Frontier Airlines 2004 Annual Report Download - page 46

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have been and are subject to market risks, including commodity price risk (such as, to a limited extent, aircraft fuel prices) and interest rate risk.
Interest Rates
Our earnings are affected by changes in interest rates due to the amounts of variable rate debt and the amount of cash and securities held. The interest rate applicable to variable rate debt
may rise and increase the amount of interest expense. At December 31, 2004, 0.4% of our total long - term debt was variable rate debt, compared to 0.3% at December 31, 2003. For
illustrative purposes only, we have estimated the impact of market risk using a hypothetical increase in interest rates of one percentage point for both our variable rate long - term debt and cash
and securities. Based on this hypothetical assumption, we would have incurred an additional $15,000 in interest expense for the year ended December 31, 2004. As a result of this hypothetical
assumption, we believe we could fund interest rate increases on our variable rate long - term debt with the increased amounts of interest income. We do not believe we have significant exposure to
the changing interest rates on our fixed - rate, long - term debt instruments, which represented 99.6% of our total long - term debt at December 31, 2004, and 99.7% of our total long - term debt at
December 31, 2003.
We currently intend to finance the acquisition of aircraft through the manufacturer, third - party leases or long - term borrowings. Changes in interest rates may impact the actual cost to us to
acquire these aircraft. To the extent we place these aircraft in service under our code - share agreements with American, US Airways, Delta and United, our reimbursement rates will be adjusted
higher or lower to reflect any changes in our aircraft rental rates.
In anticipation of financing the purchase of regional jet aircraft on firm order with the manufacturer, we entered into eight treasury lock agreements in April 2004 with notional amounts
totaling $253,500,000 and a weighted average interest rate of 4.23% with expiration dates from July 2004 through March 2005. In addition, we entered into six treasury lock agreements in
August 2004 with notional amounts totaling $120,000,000 and a weighted average interest rate of 4.8% with expiration dates from September 2004 through June 2005. Management designated
the treasury lock agreements as a cash flow hedge of a forecasted transaction. The treasury lock agreements will be settled at each respective settlement date which are expected to be the
purchase dates of the respective aircraft. We settled seven agreements during 2004 and the net amount paid was approximately $3,000,000. Any amount paid or received on the settlement date
will be amortized or accreted to interest expense over the term of the respective aircraft debt.
Equity Price Risk
The exercise of certain of the warrants that have been issued to Delta could result in dilution of our common stock, since the exercise price is less than the price of our common stock at
the time of our initial public offering.
We incurred a deferred charge for the Delta warrants of approximately $5,760,000 in the second quarter of 2004, based upon an option pricing model that considers continuous
dividend yield and dilution using an initial public offering price of $13.00; an estimated dividend yield; a risk - free interest rate commensurate with the warrant term; volatility of 40%; and an
expected life of ten years. The deferred charge will be amortized over the term of the Delta code - share agreement. In December 2004, we and Delta agreed to reduce the amount of all warrants
by 45%, which reduced the deferred warrant charge and warrant equity by approximately $6,756,000. In addition, in December 2004, we agreed to issue to Delta a warrant to purchase
960,000 shares of our common stock in connection with Delta entering into a code - share agreement with Republic Airline. The deferred warrant charges, excluding charges with respect to the
warrants issued in December 2004, will be amortized over the term of the Delta code - share agreement, as amended, resulting in an annual non - cash charge of approximately $334,000. The
deferred warrant charge for the 960,000 warrants issued in December 2004 will be amortized over the term of the Delta code - share agreement as amended and will result in an annual non - cash
charge of approximately $97,000 in 2005 and approximately $380,000 each year, thereafter. The amortization charge is recorded as a reduction of operating revenue as aircraft are placed into
service.
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