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Form 10-Q for EXPRESSJET HOLDINGS INC
7-May-2009
Quarterly Report
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion contains a number of forward-looking statements that are based on our current expectations and involve a number of risks and uncertainties, many of which are outside our control. Specifically statements regarding our future results of operations, operating costs, business prospects, growth and capital expenditures, including plans with respect to our fleet, are forward-looking statements. Important factors that could cause actual results to differ materially from the expectations expressed or implied in the forward-looking statements include known and unknown risks. Some of the known risks that could significantly impact our revenues, operating results, and capacity include, but are not limited to: our dependence on Continental Airlines, Inc. ("Continental") and our operations pursuant to a capacity purchase agreement with Continental ("Amended Continental CPA"); our charter operations; our small shareholder base; our current debt obligations; government regulations; dependence upon technology infrastructure; and any adverse effects from an aviation accident involving one of our aircraft.
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For further discussion of these risks, please see Item 1A. "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 (the "2008 10-K") and in this report. The statements in this report are made as of May 7, 2009 and the events described in forward-looking statements might not occur or might occur to a materially different extent than described in this report. We undertake no duty to update or revise any of our forward-looking statements, whether as a result of new information, future events or otherwise.
Our website address is www.expressjet.com. All of our SEC filings, together with exhibits, are available free of charge through our website as soon as reasonably practicable after we file them with, or furnish them to, the SEC.
First Quarter Financial Highlights
� Reported an $11.4 million loss for the first quarter 2009 versus a $35.7 million loss in first quarter 2008 - a 68% improvement year-over-year;
� Incurred large year-over-year variances from expense items, such as aircraft rent and fuel associated with the 214 aircraft we are currently flying for Continental being removed from our income statement as part of the Amended Continental CPA;
� Experienced increased wage pressure due to the seniority of our workforce;
� Increased revenues within our corporate aviation division by 26.6% year-over-year, excluding fuel, because it is treated as a pass-through expense:
� Used $10.1 million in cash flows from operations, versus $36.8 million in first quarter 2008, offset by investing and financing activities including:
- Repurchasing $2.8 million in equity and $1.8 million in par value of 11.25% Convertible Secured Notes due 2023;
- Borrowing $5.0 million under a revolving line of credit (the "Citigroup Credit Facility"), from Citigroup Global Markets, Inc. ("Citigroup") using a portion of our auction rate securities ("ARS") as collateral; and
- Selling $9.2 million on non-core assets to increase the strength of our balance sheet.
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First Quarter Operational Highlights
� Experienced decreased utilization of 12.3% percent based on lower utilization under our Amended Continental CPA;
� Continued to streamline operations to recognize efficiencies in our operations;
� Began a modification line of interior upgrades to add ovens, power and upgraded sidewalls and panels on our 41-seat aircraft;
� Scheduled two additional aircraft for conversion to our 41-seat configuration which will bring the total 41-seat fleet to eight aircraft; and
� Added 3 stations to our aviation services division bringing the total to 31 stations ground handled by us for Continental as well as other operators.
Outlook
As ExpressJet completes its transition from the restructuring initiated in 2008, we will continue to focus on three core areas: contract flying for mainline partners; long-term charter agreements and ad-hoc charter arrangements for customers seeking customizable travel solutions (corporate aviation) and aviation services. As we now generate revenue for actual hours flown, as opposed to hours scheduled, in our contract flying operations, our reported results will more closely follow the general trends of the aviation industry.
Currently, the industry is experiencing a significant decrease in demand due to the global economic recession. If demand declines further, the number of block hours we fly for mainline partners could decrease. However, those reductions could be somewhat offset by our partner's capability to utilize our smaller aircraft to economically serve markets that may not otherwise be viable in this reduced demand environment. We will continue to focus on providing the most economically efficient and reliable service possible to best position ourselves for potential opportunities and to weather challenges within the airline industry.
We will also continue to market our unscheduled charter services to customers seeking customizable travel solutions. The corporate aviation market has recently suffered from negative media due to public scrutiny in the current economic climate with government bailouts occurring in many industries. Contrary to this trend, our corporate aviation division is experiencing growth because we have a large fleet of dedicated aircraft and offer a greater number of seats than most of our competitors. We also provide one of the most reliable products in the industry and we have never experienced a controllable cancellation in this operation. We expect our revenues to continue growing in this division as we enter into additional contracts and continue to generate brand awareness.
We also continue to leverage our aviation services segment. This segment includes providing customer and ramp ground-handling services to Continental and other operators, interior and seat refurbishments and aircraft painting. The ground handling operations allows us to generate additional income that helps to offset the cost we incur to perform these services in support of our other operations and provide a seamless product to our partner's customers.
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The following highlights key statistics within our three core areas during first quarter 2009:
� 214 EMB-145 aircraft operated for Continental;
� 30 EMB 145 aircraft operated within our corporate aviation division;
� 31 stations under management for ground-handling contracts;
� 7 hours and 19 minutes per aircraft average utilization;
� 97.4% system-wide completion factor; and
� 160,836 block hours flown.
During 2009, we will continue to focus on keeping our variable costs at below the revenue-generating capability of our aircraft. In 2008, we cut approximately $100 million in variable and fixed expenses from our operations. During 2009, we will seek additional avenues for reducing expenses while also keeping our reliability at one of the highest levels seen in the industry. We have two labor agreements that will become amendable during 2009 for our mechanics and dispatchers. We will work with those labor groups to ensure we maintain our competitive cost structure. Absent a combination of adverse factors outside of our control, we expect to break even or have slight positive cash contribution from our operations in 2009.
As of March 31, 2009, our available liquidity (including restricted and unrestricted cash and our ARS holdings) was $117.1 million. We plan to continue to focus on improving our balance sheet through generating cash flow from operations, selling non-core assets and making repurchases under our board approved securities repurchase program during 2009. We also intend to continue evaluating the market for our ARS holdings to attempt to monetize the assets at or near face value and recently initiated litigation against Royal Bank of Canada related to such investments brokered by the firm.
We believe that our existing liquidity, projected 2009 cash flows (including the incremental sources of liquidity described above), will be sufficient to fund current operations and our financial obligations through the twelve months ending March 31, 2010. However, as noted above, factors outside our control may dictate that we alter our current plans and expectations.
Critical Accounting Policies and Estimates
The following are changes to our accounting policies and estimates described in our 2008 10-K.
Adopted Accounting Pronouncement. On January 1, 2009, we adopted the Financial Accounting Standards Board's ("FASB") Staff Position No. APB 14-1, "Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)" ("FSP APB 14-1"), which applies to all convertible debt instruments that have a "net settlement feature", meaning that such convertible debt instruments, by their terms, may be settled either wholly or partially in cash upon conversion. FSP APB 14-1 requires issuers to account separately for the liability and equity components of certain convertible debt instruments in a manner that reflects the issuer's nonconvertible debt (unsecured debt) borrowing rate when interest cost is recognized. FSP APB 14-1 requires we split a component of the debt, classification of that component in equity and the accretion of the resulting discount on the debt to be recognized as part of interest expense in our consolidated statements of operations.
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FSP APB 14-1 requires retrospective application to the terms of instruments as they existed for all periods presented. The adoption of FSP APB 14-1 affects the accounting for our original 4.25% Convertible Notes due 2023 issued in 2003 (the "Original 4.25% Convertible Notes due 2023") which on August 2, 2008, became our 11.25% Convertible Secured Notes due 2023. The retrospective application of this pronouncement resulted in increased non-cash interest expense for 2003 through 2008. We have retrospectively adjusted the consolidated statement of operations for the three months ended March 31, 2008 to include non-cash interest expense (presented as Amortization of debt discount on our consolidated statements of operations) of $7.1 million related to our Original 4.25% Convertible Notes due 2023. In addition, the adoption of FSP APB 14-1 required us to move the $27.8 million gain originally recorded in August 2008 when we modified our 11.25% Convertible Secured Notes due 2023, to additional paid-in capital. Also, as described in Item 8. "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 9 - "Long-term Debt" in our 2008 10K, in August 2008 we issued 16.4 million shares (reverse split-adjusted) of our common stock in payment of the repurchase price for the $59.7 million principal amount of the Original 4.25% Convertible Notes due 2023. The adoption of FSP APB 14-1 required us to recognize a gain on extinguishment of debt and a decrease to additional paid-in capital of $32.8 million as the fair value of our Original 4.25% Convertible Notes due 2023 was below the repurchase price of $59.7 at the time of the transaction. Adjustments to income taxes have been recorded on the foregoing adjustments to the extent tax benefits were available.
Results of Operations
The following discussion provides an analysis of our results of operations and reasons for material changes in those results for the three months ended March 31, 2009, compared to the corresponding period ended March 31, 2008.
Comparison of Three Months Ended March 31, 2009 to Three Months Ended March 31, 2008
Operating Revenue and Segment Profit (Loss)
The table below (in thousands, except percentage data) sets forth the changes in revenue, direct segment costs and segment profit (loss) from the three months ended March 31, 2009 to the same period in 2008. A significant portion of our operating expenses and infrastructure is integrated across segments (e.g., for maintenance, non-airport facility rentals, outside services, general and administrative expenses) in order to support our entire fleet of aircraft; therefore, we do not allocate these costs to the individual segments identified above, but evaluate them for our consolidated operation. The presentation of our consolidated shared costs is consistent with the manner in which these expenses are reviewed by our chief operating decision makers. These costs are included as a part of the analysis of our operating expenses below.
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Three Months Ended March 31,
Total 2008 Total Revenue (as restated Revenue Increase / 2009 % - Note 1) % (Decrease) Change %
Revenue from
customers:
Contract
Flying $ 160,268 94.4 % $ 365,674 81.6 % $ (205,406 ) (56.2 )% Branded
Flying - n/a (1) 72,870 16.3 (72,870 ) n/a (1) Aviation
Services 11,919 7.0 11,200 2.5 719 6.4 Eliminations (2,478) (1.4 ) (1,576 ) (0.4 ) 902 57.2 Total Revenue
from
customers 169,709 100.0 448,168 100.0 (278,459 ) (62.1 )
Contract
Flying 119,366 70.3 275,380 61.4 (156,014 ) (56.7 ) Branded
Flying - n/a (1) 118,084 26.4 (118,084 ) n/a (1) Aviation
Services 5,730 3.4 6,177 1.4 (447 ) (7.2 ) Eliminations (2,478 ) (1.4 ) (1,576 ) (0.4 ) 902 57.2 Total Direct
segment costs 122,618 72.3 398,065 88.8 (275,447 ) (69.2 ) Segment
profit 47,091 27.7 50,103 11.2 (3,012 ) (6.0 ) Other shared
expenses,
including
transition
costs (58,107 ) (85,086 ) Impairment
charges on
investments - (13,661 ) Amortization
of debt
discount (780 ) (7,078 ) Interest
expense (2,029 ) (2,355 ) Interest
income 348 2,363 Capitalized
interest 62 400 Equity
investments
loss, net (377 ) (685 ) Other, net (85 ) 80 Consolidated
income (loss)
before
income taxes $ (13,877 ) $ (55,919 )
(1) Branded flying operations were suspended on September 2, 2008.
The table below (in thousands, except percentage data) sets forth the segment profit (loss) for the three months ended March 31, 2009 and the three months ended March 31, 2008 for each segment.
Contract Aviation
Flying Services
-------------------- -------------------
Total Total
2009 Revenue % 2009 Revenue %
------- --------- ------ ---------
Revenue from customers 160,268 100.0 11,919 100.0
Direct segment costs 119,366 74.5 5,730 48.1
Segment profit (loss) 40,902 25.5 6,189 51.9
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Contract Branded Aviation
Flying Flying Services
--------------------- ---------------------- --------------------
Total Total Total
2008 Revenue % 2008 Revenue % 2008 Revenue %
------- --------- ------- --------- ------ ---------
Revenue from customers 365,674 100.0 72,870 nm 11,200 100.0
Direct segment costs 275,380 75.3 118,084 nm 6,177 55.2
Segment profit (loss) 90,294 24.7 (45,214 ) nm 5,023 44.8
Contract Flying. Block hours for contract flying with Continental were down 9.5% for the three months ended March 31, 2009 as compared to the same period ended March 31, 2008. The decrease in operating revenue and expenses within our Contract Flying segment is primarily due to operating under the Original Continental CPA in 2008 versus under the Amended Continental CPA in 2009 as a result of the different revenue and expense structures contained in each agreement.
Prior to July 1, 2008, Airlines was entitled to receive payment for each block hour that Continental scheduled it to fly and was based on a formula designed to provide Airlines with a target operating margin of 10%. Under the Amended Continental CPA, which became effective July 1, 2008, revenues are calculated at a pre-determined rate based on block hours flown at considerably lower rates then under the Original Continental CPA. Likewise, under the Amended Continental CPA, Continental is responsible for the cost of providing fuel for all flights and for paying aircraft rent for all aircraft covered by the Amended Continental CPA and, therefore, these items are not included in our statements of operations beginning with July 1, 2008.
Additionally, Delta Airlines ("Delta") and ExpressJet agreed to terminate our capacity purchase agreement (the "Delta CPA") effective September 2, 2008, and accordingly, there was no activity in operations for the Delta CPA for the three month period ended March 31, 2009. Airlines earned approximately $15.7 million in revenue under the Delta CPA for the three months ended March 31, 2008.
Branded Flying. Airlines suspended flying under our ExpressJet brand and our pro-rate flying arrangement with Delta (the "Delta Prorate") effective September 2, 2008, and accordingly, there was no activity in operations under the ExpressJet brand or the Delta Prorate for the three month period ended March 31, 2009.
Aviation Services. For the three months ended March 31, 2009, Aviation Services had a segment profit margin of 51.9%, up from 44.8% for the three months ended March 31, 2008. This increase in profit was primarily a result of labor efficiencies within the segment.
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Operating Expenses
The table below (in thousands, except percentage data) sets forth the
changes in operating expenses from the three months ended March 31, 2009 to the
three months ended March 31, 2008.
Fiscal Year
---------------------------------------------
Total Total Increase /
2009 Revenue % 2008 Revenue % (Decrease) Change %
------- --------- ------- --------- ---------- --------
Wages, salaries and
related costs $ 79,675 46.9 % $ 114,605 25.6 % $ (34,930 ) (30.5 )%
Maintenance, materials and )
repairs 38,802 22.9 55,646 12.4 (16,844 (30.3 )
Other rentals and landing )
fees 12,895 7.6 29,687 6.6 (16,792 (56.6 )
Depreciation and )
amortization 7,704 4.5 8,638 1.9 (934 (10.8 )
Outside services 7,595 4.5 16,719 3.7 (9,124 ) (54.6 )
Aircraft rentals 5,472 3.2 86,758 19.4 (81,286 ) (93.7 )
Aircraft fuel and related )
taxes 3,221 1.9 97,986 21.9 (94,765 (96.7 )
Ground handling 3,105 1.8 26,011 5.8 (22,906 ) (88.1 )
Marketing and distribution 1,325 0.8 11,891 2.7 (10,566 ) (88.9 )
Other operating expenses 20,931 12.3 35,210 7.9 (14,279 ) (40.6 )
------- ------- ----------
Total operating expenses $ 180,725 106.5 $ 483,151 107.8 $ (302,426 ) (62.6 )
------- ------- ----------
The following explanations are related to changes between the three months ended March 31, 2009 to the same period in 2008.
Wages, salaries and related costs decreased 30.5% in the three months ended March 31, 2009 when compared to the same period in 2008 primarily due to significant headcount reductions associated with the suspension of flying under our ExpressJet brand and our pro-rate flying arrangement with Delta that went into effect September 2, 2008.
Maintenance, materials and repairs decreased 30.3% in the three months ended March 31, 2009 when compared to the same period in 2008, which is in line with the system-wide decrease in block hours of 30.6% over the same period.
Other rentals and landing fees decreased 56.6% for the first quarter when compared to the same period in 2008. As a result of our suspended operations, expenses associated with landing fees decreased approximately 19%. A second factor resulting in lower expense relates to the process of transitioning station management of a majority of the stations under the Amended Continental CPA from ExpressJet to Continental. For further detailed discussion of all the terms and specifics of the Amended Continental CPA, refer to Item 8. "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 2 - Contract Flying" in our 2008 10-K. As a result, the associated facility rentals are now incurred directly by Continental and the related expense is no longer included in our statements of operations.
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Aircraft rentals expense decreased 93.7% for the quarter ended March 31, 2009 versus the quarter ended March 31, 2008 primarily due to new terms under the Amended Continental CPA which became effective July 1, 2008. Under the Amended Continental CPA, Continental is responsible for paying aircraft rent for all aircraft operated for Continental thereunder and, therefore, the related expense is no longer included in our statements of operations. In addition, lease payments for the 30 aircraft operating outside of the Amended Continental CPA are at significantly lower rates than the lease obligations under the Original Continental CPA.
Aircraft fuel and related taxes decreased 96.7% during the first quarter of 2009 when compared to the first quarter of 2008 primarily due to new terms under the Amended Continental CPA which became effective July 1, 2008. Prior to July 1, 2008, our fuel price, including related fuel taxes, was capped at 71.20 cents per gallon under the Original Continental CPA. Under the Amended Continental CPA, Continental is responsible for the cost of providing fuel for all aircraft covered by the Amended Continental CPA and, therefore, the related expense is no longer included in our statements of operations.
GroundHandlingexpense decreased 88.1% primarily due to new terms under the Amended Continental CPA which became effective July 1, 2008. Under the Amended Continental CPA, Continental is responsible for the station expenditures directly. In addition, under the Amended Continental CPA, Continental is responsible for the cost of providing fueling services for all aircraft covered by the Amended Continental CPA and, therefore, the related ground handling and aircraft servicing expense related to operations in respect of the Amended Continental CPA is no longer included in our statements of operations.
Marketing and Distribution expense decreased 88.9% primarily due to the suspension of flying under our ExpressJet brand and the Delta Prorate that became effective September 2, 2008. All marketing and distribution costs for aircraft operating within the Amended Continental CPA are incurred directly by Continental.
Non-Operating Expenses
The table below (in thousands, except percentage data) sets forth the
changes in non-operating expenses from the three months ended March 31, 2009 to
the three months ended March 31, 2008.
Fiscal Year
----------------------------------------------------
2008
Total (as restated Total Increase /
2009 Revenue % - Note 1) Revenue % (Decrease) Change %
------ --------- ------------ --------- ---------- --------
Impairment charge on %
investments $ - - % $ (13,661 ) (3.0 )% $ 13,661 nm
Amortization of debt )
discount (780 ) (0.5 ) (7,078 ) (1.6 ) 6,298 (89.0
Interest expense (2,029 ) (1.2 ) (2,355 ) (0.5 ) 326 (13.8 )
Interest income 348 0.2 2,363 0.5 (2,015 ) (85.3 )
Capitalized interest 62 0.0 400 0.1 (338 ) (84.5 )
. . .
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