Analysts praised Republic Holdings Inc (RJET) for its strategy to place the 17 aircraft idled by the end of its Frontier Jet Express deal when Frontier filed for bankruptcy last spring. In fact, CEO Bryan Bedford said the margins expected from the loans were often better than the margins the company gets on its various code-share agreements.
The question of the $70 million in loans was the first one asked during the investors call accompanying the release of RJET’s third quarter results as analysts sought assurances that the investments resulted from a sound strategic plan. However, it is clear the main goal was to place the idle aircraft that creates a $200,000 per month, per aircraft drag on Republic’s books.
Bedford earlier told Regional Aviation News that the airline was not taking on a venture capital role but rather making each decision on a case-by-case basis. “We wouldn’t have done these deals if we didn’t feel they would work and we didn’t feel secure about our investment,” he said. “As for Frontier we had a $260 million unsecured creditor’s claim that we are trying to mitigate and we have done that. We may have mitigated about half but we have also put us in a priority position as far as repayment is concerned. It is highly secured and we have taken a risk that was unknown – maybe five cents on the dollar – and turned it into one that maybe 25 cents on the dollar. It was a business decision made in the best interest of our stakeholders.
“As for Molulele, that is a straight capacity purchase plan,” he continued. “Their underlying business plan was sound and our executive committee thought it was worth investing in. I don’t have the statistics on the growth in the Hawaiian market, but if you take all the seats of those carriers and if you compare March 2008 and March 2009 you’ll still see probably a 20+ percent reduction in capacity. All the capacity that go! and Mokulele have don’t amount to all of Aloha’s 737s.”
Taking the last deal first, Bedford explained that the $35 million loan to US Airways recognized the importance of the partnership between the two carriers, dating back to 1974 when it was an Allegheny Commuter. “There is a special bond between the companies,” he said. “When fuel was in the $140 per barrel, these guys put together a heroic restructuring and recapitalization program and presented it to us with full transparency. Thirty three percent of our total revenue and fleet size is with US Airways and they are, by far, our largest partner. There is no doubt that anything that is helpful to their restructuring program is the right thing to do for our stakeholders.” The US Airways loan agreement was for an initial $10 and if it takes the additional $25 million by March 31 its agreement with Chautauqua would be extended beyond its current expiration date in March 2013 to June 2014.
“As it relates to the more tactical moves with Midwest and Mokulele,” Bedford continued, “both had direct operating benefits to Republic. Clearly we wouldn’t have gotten into the loan business had they not been tied to operating agreements. The direct negative cash burn on the aircraft is $200,000 per aircraft which is equal to $8 million per quarter. It doesn’t take a lot of thought to support extending credit to these guys on a fully secured basis with good rates of return to make the investments attractive. These are investments that will hopefully pay dividends down the road.”
He told analysts that the loans carried a 10-12 percent rate of return. “Different loans have different risks,” said Bedford, adding Republic does not discuss margins in its capacity purchase agreements since they vary on the cost of fuel and the agreement. “But stripping out where fuel is, there is no doubt that the agreements used to reposition our Frontier aircraft is lower than Frontier but better than having them sit on the ground.” Bedford also noted that while the three airlines within the group were not at minimums with all their partners, there were with some but expected utilization to me normal as they enter the high season next year.
Bedford indicated the Midwest Airlines loan of $25 million was secured and collateralized and senior to the other lender Texas Pacific Group (TPG). The Debtor in Possession loan of $12.5 million to Frontier is also secured and senior and ahead of any administrative claims. As for Mokulele, the loan is secured and backed by the assets of the company. Finally, he said, the US Airways loan is an unsecured loan but cross collateralized on its slot loan agreements Republic has with its major partner as well as its service agreements with Republic and Chautauqua.
“As for the margins, different loans have different levels of risk but we think each loan has a risk adjusted rate return similar to market rates and general have higher yields than the margins in our code-share agreements,” he said, which a chuckle. While the Mokulele deal includes an option for Republic to take a 45 percent equity stake in the company, none of the other loans included equity provisions.
Bedford also discussed its recently announced reduction in service with American which reduced the number of ERJ 140s from 15 to 13 beginning June 1. The company opened up discussions with AMR when fuel was at $145 per barrel. “We were trying to do things to be helpful,” he said. “They were making some tough decisions including grounding their 135s and Saabs as well as terminating the Trans States relationship.”
AMR must reimburse Chautauqua for the carrying costs of the two idled aircraft unless Republic can place them in alternate service or sell them. The reimbursement rate AMR pays Republic was also reduced by three percent effective April 1, 2009, but, said Bedford carried with it some confusion. In exchange, Republic gained an extension on the early termination rights held by American, which expired at the end of September. “Prior to the amendment,” he said, “American had the ability to early terminate with 180 days notice any time after September 30 2008. With the amendment notice moved back three years, moving it back until September 30 2011, with any cuts becoming effective March 2012.”
In July, RJET received notice from United Air Lines that United was exercising its right to early terminate the United Express Agreement that provides for the company to operate seven 50-seat ERJ 145 aircraft. The termination will be effective December 31, 2009. The agreement to operate 38 ERJ 170 aircraft is unaffected by United's termination letter and there is no early termination provision in the E170 agreement.
RJET reported operating revenues of $385.2 million for the quarter ended September 30, a 16.7 percent increase. The company reported net income of $17.0 million compared to $20.2 million reported in the prior year’s third quarter and earnings per diluted share was $0.50, compared to $0.49 for the same period last year.
Excluding reimbursement for fuel expense, regional airline service revenues increased 11.5 percent for the third quarter of 2008. This increase was primarily a result of an 8.2 percent increase in available seat miles (ASMs) and a 3.8 percent increase in block hours. The company also recognized approximately $7.9 million of deferred revenue related to the removal of the E135 fleet from Delta.
Total operating expenses for the third quarter of 2008, including interest expense but excluding fuel charges (which are reimbursable by the company’s major partners), of $261.2 million, increased approximately 14.6 percent from $227.9 million for the same quarter of 2007. Operating cost per ASM (CASM), including interest expense but excluding fuel was 7.94¢ for the third quarter of 2008. During the quarter the company incurred expenses totaling $7.4 million including an accrual for the estimated return costs of the ERJ 135 aircraft and an adjustment to the carrying value of these assets to their future sales price. Excluding this an the ERJ 170 carrying costs, CASM decreased to 7.48¢ for the third quarter of 2008, from 7.50¢ for the same quarter of 2007.
During the quarter the company took delivery of six new ERJ 175 regional jets. One was placed into fixed-fee service for US Airways and five have been placed into fixed-fee service for Delta. The company entered into fixed-rate debt financing arrangements for these aircraft. It also returned one 37-seat E135 aircraft to the lessor during the quarter bringing its fleet to 233 regional jet aircraft as the quarter ended.
It’s new Delta agreement under which it sheds the ERJ 135s mitigated the company’s bankruptcy claim against Delta as well as cancelled the warrants granted to Delta in a deal cut during bankruptcy. The value of the claim and the fair value of the surrendered warrants were recorded as deferred revenue totaling about $80 million with Delta to the accelerated removal of the aircraft, RJET was required to accelerate recognition of deferred revenue that was attributable to the ERJ 135 aircraft. Consequently, the total amount of acceleration of that deferred revenue was $7.9 million. On the expense side the aircraft removed during the quarter were adjusted to the future sales prices and the company accrued for the return cost of aircraft amounts totaling $7.4 million.
Bedford reported there has been no significant dilution in aircraft values. “The airline is contracted to sell RJs in April 2009 but hasn’t seen a materially negative change in the aircraft values. The sales in the third quarter were the same price we are looking at for the ones that are teed up for Q1 and Q2 of next year,” said Bedford.
The company’s long-term debt increased to $2.16 billion as of September 30, 2008, compared to $1.91 billion at December 31, 2007. All of the company’s long-term debt is at fixed interest rates and is secured by the aircraft. The company also has significant long-term operating lease obligations. At a 7 percent discount factor, the present value of these lease obligations was approximately $700 million as of September 30, 2008.
At September 30, 2008 the company had $134.2 million in cash and cash equivalents compared to $164.0 million as of December 31, 2007.