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ExpressJet widens losses, focused on cost reduction before merger

Analysis

The very last North American airline to report its second quarter results, ExpressJet said it lost USD18.6 million including special items, a 42% increase from the USD13 million loss posted in the year-ago period. Excluding special items, the loss totaled USD5 million. However, it followed its other regional counterparts in reporting increasing block hours in its Continental and United express agreements. CEO Tom Hanley reported the 18% increase in block hours over the year-ago period, adding that during the quarter it expanded its United Express operation to 32 aircraft. It is now trying to extend 10 short-term aircraft (scheduled to expire at the end of the year) into 2011.

Interest in the troubled carrier had been tailing off since mid-2009 and yesterday only two analysts bothered to tune into the conference call and ask questions, the most important of which was whether shareholders could get more if results significantly improved before the closing of its acquisition by SkyWest Inc and merger with SkyWest subsidiary Atlantic Southeast Airlines.

See related report: SkyWest to acquire ExpressJet in continued US regional consolidation

Hanley did not answer the question, referring analysts instead to its merger filing, a 72-page pile of legaleze. A review of the document indicates the answer is no, USD6.75 is it. But then comes this paragraph indicating that they may get more but it is highly unlikely given the health of the company. "The Merger Consideration shall be adjusted to reflect fully the effect of any stock split, reverse stock split, stock dividend, reorganization, recapitalization, consolidation, exchange or other like change with respect to the Company Common Stock occurring after the date hereof and prior to the Effective Time (including any dividend or distribution on the Company Common Stock of securities convertible into Company Common Stock, as applicable)."

It also revealed that should the merger not go through the one that kills the deal will have to pay a USD4 million termination fee. In addition, the agreement may be terminated if not consummated before "January 15, 2011 (subject to extension in certain circumstances to April 15, 2011) and in other customary circumstances. Except for possible termination fees, all costs and expenses incurred by ExpressJet and SkyWest shall be paid by the party incurring such expenses."

The ink was hardly dry on its agreement with SkyWest when a lawsuit was filed against ExpressJet calling for an investigation into the acquisition. A similar suit was filed in the United/Continental merger resulting in further disclosures to shareholders about details of the deal. The ExpressJet suit was filed by Bull & Lifshitz, LLP suggesting alleged improprieties regarding the sale. It wants to investigate whether the ExpressJet board breached their fiduciary duty and whether the deal provides adequate value, even as it more than doubles the price the stock was trading before the merger announcement.

2Q2010 Results

ExpressJet losses in the first half ex special items totaled USD18.2 million. Total expenses rose 18.9% to USD215.7 million or USD1 per diluted share. However, including special item, the company reported a loss of USD34.7 million or USD1.92 per diluted share for the six months ended June 30, 2010.

Hanley reported that the company is making progress on its cost-cutting initiative - Operation Green Light - announced in June. However, management has been distracted by the month-long merger negotiations, limiting the progress they had hoped to make. Even so, ExpressJet expects to cut costs another USD4-5 million during the second half.

Operation Green Light was billed as the first step in a multi-phase process designed to provide USD40 million in run-rate savings between now and 2012 as part of a challenge from the board as Hanley assumed his new post as CEO in April. "We believe this plan will allow the company to move forward and all ExpressJet stakeholders to benefit from a company that possesses a solid, financial foundation and sustainable profits," he said in June. "The first phase of the plan focuses on initiatives that will stem the losses ExpressJet incurred in the recent quarters. The next phase of the plan will be designed to provide ExpressJet with a competitive cost structure and a stronger balance sheet to support growth and new, profitable opportunities."

In addition to productivity increases, the plan calls for reducing corporate overhead and a hiring freeze; increasing safety procedures to reduce worker's comp claims and lower restricted cash requirements; collecting revenue currently owed under third-party contracts; improving crew planning procedures to increase productivity and lower related travel expenses and increasing maintenance productivity and lowering vendor costs.

"We have made some progress," said Hanley yesterday. "But it is fair to say, a good chunk of management time over last few weeks and months have been dedicated to evaluating and supporting the SkyWest transaction. But we have moved forward solidly in the maintenance area with significant improvements in our approach to on-condition items. Historically, we have changed out the entire cabin and are now looking at refurbishment while still maintaining the appearance we want in the airplane. We have also gained better sourcing within the maintenance area which is extremely leveraged and made improvements in our power-by-the-hour and component support.

"We are also seeing improvements in productivity and block hours have improved by not adding as many workers as we might otherwise have," he continued, adding that the average utilization has gone to 9.12 hours per day for Continental and 9.78 for United, up 8.2% for each aircraft. "So we are working a little bit smarter and making progress. On the crew side, we saw productivity improvements in both May and June year over year and we are constantly trying to figure out how to improve utilization as we build out our United operation. We now have a base in Chicago which has helped on the productivity of the crew. Everyone is now in place so training will decline as we put more focus on training for attrition."

Under its capacity purchase agreement with Continental Airlines, Inc., ExpressJet flew 170,962 block hours during second quarter 2010 using an average of 206 aircraft - a 4.3% improvement year on year. The eight fewer aircraft used for Continental moved to the United operation during the second quarter. The airline generated 2.2 billion revenue passenger miles on 2.7 billion available seat miles, producing a load factor of 81.8% within its Continental Express operation.

Its United operation grew from 22 aircraft in April to 32 during May and June producing 25,556 block hours. It spent USD1 million in start up costs for the new United flying which was USD500 million less than it had originally forecast at the end of 1Q-2010.

For the three months ended June 30, 2010, ExpressJet flew 355 million available seat miles generating 276 million revenue passenger miles and a load factor of 77.6% within the United Express operation. For the six months ended June 30, ExpressJet flew 552 million available seat miles generating 414 million revenue passenger miles and a load factor of 75% within its United Express operation. Currently, ExpressJet operates 32 aircraft in its United Express operation.

Charter flying

ExpressJet flew 2,067 block hours during the second quarter within its corporate aviation (charter) operation. Within the operation, ExpressJet used an average of nine aircraft during the quarter as this operation was downsized to six aircraft by June 30.

Charter revenue in the second quarter totaled USD7.9 million and USD23.4 million for the six months ended June 30, 2010. Aviation services (stations and services) revenue totaled USD9.5 million for 2Q-2010 and USD18.2 million for the first half.

Aviation Services

During the quarter, ExpressJet added one additional ground handling station and three additional contracts at established stations for a total of 46 contracts at 32 stations. Total activity during the quarter as measured by aircraft turns was 19,869.

Financial Overview

ExpressJet generated USD207 million in revenues during 2Q-2010, compared to USD170.6 million for the year-ago period. During the first have revenues totaled USD396.3 million in revenues for the six months ended June 30, 2010 versus USD340.3 million for 1H-2009.

Its United and Continental agreements generated USD189.6 million in block hour revenue and pass-through reimbursements during the second quarter 2010 versus USD149.4 million during second quarter 2009. Increased utilization of the Continental Express fleet and the full deployment of the United Express flying continue as the primary drivers for revenue improvement during second quarter 2010. The second quarter 2010 block hour revenue was net of USD1.4 million paid to Continental for utilization improvements and performance penalties.

During the quarter, ExpressJet spent USD1 million in start-up costs as it completed the induction of aircraft into its United Express operation.

Despite block hour improvements, no ongoing United start-up costs and progress on the Operation: Green Light Plan, the company expects to experience continued financial pressure on consumer-price index revenue rate increase of 0.76% under the Continental capacity purchase agreement that became effective 1-July-2010, according to CFO Phung Ngo-Byrnes. She also said that pressure would also result from the remaining USD6.1 million balance on Continental utilization incentives and the remaining amortization of United warrants through Apr-2013.

ExpressJet ended the second quarter 2010 with USD108.2 million in cash, cash equivalents and short-term investments - a USD1.9 million improvement versus first quarter 2010. The cash balance included USD20.4 million in restricted cash and USD967,000 in short-term investments, after accounting for adjustments to impair the value of these assets.

Its balance sheet was improved with the collection of USD18.2 million in tax receivables and repurchasing or announcing redemptions for USD18.6 million par value of its 11.25% Convertible Secured Notes due 2023. It also monetized its remaining auction rate securities balance and is repaying the USD5 million outstanding credit facility provided by Citigroup related to its auction rate securities.

After completing the announced redemptions, ExpressJet's remaining balance on 11.25% Convertible Secured Notes due 2023 will be USD33.6 million. This balance represents the par value due to noteholders when the notes become due in August 2023 and a 43% reduction in these notes versus the end of 2Q-2009. The redemption of USD10 million in par value of its 11.25% Convertible Secured Notes due 2023 will save ExpressJet approximately USD1.1 million annually in interest expense.

After completing these redemptions, the remaining balance in ExpressJet's securities repurchase program will be USD11.8 million. The company expects any future purchases of securities under the securities repurchase program to be made periodically in the open market or in privately negotiated transactions.

Capital expenditures during the quarter totaled approximately USD0.9 million compared to USD1.5 million during the second quarter 2009. ExpressJet expects remaining capital expenditures for the year to range from USD1 million to USD3 million to meet operational requirements.

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