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Monday, July 14, 2008

Mesa Posts $17.5M Profit, Seeks to Sell Kunpeng Interest

With few investment analysts on its quarterly conference call, Mesa Air Group Chair Jonathan Ornstein did his best to put a positive spin on the airline’s prospects but only seemed to succeed in tap dancing around question what few questions were asked.
The airline posted a pro forma net loss for the second quarter of $4.1 million or $0.15 per diluted share. It did earn an after tax profit of $17.5 million from continuing operations on operating revenues of $320.3 million. The profit represents $20 million swing from the $22.6 million loss posted in the year-ago period, and comes at a time when it has experienced several blows, including the termination of subsidiary Freedom Airlines 50-seat flying for which Mesa gained a temporary injunction to forestall bankruptcy. No date has been set for that trial. It also settled the Hawaiian lawsuit for $52. 5 million, regaining more that $37 million from the $90 million bond it posted after it lost the suit. Finally, it closed its Air Midwest subsidiary during the quarter. Subsequent to March 31, 2008, the company sold 14 of its 34 Beechcraft 1900D aircraft and It recorded a gain in the quarter ended June 30, 2008 of approximately $7.5 million in connection with these negotiations and in preparation for marketing the remaining 20 Beechcraft 1900D aircraft during the second quarter. It also concluded that the fair value of the remaining 20 aircraft was less then the carrying value and therefore recorded an impairment charge of $9.1 million during the quarter ended March 31, 2008.

Mesa Negotiating to Sell Kunpeng
The company grew its Chinese joint venture, Kunpeng Airlines, delivering one additional CRJ-200 to the joint venture in the second quarter for a total of five, flying primarily out of a hub in Xian, China. However, losses and the fact it can no longer place aircraft with the new carrier has prompted the airline to seek to shed the operation.
“Kunpeng has incurred losses since its inception and is expected to continue to incur losses for the foreseeable future,” said Mesa in its SEC filing. “The company’s inability to sell its interests to Shenzhen Airlines or another third party could have a negative impact on its operations and future profitability.
Mesa Air Group is required to invest $28 million in Kunpeng on or before May 16, 2009, according to its recent SEC filing. In addition to its 44 percent joint venture interest in Kunpeng Airlines, MAG’s subleases brought in $1.1 million in sublease revenue for the quarter ended March 31. At March 31, 2008, the company had gross receivables from Kunpeng of approximately $3.4 million. In addition, Kunpeng informed Mesa that it no longer required the additional 15 CRJ 200s it had expected to deliver to the joint venture.
Its SEC filing noted that the company accounts for its investment in the Kunpeng Airlines joint venture with Shenzhen Airlines using the equity method of account, under which it adjusts the carrying amount of its investment for its share of the earnings or losses. Its ownership includes 44 percent of the joint venture after taking into consideration the five percent interest held for the exclusive benefit of an unaffiliated third party. Shenzhen and Mesa Air Group share losses according to their respective percentage ownership, with Mesa’s exposure capped at a percentage of the gross revenues of Kunpeng that is materially below its percentage ownership interest.
For the six months ended March 31, 2008, the amount of the loss recorded by Mesa was less than its relative ownership percentage as a result of this provision. To the extent that prior-year losses are carried forward by Shenzhen as a result of this provision, the profit of the current year shall first be used to cover the additional loss that was previously born by Shenzhen from any prior year.

Operating revenues for go! increased $1.3 million as a result of an increase in average fares and capacity reductions in the Hawaiian Islands resulting from the loss of Aloha. Go! increased the number of inter-island flights after Aloha’s Chapter 7 filing.
Mesa reported that both fuel prices and fares have continued to rise. “If fuel prices had remained where they were when we launched operations,” said Ornstein, “it is fair to say go! would now be profitable. The question remains what will happen to fuel over the next six months. In Hawaii, we have seen fare increases but that has not led to a significant decrease of traffic in terms of total dollars. Fares are still a reasonable bargain in terms of getting around the islands. We are opposed to baggage charges but continue to look for other revenues sources with our work with wholesale tour operations and U.S. mail.”
Hawaiian Airlines CEO Mark Dunkerly said since its inception go! lost $34.7 million. "I think the question about go!'s future viability at the moment is more closely linked to their parent's viability in the larger sense than it is about Hawaii per se," Dunkerley said, speaking before the Honolulu Star Bulletin Editorial board. "But I think what we have to do, what both airlines have to do here, is find a way of being as efficient as they possibly can. And fares have to go up." As for whether go! can make money operating against Hawaiian, Dunkerly said: “That's hard for me to answer because it sort of presupposes that's what they want to do."

MAG Results
Total operating revenues for the second quarter increased $24.0 million, or 8.1 percent from the same quarter in 2007. Pro forma net adjustments on an after tax basis were the following: $21.0 million benefit as a result of a negotiated settlement with Hawaiian Airlines, $4.5 million gain on repurchase of convertible notes, $1.9 million gain on securities, lease return costs of $3.3 million, startup costs associated with the Chinese joint venture of $0.9 million, go! legal costs of $0.6 million and $1.1 million of other expenses. As of March 31, 2008, the company's cash, cash equivalents, restricted cash and marketable securities were approximately $158.1 million, which includes $102.8 million in restricted cash.
Total Available Seat Miles (ASM's) for the second quarter of fiscal 2008 decreased 10.4 percent from the second quarter of 2007 primarily after aircraft dropped from 201 March 31, 2007 to 178 March 31, 2008, when it had 84 50-seat regional jets, 41 86-seat regional jets, two 76-seat regional jets and 20 66-seat regional jets, 16 37-seat turboprops and 15 19-seat turboprops. As of March 31, 2008, the company operated 50 regional jets and 15 turboprops on a code-share basis with US Airways, 53 regional jets and ten turboprops for United and 39 regional jets for Delta. The company also flew six turboprops at Mesa Airlines and five regional jets in Hawaii operating as go!.
"During the second quarter we resolved a number of important issues," said Ornstein. "However, there remain many significant challenges to overcome both here at Mesa and with the industry."

Approximately 99 percent of passenger revenue in the second quarter of fiscal 2008 was associated with revenue-guarantee, code-share agreements and 94 percent of fuel purchases were reimbursed under revenue-guarantee code-share agreements.
In the quarter ended March 31, 2008, net operating revenue increased $24.0 million, or 8.1 percent, to $320.3 million from $296.3 million for the quarter ended March 31, 2007. Contract revenue decreased $3.5 million or 1.1 percent, driven primarily by the elimination of the Delta Dash-8 operation at JFK International Airport, which had contributed $9.4 million of revenue in the quarter ended March 31, 2007. Freight and other revenue increased by approximately $1.0 million primarily owing to sublease income from our Chinese joint venture. Net operating revenue in the quarter ended March 31, 2007 was negatively impacted by a ($25.3) million charge for impairment of contract incentives.
In the quarter ended March 31, 2008, flight operations expense decreased $6.3 million, or 6.6 percent, to $89.2 million from $95.5 million for the quarter ended March 31, 2007. On an ASM basis, flight operations expense increased 4.3 percent to 4.5 cents per ASM in the quarter ended March 31, 2008 from 4.3 cents per ASM in the quarter ended March 31, 2007.
The company was unable to reduce costs at the same rate as the ASM reductions. Its decreases, however, were primarily driven by a $3.5 million decrease in wages and employee-related expenses. Additionally, there was a net $2.7 million decrease in aircraft and aircraft related lease expense due to a decrease in the number of aircraft in operation year-over-year as well as a shift of aircraft types within our fleet.
In the quarter ended March 31, 2008, fuel expense increased by $17.8 million or 17.6 percent, to $118.8 million from $101.0 million for the quarter ended March 31, 2007. On an ASM basis, fuel expense increased 31.3 percent to 6.0 cents per ASM in the quarter ended March 31, 2008 from 4.6 cents per ASM in the quarter ended March 31, 2007. Average fuel cost per gallon increased $0.99, to an average of $3.02 for the quarter ended March 31, 2008 from an average of $2.03 per gallon for the quarter ended March 31, 2007. The cost per gallon increase resulted in a $37.7 million unfavorable price variance, of which $1.6 million related to go! but was partially offset by a decrease in the gallons of fuel purchased in the quarter ended March 31, 2008, which resulted in a $20.0 million favorable volume variance.
The volume decrease is primarily due to a new direct supply agreement with United Airlines at five large stations. In the quarter ended March 31, 2008, approximately 95 percent of fuel costs were reimbursed by our code-share partners. In most cases, under code-share arrangements, the company is contractually responsible for procuring the fuel necessary to conduct its operations, and fuel costs are then passed through to code-share partners via weekly invoicing. The United code-share agreement contains an option that allows United to assume the contractual responsibility for procuring and providing the fuel necessary to operate the flights that Mesa operates for United. United exercised this option at five of the stations we operate, and as a result, it no longer incur fuel expense or recognize related fuel pass-through revenue for these five United stations.
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