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Article by DailyStocks_admin    (09-08-08 06:03 AM)

Filed with the SEC from Aug 28 to Sep 03:

ExpressJet Holdings (XJT)
Hayman Advisors wants ExpressJet to increase the size of its board to 10 directors from nine, and appoint William Loftus to the new Class III directorship. Hayman has been in talks with ExpressJet about the company's business, relationship with Continental Airlines (CAL) and developments in the airline industry. Hayman holds 3,948,578 shares (1.8% of the total outstanding).

BUSINESS OVERVIEW

Our Business Segments

ExpressJet has three reportable segments which are the basis of our internal financial reporting: Contract Flying, Branded Flying and Aviation Services.

Contract Flying includes our Corporate Aviation (charter) division and our capacity purchase agreements with Continental and Delta. Under Contract Flying, revenues are contractually determined, eliminating our exposure to fluctuations in fuel prices, fare competition and passenger volumes. Under these arrangements, our partners bear the revenue risk and cost of marketing, distributing and selling seats directly to passengers on our aircraft while we are responsible for the operation and maintenance of the aircraft.

Branded Flying includes operations under the ExpressJet brand and the Delta Prorate. Revenues for this flying are derived from passengers flying on scheduled air service. We are responsible for local market pricing, scheduling and revenue management, and the operation and maintenance of the aircraft. Our flying under the Delta Prorate provides us with a prorated portion of the airfare plus an incentive for passengers connecting onto Delta's network.

Aviation Services includes our ground-handling services pursuant to contracts with Continental and other airlines at airport locations across the United States, as well as those performed by Services. During the first half of 2007, we rebranded American Composites, LLC (“American Composites”) and InTech Aerospace Services, LP (“InTech”), our wholly owned subsidiaries, and Saltillo under the ExpressJet Services name. These entities provide composite, sheet metal, paint, interior (including seat refurbishment) and thrust reverser repairs throughout our five facilities in the United States and Mexico.

Our Products and Services

Prior to 2007, virtually all of our revenue came from the Continental CPA and our entire fleet of 274 aircraft was flown in support of Continental’s network. Continental advised us in December 2005 of its decision to reduce Airlines’ flying under the Continental CPA by 25% or 69 aircraft. The first two aircraft came out of the Continental network in late December 2006, followed by 34 aircraft during the first quarter of 2007, 30 aircraft in the second quarter and three aircraft in the third quarter. As they exited our Continental Express operation, the aircraft were rapidly repainted, retrofitted with upgraded seat cushions and other modifications and placed into other business platforms. The business platforms developed to employ these aircraft required considerable investment of capital to modify the aircraft, design and construct our facilities at over 25 airport locations, create a marketing and sales infrastructure and develop technology to support our own Branded, charter and Delta flying. These efforts were in addition to recruiting, hiring, and training all disciplines across the various business platforms. The result is an infrastructure that has afforded us the ability to:




•


continue our capacity flying with Continental;


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develop our own brand through scheduled flying as ExpressJet Airlines;


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commence capacity-purchase and prorate flying for Delta;


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establish a niche in the corporate and ad-hoc charter service market; and


•


broaden the scope of our maintenance and ground handling capabilities.

Our diversification continues in 2008 as we seek additional opportunities to fly for legacy carriers and to further leverage our capabilities. This is a dynamic process and will remain so for the foreseeable future as we seek to optimize revenue generation from our assets.

Contract Flying

As of December 31, 2007 we averaged over 1,100 daily contract flying departures, offering passenger service to over 175 destinations in North America, including Mexico as well as the Caribbean, and some charter service into South America. We generated $1.5 billion of revenue (87.3% of our total consolidated revenue) in this segment.

Continental Capacity Purchase and Other Agreements

General. Prior to 2007, we derived substantially all of our revenue from the Continental CPA. As we diversified to provide airline services to a broader range of customers during 2007, our dependence on Continental has decreased. However, a significant portion of our revenue and cash flows is still attributable to the Continental CPA. Under the Continental CPA, Airlines operates flights on behalf of Continental as Continental Express. Continental controls and is responsible for scheduling, pricing and managing seat inventories and is entitled to all revenue associated with the operation of the aircraft. We also have various other agreements with Continental that govern our relationship.

Under the Continental CPA, all marketing-related costs normally associated with operating an airline are borne by Continental. These costs include:




•


reservations and sales;


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commissions;


•


advertising;


•


revenue accounting;


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fare and tariff filings; and


•


food and beverage service.

Payment. Under the Continental CPA, Airlines is entitled to payment for each block hour that Continental schedules it to fly. Payment is based on a formula designed to provide Airlines with a target operating margin of 10% before taking into account variations in certain costs and expenses that are generally within our control. The agreement provides that the original cost components used in this formula would remain in place until December 31, 2004, after which, new rates were to be established annually using the same methodology. We have exposure for most labor costs and some maintenance and general administrative expenses if the actual costs are higher than those reflected in Airlines’ estimated block hour rates.

2001-2004. A quarterly reconciliation payment was to be made by Continental to Airlines, or by Airlines to Continental, if the operating margin calculated, as described below (the "prevailing margin") was not between 8.5% and 11.5% in any fiscal quarter. When the prevailing margin exceeded 11.5%, Airlines paid Continental an amount sufficient to reduce the margin to 11.5%. Had the prevailing margin been less than 8.5%, Continental would have paid Airlines an amount sufficient to raise the margin to 8.5%. Certain items were excluded from the calculation of the prevailing margin, including:




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actual labor costs that differed from those reflected in Airlines’ block hour rates;


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performance incentive payments, including payments from controllable cancellation performance (cancellations other than weather or air traffic control caused cancellations);


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litigation costs outside the normal course of business; and


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other costs that were not included in Airlines’ block hour rates (or covered by any adjustments to them) and were not reasonable and customary in the industry.

From 2001 to 2004, the quarterly prevailing margins, before any reconciliation payments, were always above 8.5%.

In addition, to the extent that Airlines’ rate of controllable cancellations (such as those due to maintenance or crew availability) was lower than its historical benchmarks, Airlines was entitled to incentive payments; conversely, Airlines would have had to pay Continental if its controllable cancellations exceeded these benchmarks. Because these incentive benchmarks were based on historical five-year rolling averages of monthly controllable cancellations, lower controllable cancellations that resulted in higher incentive payments in the near term reduced Airlines’ opportunity to earn incentive payments in the future. Also, because Airlines used monthly rolling averages, its opportunity to earn these payments in any particular fiscal quarter was affected by monthly variations in historical controllable cancellation rates. Airlines was also entitled to receive a small per-passenger fee and incentive payments for on-time departure and baggage handling performance.

2005 Rate Negotiation and Amendment. As part of the 2005 rate negotiation, we agreed to cap Airlines’ prevailing margin at 10.0% in an attempt to ensure the long-term stability of the Continental CPA. Airlines also began including previously unreconciled costs, as discussed above, within the margin band, although it is not reimbursed if these costs are higher and cause its prevailing margin to fall below the 8.5% margin floor. Airlines remained entitled to receive incentive payments from Continental if its rate of controllable cancellations was lower than its historical benchmark, but was no longer required to pay Continental a penalty for controllable cancellations unless the rate rises above 0.5%. Airlines continued to receive a small per-passenger fee and incentive payments for certain on-time departure and baggage handling performance.





(1)


Under our fuel purchase agreement with Continental, 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. If the fuel purchase agreement with Continental were not in place, the fuel cost, including related taxes, would have been $2.43, $2.04 and $1.80 per gallon for the years ended December 31, 2007, 2006 and 2005 respectively.


(2)


Depreciation is reconciled for assets and capital projects accounted for in the Continental CPA or those approved by Continental outside of the 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 the block hour rates (or covered by adjustments to them) or are not reasonable and customary in the industry.

In 2007, the fully reconciled costs and costs within the margin band under the Continental CPA represented approximately 59% and 40% of operating costs associated with Continental CPA flying, respectively, in addition to 1% of costs related to the Continental CPA which could not be included in either reimbursable grouping such as certain labor and arbitration costs. In 2006, the fully reconciled costs and costs within the margin band under the Continental CPA represented approximately 63% and 35% of operating costs associated with Continental CPA flying, respectively. The remaining 2% of operating costs in 2006 were incurred outside of the Continental CPA in order to support our diversification strategies for the 69 aircraft released from the Continental CPA as well as the administrative operations we assumed from Continental in 2007.

Some costs that were unreconciled under the Continental CPA prior to 2005 now require Airlines to make a reconciliation payment to Continental if the differences cause the prevailing margin to be greater than 10.0%. However, if the differences cause the prevailing margin to be less than 8.5%, they remain unreconciled. These costs are:




•


wages and salaries; and


•


benefits not included in the table above.

2006 Rate Setting. In September 2005, Continental proposed a number of amendments to the Continental CPA, which would have, among other things, significantly reduced the amount Continental pays us for the regional airline service we provide. We negotiated with Continental to try to reach an agreeable compromise. Our board of directors, which typically meets five times a year, held 12 meetings in 2005, six of which were special meetings to consider Continental’s proposals and to formulate counterproposals. Based on its evaluations, including the analysis of independent financial advisers, the board determined that the rates proposed by Continental would not be in the best interest of our stockholders and declined Continental’s proposal. We made counterproposals that we believed addressed Continental’s concerns, but were fair to our stockholders as well. In December 2005, Continental announced that it believed the rates under the Continental CPA had become too expensive and that it would terminate 25% of our flying under that agreement. Although the Continental CPA contemplates a November 1 deadline for setting the following year’s rates, the 2006 scheduled block hour rates were finalized in April 2007 consistent with the methodology set forth in the agreement.

2007 Rate Setting. In 2006, Continental challenged our interpretation of the Continental CPA and sought to impose rates for 2007 that we believed were inconsistent with the methodology established in the agreement. We were unable to agree on the 2007 rates and, in accordance with the terms of the Continental CPA, we submitted our dispute to binding arbitration. The arbitration panel determined that the annual 2007 budgeted rates originally presented by Airlines should be reduced in the aggregate by $14.2 million (or less than 1.0% of our total Continental CPA operating revenue), which included the 10% target operating margin. Although we believe our original rates were appropriate, we were pleased with the panel’s decision. The 2007 scheduled block hour rates were finalized in October 2007, and w e recorded our passenger revenue under the Continental CPA using the block hour rates determined by the panel for all of 2007.

2008 Rate Setting. We began 2008 rate discussions with Continental last September. The Continental CPA contemplates a November 1 deadline for setting the rates; however, the parties agreed to extend the deadline. Although we believed that we were nearing completion of the rate setting process, Continental advised us on February 28, that if we were unable to reach agreement by March 14, they might initiate arbitration proceedings again in accordance with the provisions of the Continental CPA. We can also initiate arbitration if we think it necessary. As of the date of this filing neither party has triggered arbitration and we remain hopeful that it will not be necessary. Continental also advised us that it believes that it overpaid Airlines by $6 million in 2007 and $2.1 million in 2006. We believe that if we were required to arbitrate these matters we would prevail. However, we may not be successful in resolving these disputes without reducing our 2008 income. We cannot currently predict the timing or the resolution of these matters. Although we are hopeful that we can agree on rates and resolve Continental’s other claims without arbitration, there can be no assurance that we will be successful in doing so.

If we are required to arbitrate, each party will select one arbitrator, and those two arbitrators will select the third arbitrator to complete the panel. The Continental CPA sets forth procedures and a schedule that will likely result in a hearing and the issuance of a final decision by late in the second or early in the third quarter of 2008. ExpressJet will continue to be paid under the 2007 block hour rates during the arbitration process and expects the decision setting the revised rates to be retroactive to January 1, 2008.

Scope of Agreement. At December 31, 2007, the Continental CPA covered 205 of Airlines’ existing fleet of 274 aircraft. The agreement permits us to fly under our own code or on behalf of other airlines but prohibits our flying in certain markets unless such flying is conducted on behalf of Continental. The Continental CPA states that:




•


at Continental’s hubs, we may only fly for Continental;


•


at any other airport where Continental, its subsidiaries and other regional jets operating under Continental’s code as their primary code operate an average of more than 50 flights daily (currently there are no such airports), we may only fly for Continental; and


•


we cannot operate any of our aircraft subject to the agreement or use our passenger-related airport facilities employed under the agreement for other carriers or for flights under our own code.

Our license from Continental to use the Continental Express name and other trademarks is non-exclusive

The Continental CPA also provides that Continental has the right to withdraw a limited number of our regional jets covered by the agreement under certain circumstances upon 12-months notice. As discussed above, in late December 2005, Continental delivered a withdrawal notice with respect to 69 aircraft, the maximum number that it could withdraw at that time. Under the terms of the agreement, Continental cannot withdraw additional aircraft until December 28, 2009. Continental can terminate the agreement at any time upon 12-months notice, which would also terminate the scope limitations noted above.

So long as scheduled flights under the Continental CPA represent at least 50% of all our scheduled flights, or at least 200 of our aircraft are covered by the agreement, we are required to allocate our crews, maintenance personnel, facilities and other resources on a priority basis to scheduled flights under the agreement above all of our other flights and aircraft.

Aircraft Financing. Airlines currently leases or subleases all of its existing aircraft from Continental. Under the Continental CPA, Continental is required to purchase or lease from Empresa Brasileira de Aeronautica S.A. (“Embraer”) or its designee aircraft to be flown under the agreement, participate in the financing and to lease or sublease these aircraft to us. Aircraft withdrawn from the Continental CPA become “Uncovered Aircraft” as defined in the agreement, and the agreement contains a provision for the interest rate implicit in calculating the scheduled lease payments we make to Continental under the relevant leases or subleases to automatically increase by 200 basis points.

We have the option to purchase up to an additional 75 Embraer ERJ-145XR aircraft. Our next option exercise date is August 1, 2008. If we do not exercise or extend our option as of this date, 25 options will expire. These aircraft would be Uncovered Aircraft since Continental has declined to include them under the Continental CPA. These options may be exercised for other types of aircraft within the ERJ-145 line of aircraft, which include the ERJ-135, ERJ-145 and ERJ-145XR (“ERJ-145 Family”). We would have to finance our acquisition of these aircraft independently.

Continental has the right to terminate, at any time, any Uncovered Aircraft sublease and take possession of the aircraft so long as it provides us a replacement aircraft and we can obtain financing reasonably satisfactory to us. If we cannot obtain such financing, we are not required to take the replacement aircraft. Continental does not have any obligation to finance, arrange to finance or participate in the financing of any aircraft acquired outside the Continental CPA.

Airport Facilities, Slots and Route Authorities . Most of the airport facilities that Airlines uses in its Continental Express operation are leased from airport authorities by Continental. Under Airlines’ master facility and ground handling agreement with Continental, Airlines is entitled to use these facilities to fulfill its obligations under the Continental CPA. However, it is not permitted to use airport terminal facilities leased by Continental to service other carriers or operate flights under its own code without Continental’s approval. Furthermore, we must use those facilities that are non-terminal facilities on a priority basis to support the scheduled flights that Airlines flies on behalf of Continental so long as those flights constitute at least 50% of our total scheduled flights or at least 200 of our aircraft are covered by the Continental CPA.

All terminal facility rent at Continental’s hub airports are borne by Continental, and Airlines pays for incremental rent at other Continental-managed locations. Additional rent can be incurred at Continental-managed locations when Airlines operates all flights during a quarter. At locations Airlines manages, rent is allocated between Continental and Airlines based on the number of each carrier’s respective passengers.

Continental is generally responsible for all capital and start-up costs for airport terminal facilities at its hub airports and at any other facilities where it elects to provide ground handling services to Airlines. If Continental elects to provide ground handling services at any facility where Airlines previously did so, Continental is required to reimburse Airlines at the net book value for all fixtures and other unremovable capitalized items Airlines funded at that facility. We are generally responsible for capital and start-up costs associated with airport terminal facilities where Airlines flies and any non-terminal facilities not regularly used by Continental. If Airlines exits a market at the direction of Continental (and we do not re-enter that market within six months flying under our own code or that of an airline other than Continental), Continental will reimburse us for certain book and severance losses incurred in connection with the closure of the related facility. If the Continental CPA is terminated, we may be required to vacate the terminal facilities (or all facilities if the termination results from our material breach of the agreement) that are subleased to Airlines by Continental, and to use commercially reasonable efforts to assign to Continental or its designee any of the facility leases in our name.

In addition, there are provisions in the Continental CPA that require us to use commercially reasonable efforts to transfer, subject to applicable laws, to Continental or its designee any of our airport take-off or landing slots, route authorities or other regulatory authorizations used for Airlines’ scheduled flights under the agreement.

Ground Handling. Airlines provides ground handling and other support services, including baggage handling, station operations, ticketing, gate access and other passenger, aircraft and traffic servicing functions for Continental at several of our airport locations. In exchange, Continental pays us an amount equal to Airlines’ incremental cost for providing these services. Continental provides the same services for Airlines at its stations, including its hub airports. The cost for these services is based on the number of scheduled aircraft and the rates stipulated in the Continental CPA. Effective January 1, 2007, we began providing ground handling and other support services at fixed rates for other Continental Airlines regional service providers including Republic and Colgan that operate under the Continental Express banner at 15 Continental/Continental Express stations.

Most Favored Nations. So long as Continental is our largest customer, if we enter into a capacity purchase or economically similar agreement with another major airline (defined as any airline with annual revenues greater than $500 million, prior to adjustment for inflation since 2000) to provide regional airline service for more than 10 aircraft on terms and conditions that are, in the aggregate, less favorable to us than those in the Continental CPA, that agreement has a provision that may allow Continental to amend it to conform to the terms and conditions of our new agreement.

In addition, a labor disruption other than a union-authorized strike may cause us to be in material breach of the Continental CPA. Under the agreement, whenever Airlines fails to complete at least 90% of its aggregate scheduled flights (based on available seat miles) in three consecutive calendar months or at least 75% of its aggregate scheduled flights (based on available seat miles) in any 45-day period (in each case, excluding flights cancelled due to union-authorized labor strikes, weather, air traffic control or non-carrier specific airworthiness directives or regulatory orders), we will be deemed to be in material breach of the agreement. A labor disruption other than a union-authorized strike could cause Airlines to fail to meet these completion requirements and, as a result, cause us to be in material breach of the agreement. See further discussions below regarding remedies for breach of the agreement by either Continental or us.

Term and Termination of Agreement and Remedies for Breach . The Continental CPA is scheduled to expire on December 31, 2010. At its sole election, Continental can extend the term of the agreement for up to four additional five-year terms through December 31, 2030 upon written notice delivered at least 24 months prior to the expiration of the initial term. Continental’s first option to extend must be delivered to us by December 31, 2008.

Continental may terminate the agreement at any time with 12-months notice, or for cause without notice. “Cause” is defined as:




•


our bankruptcy;


•


suspension or revocation of Airlines’ authority to operate as a scheduled airline;


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cessation of Airlines’ operations as a scheduled airline, other than as a result of a union-authorized labor strike or any temporary cessation not to exceed 14 days;


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a union-authorized labor strike that continues for 90 days; or


•


our intentional or willful material breach that substantially deprives Continental of the benefits of the agreement, which is not cured within 90 days of notice of the breach.

Continental may also terminate the agreement at any time upon our material breach that does not constitute cause, but continues uncured for 90 days after we receive notice of the breach. If we materially breach the agreement (including for cause) and, for breaches other than cause, fail to cure the breach within 60 days after we receive notice of the breach, we will have to pay Continental an amount equal to the expected margin contained in the block hour rates for scheduled flights from the 60th day (or immediately, without receipt of any notice, if the breach is for cause) until the breach is cured. In addition, Continental may terminate the agreement immediately without notice or giving us an opportunity to cure if it makes a reasonable and good faith determination, using recognized standards of safety, that there is a material safety concern with our operation of any flights under the Continental CPA.

If Continental materially breaches the agreement and fails to cure the breach within 60 days after we notify it of the breach, we will be entitled to obtain our payments directly from an airline clearing house from the 60th day for the duration of the default. In addition, Continental and we are each entitled to seek damages in arbitration and to reach equitable remedies.

Disposition of Aircraft upon Early Termination. If Continental terminates the Continental CPA for cause, it will also have the right at that time to terminate Airlines’ leases or subleases for aircraft covered by the agreement and take possession of these aircraft. If Continental terminates the agreement for any reason other than for cause, we have the option to cancel all or any number of our leases or subleases with Continental for aircraft covered by the agreement at the time of termination. However, if Airlines terminates any of these subleases, it will lose access to the subject aircraft, which would reduce the size of our fleet and affect our future ability to generate revenue. If Airlines elects not to terminate these leases or subleases, the agreement contains a provision for the interest rate implicit in calculating the scheduled lease payments we make to Continental under the relevant leases or subleases to automatically increase by 200 basis points.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand our operations and our current business environment. MD&A is provided as a supplement to—and should be read in conjunction with—our consolidated financial statements and the accompanying notes thereto contained in "Item 8. Financial Statements and Supplementary Data" of this report. This overview summarizes MD&A, which includes the following sections:




•


Our Business — a general description of our business, including our business segments; our objective; our areas of focus; and challenges and risks of our business.


•


Critical Accounting Policies and Estimates — a discussion of accounting policies that require critical judgments and estimates.


•


Operations Review — an analysis of our consolidated results of operations, including appropriate segment disclosures, for the three years presented in our consolidated financial statements.


•


Liquidity, Capital Resources and Financial Position — an analysis of cash flows; off–balance sheet arrangements and aggregate contractual obligations; an overview of financial position; and the impact of inflation and changing prices.

Our Business

General

ExpressJet Holdings, Inc. (“Holdings”) has strategic investments in the air transportation industry. Our principal asset is all of the issued and outstanding shares of stock of XJT Holdings, Inc., the sole stockholder of ExpressJet Airlines, Inc. (referred to below as “Airlines” and, together with Holdings, as “ExpressJet”, “we” or “us”). Airlines currently operates a fleet of 274 aircraft. As of December 31, 2007, we provided the following services:

Contract Flying




•


205 aircraft for Continental Airlines (“Continental”) as Continental Express pursuant to a capacity purchase agreement (the “Continental CPA”);




•


10 aircraft for Delta Air Lines (“Delta”) as Delta Connection pursuant to a capacity purchase agreement (the “Delta CPA”);




•


9 aircraft in our Corporate Aviation division, which is dedicated to charter contracts and ad-hoc charter arrangements.

Branded Flying




•


39 aircraft under our ExpressJet brand; and




•


11 aircraft for Delta pursuant to a prorate revenue agreement (the “Delta Prorate”), under which we share passenger revenue risk and incur pricing, scheduling and revenue management costs

Aviation Services includes our ground-handling services pursuant to our contracts with Continental and other airlines at airport locations across the United States, as well as ExpressJet Services, LLC (“Services”), our wholly owned repair and overhaul subsidiary. During the first half of 2007, we rebranded American Composites, LLC (“American Composites”) and InTech Aerospace Services, LP (“InTech”), our wholly owned subsidiaries, and Saltillo Jet Center (“Saltillo”), a majority-owned subsidiary, under the name ExpressJet Services. These entities provide composite, sheet metal, paint, interior (including seat refurbishment) and thrust reverser repairs throughout our five facilities in the United States and Mexico. Revenues are earned and recognized when we complete various jobs and bill our customers for the products and/or services delivered.

Our primary business is flying 274 aircraft for various customers. During 2007, we diversified our business from flying solely for one corporate customer to flying for several, including the general public on our own brand. Prior to 2007, we derived substantially all of our revenues from our Continental Express operations. In 2007, we continued developing our Services subsidiary and Saltillo. In each of these areas, we believe that our operational excellence and our commitment to customer service are our greatest strengths

Our Objective

Our goal is to use our assets and capabilities, including reliable operation performance, brand, financial strength, distribution system, and a strong commitment by our management and employees to achieve long-term sustainable growth. Our plans for sustainable growth include the following:




•


Being a great place to work where people are encouraged to achieve their best performance.




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Delivering the best products and services to a diversified base of customers.




•


Establishing a winning network of partners and develop ways to expand these relationships.




•


Maximizing the return to our stockholders while being mindful of our overall responsibilities to all stakeholders .

Contract Flying

Continental

Our relationship with Continental remains crucial to our success since 75% of our fleet continues to support Continental’s network. We believe the service we provide Continental has been effective in helping Continental to fully develop its route network and gain recognition as a premier service provider. We provide Continental seamless service to approximately 150 markets in the U.S., Mexico, Canada and the Caribbean. We believe our operations will continue to meet all of Continental’s reliability measurements, and we expect our results of operations to generate steady operating income, as long as the current Continental CPA remains unchanged.

The Continental CPA is scheduled to expire on December 31, 2010. At its sole election, Continental can extend the term of our agreement for up to four additional five-year terms through December 31, 2030 upon written notice delivered at least 24 months prior to the expiration of the initial term. Continental’s first option to extend must be delivered to us by December 31, 2008. In addition, Continental can cancel the Continental CPA at any time, upon providing 12-months notice. At this time, we have no indication whether Continental will elect to cancel or extend the agreement; consequently, we will continue to evaluate the alternatives provided to us within the provisions of the Continental CPA.

We began 2008 rate discussions with Continental last September. The Continental CPA contemplates a November 1 deadline for setting the rates; however, the parties agreed to extend the deadline. Although we believed that we were nearing completion of the rate setting process, Continental advised us on February 28, that if we were unable to reach agreement by March 14, they might initiate arbitration proceedings again in accordance with the provisions of the Continental CPA. We can also initiate arbitration if we think it necessary. As of the date of this filing neither party has triggered arbitration and we remain hopeful that it will not be necessary. Continental also advised us that it believes that it overpaid Airlines by $6 million in 2007 and $2.1 million in 2006. We believe that if we were required to arbitrate these matters we would prevail. However, we may not be successful in resolving these disputes without reducing our 2008 income. We cannot currently predict the timing or the resolution of these matters. Although we are hopeful that we can agree on rates and resolve Continental’s other claims without arbitration, there can be no assurance that we will be successful in doing so.

If we are required to arbitrate, each party will select one arbitrator, and those two arbitrators will select the third arbitrator to complete the panel. The Continental CPA sets forth procedures and a schedule that will likely result in a hearing and the issuance of a final decision by late in the second or early in the third quarter of 2008. ExpressJet will continue to be paid under the 2007 block hour rates during the arbitration process and expects the decision setting the revised rates to be retroactive to January 1, 2008.

Delta

Airlines currently operates 10 aircraft as Delta Connection pursuant to the Delta CPA, which began June 1, 2007. The agreement has a two-year term and is subject to two one-year extensions at Delta’s option. Delta is responsible for scheduling, marketing, pricing and revenue management on the aircraft and collects all passenger revenue. Airlines operates, maintains and finances the aircraft.

Under the Delta CPA, Airlines receives a base rate for each completed block hour and departure and is reimbursed for certain pass-through costs, such as fuel expenses and certain airport costs. Airlines has the ability to earn monthly and semi-annual incentive payments for exceeding completion and on-time benchmarks (referred to as monthly incentives) and a high completion factor, high Department of Transportation (“DOT”) rankings for on-time arrivals and customer satisfaction (referred to as semi-annual incentives). For the year ended December 31, 2007, we met all of our monthly incentive metrics with the exception of the on-time benchmark in August and November. Of the three semi-annual incentive metrics for on-time, customer service, and completion, we met only two of these metrics in 2007. We anticipate that we will continue to meet a majority of these incentives at the measurement dates, and we expect our results of operation under the Delta CPA to generate steady operating income for the term of this agreement.

Corporate Aviation

Our Corporate Aviation (charter) division currently operates nine aircraft, providing distinctive travel solutions for corporations, aircraft brokers, hospitality companies, sports teams, schools and others, including short-term flying solutions for other carriers, such as JetBlue Airways (“JetBlue”) during March and April 2007 and Frontier Airlines (“Frontier”) during November and December 2007. As with our branded aircraft, our charter aircraft are configured with 50 redesigned seats for enhanced passenger comfort, and each seat includes complimentary XM Satellite Radio with over 100 channels of audio entertainment. Customized flight service options give customers an opportunity to create a unique flight experience. Based on recent trends, we anticipate that contractual flying will be most consistent during the period from October through April. For the summer months, we experience more ad-hoc charter flying. We continue to seek longer-term contracts instead of those lasting from one-to-six months that we currently have in place and to generate steady operating income from these operations.

Branded Flying

ExpressJet Brand

We provide scheduled air service to 25 cities in the United States with approximately 200 daily departures, utilizing 39 of our aircraft, under our Branded Flying operation. Customers can access our reservation system through our consumer website, www.xjet.com, reservations call center and all four major global distribution systems. Being a part of the global computer reservation systems allows travel agents and online distributors, such as Expedia, Orbitz, Travelocity and Cheaptickets.com the visibility to see and sell our tickets.

Delta Prorate

On July 1, 2007, Airlines began scheduled air service with eight aircraft under the Delta Prorate. At this time, we are responsible under this arrangement for scheduling, pricing, revenue management, as well as the operation and maintenance of the aircraft, and earn a prorated portion of the fare plus an incentive for passengers connecting onto Delta's network. In December 2007, we transitioned three additional aircraft from our ExpressJet brand flying for a total of 11 aircraft under this arrangement. As Airlines is party to both the Delta CPA and the Delta Prorate, our relationship with Delta is important as we continue to establish our network of corporate customers.

We have not yet been profitable in our Branded Flying operation and do not anticipate that we will be profitable in 2008 as we continue to establish our ExpressJet brand. We continue to evaluate and modify our schedules, promotions and marketing programs to establish our brand and shift our traffic mix from heavily leisure to more business/corporate travel and minimize our exposure during seasonal peaks and valleys. We continue to enhance our infrastructure to facilitate timely information and permit us to make better tactical decisions and mitigate our losses in underperforming markets.

Aviation Services

Aviation Services includes our ground-handling services pursuant to our contracts with Continental and other airlines at airport locations across the United States, as well as Services, our wholly owned repair and overhaul subsidiary. During the first half of 2007, we rebranded American Composites, InTech and Saltillo, under the Services name, which provides third-party maintenance for interior and exterior work on aircraft. We will continue to leverage our operation expertise developed from this business segment to cost-effectively operate our 274 aircraft for our current customers and attract potential customers.

Our 2008 Outlook

General

Many factors could materially affect our results of operations; 2008 will be a challenging year for us. Among the most significant factors outside our control are economic conditions, possible industry consolidation and, to some extent, fuel costs within our Branded Flying segment.

Many economists believe the U.S. economy is in a recession. The airline industry is highly cyclical, and the growth in demand for air travel is correlated to the growth in the U.S. and global economies. An economic recession could have an adverse effect on our results of operations and financial condition.

Recent media reports have indicated that various U.S. legacy carriers are considering consolidation. As a regional service provider for legacy carriers, our preference is to continue in long-term capacity arrangements, but the outcome of industry consolidations could adversely affect our competitive position.

In 2008, our focus is primarily on factors within our control, including:




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working with Continental to set the appropriate rates pursuant to the Continental CPA




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discussing changes to the Continental CPA to enhance our long-term working relationship;




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developing our relationship with Delta as we continue to expand both contract and prorate flying;




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negotiating additional longer-term contracts for our corporate charters;




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adjusting our Branded Flying as necessary to respond to external cost factors, such as fuel, economic downturns and distribution costs; and




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controlling our internal costs, such as crew and outside services costs

Our relationship with Continental remains crucial to our success since 75% of our fleet continues to support Continental’s network. We began 2008 rate discussions with Continental last September, with no resolution. Continental advised us on February 28, that if we were unable to reach agreement by March 14, they may initiate arbitration proceedings again in accordance with the provisions of the Continental CPA. We would also be able to initiate arbitration after March 14 if we thought it necessary. As of the date of this filing neither party has triggered arbitration and we remain hopeful that it will not be necessary. The Continental CPA sets forth procedures and a schedule that would likely result in a hearing and the issuance of a final decision by late second or early third quarter of 2008 if we were required to arbitrate. ExpressJet would continue to be paid under the 2007 block hour rates during the arbitration and would expect the decision setting revised rates to be retroactive to January 1, 2008. The outcome of our 2008 rate setting process is uncertain and may adversely impact our results and cash flows from operations if we are unable to negotiate reasonable terms with Continental.

We expect our Branded Flying to incur a significant loss for the full year 2008 as we commence its second year of flying in April 2008 and continue to establish our brand, refine our reservations and marketing, adjust our schedule appropriately, seek to increase our market share (or stimulate demand) and manage our yields. However, absent a combination of adverse factors outside of our control, such as a significant further deterioration of the U.S. economy, Continental’s inability to pay us pursuant to the terms of the existing capacity purchase agreement, further material increases in the cost of fuel, or industry consolidation, which could result in the formation of one or more airlines with greater financial resources than ours to compete more fiercely in the markets we operate, we believe that our Contract Flying will generate sufficient operating income to offset a significant portion of any loss, subject to the considerations set forth below.

As of December 31, 2007, we held $189 million in unrestricted cash and cash equivalents. In early 2008, we invested approximately $65 million in auction rate securities (“ARS”) which are primarily backed by student loans that are guaranteed by the U.S. government and have AAA long-term ratings from Moody’s and Standard & Poor’s. For a detailed list of our ARS, please see Exhibit 10.19. The securities are held at Citigroup Global Markets, Inc., Banc of America Securities, LLC and Royal Bank of Canada Capital Markets. While the contractual maturities of the underlying securities within these ARS fall in years maturing after 2015, each security has a reset period of either seven or 28 days. Beginning February 11, 2008, auctions for these securities were not successful, resulting in our continuing to hold them and the issuers paying interest at the maximum contractual rate. At this time, we have ceased purchasing additional ARS and have a standing sell order for our current ARS portfolio. However, continued unsuccessful auctions could result in our holding our current ARS beyond their next scheduled auction reset dates, thereby limiting their short-term liquidity. If liquidating these investments becomes necessary, we have received a level of commitment to borrow against some of our current ARS portfolio.

We have significant financial obligations due in 2008. We can satisfy the largest of these obligations, our convertible notes, with either cash, shares of our common stock, or a combination thereof. For risks associated with settling the obligation in common stock, please refer to Item 1A, “Risk Factors”. In addition, we are evaluating our options for meeting these obligations, including the possibility of a secured financing transaction permitting us to pay a substantial portion of the convertible notes in cash while maintaining a healthy cash balance and avoiding the dilution to equity that would result from a stock settlement of the convertible notes. However, as our options to satisfy the convertible notes, as described above, depend on several factors outside of our control, we are also continuing to evaluate additional steps within our control that we could take if our ability to meet our obligations were limited. These include, individually or in combination if required:




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reducing capital expenditures to only those required by law or operational necessities;




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borrowing against or liquidating our ARS holdings, including at a discount if necessary;




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selling assets, tangible or intangible, or subleasing the aircraft we lease from Continental;




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transferring some or all of the aircraft currently dedicated to our ExpressJet brand flying to other operations, or grounding them entirely if circumstances so required.

We believe that our existing liquidity, projected 2008 cash flows, including the incremental sources of liquidity described above, if needed, will be sufficient to fund current operations and our financial obligations through the year ending December 31, 2008. However, as noted above, factors outside our control may dictate that we alter our current plans and expectations.


Contract Flying

Continental. Since 2005, Continental has proposed a number of amendments to the Continental CPA, which would have, among other things, significantly reduced the amount Continental pays us for the regional airline service we provide and would have dramatically reduced our rights to the aircraft. We negotiated with Continental to try to reach an agreeable compromise. Our board of directors, which typically meets five times a year, held 12 meetings in 2005, six of which were special meetings to consider Continental’s proposals and to formulate counterproposals. Based on their evaluations, including the analysis of independent financial advisers, the board determined that the rates proposed by Continental would not be in the best interest of our stockholders and declined Continental’s proposals. We made counterproposals that we believed addressed Continental’s concerns, but were fair to our stockholders as well. However, to date, we have not been able to reach a long-term agreement. Additionally, we were unable to agree on the 2007 rates and, in accordance with the terms of the Continental CPA, submitted our dispute to binding arbitration. The arbitration panel determined that the annual 2007 budgeted rates originally presented by Airlines should be reduced by only $14.2 million in the aggregate (or less than 1.0% of total Continental CPA operating revenue), which included the 10% target operating margin. We recorded our Continental CPA revenue based on the final rates determined by the arbitration panel.

Further, the Continental CPA is scheduled to expire on December 31, 2010. At its sole election, Continental can extend the term of our agreement for up to four additional five-year terms through December 31, 2030 upon written notice delivered at least 24 months prior to the expiration of the initial term. Continental’s first option to extend must be delivered to us by December 31, 2008. In addition, Continental can cancel the Continental CPA at any time, upon providing 12-months notice. At this time, we have no indication whether Continental will elect to cancel or extend the agreement; consequently, we will continue to evaluate the alternatives provided to us within the provisions of the Continental CPA.

We began 2008 rate discussions with Continental last September. The Continental CPA contemplates a November 1 deadline for setting the rates; however, the parties agreed to extend the deadline. Although we believed that we were nearing completion of the rate setting process, Continental advised us on February 28, that if we were unable to reach agreement by March 14, they might initiate arbitration proceedings again in accordance with the provisions of the Continental CPA. We can also initiate arbitration if we think it necessary. As of the date of this filing neither party has triggered arbitration and we remain hopeful that it will not be necessary. Continental also advised us that it believes that it overpaid Airlines by $6 million in 2007 and $2.1 million in 2006. We believe that if we were required to arbitrate these matters we would prevail. However, we may not be successful in resolving these disputes without reducing our 2008 income. We cannot currently predict the timing or the resolution of these matters. Although we are hopeful that we can agree on rates and resolve Continental’s other claims without arbitration, there can be no assurance that we will be successful in doing so.

If we are required to arbitrate, each party will select one arbitrator, and those two arbitrators will select the third arbitrator to complete the panel. The Continental CPA sets forth procedures and a schedule that will likely result in a hearing and the issuance of a final decision by late in the second or early in the third quarter of 2008. ExpressJet will continue to be paid under the 2007 block hour rates during the arbitration process and expects the decision setting the revised rates to be retroactive to January 1, 2008.

Delta . Airlines currently operates 10 aircraft as Delta Connection pursuant to the Delta CPA, which began June 1, 2007. The agreement has a two-year term and is subject to two one-year extensions at Delta’s option. Delta is responsible for scheduling, marketing, pricing and revenue management on the aircraft and collects all passenger revenue. Airlines operates, maintains and finances the aircraft. Although we do not anticipate expanding our services to Delta under a capacity purchase agreement at this time, our focus is for Delta to automatically renew its extensions as available and to expand with us through our prorate flying or through other marketing alliances, such as sharing in frequent flyer programs.

Corporate Aviation. Our goal for 2008 is to expand our Corporate Aviation (charter) division. We will continue to evaluate various corporate shuttle opportunities, including seasonal flying for other air carriers during high-demand periods to complement our current contracts. Our current contracts are the most consistent during the period from October through April, and generate steady operating income throughout the year. Additionally, we continue to seek longer-term contracts instead of those lasting from one to six months that we currently have in place to enhance consistency in aircraft and crew planning and to maximize our operational efficiency.

Branded Flying

ExpressJet Brand . We have not yet been profitable in our Branded Flying operation and do not anticipate that we will be profitable in 2008 as we continue to establish our ExpressJet brand. We continue to evaluate and modify our schedules, promotions and marketing programs to establish our brand and shift our traffic mix from heavily leisure to more business/corporate travel and minimize our exposure during seasonal peaks and valleys. We continue to enhance our infrastructure to facilitate timely information and permit us to make better tactical decisions and mitigate our losses in underperforming markets.

We believe that the flexibility of our business platforms will enable us to sustain our liquidity and meet our financial obligations through 2008. However, if sufficient losses occurred in the Branded Flying segment we could remove from service a portion or all of the aircraft employed in this segment in 2008. Our April 2008 schedule for ExpressJet Brand flying was adjusted in February 2008 in response to industry challenges and high fuel costs. In addition to eliminating routes with weak demand, we plan to decrease aircraft utilization from 11 hours per day to 9 hours per day. Total daily departures will decrease from 200 to 172 and overall capacity will be reduced approximately 11% from the capacity originally planned for 2008. We believe these changes will increase yields on the remaining capacity in the remaining markets such that it will exceed the impact of the planned capacity reductions.

Delta Prorate . We have not yet been profitable in this operation and do not anticipate that we will be profitable in 2008; however, Delta is very important to us as we continue to establish our network of corporate customers and as we hope to become profitable in the future. We currently operate 11 aircraft under the Delta Prorate. In 2008, we intend to expand our promotions and marketing programs for Delta Prorate flying in order to solidify Delta’s and our presence in Los Angeles, California and to potentially add services to markets that complement Delta’s network and enhance our future operating income.

Fuel Costs. High fuel prices continue to increase our costs and diminish profitability. Our results of operations for Branded Flying have been impacted by record high fuel prices, similar to the rest of the airline industry, and we have implemented a strategy using fixed forward price contracts for fuel to reduce the volatility of changing fuel prices over a rolling 12-month period on a quarterly basis. Fixed-price arrangements consist of an agreement to purchase defined quantities of aviation fuel from a third party at a stated price. As of December 31, 2007, we had committed to purchase 15.1 million gallons, or 85% of our anticipated Branded Flying fuel needs for the first quarter of 2008, at a weighted average price per gallon of $2.40, excluding taxes and into-plane fees. Additionally, we have committed to purchase 11.9 million gallons for the second quarter of 2008, 9.0 million gallons for the third quarter of 2008, and 6.0 million gallons for the fourth quarter of 2008. For the first quarter of 2009, we have contracted to purchase 3.0 million gallons. This represents approximately 70% and 22% of our anticipated Branded Flying fuel needs for 2008 and the first quarter of 2009, respectively. Although, our forecasted fuel needs outside of our CPA’s with Continental and Delta are covered under these fixed forward price contracts in 2008, a substantial increase in the price of jet fuel, to the extent our price contracts are impacted, or the lack of adequate fuel supplies in the future, could still have a material adverse effect on our Branded operation.

Comparison of 2007 to 2006

Operating Revenue and Segment Profit / (Loss)

The table below (in millions, except percentage data) sets forth the changes in revenue, direct segment costs and segment profit (loss) from 2007 to 2006. Before 2007 we did not have any segments that were deemed material. As such, revenues and costs are shown in Contract Flying only. A significant portion of our operating expenses and infrastructure is integrated across segments (e.g., for maintenance, non-airport facility rentals, outside services, general and administrative expenses) in order to support our entire fleet of 274 aircraft; therefore, we do not allocate these costs to the individual segments identified above, but evaluate them for our consolidated operation. Additionally, due to the transition of our 69 aircraft released from the Continental CPA in 2007, we incurred approximately $13.5 million in transition expenses associated with painting, maintenance modifications and training to ready our operation for flying outside of the Continental CPA. These costs were not included in our measurement of segment profitability as they are expected to be nonrecurring. We believe that the presentation of our consolidated shared costs and transition costs is consistent with the manner in which these expenses are reviewed by our chief operating decision makers. These costs are included as a part of the analysis of our operating expenses below.

Contract Flying. Our decrease in operating revenue for contract flying is primarily due to the withdrawal of 69 aircraft from the Continental CPA. This decrease was partially offset by commencing contract flying under the Delta CPA and charter flying in 2007.

Since a substantial portion of Airlines’ costs under the Continental CPA are reconciled for differences between actual costs and estimated costs included in block hour rates at a 10.0% operating margin (see Item 1. Business – Continental Capacity Purchase and Other Agreements for further discussion of the details related to this cost reconciliation), if Airlines’ prevailing margin (before any reconciliation payments) fell outside its margin band of 8.5% to 10.0% for 2007 and 2006, Airlines’ revenue would have been adjusted to bring it back to its floor or cap. Reconciliation payments from Continental in 2007 netted $4.2 million to us. The 2007 reconciliation payment was primarily caused by the lower rates resulting from arbitration with Continental in 2007. Reconciliation payments to Continental totaled $7.3 million for 2006. The 2006 reconciliation payment was primarily driven by lower actual wages, salaries and related costs and maintenance, materials and repair expenses as compared to the estimated costs in the agreements block hour rates.

On July 27, 2007, the three-member arbitration panel issued its decision relating to the 2007 block hour rates that Continental paid Airlines for regional jet service in 2007. The panel considered various components related to the proposed rates that we charge Continental in connection with regional jet service, including the costs that formed the basis for our 2007 rate proposal and the allocation of certain costs between the parties. The panel did not make any changes to the costs included in our 2007 budgeted rates except as those costs related to allocation. The panel determined that the annual 2007 budgeted rates originally presented by Airlines should be reduced in the aggregate by $14.2 million, which includes the 10% operating margin. As a result of the panel’s decision, we recorded our passenger revenue pursuant to the terms of the Continental CPA using the block hour rates determined by the panel for the year ended December 31, 2007.

Branded Flying. We began Branded Flying on April 2, 2007. Although passenger revenue from such flying was less than 11% of our total operating revenue for 2007, we believe that our passenger revenue will continue to grow contingent upon our ability to use marketing and promotion programs to shift our traffic mix from heavily leisure travel to more business/corporate travel. This shift will reduce our exposure during the seasonal peaks and valleys experienced by the airline industry.

We were not profitable in this operation in 2007. Our results of operations have been impacted by record high fuel prices, similar to the rest of the airline industry and an average load factor for 2007 being 55.7%. Therefore for fuel, we implemented a strategy by entering into fixed forward price contracts with our fuel provider using a systematic method for determining the volume and the price for which to enter into the contracts for a rolling 12-month period on a quarterly basis. Our average load factor primarily resulted from several factors including a lack of brand awareness and a very aggressive redeployment of aircraft to Branded driven by the pace of the aircraft coming out of the Continental CPA. As outlined above, to increase our load factor we are trying to shift our traffic mix from heavily leisure to more business/corporate travel. Although our fixed forward price fuel contracts partially mitigate our exposure to fuel price fluctuation, fuel still continues to be a driving force in determining Branded Flying’s profitability along with our ability to shift our traffic mix from leisure to more business travel. Additionally, we incurred marketing and distribution costs related to supporting the revenues for this segment. Under the terms of our contractual flying, these costs are incurred by the major airline with which we contract.

Aviation Services. Aviation Services was included in Contract Flying in 2006 as it was not deemed material for segment reporting purposes. In 2007, Aviation Services had a segment profit margin of 38.0%. This segment profit margin and increases in operations for aviation services was related to additional fixed-rate contracts for ground handling which began in 2007.

Wages, salaries & related costs increased 13.2% from 2006 to 2007 due to our growth in our work force to support changes in our flight operations and our corporate infrastructure and increases in wage rates under some of Airlines’ collective bargaining agreements. In conjunction with the increases in base wages, we incurred approximately $13.3 million higher employee benefit costs, such as medical coverage, workers’ compensation costs and 401(k) expenses in 2007. In addition, we experienced an increase in overtime pay for our pilots as a result of our training backlog in the early part of the year and for our maintenance workers due to the transition to our new maintenance bases.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Operational Review

Many factors could materially affect our results of operations making 2008 a challenging year for us. Airlines currently offers scheduled airline services with approximately 1,500 departures to 175 destinations in North America and the Caribbean. For the three months ended June 30, 2008, Airlines operated under the Continental CPA at a 98.1% and 99.9% completion factor and controllable completion factor, respectively, which excludes cancellations due to weather and air traffic control. For the six months ended June 30, 2008, Airlines operated under the Continental CPA at a 96.9% and 99.8% completion factor and controllable completion factor, respectively. Company-wide, Airlines achieved overall completion factors of 98.4% and 97.5%, respectively, for the three and six months ended June 30, 2008.

We plan to end 2008 with 235 operating aircraft, 205 flying as Continental Express and 30 in our Corporate Aviation Division. As a result of the fleet reduction and decreased flying on behalf of Continental we expect to operate approximately 30% less block hours during the 4 th quarter of 2008 versus the 2 nd quarter of 2008.

2008 Outlook

Industry. The airline industry is very competitive and is facing unprecedented challenges including a weak U.S. economy and dramatic price increases in fuel that are having a crippling effect on the aviation industry. Some airlines have been able to use the bankruptcy process to restructure and lower their operating costs. Additional pressures on airlines from potential consolidation among legacy carriers, the Internet as a distribution system and the intense competition from lower-cost carriers have resulted in announcements of significant capacity reductions, increases in fuel surcharges, fares and other fees. In addition, regional carriers’ networks have become susceptible to mainline partner risks as legacy carriers are becoming more aggressive in down-sizing and terminating contracts.

Continental CPA. Our relationship with Continental remains central to our success as a majority of our fleet continues to support Continental’s network. In June, we entered into a new seven-year capacity purchase agreement with Continental by amending and restating the existing Continental CPA. The amended Continental CPA, which became effective July 1, 2008, will allow us to continue flying the 205 aircraft currently flown for Continental for the foreseeable future while providing Continental the right after one year to withdraw up to 15 aircraft. Additionally, our revenue for the last half of 2008, from the amended Continental CPA, will be significantly lower than the revenue from the Continental CPA recorded in the first half of the year, as it will be based on a fixed, pre-determined rate based on block hours flown. The amended agreement significantly decreases Continental’s governance rights under the original agreement, including easing change-of-control limitations on ExpressJet, reducing restrictions on ExpressJet flying into Continental’s hub airports, and removing the most-favored-nation clause, allowing ExpressJet to actively pursue flying for other carriers and to consider other strategic alternatives. The amended agreement also removes Continental’s ability to early terminate the agreement without cause.

The amended agreement provides payments to us at a pre-determined rate based on block hours flown and reimburses us for various pass-through expenses including passenger liability insurance, hull insurance, war risk insurance, landing fees and substantially all regional jet engine expenses under current long-term third-party contracts with no margin or mark-up. Under the amended Continental CPA, Continental will be responsible for the cost of providing fuel for all flights and for paying aircraft rent for all aircraft covered by the amended Continental CPA and, therefore, these items will not be reflected in our future statements of operations. The fixed block hour rates are considerably lower than the rates under the original agreement and will be subject to annual escalations tied to a consumer price index (capped at 3.5%) at each anniversary date. ExpressJet intends to return to Continental up to 39 aircraft previously released from the original capacity purchase agreement, with Continental bearing the expenses related to the aircraft following their return. ExpressJet also is focused on aggressively reducing costs in the coming months in response to the amended agreement with Continental and the economic difficulties facing the entire airline industry.

Of the 69 aircraft operating outside of the Continental CPA, we will retain 30 aircraft at reduced rental rates to operate within ExpressJet’s Corporate Aviation division. These aircraft will be dedicated to existing and new long-term charter flying arrangements, corporate shuttle arrangements and ad-hoc charter service. Beginning September 2, 2008, the remaining 39 aircraft will transition back to Continental.

We also entered into a settlement agreement with Continental to release the parties’ claims at the time of the agreement to amend the then existing capacity purchase agreement, relating to certain identified payments under such capacity purchase agreement, including disputes previously disclosed as possible matters for arbitration.

Capacity Reductions and Cost Savings Initiatives. Although we believe we made exceptional progress in establishing our brand, increasing our market share and adjusting our schedule appropriately, dramatically high fuel prices have continued to make the Branded Flying operation impossible to sustain. On July 8, 2008, we announced the suspension of flying under several lines of our at-risk flying operations in September 2008. Additionally, we mutually agreed to terminate our capacity purchase and pro-rate flying agreements with Delta Air Lines effective September 2, 2008. As a result of the announced reductions in flying, we expect to operate approximately 30% less block hours during the 4 th quarter 2008 versus the 2 nd quarter 2008. For the remainder of 2008 we expect to spend $20 million for severance, meeting aircraft return conditions and early termination of marketing and facility contracts related to our Branded Flying segment. However, we expect to achieve $65 million annually in volume savings through this reduction in flying.

In addition, due to our aggressive capacity reductions, we must manage wages, maintenance and overhead to achieve profitability. We are currently seeking approximately $36 million in wage and benefit reductions from all of our employees, including our unionized workgroups. Effective July 15, we instituted a 5% wage and benefit reduction for our management and clerical staff, including management and clerical staff expected head count reductions, this brings us to 30% of our stated savings goal. The remaining reductions need to be achieved during the third quarter 2008 and will become effective immediately.

Convertible Debt . On August 1, 2008, holders of our 4.25% convertible notes due 2023 had the right to require us to repurchase their notes at a price equal to 100% of the principal amount of the notes plus any accrued and unpaid interest. Under the indenture governing the convertible notes, we were able to satisfy the obligation with either cash, shares of our common stock, or a combination of cash and shares. Since June 30, 2008, we took the following actions under consultation with our independent financial advisors:




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Received shareholders approval for two proposals that provided us greater flexibility in satisfying our repurchase obligations with respect to the convertible notes, which included the ability to issue such number of shares of our common stock as necessary to repurchase all outstanding convertible notes that were tendered on July 31, 2008, and an increase of our authorized common stock from 200 million shares to 400 million shares;


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Commenced our repurchase offer for the convertible notes and provided written notice to the trustee of our intention to pay the repurchase price wholly in shares of our common stock;




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Unilaterally amended the indenture governing the notes to increase the coupon from 4.25% to 11.25% over the remaining note term, to provide security based on a pro-rata amount of collateral and to provide for an additional repurchase date on August 1, 2011, in order to provide improved terms and additional flexibility for the noteholders; thus, incentivizing existing holders to retain their notes in lieu of tendering; and




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Issued 163.8 million shares of our common stock in payment of the repurchase price for the $59.7 million principal amount of the notes validly tendered and to settle accrued and unpaid interest due August 1, 2008. Because the common stock was issued in exchange for the convertible notes exclusively with the existing holders of the notes, and no commission or other compensation was paid in soliciting the exchange, the securities are exempt from registration under Section 3(a)(9) of the Securities Act of 1933.

Following the completion of the tender offer, $68.5 million aggregate principal of our 4.25% Convertible Notes due 2023 remains outstanding. As provided in the amended indenture governing the notes, the notes have become our 11.25% Convertible Notes due 2023.

Results of Operations

The following discussion provides an analysis of our results of operations and reasons for material changes in those results for the three and six months ended June 30, 2008, compared to the corresponding periods ended June 30, 2007.

Comparison of Three Months Ended June 30, 2008 to Three Months Ended June 30, 2007

Operating Revenue and Segment Profit / (Loss)

The table below (in thousands, except percentage data) sets forth the changes in revenue, direct segment costs and segment profit (loss) from the three months ended June 30, 2008 to the same period in 2007. A significant portion of our operating expenses and infrastructure is integrated across segments (e.g., for maintenance, non-airport facility rentals, outside services, general and administrative expenses) in order to support our entire fleet of 274 aircraft; therefore, we do not allocate these costs to the individual segments identified above, but evaluate them for our consolidated operation. The presentation of our consolidated shared costs is consistent with the manner in which these expenses are reviewed by our chief operating decision makers. These costs are included as a part of the analysis of our operating expenses below.

Contract Flying. Our decrease in operating revenue for contract flying is primarily due to the timing of aircraft withdrawals from the Continental CPA. During the three months ended June 30, 2007, 30 aircraft partially contributed to our contract flying revenue until such time that they were withdrawn from the Continental CPA and redeployed to our other lines of business. For the three months ended June 30, 2008, all aircraft outside of the Continental CPA had transitioned and were not contributing to contract flying revenue. This decrease was partially offset by commencing contract flying under the Delta CPA which began in June 2007.

Branded Flying. We began Branded Flying on April 2, 2007. Our revenue from such flying was approximately 18% of our total operating revenue for the three months ended June 30, 2008.

We were not profitable in this operation in the three months ended June 30, 2008. Our results of operations have been impacted by record high fuel prices affecting the entire airline industry. We implemented a strategy to limit the impact of future price increases by entering into fixed forward price contracts with our fuel provider discussed above in Item 1. “Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 9 – Commitments and Contingencies” for further information on our fixed forward price contracts. Our average load factor was negatively impacted by several things, including a lack of brand awareness and a very aggressive redeployment of aircraft to Branded Flying driven by the pace of the aircraft released from the Continental CPA. In July 2008, we announced that we will discontinue flying under the ExpressJet brand and Delta Prorate agreement effective September 2008 due to crippling high fuel prices that have made the Branded Flying operations impossible to sustain.

Aviation Services. Aviation Services was included in Contract Flying in the three months ended June 30, 2007 as it was not deemed material for segment reporting purposes. For the three months ended June 30, 2008, Aviation Services had a segment profit margin of 46.6%, up from 30.3% for the three months ended June 30, 2007, due primarily to additional ground handling contracts secured at more favorable rates than in 2007.

Operating Expenses

The table below (in thousands, except percentage data) sets forth the changes in operating expenses from the three months ended June 30, 2008 to the three months ended June 30, 2007.

Aircraft fuel and related taxes increased 30.3% primarily due to the diversification of our operations into other business platforms and the increasing cost of fuel. Our fuel price, including related fuel taxes, is capped at 71.20 cents per gallon under the Continental CPA while the average price of our fuel, including related fuel taxes, for our operations outside of the Continental CPA was $3.02 per gallon.

Special charges increased $22.1 million primarily due a $12.8 million non-cash impairment of goodwill related to the original Continental CPA, an $8.6 million non-cash impairment to write-off certain capital assets, primarily non-moveable equipment, building and aircraft improvements (associated with our Branded Flying Segment) and $0.7 million non-cash charge related to previously disputed base closure costs associated with the original Continental CPA. Similar impairment charges did not occur during the three months ended June 30, 2007.

Impairment charges on investments increased $5.2 million as we impaired our remaining investment in Wing. We review our investments in unconsolidated affiliates for impairment whenever events or changes in business circumstances indicate that the carrying amount of the investments may not be fully recoverable. See Note 5 – Investments in Other Entities” for further discussion of this impairment.

CONF CALL

Kristy Nicholas

On the call we have Jim Ream, President and Chief Executive Officer, and Phung Burns, Staff Vice President-Finance, Controller and Interim Chief Financial Officer.

Portions of this call may contain forward-looking statements not limited to historical facts, but reflecting our current beliefs, expectations and our intentions regarding future events. A number of factors could cause actual results to differ materially from those in the forward-looking statements. Additional information concerning risk factors that could affect our actual results is described in our filings with the SEC, including our 2007 10-K.

During this call certain non-GAAP certain financial disclosures may be made relating to our performance measures. In accordance with SEC rules we will provide a reconciliation to our most directly comparable GAAP financial measures on our website at www.ExpressJet.com. Jim will cover the operating and financial results for the quarter and then he will take questions.

Now I'd like to introduce Jim Ream.

James Ream

Let me get the highlights and then open it up to questions.

We, as you saw in the press release closed the quarter, had a net loss of $31.7 million. The quarter includes some non-recurring charges related to some fleet decisions that we've made re: some analysis of the goodwill results that was on the books as the [inaudible] from Continental, all related to some subsequent business decisions we're going to talk about later on in the call.

If you normalize for these write-offs, our operating income loss would have been cut in half. We would have had about a $22 million improvement year-over-year on an operating level, and that includes another $10 million of fuel price impact in the second quarter of this year.

So we feel that we made substantial progress on the revenue side with all the businesses that we're involved with. Obviously the things that I want to talk about next involve the events that we've made decisions on make going into the second quarter particularly relevant. So we did want to close. But we did want to talk about the second quarter that we did end it with $191 million in cash. That includes the restricted cash and the impaired value of the auction rate securities.

Well first let me talk about the announcement we made in the last 60 days where we had reached a new agreement with Continental Airlines. The agreement is for seven years starting in July and we're just starting our second month under that new agreement.

The agreement has given some significant economic concessions to Continental Airlines in order to secure a long-term transaction. It's based on two facts. One, that they had the contractual flexibility to come in and reset the economics on this agreement. They made it pretty clear that the agreement was not workable the way it was today and that they were going to terminate if we were not able to reach some positive outcome.

So we worked pretty hard to try to get to the economic benchmark that they were shooting for. Our opinion is the economic benchmark is going to be a little bit geared towards more of a marginal bid. It may come from another operator that had already had their business in place.

So it's really going to be a stretch for us to be successful under the new agreement. We're going to have to have very much unit cost improvement in order for us to have some modest amount of income under the new CPA and I feel that we've got a reasonable shot of hitting that unit cost improvement, but as a result of that we're still going to earn probably a fair amount less than most of our peers in the industry on a per tail basis.

So they have the contractual flexibility but more importantly just as the industry has gotten far more challenging and with fuel prices in particular putting a lot of pressure on smaller aircraft, it really just reflects the economic value of the under lying airplane that we're using in serving Continental Airlines. It obviously doesn't make sense for them to lose hundreds of millions and then for us to make tens of millions with an airplane that's supporting that network and the one that's suffering the most from higher fuel prices.

I really feel that we've really got kind of a right value proposition now for Continental given where fuel is and an airplane that's of value to their network. And I think that's really mostly what's reflective in this new CPA. We're working with all of our suppliers and unions to sit down and make sure they understand what we need to do to hit the cost targets in order for us to be successful. Those discussions are going along very productively and I feel that we're making good progress and we hope to have that wrapped up here over the course of the next say 45 days to 60 days or so.

If we're not successful in those conversations, then I'm not sure we have a sustainable business. So it's pretty important that we get this done. They understand that and I think that's why those conversations are going along pretty well.

The challenge we have is that with the fleet decisions, and I'll talk about some of those, and with where the industry is generally and how all networks are pulling their capacity down, is that we're looking at a fair amount fewer ASM's in the fourth quarter than we're flying currently. So it's somewhere in the neighborhood of a 30% drop off in the capacity.

So above and beyond getting the unit cost improvement, we also need to get dollar-for-dollar of expense savings for all those ASM's. That's going to be pretty challenging given how quickly those ASM's are disappearing from us, and usually some of this takes a little bit of time to work your way through as you're committed on schedules, maintenance programs and so on to be able to react to this quickly.

I feel we're going to have obviously some pressure on us in the third quarter as we go through the fleet transition and then as we get to the fourth quarter we're still going to have to work pretty hard to try to get all those expense items identified given the drop off in the amount of ASM's that we're dealing with.

On the positive side we've cleared up how the MSN works. We've eliminated that out of the CPA, it gives us more flexibility to look at other opportunities that may present themselves. We've solved the corporate governance issues. We're cleaned up and very much more market rate than where they were previously.

Continental agreed to take aircraft back. Of the 69 that we're operating on our own and bear the cost of whatever the fleet disposition is that they decide upon with those aircraft, and for any airplanes that they retained, that they would reset the lease rates on those aircraft to very much represent the new market value of this aircraft, and I think gives us a fair amount of flexibility as we look at opportunities based on that.

Not surprisingly, the conversation going along with Delta have been very much the same. First it was going to be less expensive for them to park the aircraft that we had under the capacity buy agreement, than it was to operate and just pay us out on all the fixed amounts that we had in that contract. We sat down and worked out a transition plan with them on those 10 airplanes. And then the aircraft that we are working for them out of LAX, they're certainly long 50-seat airplanes, and felt that they had adequate resources to cover what their plans were for LAX and would no longer need us to support that part of the operation. We've put those two together and we're going to eliminate all of our flying with Delta on September 2.

With the option by Continental to return aircraft, it also changed the analysis on all of our branded operation. While we've made consistent progress quarter in and quarter out and we're pretty darn happy with the revenue performance looking at our first year anniversary going into this summer, obviously a lot of the progress we've made on the revenue side was just being consumed with an ever increasing fuel price. It put a lot of pressure on us.

Obviously as I mentioned fuel prices going up put a lot of pressure to follow the aircraft and so this aircraft was really struggling at where fuel prices currently are. Even though we just saw an accelerating awareness level, and a vastly improving loyalty program, great participation by the communities, we have made a decision that at this time it does not make sense for us to continue with the scheduled branded service and so we are going to terminate all those operations on September 2 as well.

It was a really painful decision because I think you know our folks did such a great job of creating a real positive, meaningful impact on the passengers that we had, and the communities really were responding. I think we're pretty comfortable with the market share we had gotten in the first year and we thought that we would continue to improve upon that, but again, where fuel is just made that decision impossible carry this operation forward so we will terminate that September 2 as well.

We are making really good progress on our corporate charter service business. The [inaudible] revenues in the second quarter grew over 3.5 times versus last year's second quarter. Looking at the third quarter, that growth rate will be even higher on a year-over-year basis.

While it was very operationally challenging to make this work the way customers need for it to work, sales cycles can be longer to get the more longer term agreements and to get those ultimately in place we've made so much progress here that we're going to continue to grow this business.

As I mentioned, we've got the new lease rate agreements with Continental. It really allows us a lot of flexibility to use these aircraft in more of a lower utilization environment than we had before and we've made so much progress that we're going to continue to grow this. Of the 69 airplanes, we're going to keep 30 under these new lower lease rates and put them in this unscheduled corporate and charter based business and continue to grow this as we can.

That leaves 205 airplanes working for Continental. They have the right to pull that down to 190 aircraft starting June of next year, and we're working with them on the schedule for this upcoming winter. But obviously, much less utilization on the aircraft that we're flying with them, just based on their re-sizing their own network, based on where they feel demand is going to be for the upcoming winter period.

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