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Monday, August 2, 2004

Independence Air Off To Better Start Than Expected

Yields Are Poor; Load Factors Look Good

Although Atlantic Coast Airlines [ACAI] lost more money than expected in the second quarter, Wall Street analysts seems pleased with the initial performance of the company's new airline, Independence Air. In fact, one brokerage has upgraded it stock recommendation.

Atlantic Coast reported a second quarter loss of $27.1 million, or 60 cents per share, on revenue of $190.4 million, compared to earning $45.7 million, or $1.01 per share, in the same period of 2003 on revenue of $227.1 million.

CFO Richard Surratt had earlier warned that the company would lose about $10 million, or about 18 cents per share, in the second quarter as it launches Independence Air and transitions out of its code-share partnership with United Airlines [UALAQ]. When nearly $25 million in pre-tax charges for the early retirement of 10 Jetstream 41s and three Dornier 328Jets is factored out, Surratt explained that the difference between the early projections and final numbers boils down to three issues totaling slightly more than $3 million, or 4 cents per share.

United withheld $1.1 million in payments in June and threatens to withhold portions of its July and August payments, he said. Atlantic Coast has turned to the bankruptcy court to compel United to pay money still due under the code-share contract.

Atlantic Coast ends its relationship with United on Aug. 3 when its flies its last flight of that day. At that time, all 87 Bombardier [BBD] CRJ 200s will be devoted to the Independence fleet and all Jetstream 41 turboprops will be retired. By Sept. 1, Independence will have completed its initial launch with 600 daily departures based at Washington Dulles International Airport to 35 destinations.

The carrier later this month will announced two more regional jet markets with service to begin in October. An August announcement is also planned for the first Airbus 319 routes. The first 132-seater planes will go into service in November. After exercising another option, Independence will have 28 total Airbus 319s in its fleet.

And, a firm date has been set to end the Delta Connection relationship - Nov. 2. Beginning in August, Atlantic Coast will stop flying the Dornier 328Jets for Delta Air Lines [DAL]. The bulk of the 33 planes will not be retired until November.

It remains an open question as to what will happen with the 328s. Exercising its rights under the partnership contract, Atlantic is asking Delta to assume responsibility for the lease payments and re-assign them within the Delta family. There is a real probability, Surratt said, that the financially troubled Delta will not take the planes, leaving Atlantic stuck with the $25 million annual lease payment. Atlantic may find new users for the planes, but probably at a lower lease payment, he added.

Because of so many uncertainties, Surratt said that Atlantic would not provide any further earnings guidance for the rest of the year. Likewise, he said, the carrier would not provide any estimates as to what its year-end cash balance might be.

The carrier's June 30 cash balance was $357 million from which the company made a July deposit of nearly $50 million on the new Airbus fleet. Analyst James Parker, of Raymond James, believes the balance will now be below the $175 million that was once projected for March 30, 2005. Parker has increased his estimate of 2004 losses to $1.63 per share from an original projection of $1.26 per share. In 2005, he now estimates the company will lose $1.33 per share - a drop of 53 cents per share.

Despite the lower estimates, Parker has upgraded his stock recommendation from "underperform" to "market perform" as the stock price has largely been discounted. "Furthermore, we don't think there is a substantial near-term downside to ACAI's share price."

Faced with a very competitive environment, CEO Kerry Skeen told analysts that Independence has been operating "in a very difficult yield environment - and hopefully the extreme or irrational moves by others will settle down."

As the company flies more than 200,000 seats each week by the end of August, Skeen projects that the load factor will be a "very encouraging" 57 to 60 percent. As more cities are brought online, he said, the carrier is beginning to see connectivity across the network. At the moment, 76 percent of the passengers are from the Washington area.

"Independence appears off to a respectable start," said JP Morgan analyst Jamie Baker, "that is if load factors and utilizations are any indication. Frankly, this is about 15 points above what our best guess would have been." Baker also notes that Independence's full Bombardier fleet schedule becomes effective just as the busiest travel season ends.

As if to underscore the competition Independence faces, Baker said that September's capacity will increase an average 172 percent in non-stop Independence markets. Not only has Independence added to the capacity, but United also has increased its capacity by 36 percent along these same routes. In Knoxville, for example, capacity in September will grow by 400 percent. Independence will add 300 flights to the schedule while United Express will boost its schedule from 87 flights in September 2003 to 134 flights scheduled this September.

"Needless to say, the increase in Independence markets fall well beyond the traffic levels likely to be stimulated by the presence of low fares," Baker said. "As the Independence network continues to mature, we expect it to become an increasingly negative industry catalyst" triggering fare reductions outside of the Dulles market.

>>Contacts: James Parker, Raymond James, (404) 442-5857; Jamie Baker, JP Morgan, (212) 622-6713.<<

A new name


Effective Aug. 4, Atlantic Coast Airline Inc. will be renamed as FLYi Inc. Its ticker will be: FLYI.


Independence Air Load Factors
Average Weekly Seats Load Factor
June - 26,900
July - 132,000
August - 206,200
Source: Company reports
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