------------------------------------------- Maintenance, materials and repair costs increased by $10.7 million, or 21.6%, in 2013, as compared to 2012. The increase in maintenance costs is primarily due to the aging of our fleet, which requires more comprehensive work during routine scheduled maintenance, as well as the timing of the mix of maintenance checks performed during 2013 as compared to 2012. On October 15, 2013, we had an aircraft experience an engine failure shortly after takeoff. The airframe and engine incurred damage as a result of the failure. We anticipate we will recover insurance proceeds to cover the expenses related to this incident and therefore we have expensed the insurance deductible of approximately $0.8 million included in maintenance, materials and repairs expense. On a per-ASM basis, maintenance, materials and repair costs were generally flat due to the one time costs associated with the seat maintenance program we incurred in 2012. Maintenance expense and amortization of deferred heavy maintenance events is expected to increase significantly as our fleet continues to age, resulting in the need for additional repairs over time. Depreciation and amortization increased by $16.7 million, or 109.4%, primarily due to deferred heavy aircraft maintenance events, which in turn resulted in higher amortization expense recorded in 2013 compared to 2012. Other operating expenses in 2013 increased by $16.7 million, or 13.1%, compared to 2012 primarily due to an increase in departures of 14.9% which led to increases in variable operating expenses such as ground handling and security expense. On a per-ASM basis, our other operating expenses decreased as compared to the same period in 2012. The decrease is primarily due to better operational performance during 2013 as compared to 2012 which helped drive lower passenger re-accommodation expenses. In addition, we incurred less software consulting costs related to our Enterprise Resource Planning (ERP) system implementation during 2013 as compared to 2012. Special charges (credits) for 2012 primarily include a $9.1 million gain related to the sale of four permanent air carrier slots at Ronald Reagan National Airport (DCA), offset by $0.6 million in secondary offering costs. 2012 compared to 2011 Operating expense increased by $217.6 million for 2012 compared to 2011 mostly due to increases in fuel and labor costs, which were primarily driven by our 21.3% capacity growth, in addition to increases in other operating costs. Our adjusted CASM ex fuel for 2012 increased by 4.9% as compared to the same period in 2011. During 2012, we incurred higher other operating expenses driven by higher costs associated with passenger re-accommodations related to slightly higher flight cancellations. Additionally, overall increased rates at the airports resulted in increased variable operating costs such as ground handling expenses and travel and lodging expense. During 2012, we also incurred an increase in maintenance costs related to our seat maintenance program and an increase in deferred heavy aircraft maintenance events, which in turn resulted in higher heavy maintenance amortization expense. Our average stage length for 2012 decreased by 1.3%, contributing to the year-over-year increase in adjusted CASM ex fuel. Aircraft fuel expense increased from $388.0 million in 2011 to $471.8 million in 2012, representing 41.2% of our total operating expenses for 2012. The increase was primarily due to an 18.1% increase in fuel gallons consumed as well as a 3.8% increase in fuel prices. The difference between aircraft fuel expense and economic fuel expense and the elements of the changes are illustrated in the following table: Year Ended December 31, 2012 2011 Percent Change (in thousands, except per gallon amounts) Into-plane fuel expense $ 471,542$ 392,278 20.2 % Cash paid (received) from settled derivatives, net 175 (7,436 ) (102.4 )% Economic fuel expense 471,717 384,842 22.6 %



Impact on fuel expense from unrealized (gains) and losses arising from mark-to-market adjustments to our outstanding fuel derivatives

46 3,204 (98.6 )%



Aircraft fuel expense (per Statement of Operations) $ 471,763 $

388,046 21.6 % Fuel gallons consumed 142,991 121,030 18.1 % Economic fuel cost per gallon $ 3.30 $ 3.18 3.8 % Into-plane fuel cost per gallon $ 3.30 $ 3.24 1.9 % 47

-------------------------------------------------------------------------------- Fuel gallons consumed increased 18.1% as a result of increased operations, as evidenced by an 18.8% increase in block hours. Our average daily aircraft utilization in 2012 increased slightly compared to 2011. We estimate the fuel savings related to the 136 flights cancellations due to Hurricane Sandy were approximately $0.6 million. Total net loss recognized for hedges that settled during 2012 was $0.2 million, compared to a net loss of $7.4 million in 2011. These amounts represent the net cash paid (received) for the settlement of hedges. Labor costs in 2012 increased by $37.2 million, or 20.5%, compared to 2011, primarily driven by a 22.4% increase in our pilot and flight attendant workforce as we increased our fleet size by 21.6%, or eight aircraft, during 2012. During 2012, we incurred an incremental $3.8 million of share-based compensation recorded within salaries, wages and benefits, driven primarily by the commencement of the Performance Share Awards program in 2012. During 2012, aircraft rent increased $27.1 million, or 23.3%, mainly due to the delivery of eight Airbus A320 aircraft subsequent to the fourth quarter of 2011. All aircraft were financed through operating leases. The increase of aircraft rent expense on a per-ASM basis is primarily due to the fact that we incurred $2.5 million of additional aircraft rent during 2012 related to a short-term lease agreement with a third-party provider (wet-leased aircraft) to maintain desired capacity during the summer months. Landing fees and other rents for 2012 increased by $15.6 million, or 29.5%, compared to 2011 primarily due to a 19.9% increase in departures. On a per-ASM basis, the increase in landing fees and other rents of 7.1% during 2012 as compared to the prior year period is due to increased volume at higher-cost airports, including the addition of six new airports served in 2012, which on average are higher-cost airports than the system average. The increase in distribution expense of $5.3 million, or 10.4%, in 2012 compared to 2011 was primarily due to increased volume and an increase of approximately 4.1 percentage points year-over-year in the percentage of sales from third-party travel agents, which are more expensive than sales directly through our website. This shift in distribution mix did not materially affect operating income because the revenues received from sales through third-party travel agents are designed to at least offset the associated incremental costs. The decrease on a per-unit basis is primarily due to a decrease of approximately 14% in credit card fee rates period over period. The following table shows our distribution channel usage: Year Ended December 31, 2012 2011 Change Website 64.2 % 66.3 % (2.1 ) Third-party travel agents 27.2 23.1 4.1 Call center 8.6 10.6 (2.0 ) Maintenance, materials and repair costs increased by $15.4 million, or 45.4%, in 2012. The increase in maintenance costs is primarily due to $6.8 million in one-time start-up costs of the seat maintenance program, which was introduced and completed in 2012. We do not expect the ongoing expense of our seat maintenance program to have a material impact on our overall future maintenance cost outlook. The average age of our fleet increased to 4.6 years as of December 31, 2012 from 4.5 years as of December 31, 2011. Maintenance expense is expected to increase significantly as our fleet continues to age, resulting in the need for additional repairs over time. Depreciation and amortization increased by $7.5 million, or 96.6%, primarily due to deferred heavy aircraft maintenance events, which in turn resulted in higher amortization expense recorded in 2012 compared to 2011. Other operating expenses in 2012 increased by $36.7 million, or 40.3%, compared to 2011 primarily due to a 19.9% increase in departures. Overall increased rates at the airports we serve resulted in increased variable operating costs such as ground handling expenses and travel and lodging expense in 2012 compared to 2011. The increase on a per-ASM basis of 17.7% is primarily due to a shift in our route network to include higher volumes at the higher-cost airports we serve. In addition, we experienced increases in travel and lodging costs driven by both volume and hotel rate increases associated with increased training and scope of operations, as well as higher passenger re-accommodation expenses associated with slightly higher flight cancellations during 2012. We also incurred additional expenses related to the implementation of our ERP system. Special charges (credits) for 2012 primarily include a $9.1 million gain related to the sale of four permanent air carrier slots at Ronald Reagan National Airport (DCA), offset by $0.6 million in secondary offering costs. Special charges for 2011 relate to termination costs of $2.6 million in connection with our IPO, including $1.8 million paid to Indigo Partners, LLC to 48 -------------------------------------------------------------------------------- terminate its professional services agreement with us and $0.5 million paid to three individual, unaffiliated holders of our subordinated notes. Other (income) expense, net 2013 compared to 2012 Other (income) expense, net decreased from $(0.6) million in 2012 to $(0.1) million in 2013. The decrease is primarily driven by a decrease of $0.5 million of interest income year over year due to the lower interest rates year over year that we earn from our money market investments. 2012 compared to 2011 In 2011 we incurred $22.1 million of other (income) expense, net compared to $(0.6) million in 2012. During 2011, the interest expense is related to interest on debt for five months in 2011 prior to the elimination of debt in 2011 in conjunction with the IPO in June 2011. Related-party and non-related interest expense incurred in 2011 was $21.0 million and $3.8 million, respectively, and was offset slightly by capitalized interest. During 2012, we earned interest income on money market investments of $0.9 million offset by other expense of $0.3 million. Income Taxes Our effective tax rate was 37.4% compared to 37.9% in 2012 and 37.8% in 2011. While we expect our tax rate to be fairly consistent in the near term, it will tend to vary depending on recurring items such as the amount of income we earn in each state and the state tax rate applicable to such income. Discrete items particular to a given year may also affect our effective tax rates. 49 --------------------------------------------------------------------------------



Quarterly Financial Data (unaudited)

Three Months Ended June 30, June 30, March 31, 2012 2012 September 30, 2012 December 31, 2012 March 31, 2013



2013 September 30, 2013December 31, 2013

(in thousands except share and per share amounts) Total operating revenue $ 301,495 $ 346,308 $ 342,317 $ 328,268 $ 370,437 $ 407,339 $ 456,625 $ 419,984 Passenger 180,078 211,812 202,181 188,721 218,897 241,119 279,499 246,503 Non-ticket 121,417 134,496 140,136 139,547 151,540 166,220 177,126 173,481 Operating income 37,244 55,132 49,681 31,933 49,669 66,758 97,804 68,061 Net income (loss) $ 23,419 $ 34,591 $ 30,884 $ 19,566 $ 30,554 $ 42,068 61,103 43,193 Earnings Per Share: Basic $ 0.32 $ 0.48 $ 0.43 $ 0.27 $ 0.42 $ 0.58 $ 0.84 $ 0.59 Diluted $ 0.32 $ 0.48 $ 0.43 $ 0.27 $ 0.42 $ 0.58 $ 0.84 $ 0.59 Weighted average shares outstanding Basic 72,292,164 72,379,185 72,427,490 72,442,183 72,486,209 72,592,973 72,631,646 72,657,916 Diluted 72,498,705 72,583,690 72,658,298 72,622,718 72,804,245 72,992,084 73,002,761 73,195,479 50

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Three Months Ended March 31, June 30, September 30, December 31, March 31, June 30, September 2012 2012 2012 2012 2013 2013 30, 2013 December 31, 2013 Other operating statistics Aircraft at end of period 40 42 42 45 49 50 51 54 Airports served (1) 50 52 53 53 52 55 54 53 Average daily Aircraft utilization (hours) 12.8 12.9 12.8 12.6 12.6 12.8 12.8 12.5 Average stage length (miles) 912 902 892 932 941 935 956 998 Passenger flight segments (thousands) 2,349 2,613 2,814 2,647 2,768 3,111 3,374 3,161 Revenue passenger miles (RPMs) (thousands) 2,194,350 2,397,663 2,552,316 2,519,392 2,661,491 2,930,912 3,241,309 3,167,376 Available seat miles (ASMs) (thousands) 2,589,014 2,826,916 2,972,651 2,956,150 3,127,214 3,420,257 3,637,951 3,675,972 Load factor (%) 84.8 84.8 85.9 85.2 85.1 85.7 89.1 86.2 Average ticket revenue per passenger flight segment ($) 76.65 81.06 71.85 71.30 79.09 77.51 82.84 77.98 Average non-ticket revenue per passenger flight segment ($) 51.68 51.47 49.80 52.73 54.75 53.43 52.50 54.88 Operating revenue per ASM (RASM) (cents) 11.65 12.25 11.52 11.10 11.85 11.91 12.55 11.43 CASM (cents) 10.21 10.30 9.84 10.02 10.26 9.96 9.86 9.57 Adjusted CASM (cents) (2)(3) 10.18 10.26 10.15 10.03 10.14 9.78 10.00 9.67 Adjusted CASM ex fuel (cents) (2) 5.99 6.05 6.02 5.93 6.04 6.00 5.86 5.78 Fuel gallons consumed (thousands) 32,730 35,829 37,761 36,670 38,628 42,683 45,521 45,100 Average economic fuel cost per gallon ($) 3.31 3.32 3.26 3.31 3.32 3.03 3.31 3.17 (1) Includes airports served during the period that had service canceled as of the end of the period. Previously, we reported only airports served during the period with continuing operations. (2) Excludes special charges (credits) of $(0.1) million (less than (0.01) cents per ASM) in the three months ended March 31, 2012, $0.0 million (less than 0.01 cents per ASM) in the three months ended June 30, 2012, $(8.3) million ((0.28) cents per ASM) in the three months ended September 30, 2012, $(0.1) million (less than (0.01) cents per ASM) in the three months ended December 31, 2012, $0.0 million (less than 0.01 cents per ASM) in the three months ended March 31, 2013, $0.0 million (less than 0.01 cents per ASM) in the three months ended June 30, 2013, $0.4 million (0.01 cents per ASM) in the three months ended September 30, 2013 and $(0.3) million ((0.01) cents per ASM) in the three months ended December 31, 2013. These amounts are excluded from all calculations of Adjusted CASM provided in this annual report. Please see "Management's Discussion and Analysis of Financial Condition and Results of Operations-Our Operating Expenses-Special Charges (Credits)." (3) Excludes unrealized mark-to-market (gains) and losses of $0.3 million (0.01 cents per ASM) in the three months ended March 31, 2012, $1.1 million (0.04 cents per ASM) in the three months ended June 30, 2012, $(0.9) million ((0.03) cents per ASM) in the three months ended September 30, 2012, $(0.4) million ((0.01) cents per ASM) in the three months ended December 31, 2012, $3.4 million (0.11 cents per ASM) in the three months ended March 31, 2013, $5.8 million (0.17 cents per ASM) in the three months ended June 30, 2013, $(5.7) million ((0.16) cents per ASM) in the three months ended September 30, 2013 and $(3.2) million ((0.09) cents per ASM) in the three months ended December 31, 2013. Please see "Management's Discussion and Analysis of Financial Condition and Results of Operations-Our Operating Expenses-Critical Accounting Policies and Estimates." 51

-------------------------------------------------------------------------------- LIQUIDITY AND CAPITAL RESOURCES Our primary source of liquidity is cash on hand and cash provided by operations. Primary uses of liquidity are for working capital needs, capital expenditures, aircraft pre-delivery deposits (PDPs) and maintenance reserves. Our total cash at December 31, 2013 was $530.6 million, an increase of $113.8 million from December 31, 2012. Currently our single largest capital need is to fund the acquisition costs of our aircraft. PDPs relating to future deliveries under our agreement with Airbus are required at various times prior to each delivery date. During 2013, $36.7 million of PDPs have been returned related to delivered aircraft in the period, and we have paid $107.0 million in PDPs for future deliveries of aircraft and spare engines. As of December 31, 2013, we have secured financing commitments with third parties for seven aircraft deliveries from Airbus, scheduled for delivery in 2014, and for five aircraft to be leased directly from a third party, scheduled for delivery between 2015 and 2016. We do not have financing commitments in place for the remaining 105 Airbus firm aircraft orders scheduled for delivery between 2014 and 2021. In addition to funding the acquisition of our future fleet, we are required to make maintenance reserve payments for a majority of our current fleet. Maintenance reserves are paid to aircraft lessors and are held as collateral in advance of our performance of major maintenance activities. In 2013, we recorded an increase of $24.1 million in maintenance reserves, net of reimbursements, and as of December 31, 2013, we have $220.7 million ($59.2 million in prepaid expenses and other current assets and $161.5 million in aircraft maintenance deposits) on our balance sheet, representing the amount paid in reserves since inception, net of reimbursements. As of December 31, 2013, we are compliant with our credit card processing agreements, and not subject to any credit card holdbacks. The maximum potential exposure to cash holdbacks by our credit card processors, based upon advance ticket sales and $9Fare Club memberships as of December 31, 2013 and December 31, 2012, was $188.6 million and $144.8 million, respectively. During 2011, we completed our IPO, which raised net proceeds of $150.0 million after repayment of debt, payment of transaction expenses and payments of fees to certain unaffiliated holders of our notes. Additionally, during 2011, the IPO allowed us to amend our agreements with our credit card processors enabling us to eliminate our restricted cash balance (holdback) and increase our unrestricted cash balance. Net Cash Flows Provided By Operating Activities. Operating activities in 2013 provided $195.4 million in cash compared to $113.6 million provided in 2012. The increase is primarily due to larger operating profits in 2013 as compared to 2012. In addition, a slightly higher air traffic liability year-over-year led to higher cash inflows at the end of 2013. This increase is driven by higher capacity and future bookings. Operating activities in 2012 provided $113.6 million in cash compared to $171.2 million provided in 2011. The decrease is primarily due to $72.7 million received from the release of all credit card holdbacks in 2011 coupled with significantly higher heavy scheduled maintenance costs in 2012, slightly offset by cash inflows received on future travel as of December 31, 2012. Net Cash Flows Used In Investing Activities. During 2013, investing activities used $90.1 million, compared to $27.3 million used in 2012. The increase is mainly due to an increase in paid PDPs, net of refunds, during 2013, compared to 2012, driven by the timing of aircraft deliveries and our amended order with Airbus. This was offset by $9.1 million received as a result of proceeds from the sale of slots at Ronald Reagan National Airport (DCA). Capital expenditures decreased year-over-year mainly due to higher expenses incurred in 2012 related to the implementation of our ERP system. During 2012, investing activities used $27.3 million, compared to $67.2 million used in 2011. The decrease is mainly due to the refund of $40.5 million in PDPs related to the delivery of seven aircraft from Airbus and corresponding sale and leaseback transactions, and the sale of airport slots for $9.1 million. These effects were offset by higher capital expenditures, including the purchase of two spare engines for $10.3 million during 2012. Net Cash Provided By Financing Activities. During 2013, financing activities provided $8.5 million. We received $6.9 million in proceeds from the sale of one spare engine as part of sale and leaseback transactions, retained $1.9 million as a result of excess tax benefits related to share-based payments and received cash as a result of exercised stock options. Additional cash used in financing activities consisted of cash used to purchase treasury stock. As of December 31, 2013, an estimated remaining cash benefit of $5.6 million is expected to be paid to our Pre-IPO Stockholders under the terms of the TRA. During 2012, $12.8 million was used for financing activities driven mostly by the payment to Pre-IPO Stockholders pursuant to the TRA offset by the proceeds received from the sale of two spare engines as part of sale and leaseback transactions. 52 -------------------------------------------------------------------------------- During 2011, we completed our recapitalization and initial public offering, from which we received $150.0 million in proceeds, net of underwriting fees, transaction costs and our repayment of $20.6 million of stockholder debt of which $2.3 million was paid in kind interest and included in operating activities. Remaining stockholder debt was exchanged for newly issued shares of our common stock. In addition, during 2011 we received $4.5 million in proceeds from the sale of one engine as part of a sale leaseback transaction. Commitments and Contractual Obligations The following table discloses aggregate information about our contractual obligations as of December 31, 2013 and the periods in which payments are due (in millions): 2019 and 2014 2015 - 2016 2017 - 2018 beyond Total Operating lease obligations $ 203 $ 396 $ 319 $ 527$ 1,445 Flight equipment purchase obligations 559 1,252 1,348 2,197 5,356 Other 5 10 6 - 21 Total future payments on contractual obligations $ 767$ 1,658 $



1,673 $ 2,724$ 6,822

Some of our master lease agreements provide that we pay maintenance reserves to aircraft lessors to be held as collateral in advance of our required performance of major maintenance activities. Some maintenance reserve payments are fixed contractual amounts, while others are based on actual flight hours. In addition to the contractual obligations disclosed in the table above, we have fixed maintenance reserve payments for these aircraft and related flight equipment, including estimated amounts for contractual price escalations, which are approximately $7.4 million in 2014, $7.6 million in 2015, $8.0 million in 2016, $7.4 million in 2017, $5.8 million in 2018 and $18.4 million in 2019 and beyond. Additionally, we are contractually obligated to make payments to the Pre-IPO Stockholders under the Tax Receivable Agreement. As of December 31, 2013, we estimated the TRA liability to be $5.6 million. For additional information, please see "Notes to Financial Statements-18. Initial Public Offering and Tax Receivable Agreement". Off-Balance Sheet Arrangements We have significant obligations for aircraft as all 54 of our aircraft are operated under operating leases and therefore are not reflected on our balance sheets. These leases expire between 2016 to 2025. Aircraft rent payments were $166.3 million and 140.8 million for 2013 and 2012, respectively. Our aircraft lease payments for 49 of our aircraft are fixed-rate obligations. Five of our leases provide for variable rent payments, which fluctuate based on changes in LIBOR (London Interbank Offered Rate). Our contractual purchase commitments consist primarily of aircraft and engine acquisitions through manufacturer and aircraft leasing companies. During 2013, we converted ten Airbus A320 orders to Airbus A321 orders and converted five Airbus A321 orders to Airbus A321neo orders. As of December 31, 2013, our aircraft orders consisted of the following: Airbus Third-Party Lessor A320 A320NEO A321 A321NEO A320NEO Total 2014 11 11 2015 11 2 1 14 2016 5 8 4 17 2017 10 10 20 2018 6 5 11 2019 8 5 13 2020 13 13 2021 18 18 37 45 25 5 5 117 We also have six spare engine orders for V2500 SelectOne engines with IAE and nine spare engine orders for PurePower PW 1100G-JM engines with Pratt & Whitney. Spare engines are scheduled for delivery from 2014 through 2024. 53 -------------------------------------------------------------------------------- As of December 31, 2013, we had lines of credit related to corporate credit cards of $18.6 million from which we had drawn $3.7 million. As of December 31, 2013, we had lines of credit with counterparties for both physical fuel delivery and jet fuel derivatives in the amount of $34.5 million. As of December 31, 2013, we had drawn $13.8 million on these lines of credit. We are required to post collateral for any excess above the lines of credit if the derivatives are in a net liability position and make periodic payments in order to maintain an adequate undrawn portion for physical fuel delivery. As of December 31, 2013, we have $6.0 million in uncollateralized surety bonds and a $25.1 million unsecured standby letter of credit facility, representing an off balance-sheet commitment, of which $10.4 million had been drawn upon for issued letters of credit. 54 -------------------------------------------------------------------------------- GLOSSARY OF AIRLINE TERMS Set forth below is a glossary of industry terms: "Adjusted CASM" means operating expenses, excluding mark-to-market gains or losses, loss on disposal of assets, and special charges (credits), divided by ASMs. "Adjusted CASM ex fuel" means operating expenses excluding aircraft fuel expense, loss on disposal of assets, and special charges (credits), divided by ASMs. "AFA-CWA" means the Association of Flight Attendants-CWA. "Air traffic liability" or "ATL" means the value of tickets sold in advance of travel. "ALPA" means the Airline Pilots Association, International. "ASIF" means an Aviation Security Infrastructure Fee assessed by the TSA on each airline. "Available seat miles" or "ASMs" means the number of seats available for passengers multiplied by the number of miles the seats are flown, also referred to as "capacity". "Average aircraft" means the average number of aircraft in our fleet as calculated on a daily basis. "Average daily aircraft utilization" means block hours divided by number of days in the period divided by average aircraft. "Average economic fuel cost per gallon" means total aircraft fuel expense, excluding mark-to-market gains and losses, divided by the total number of fuel gallons consumed. "Average non-ticket revenue per passenger flight segment" means the total non-ticket revenue divided by passenger flight segments. "Average ticket revenue per passenger flight segment" means total passenger revenue divided by passenger flight segments. "Average stage length" represents the average number of miles flown per flight. "Average yield" means average operating revenue earned per RPM, calculated as total revenue divided by RPMs. "Block hours" means the number of hours during which the aircraft is in revenue service, measured from the time of gate departure before take-off until the time of gate arrival at the destination. "CASM" or "unit costs" means operating expenses divided by ASMs.



"CBA" means a collective bargaining agreement.

"CBP" means United States Customs and Border Protection.

"DOT" means the United States Department of Transportation.

"EPA" means the United States Environmental Protection Agency.

"FAA" means the United States Federal Aviation Administration. "FCC" means the United States Federal Communications Commission. "FLL Airport" means the Fort Lauderdale-Hollywood International Airport. "GDS" means Global Distribution System (e.g., Amadeus, Galileo, Sabre and Worldspan). "Into-plane fuel cost per gallon" means into-plane fuel expense divided by number of fuel gallons consumed. "Into-plane fuel expense" represents the cost of jet fuel and certain other charges such as fuel taxes and oil. "Load factor" means the percentage of aircraft seats actually occupied on a flight (RPMs divided by ASMs). 55 -------------------------------------------------------------------------------- "NMB" means the National Mediation Board. "Operating revenue per ASM," "RASM" or "unit revenue" means operating revenue divided by ASMs. "OTA" means Online Travel Agent (e.g., Orbitz and Travelocity). "Passenger flight segments" means the total number of passengers flown on all flight segments. "PDP" means pre-delivery deposit payment. "Revenue passenger mile" or "RPM" means one revenue passenger transported one mile. RPMs equals revenue passengers multiplied by miles flown, also referred to as "traffic". "RLA" means the United States Railway Labor Act. "TWU" means the Transport Workers Union of America. "TSA" means the United States Transportation Security Administration. "ULCC" means "ultra low-cost carrier." "VFR" means visiting friends and relatives. "Wet-leased aircraft" means a lease where the lessor provides for aircraft, crew, maintenance and insurance, also known as an "ACMI". 56



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Source: Edgar Glimpses


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