Form 10-Q

Commission File Number 1-31300


EXPRESSJET HOLDINGS, INC.
(Exact name of registrant as specified in its charter)

713-324-2639
(Registrant's telephone number, including area code)

NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last report)

            Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

            Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

As of April 20, 2005, 54,475,928 shares of common stock were outstanding.

TABLE OF CONTENTS

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

EXPRESSJET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

  Table of Contents

EXPRESSJET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)

(continued on next page)

Table of Contents

EXPRESSJET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share data)

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

Table of Contents

EXPRESSJET HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

Table of Contents

EXPRESSJET HOLDINGS, INC.AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

            We are a regional U.S. air carrier engaged in the business of transporting passengers, cargo and mail.  Our principal asset is all of the issued and outstanding shares of capital stock of XJT Holdings, Inc., the sole owner of the issued and outstanding shares of common stock of ExpressJet Airlines, Inc., which operates as “Continental Express” (together, "ExpressJet," "we," "us" and "our").  All of our flying is currently performed on behalf of Continental Airlines, Inc. (“Continental”) pursuant to a capacity purchase agreement, and substantially all of our revenue is received under that agreement.  We are the exclusive regional jet provider for Continental out of New York/Newark, Houston and Cleveland and additional non-hub service.  The capacity purchase agreement covers all of our existing fleet and all of our regional jets currently subject to firm aircraft orders.  We are economically dependent upon Continental for our operations and cash flows.

            The accompanying interim consolidated condensed financial statements have been prepared in conformity with U.S. generally accepted accounting principles and are consistent in all material respects with those applied in our annual report on Form 10-K for the year ended December 31, 2004 (the “2004 10-K”).  The preparation of these financial statements requires us to make estimates and judgments that affect the amounts reported in the financial statements and the related disclosures.  The actual results may differ from our estimates.  Please see our 2004 10-K for a detailed description of our critical accounting estimates.  The SEC has defined critical accounting estimates as the ones that are most important to the portrayal of a company's financial condition and results of operations and require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain.

            The interim financial information is unaudited, but reflects all adjustments necessary in our opinion to provide a fair presentation of our financial results for the interim periods presented.  These adjustments are of a normal, recurring nature.  Certain amounts reported in previous periods have been reclassified to conform to the current presentation.  These interim consolidated condensed financial statements should be read in conjunction with the financial statements and the notes thereto contained in our 2004 10-K.

Note 1 – Principles of Consolidation

            The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles and include the accounts of ExpressJet Holdings, Inc. and its subsidiaries.  In addition, we have consolidated the results of operations and financial condition of a European start-up company in which we invested in March 2005 in accordance with Financial Accounting Standards Board Interpretation 46(R) – "Consolidation of Variable Interest Entities (Revised December 2003) – an Interpretation of ARB No. 51" ("FIN 46R").  We currently own one share less than 50% interest in this entity.  The results of operations of this company were immaterial for the three months ended March 31, 2005.  All intercompany transactions have been eliminated in consolidation.

Note 2 – Capacity Purchase Agreement

            As part of our 2005 rate negotiation, we agreed to cap our prevailing margin at 10.0%.  We also now include previously unreconciled costs within the margin band, although we will not be reimbursed if these costs are higher and cause our prevailing margin to fall below our 8.5% margin floor.  In addition, we are still entitled to receive incentive payments from Continental if our rate of controllable cancellations is lower than our historical benchmark; however, we will not be required to pay Continental a penalty for controllable completion factors below our historical benchmark unless the controllable completion factor falls below 99.5%.  We will also continue to receive a small per-passenger fee and incentive payments for certain on-time departure and baggage handling performance.

Table of Contents

            The table below describes how variations between our actual costs and our estimated costs, as determined in the block hour rates, are treated under the capacity purchase agreement effective January 1, 2005.

(1)		Fuel and fuel tax expense are reconciled to the lower of the actual costs or the agreed-upon caps of 66.0 cents per gallon and 5.2 cents per gallon, respectively, based on our fuel purchase agreement with Continental.  If the fuel agreement with Continental were not in place, our fuel cost, including related taxes, would have been $1.53 per gallon for the three months ended March 31, 2005.
(2)		Depreciation is reconciled for assets and capital projects accounted for in the capacity purchase agreement or those approved by Continental outside of the capacity purchase agreement.
(3)		The prevailing margin used to calculate the reconciliation payment does not take into account performance incentive payments, including payments from controllable cancellation performance, litigation costs above a historical benchmark and other costs that are not included in our block hour rates (or covered by adjustments to them) or are not reasonable and customary in the industry.

Table of Contents

            Certain costs that were unreconciled under the capacity purchase agreement prior to 2005 will now result in our making a reconciliation payment to Continental if the differences cause our prevailing margin to be greater than 10.0%.  However, if the differences cause our prevailing margin to be less than 8.5%, they will remain unreconciled.  These costs are:

            As a result of the rate resetting process for 2005, we expect our future operating margin, excluding incentives, to be closer to our target operating margin of 10.0%.  For instance, our operating margin for the three months ended March 31, 2005 was 10.3% as compared to 13.4% for the same period in 2004.

            For a detailed description of our capacity purchase agreement, please see Item 1. “Business — Capacity Purchase and Other Agreements with Continental Airlines” in our 2004 10-K.

Note 3 – Earnings Per Share

            The following table sets forth the computation of basic and diluted earnings per share for the three months ended March 31, 2005 and 2004 (in thousands):

            We excluded 122,500 shares of restricted stock from the weighted average shares used in computing basic earnings per share for the three months ended March 31, 2005, as these shares were not vested as of the end of the period.  No restricted stock was outstanding for the three months ended March 31, 2004.

            We adopted the Emerging Issues Task Force Issue No. 04-08 — “The Effect of Contingently Convertible Debt on Diluted Earnings per Share” on December 15, 2004.  As a result, we included the potential common stock equivalents related to our senior convertible notes in our computation of diluted earnings per share and restated the prior period presentation.

Table of Contents

            Weighted average common shares outstanding for diluted earnings per share calculation include the incremental effect of shares that would be issued upon the assumed exercise of stock options and restricted stock not yet vested.  We excluded the following common stock equivalents from our diluted earnings per share calculations, because their inclusion would have been anti-dilutive:

Note 4 – Stock Plans and Awards

           We continue to account for our stock-based compensation arrangements using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25 — “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations.  We have two stock-based compensation plans: the ExpressJet Holdings, Inc. 2002 Stock Incentive Plan (the “Incentive Plan”) and the ExpressJet Holdings, Inc. 2003 Employee Stock Purchase Plan (the “ESPP”).

           The Incentive Plan permits us to grant stock options and restricted stock to our employees and non-employee directors.  Under APB 25, if the exercise price of our stock options equals the fair market value of the underlying stock on the date of grant, no compensation expense is recognized.  Since our stock options have all been granted with exercise prices that equal fair market value, no compensation expense has been recognized under APB 25.  We recognize compensation expense for our restricted stock in accordance with APB 25.  The total compensation expense to be incurred for each restricted stock grant equals the product of the number of shares issued and the closing price of our common stock on the issuance date; the expense is recognized over the vesting period of each grant in accordance with the method specified in Financial Accounting Standards Board Interpretation No 28 — “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans” (“FIN 28”).  Under APB 25, we do not recognize compensation expense related to the ESPP.

            In May 2004, our board of directors approved the issuance of restricted stock to various employees and non-employee directors pursuant to the Incentive Plan.  As of March 31, 2005, 122,500 shares of restricted stock, net of forfeitures, were outstanding.  Restricted shares granted to our employees typically vest ratably over a four-year period.  Restricted shares granted to our non-employee directors vest over six months.

            In January 2005, we issued 32,083 shares of our common stock to our employees pursuant to the ESPP at $10.37 per share.  In January and July 2004, 36,684 and 36,286 shares of our common stock were issued to our employees at $12.75 and $10.32 per share, respectively.

Table of Contents

           The following table illustrates the effect on net income and earnings per share assuming the compensation costs for our stock options, restricted stock and ESPP were determined using the fair value method, prorated over the vesting periods in accordance with FIN 28, at the grant dates as required under Statement of Financial Accounting Standard No. 123 – “Accounting for Stock-Based Compensation” for the three months ended March 31, 2005 and 2004 (in thousands, except for per share data):

            The pro forma effect on net income per share is not representative of the pro forma effects in future periods.

            In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard No. 123 (Revised 2004) — “Share-Based Payments” (“SFAS 123R”) which will impact our method of accounting for our stock compensation.  See a detailed description of SFAS 123R below in “—Note 8.” 

Note 5 – Note Payable to Continental

            At March 31, 2005, our note payable to Continental, including current maturities, had an outstanding balance of $98.8 million.  The note accrues interest based on the three-month LIBOR plus 1.25% per annum.  For the three months ended March 31, 2005 and 2004, our interest rates were 3.81% and 2.41%, respectively. 

            The quarterly payment on the note for principal and interest is $27.9 million, payable through the earlier of March 31, 2007 or until the principal balance and any accrued unpaid interest are paid in full.  We currently expect to pay off this obligation by March 2006.  In September 2004, we made a voluntary principal prepayment of $27.0 million, which reduced our required quarterly principal and interest payments for March 31, 2005.  Accordingly, an interest-only payment of $0.9 million was made on March 31, 2005.  The note is an unsecured general obligation and is subordinated in right of payment to all of our future senior indebtedness.

Table of Contents

Note 6 – Income Taxes

            At December 31, 2004, we had federal net operating loss carryforwards of approximately $17.4 million, which expire in 2019.

            In conjunction with our initial public offering (“IPO”) in April 2002, the tax basis of our tangible and intangible assets was adjusted to fair value.  This adjustment to tax basis should result in additional tax deductions being available to us through 2017.  In accordance with our tax agreement with Continental, to the extent we generate taxable income sufficient to realize the additional tax deductions, we are required to pay Continental a percentage of the amount of tax savings actually realized, excluding the effect of any loss carrybacks.  We are required to pay Continental 100% of the first third of the anticipated tax benefit, 90% of the second third and 80% of the last third.  However, if the tax benefits are not realized by the end of 2018, we will be obligated to pay Continental 100% of any benefit realized after that date.  Since these payments are solely dependent on our ability to generate sufficient taxable income to realize these deferred tax assets, they are recorded as an obligation to Continental within the deferred tax asset accounts, and the portion we may retain in the future is offset by a valuation allowance.  At the IPO, the valuation allowance and the obligation to Continental offset the step-up in basis of assets in our long-term deferred tax asset account.  Net payments of approximately $5.1 million were made to us by Continental under the agreement during the three months ended March 31, 2005.  During the three months ended March 31, 2004, we made approximately $13.1 million of net payments to Continental under the tax agreement.

            The tax agreement requires Continental to reimburse us for any net increase in our cash tax payments resulting from any decreased availability of net operating loss carryovers related to the basis increase at the time our payment occurs.  The resulting receivable and/or payable is recorded within the deferred tax asset account since its performance is dependent on our ability to generate taxable income.

            No valuation allowance was established on our net operating loss carryforwards or on our receivable from Continental for reimbursing carryforward losses utilized resulting from the basis increase because we believe our stand-alone taxable income will be sufficient to utilize substantially all of these assets within the next several years.

            We believe that our IPO created a change in ownership limitation on the utilization of our federal tax attribute carryforwards, primarily net operating losses.  Section 382 of the Internal Revenue Code limits our utilization of these attributes to offset up to approximately $43.3 million of post-change taxable income per year.  This limitation did not have any impact on our financial condition during the three months ended March 31, 2005 or 2004.

            Our tax agreement increases our dependence on Continental’s financial condition.  If it is determined that any of the tax benefits related to the basis increase should not have been available at the time of utilization and, as a result, we are required to pay additional taxes, interest and penalties, then we could be adversely affected if Continental were unable to pay us under its indemnification for these accounts.

Table of Contents

Note 7 – Commitments and Contingencies

Purchase Commitments and Contingencies

            As shown in the following table, our fleet consisted of 250 regional jets at March 31, 2005.  Our aircraft purchase commitments (firm orders) and aircraft options as of March 31, 2005 are also shown below.

            During the three months ended March 31, 2005, we took delivery of five ERJ-145XR aircraft and expect to take delivery of the remaining 24 firm orders for ERJ-145 XR aircraft through the second quarter of 2006.  As of March 31, 2005, the estimated aggregate cost of our firm commitments for Empresa Brasileira de Aeronautica S.A. (“Embraer”) aircraft was approximately $0.5 billion.  We will not have any obligation to take any of the aircraft under firm commitments if they are not financed by a third party and leased to either Continental or us.  We also have options to purchase an additional 100 Embraer regional jets.

            In addition, as of March 31, 2005, we expect to purchase up to three spare engines for approximately $9.0 million to support our existing aircraft and the remaining 24 aircraft on firm order.  We anticipate the delivery of these spare engines by December 2005.  We currently have no financing in place for these spare engines and have no obligation to acquire two of these engines if the firm order aircraft are not delivered to us for any reason.

Collective Bargaining Agreements

            Approximately 70% of our employees are covered by collective bargaining agreements, including our pilots, mechanics, dispatchers and flight attendants.  The contracts with our pilots, mechanics and dispatchers will be amendable in December 2008, August 2009 and July 2009, respectively.  The contract with our flight attendants, who are represented by the International Association of Machinists and Aerospace Workers (“IAM”) and comprise approximately 17% of our employees, became amendable in December 2004.  We are not currently engaged in negotiations with our flight attendants, but expect to resume negotiations when the IAM completes its current concession negotiations with Continental.  At this time we cannot predict the outcome of these negotiations. 

Table of Contents

General Guarantees and Indemnifications

            Additionally, we are party to many contracts in which it is common for us to agree to indemnify third parties for tort liabilities that arise out of or relate to the subject matter of the contract.  In some cases, this indemnity extends to related liabilities arising from the negligence of the indemnified parties, but typically excludes liabilities caused by gross negligence or willful misconduct.  We cannot estimate the potential amount of future payments under these indemnities until events arise that would trigger a liability under the indemnities.  However, we expect to be covered by insurance for a material portion of these liabilities, subject to deductibles, policy terms and conditions.

Note 8 – Recently Issued Accounting Standards

            In December 2004, the FASB issued SFAS 123R, which is a revision of SFAS 123.  SFAS 123R supersedes APB 25 and amends Statement of Financial Accounting Standards No. 95 — “Statement of Cash Flows.”  Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123.  However, SFAS 123R requires all share-based payments to employees to be recognized in the income statement based on their fair values.  Pro forma disclosure is no longer an alternative. 

            In April 2005, the SEC delayed the adoption requirement of SFAS 123R to the first fiscal year beginning after June 15, 2005 for public companies.  Early adoption will be permitted in periods in which financial statements have not yet been issued.  SFAS 123R permits public companies to adopt its requirements using one of two methods:

We plan to adopt SFAS 123R using the modified prospective method on January 1, 2006.

            As permitted by SFAS 123, we currently account for share-based payments to employees using APB 25’s intrinsic value method and, as such, recognize no compensation cost for employee stock options and purchase plans.  Accordingly, the adoption of SFAS 123R’s fair value method will significantly impact our results of operations, although it will not impact our overall financial position.  The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future.  However, had we adopted SFAS 123R in prior periods, the impact would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net income and earnings per share in “— Note 4” above.  SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature.  This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption.  We cannot estimate the impact of this change in the future (because it depends on, among other things, when employees exercise stock options).  We did not recognize any excess tax deductions in our operating cash flows for the three months ended March 31, 2005 and 2004 as no options were exercised in these periods.

Table of Contents

Note 9 – Subsequent Events

            On April 1, 2005, ExpressJet Airlines, Inc. called for the redemption of the sole authorized and outstanding share of its non-voting Series A Cumulative Mandatorily Redeemable Preferred Stock, par value $.01 per share (“Series A Preferred Stock”), which is classified in current maturities of long-term debt.  The redemption price for the share, includ