SKYWEST INC - Quarter Report: 2012 September (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

x      QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2012

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission file number 0-14719

 

SKYWEST, INC.

 

 

444 South River Road

St. George, Utah 84790

(435) 634-3000

 

Indicate by a check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was to required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 

 

 

Table of Contents

 

SKYWEST, INC.

 

QUARTERLY REPORT ON FORM 10-Q

 

TABLE OF CONTENTS

 

PART I	FINANCIAL INFORMATION:			3
	Item 1.	Financial Statements		3
		Consolidated Balance Sheets as of September 30, 2012 (unaudited) and December 31, 2011		3
		Condensed Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the three and nine months ended September 30, 2012 and 2011		5
		Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2012 and 2011		6
		Notes to Condensed Consolidated Financial Statements		7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		15
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		27
	Item 4.	Controls and Procedures		28
PART II	OTHER INFORMATION:			28
	Item 1.	Legal Proceedings		28
	Item 1A.	Risk Factors		29
	Item 6.	Exhibits		29
		Signature		30
Exhibit 31.1	Certification of Chief Executive Officer
Exhibit 31.2	Certification of Chief Accounting Officer
Exhibit 32.1	Certification of Chief Executive Officer
Exhibit 32.2	Certification of Chief Accounting Officer

 

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PART I. FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

SKYWEST, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands)

 

ASSETS

 

		September 30, 2012			December 31, 2011
		(unaudited)
CURRENT ASSETS:
Cash and cash equivalents		$	136,458		$	129,526
Marketable securities		583,171			497,552
Restricted cash		19,449			19,434
Income tax receivable		—			1,568
Receivables, net		126,810			130,510
Inventories, net		113,704			115,211
Prepaid aircraft rents		301,259			285,737
Deferred tax assets		79,992			69,519
Other current assets		31,599			31,407
Total current assets		1,392,442			1,280,464
PROPERTY AND EQUIPMENT:
Aircraft and rotable spares		3,992,589			3,973,027
Buildings and ground equipment		280,713			291,294
		4,273,302			4,264,321
Less accumulated depreciation and amortization		(1,525,436		)	(1,380,846		)
Total property and equipment, net		2,747,866			2,883,475
OTHER ASSETS
Intangible assets, net		17,810			19,497
Other assets		90,733			98,472
Total other assets		108,543			117,969
Total assets		$	4,248,851		$	4,281,908

 

See accompanying notes to condensed consolidated financial statements.

 

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SKYWEST, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands)

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

		September 30,			December 31,
		2012			2011
		(unaudited)
CURRENT LIABILITIES:
Current maturities of long-term debt		$	175,424		$	208,398
Accounts payable		225,153			220,784
Accrued salaries, wages and benefits		119,692			112,987
Accrued aircraft rents		13,670			22,285
Income tax payable		118			—
Taxes other than income taxes		22,908			21,186
Other current liabilities		43,101			38,508
Total current liabilities		600,066			624,148
OTHER LONG-TERM LIABILITIES		54,285			50,194
LONG-TERM DEBT, net of current maturities		1,526,465			1,606,993
DEFERRED INCOME TAXES PAYABLE		603,439			567,874
DEFERRED AIRCRAFT CREDITS		92,188			98,438
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Preferred stock, 5,000,000 shares authorized; none issued		—			—
Common stock, no par value, 120,000,000 shares authorized; 76,536,122 and 75,833,696 shares issued, respectively		606,677			598,985
Retained earnings		1,135,229			1,104,144
Treasury stock, at cost, 25,280,330 and 25,221,481 shares, respectively		(371,211		)	(370,309		)
Accumulated other comprehensive income		1,713			1,441
Total stockholders’ equity		1,372,408			1,334,261
Total liabilities and stockholders’ equity		$	4,248,851		$	4,281,908

 

See accompanying notes to condensed consolidated financial statements.

 

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SKYWEST, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Dollars and Shares in Thousands, Except per Share Amounts)

(Unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2012			2011			2012			2011
OPERATING REVENUES:
Passenger		$	848,578		$	936,363		$	2,671,568		$	2,700,529
Ground handling and other		16,681			19,062			52,079			54,544
Total operating revenues		865,259			955,425			2,723,647			2,755,073
OPERATING EXPENSES:
Salaries, wages and benefits		297,106			288,401			878,596			864,675
Aircraft maintenance, materials and repairs		163,825			189,762			510,610			529,335
Aircraft fuel		71,477			160,252			372,471			448,401
Aircraft rentals		82,592			86,510			251,438			261,004
Depreciation and amortization		62,703			63,393			191,200			190,283
Station rentals and landing fees		45,336			45,902			133,523			130,850
Ground handling services		28,414			30,326			93,344			100,054
Merger and integration related costs		—			2,207			—			4,602
Other		58,832			61,845			170,228			179,777
Total operating expenses		810,285			928,598			2,601,410			2,708,981
OPERATING INCOME		54,974			26,827			122,237			46,092
OTHER INCOME (EXPENSE):
Interest income		2,053			2,215			6,049			6,295
Interest expense		(19,474		)	(20,086		)	(58,641		)	(60,358		)
Adjustment to purchase accounting gain		—			(5,711		)	—			(5,711		)
Other, net		(4,638		)	(5,351		)	(9,305		)	(8,715		)
		(22,059		)	(28,933		)	(61,897		)	(68,489		)
INCOME (LOSS) BEFORE INCOME TAXES		32,915			(2,106		)	60,340			(22,397		)
PROVISION (BENEFIT) FOR INCOME TAXES		11,982			(2,222		)	23,129			(13,028		)
NET INCOME (LOSS)		$	20,933		$	116		$	37,211		$	(9,369	)
BASIC EARNINGS (LOSS) PER SHARE		$	0.41		$	0.00		$	0.73		$	(0.18	)
DILUTED EARNINGS (LOSS) PER SHARE		$	0.40		$	0.00		$	0.72		$	(0.18	)
Weighted average common shares:
Basic		51,241			51,570			51,022			52,704
Diluted		52,153			52,315			51,608			52,704
Dividends declared per share		$	0.04		$	0.04		$	0.12		$	0.12
COMPREHENSIVE INCOME (LOSS):
Net income (loss)		$	20,933		$	116		$	37,211		$	(9,369	)
Proportionate share of other companies foreign currency translation adjustment, net of taxes		(375		)	919			(264		)	1,209
Net unrealized appreciation (depreciation) on marketable securities, net of taxes		88			(289		)	536			353
TOTAL COMPREHENSIVE INCOME (LOSS)		$	20,646		$	746		$	37,483		$	(7,807	)

 

See accompanying notes to condensed consolidated financial statements.

 

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SKYWEST, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In Thousands)

 

		Nine Months Ended September 30
		2012			2011
NET CASH PROVIDED BY OPERATING ACTIVITIES		$	244,167		$	161,399
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities		(513,574		)	(469,956		)
Sales of marketable securities		428,195			522,138
Proceeds from the sale of equipment		3,630			191
Acquisition of property and equipment:
Aircraft and rotable spare parts		(35,164		)	(91,522		)
Deposits on aircraft		—			(13,500		)
Buildings and ground equipment		(3,341		)	(10,596		)
Increase in other assets		(739		)	(2,596		)
NET CASH USED IN INVESTING ACTIVITIES		(120,993		)	(65,841		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt		—			38,227
Principal payments on long-term debt		(113,502		)	(110,536		)
Tax benefit from exercise of common stock options		206			—
Return of deposits on aircraft and rotable spare parts		—			7,150
Net proceeds from issuance of common stock		4,076			4,444
Purchase of treasury stock		(902		)	(56,166		)
Payment of cash dividends		(6,120		)	(6,417		)
NET CASH USED IN FINANCING ACTIVITIES		(116,242		)	(123,298		)
Increase (decrease) in cash and cash equivalents		6,932			(27,740		)
Cash and cash equivalents at beginning of period		129,526			112,338
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	136,458		$	84,598
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid (received) during the year for:
Interest, net of capitalized amounts		$	54,858		$	56,936
Income taxes		$	(1,440	)	$	332

 

See accompanying notes to condensed consolidated financial statements.

 

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SKYWEST, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note A — Condensed Consolidated Financial Statements

 

The condensed consolidated financial statements of SkyWest, Inc. (“SkyWest” or the “Company”) and its operating subsidiaries, SkyWest Airlines, Inc. (“SkyWest Airlines”) and ExpressJet Airlines Inc. (“ExpressJet”) included herein have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the following disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary to present fairly the results of operations for the interim periods presented. All adjustments are of a normal recurring nature, unless otherwise disclosed. The Company suggests that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.  The results of operations for the three and nine-months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results will differ and may differ materially from those estimates and assumptions.

 

Effective December 31, 2011, ExpressJet Airlines, Inc., a wholly-owned subsidiary of SkyWest (“ExpressJet Delaware”) was merged into Atlantic Southeast Airlines, Inc., another wholly-owned subsidiary of SkyWest (“Atlantic Southeast”).  On January 1, 2012, Atlantic Southeast, the surviving entity of such merger (the “ExpressJet Combination”), changed its name to ExpressJet Airlines, Inc.  In this Report, “Atlantic Southeast” refers to Atlantic Southeast Airlines, Inc., a Georgia corporation, for periods prior to the ExpressJet Combination, “ExpressJet Delaware” refers to ExpressJet Airlines, Inc., a Delaware corporation, for periods prior to the ExpressJet Combination, and “ExpressJet” refers to ExpressJet Airlines, Inc., the Utah corporation resulting from the combination of Atlantic Southeast and ExpressJet Delaware, for periods subsequent to the consummation of the ExpressJet Combination.

 

Note B — Passenger and Ground Handling Revenue

 

Passenger and Ground Handling Revenues

 

The Company recognizes passenger and ground handling revenues when the service is provided. Under the Company’s contract and pro-rate flying agreements with Delta Airlines, Inc. (“Delta”), United Air Lines, Inc. (“United”), Continental Airlines, Inc. (“Continental”), US Airways Group, Inc. (“US Airways”), American Airlines, Inc. (“American”) and Alaska Airlines (“Alaska”), revenue is considered earned when the flight is completed. Revenue is recognized under the Company’s pro-rate flying agreements based upon the portion of the pro-rate passenger fare the Company anticipates that it will receive.

 

Delta Connection Agreements

 

SkyWest Airlines and ExpressJet are each parties to a Delta Connection Agreement with Delta, pursuant to which SkyWest Airlines and ExpressJet provide contract flight services for Delta. The Delta Connection Agreements provide for fifteen-year terms, subject to early termination by Delta, SkyWest Airlines or ExpressJet, as applicable, upon the occurrence of certain events. Delta’s termination rights include (i) cross- termination rights between the two Delta Connection Agreements, (ii) the right to terminate each of the Delta Connection Agreements upon the occurrence of certain force majeure events, including certain labor-related events, that prevent SkyWest Airlines or ExpressJet from performance for certain periods, and (iii) the right to terminate each of the Delta Connection Agreements if SkyWest Airlines or ExpressJet fails to maintain competitive base rate costs, subject to certain adjustment rights. The SkyWest Airlines and ExpressJet Delta Connection Agreements contain multi-year rate reset provisions beginning in 2010 and each 5th year thereafter. In addition to the termination rights, Delta has the right to extend the term of the Delta Connection Agreements upon the occurrence of certain events or at the expiration of the initial term. SkyWest Airlines and ExpressJet have the right to terminate their respective Delta Connection Agreement upon the occurrence of certain breaches by Delta, including the failure to cure payment defaults. SkyWest Airlines and ExpressJet also have cross-termination rights between the two Delta Connection Agreements.

 

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Under the terms of the SkyWest Airlines Delta Connection Agreement, Delta has agreed to compensate SkyWest Airlines for the direct costs associated with operating the Delta Connection flights, plus a payment based on block hours flown. Under the terms of the ExpressJet Delta Connection Agreement, Delta has agreed to compensate ExpressJet for its direct costs associated with operating the Delta Connection flights, plus, if ExpressJet completes a certain minimum percentage of its Delta Connection flights, an additional percentage of such costs. Additionally, ExpressJet’s Delta Connection Agreement provides for the payment of incentive compensation upon satisfaction of certain performance goals. The incentives are defined in the ExpressJet Delta Connection Agreement as being measured and determined on a monthly and quarterly basis. At the end of each quarter, the Company calculates the incentives achieved during the quarter and recognizes revenue accordingly. The parties to the Delta Connection Agreements made customary representations, warranties and covenants, including with respect to various operational, marketing and administrative matters.

 

In the event that the contractual rates under the Delta Connection Agreements have not been finalized at quarterly or annual financial statement dates, the Company records revenues based on the lower of prior period’s approved rates, as adjusted to reflect any contract negotiations and the Company’s estimate of rates that will be implemented in accordance with revenue recognition guidelines.

 

The Delta Connection Agreements also provide that, beginning with the fifth anniversary of the execution of the agreements (September 8, 2010), Delta has the right to require that certain contractual rates under those agreements shall not exceed the second lowest of all carriers within the Delta Connection program. During the fourth quarter of 2010, SkyWest Airlines and Atlantic Southeast reached an agreement with Delta on contractual rates satisfying the 2010 rate reset provision and the second-lowest rate provision and agreed to rates through December 31, 2015. Delta additionally waived its right to require that the contractual rates payable under the Delta Connection Agreements shall not exceed the second-lowest rates of all carriers within the Delta Connection program through December 31, 2015.

 

On August 2, 2012, the Company announced that it reached an understanding with Delta to add 34 additional used dual-class Bombardier regional jet aircraft that were previously operated by other regional carriers for Delta in exchange for the early termination of 66 Bombardier CRJ200 regional jet aircraft (“CRJ200s”) under the SkyWest Airlines and ExpressJet Delta Connection Agreements.  The Company anticipates the 34 additional dual-class aircraft will be subleased from Delta for a nominal amount. The 34 additional dual-class aircraft consist of five Bombardier CRJ700 regional jet aircraft (“CRJ700s”) and 29 Bombardier CRJ900 regional jet aircraft (“CRJ900s”).  As of September 30, 2012, the Company had taken delivery of 13 CRJ900s and 2 CRJ700s. The Company anticipates that the remaining dual-class aircraft to be provided by Delta will be delivered by June 2013.  The Company anticipates that all 66 CRJ200 aircraft will be removed from the Delta Connection Agreements by December 31, 2015. Of the 66 CRJ200s to be removed from service, 41 CRJ200s are subleased from Delta for a nominal amount, which are scheduled to be returned to Delta without obligation to the Company.  As of September 30, 2012, three of the 66 CRJ200 aircraft have been removed.

 

In the event the Company has a reimbursement dispute with a major partner, the Company evaluates the dispute under its established revenue recognition criteria and, provided the revenue recognition criteria have been met, the Company recognizes revenue based on management’s estimate of the resolution of the dispute. During the quarter ended December 31, 2007, Delta notified the Company, SkyWest Airlines and Atlantic Southeast of a dispute under the Delta Connection Agreements executed by Delta with SkyWest Airlines and Atlantic Southeast. The dispute relates to allocation of liability for certain irregular operations (“IROP”) expenses that are paid by SkyWest Airlines and ExpressJet to their passengers under certain situations. As a result, Delta withheld a combined total of approximately $25 million (pre-tax) from one of the weekly scheduled wire payments to SkyWest Airlines and Atlantic Southeast during December 2007. Delta continues to withhold a portion of the funds the Company believes are payable as weekly scheduled wire payments to SkyWest Airlines and ExpressJet (See Note I for additional details).

 

United Express Agreements

 

SkyWest Airlines and United have entered into a United Express Agreement, which sets forth the principal terms and conditions governing SkyWest Airlines’ United Express operations. Under the terms of the United Express Agreement, SkyWest Airlines is compensated primarily on a fee-per-completed-block hour and departure basis and is reimbursed for fuel and other costs. Additionally, SkyWest Airlines is eligible for incentive compensation upon the achievement of certain performance criteria. The incentives are defined in the United Express Agreement as being measured and determined on a monthly basis. At the end of each month, the Company calculates the incentives achieved during the month and recognizes revenue accordingly.

 

On February 10, 2010, Atlantic Southeast and United entered into a United Express Agreement, pursuant to which ExpressJet, as successor to Atlantic Southeast, operates 14 Bombardier CRJ200s as a United Express carrier. The ExpressJet United Express Agreement is a capacity purchase agreement with a five-year term, and other terms which are generally consistent with the SkyWest Airlines United Express Agreement.

 

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On December 1, 2009, ExpressJet Delaware and United also entered into a United Express Agreement, which sets forth the principal terms and conditions governing the United Express operations presently conducted by ExpressJet. Under the terms of that United Express Agreement, to which ExpressJet became a party through the ExpressJet Combination, ExpressJet is compensated primarily on a fee-per-completed-block hour and departure basis and is reimbursed for fuel and other costs. Additionally, ExpressJet is eligible for incentive compensation upon the achievement of certain performance criteria. The incentives are defined in the ExpressJet United Express Agreement as being measured and determined on a monthly basis. At the end of each month, the Company calculates the incentives achieved during the month and recognizes revenue accordingly.

 

Continental Capacity Purchase Agreement

 

Effective November 12, 2010, ExpressJet Delaware entered into a Capacity Purchase Agreement with Continental (the “Continental CPA”), whereby ExpressJet Delaware agreed to provide regional airline service in the Continental flight system. Under the terms of the Continental CPA, to which ExpressJet succeeded as a party through the ExpressJet Combination, ExpressJet operates 227 aircraft in the Continental flight system and Continental has agreed to compensate ExpressJet on a monthly basis based on the block hours flown by ExpressJet and the weighted average number of aircraft operated by ExpressJet under the Continental CPA. Additionally, ExpressJet may earn incentive compensation for good operating performance, but is subject to financial penalties for poor operating performance. At the end of each month, the Company calculates the incentives achieved during the month under the Continental CPA and recognizes revenue accordingly.

 

Alaska Capacity Purchase Agreement

 

SkyWest Airlines and Alaska have entered into a Capacity Purchase Agreement, which sets forth the principal terms and conditions governing SkyWest Airlines’ operations for Alaska. Under the terms of the Alaska Capacity Purchase Agreement, SkyWest Airlines is compensated primarily on a fee-per-completed-block hour and departure basis and is reimbursed for fuel and other costs. Additionally, SkyWest Airlines is eligible for incentive compensation upon the achievement of certain performance criteria. The incentives are defined in the Alaska Capacity Purchase Agreement as being measured and determined on a monthly basis. At the end of each month, the Company calculates the incentives achieved during the month and recognizes revenue accordingly.

 

US Airways Express Agreement

 

SkyWest Airlines and US Airways have entered into a US Airways Express Agreement, which sets forth the principal terms and conditions governing SkyWest Airlines’ US Airways Express operations. Under the terms of the US Airways Express Agreement, SkyWest Airlines is compensated primarily on a fee-per-completed-block hour and departure basis and is reimbursed for fuel and other costs. Additionally, SkyWest Airlines is eligible to receive incentive compensation upon the achievement of certain performance criteria, but is subject to financial penalties if it fails to achieve minimum performance criteria. The incentives are defined in the US Airways Express Agreement as being measured and determined on a quarterly basis. At the end of each quarter, the Company calculates the incentives achieved during the quarter and recognizes revenue accordingly.

 

American Agreement

 

In September 2012, SkyWest Airlines and ExpressJet each entered into a Capacity Purchase Agreement with American (the “American Agreements”), which set forth the terms and conditions governing SkyWest Airlines’ and ExpressJet’s prospective American Eagle operations. SkyWest Airlines anticipates placing 12 CRJ200s into service for American on November 14, 2012 and ExpressJet anticipates placing 11 CRJ200s into service for American on February 14, 2013. The Company anticipates that the aircraft to be flown under the American Agreement will be removed from existing contracts SkyWest Airlines and ExpressJet have with another major partner.  The term of each agreement is four years. Under the terms of the American Agreements, SkyWest Airlines and ExpressJet will be compensated primarily on a fee-per-completed-block hour and departure basis and will be reimbursed for fuel and other costs. The American Agreements also provide for SkyWest Airlines and ExpressJet to receive incentive compensation upon the achievement of certain performance criteria, but also impose financial penalties if SkyWest Airlines or ExpressJet Airlines fails to achieve minimum performance criteria. The incentives are defined in the American Agreements as being measured and determined on a quarterly basis. The Company anticipates that at the end of each quarter,  it will calculate the incentives achieved during the quarter from the American Agreements and recognize revenue accordingly.

 

Other Revenue Items

 

The Company’s passenger and ground handling revenues could be impacted by a number of factors, including changes to the Company’s code-share agreements with Delta, United, Continental, Alaska, American or US Airways, contract modifications resulting from contract re-negotiations, the Company’s ability to earn incentive payments contemplated under the Company’s code-share agreements and settlement of reimbursement disputes with the Company’s major partners.

 

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Note C — Share-Based Compensation

 

The fair value of stock options granted by the Company has been estimated as of the grant date using the Black-Scholes option pricing model. During the nine months ended September 30, 2012, the Company granted options to purchase 200,115 shares of common stock under the SkyWest, Inc. 2010 Long-Term Incentive Plan (the “2010 Incentive Plan”).  The following table shows the assumptions used and weighted average fair value for stock option grants during the nine months ended September 30, 2012.

 

Expected annual dividend rate		1.23		%
Risk-free interest rate		0.81		%
Average expected life (years)		5.6
Expected volatility of common stock		.409
Forfeiture rate		0.0		%
Weighted average fair value of option grants		$	4.43

 

During the nine months ended September 30, 2012, the Company granted 290,265 restricted stock units to the Company’s employees under the 2010 Incentive Plan.  The restricted stock units have a three-year vesting period, during which the recipient must remain employed with the Company or one of the Company’s subsidiaries.  Upon vesting, a restricted stock unit will be replaced with a common share of stock. Additionally, during the nine months ended September 30, 2012, the Company granted 27,874 fully-vested shares of common stock to the Company’s directors.  The weighted average fair value of the shares of restricted stock on the date of grant was $13.06 per share.

 

The Company records share-based compensation expense only for those options and restricted stock units that are expected to vest.  The estimated fair value of the stock options and restricted stock units is amortized over the applicable vesting periods.  During the three months ended September 30, 2012 and 2011, the Company recorded pre-tax share-based compensation expense of $1.1 million and $1.2 million, respectively. During the nine months ended September 30, 2012 and 2011, the Company recorded pre-tax share-based compensation expense of $3.6 million and $4.2 million, respectively.

 

Note D — Net Income (Loss) Per Common Share

 

Basic net income (loss) per common share (“Basic EPS”) excludes dilution and is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share (“Diluted EPS”) reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted into common stock. The computation of Diluted EPS does not assume exercise or conversion of securities that would have an anti-dilutive effect on net income (loss) per common share.  During the three months ended September 30, 2012 and 2011, options to acquire 3,945,000 and 4,153,000 shares, respectively, were excluded from the computation of Diluted EPS as their impact was anti-dilutive. During the nine months ended September 30, 2012 and 2011, options to acquire 3,963,000 and 4,391,000 shares, respectively, were excluded from the computation of Diluted EPS as their impact was anti-dilutive.

 

The calculation of the weighted average number of common shares outstanding for Basic EPS and Diluted EPS for the periods indicated (in thousands, except per share data) is as follows:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2012			2011			2012			2011
		(Unaudited)						(Unaudited)
Numerator
Net Income (Loss)		$	20,933		$	116		$	37,211		$	(9,369	)
Denominator
Weighted average number of common shares outstanding		51,241			51,570			51,022			52,704
Effect of outstanding share-based awards		912			745			586			—
Weighted average number of shares for diluted net income (loss) per common share		52,153			52,315			51,608			52,704
Basic earnings (loss) per share		$	0.41		$	0.00		$	0.73		$	(0.18	)
Diluted earnings (loss) per share		$	0.40		$	0.00		$	0.72		$	(0.18	)

 

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Note E — Segment Reporting

 

Generally accepted accounting principles require disclosures related to components of a company for which separate financial information is available to and regularly evaluated by the company’s chief operating decision maker (“CODM”) when deciding how to allocate resources and in assessing performance.

 

The Company’s two operating segments consist of the operations of its two operating subsidiaries, SkyWest Airlines and ExpressJet. On December 31, 2011, ExpressJet Delaware and Atlantic Southeast merged through the ExpressJet Combination. In conjunction with the ExpressJet Combination, ExpressJet became a reportable segment. Prior year amounts have been revised to conform to the current year segment presentation. Corporate overhead expense incurred by the Company is allocated to the operating expenses of its two operating subsidiaries. The following represents the Company’s segment data for the three months ended September 30, 2012 and 2011 (in thousands).

 

		Three months ended September 30,2012
		SkyWest Airlines		ExpressJet		Other		Consolidated
Operating revenues		475,662		386,803		2,794		865,259
Operating expense		426,511		382,511		1,263		810,285
Depreciation and amortization expense		38,179		24,524		—		62,703
Interest expense		12,292		5,953		1,229		19,474
Segment profit (loss)(1)		36,859		(1,661	)	302		35,500
Identifiable intangible assets, other than goodwill		—		17,810		—		17,810
Total assets		2,639,895		1,608,956		—		4,248,851
Capital expenditures (including non-cash)		10,041		4,601		—		14,642

 

		Three months ended September 30, 2011
		SkyWest Airlines		ExpressJet		Other		Consolidated
Operating revenues		524,286		428,265		2,874		955,425
Operating expense		489,959		437,292		1,347		928,598
Depreciation and amortization expense		36,945		26,448		—		63,393
Interest expense		12,688		6,322		1,076		20,086
Segment profit (loss) (1)		21,639		(15,349	)	451		6,741
Identifiable intangible assets, other than goodwill		—		20,060		—		20,060
Total assets		2,574,209		1,762,605		—		4,336,814
Capital expenditures (including non-cash)		51,440		6,487		—		57,927

 

(1)                                  Segment profit (loss) is operating income less interest expense

 

The following represents the Company’s segment data for the nine-months ended September 30, 2012 and 2011 (in thousands).

 

		Nine months ended September 30, 2012
		SkyWest Airlines		ExpressJet		Other		Consolidated
Operating revenues		1,479,708		1,235,877		8,062		2,723,647
Operating expense		1,366,914		1,230,703		3,793		2,601,410
Depreciation and amortization expense		115,609		75,591		—		191,200
Interest expense		37,207		17,958		3,476		58,641
Segment profit (loss)(1)		75,587		(12,784	)	793		63,596
Identifiable intangible assets, other than goodwill		—		17,810		—		17,810
Total assets		2,639,895		1,608,956		—		4,248,851
Capital expenditures (including non-cash)		31,994		13,141		—		45,135

 

		Nine months ended September 30, 2011
		SkyWest Airlines		ExpressJet		Other		Consolidated
Operating revenues		1,517,230		1,229,221		8,622		2,755,073
Operating expense		1,426,679		1,278,254		4,048		2,708,981
Depreciation and amortization expense		110,225		80,058		—		190,283
Interest expense		38,040		19,033		3,285		60,358
Segment profit (loss) (1)		52,511		(68,066	)	1,289		(14,266	)
Identifiable intangible assets, other than goodwill		—		20,060		—		20,060
Total assets		2,574,209		1,762,605		—		4,336,814
Capital expenditures (including non-cash)		73,057		20,225		—		93,282

 

(1)                                  Segment profit (loss) is operating income less interest expense

 

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Note F — Fair Value Measurements

 

The Company holds certain assets that are required to be measured at fair value in accordance with GAAP. The Company determined fair value of these assets based on the following three levels of inputs:

 

Level 1	—	Quoted prices in active markets for identical assets or liabilities.
Level 2	—	Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Some of the Company’s marketable securities primarily utilize broker quotes in a non-active market for valuation of these securities.
Level 3	—	Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities, therefore requiring an entity to develop its own assumptions.

 

As of September 30, 2012, the Company held certain assets that are required to be measured at fair value on a recurring basis. Assets measured at fair value on a recurring basis are summarized below (in thousands):

 

		Fair Value Measurements as of September 30, 2012
		Total			Level 1			Level 2			Level 3
Marketable Securities
Bond and bond fund		$	579,302		$	—		$	579,302		$	—
Commercial paper		3,530			—			3,530			—
Asset backed securities		339			—			339			—
		583,171			—			583,171			—
Cash, Cash Equivalents and Restricted Cash		155,907			155,907			—			—
Other Assets (a)		3,845			—			—			3,845
Total Assets Measured at Fair Value		$	742,923		$	155,907		$	583,171		$	3,845

 

(a)          Auction rate securities included in “Other assets” in the unaudited Consolidated Balance Sheet

 

Based on market conditions, the Company uses a discounted cash flow valuation methodology for auction rate securities. Accordingly, for purposes of the foregoing condensed consolidated financial statements, these securities were categorized as Level 3 securities. The Company’s “Marketable Securities” classified as Level 2 primarily utilize broker quotes in a non-active market for valuation of these securities.

 

The Company did not make any significant transfers of securities between Level 1, Level 2 and Level 3 during the nine months ended September 30, 2012.  The Company’s policy regarding the recording of transfers between levels is to record any such transfers at the end of the reporting period.

 

The following table presents the Company’s assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at September 30, 2012 (in thousands):

 

Fair Value Measurements Using Significant Unobservable Inputs

(Level 3)

 

		Auction Rate Securities
Balance at January 1, 2012		$	3,793
Total realized and unrealized gains or (losses)
Included in earnings		—
Included in other comprehensive income		52
Transferred out		—
Settlements		—
Balance at September 30, 2012		$	3,845

 

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The fair value of the Company’s long-term debt classified as Level 2 was estimated using discounted cash flow analyses, based on the Company’s current estimated incremental borrowing rates for similar types of borrowing arrangements. The fair value of the Company’s long-term debt is estimated based on current rates offered to the Company for similar debt and was estimated to be $1,778.7 million as of September 30, 2012, as compared to the carrying amount of $1,701.9 million as of September 30, 2012.

 

Note G — Income Taxes

 

Primarily as a result of decreases in the Company’s estimated pre-tax income, the Company’s estimated annual effective tax rate for the three and nine-month periods ended September 30, 2011 varied from the federal statutory rate of 35%.  The variance also reflected a proportionate increase in expenses with limited tax deductibility relative to the Company’s pre-tax income for the year ended December 31, 2011.

 

Note H — Investments in Other Companies

 

In September 2008, the Company entered into an agreement to acquire a 20% interest in Trip Linhas Aereas, a regional airline operating in Brazil (“TRIP”).  As of September 30, 2012, the Company’s investment balance in TRIP was $19.5 million. In connection with the investment in TRIP, the Company entered into a put option agreement with the majority shareholder of TRIP that allows the Company to put its investment to TRIP’s majority shareholder at an established price based on a 5% annual rate of return over the investment period.

 

On July 12, 2012, the Company sold its interest in TRIP for a price of $42 million.  The purchase price is scheduled to be paid in three installments over a two-year period and may be accelerated upon the occurrence of certain conditions identified in the purchase agreement.  As part of the sale transaction, the Company also received an option to acquire 15.38% of the ownership in Trip Investimentos Ltda., the purchaser of the Company’s TRIP shares (“Trip Investimentos”).  The option has an initial exercise price per share equal to the price paid by Trip Investimentos to acquire the TRIP shares from the Company. The exercise price escalates annually at a specified rate and the Company can exercise the option, at its discretion, between the second and fourth anniversaries of the Company’s receipt of the final required installment payments from Trip Investimentos. Under the terms of the agreement, Trip Investmentos. cannot transfer the TRIP shares until the three installment payments have been made.  The restriction on Trip Investimentos’ ability to transfer the TRIP shares prevents the transaction from being recognized as a sale.  As a result, the Company will account for the transaction as a sale once all three installment payments have been made. The Company has no continuing involvement with the TRIP shares.  As of September 30, 2012, the Company had received the first installment payment of $8.4 million.  This payment was recorded as an “Other Long-Term Liability” on the Company’s consolidated balance sheet. The second installment payment is due July 12, 2013 for an amount of $16.8 million.  The third installment payment is due July 12, 2014 for an amount of $16.8 million.  The future installment payments and the option to purchase 15.38% of Trip Investimentos represent variable interests in TRIP Investimentos, which is a variable interest entity.  The Company has no equity interest and no control over Trip Investimentos, and therefore the Company does not consolidate Trip Investimentos.

 

On September 29, 2010, the Company invested $7 million for a 30% ownership interest in Mekong Aviation Joint Stock Company, an airline operating in Vietnam (“Air Mekong”). During 2011, the Company invested an additional $3 million in Air Mekong. As of September 30, 2012, the Company’s investment balance in Air Mekong was $1.3 million.

 

The Company’s investments in TRIP and Air Mekong have been recorded as an “Other assets” on the Company’s consolidated balance sheet. The Company accounts for its investments in TRIP and Air Mekong using the equity method of accounting. The Company records its equity in TRIP’s and Air Mekong’s earnings on a one-quarter lag. The Company’s portion of the losses incurred by TRIP and Air Mekong for the nine months ended September 30, 2012 and 2011 was $10.1 million (pre-tax), and $8.5 million (pre-tax), respectively. In connection with the sale of its investment in TRIP on July 12, 2012, the Company relinquished its board seat and voting rights and no longer has significant influence over the operations of TRIP.  As a result, the Company ceased to account for its investment in TRIP under the equity method beginning on July 12, 2012 and, subsequent to that date, will account for its investment in TRIP under the cost method.

 

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Note I — Legal Matters

 

The Company is subject to certain legal actions which it considers routine to its business activities. As of September 30, 2012, the Company’s management believed, after consultation with legal counsel, that the ultimate outcome of such legal matters is not likely to have a material adverse effect on the Company’s financial position, liquidity or results of operations. However, the following is a significant outstanding legal matter.

 

SkyWest Airlines and ExpressJet v. Delta

 

During the quarter ended December 31, 2007, Delta notified the Company, SkyWest Airlines and Atlantic Southeast, of a dispute under the Delta Connection Agreements executed by Delta with SkyWest Airlines and Atlantic Southeast. The dispute relates to the allocation of liability for certain irregular operation (“IROP”) expenses paid by SkyWest Airlines and Atlantic Southeast  to their passengers and vendors under certain situations. During the period between the execution of the Delta Connection Agreements in September 2005 and December 2007, SkyWest Airlines and Atlantic Southeast passed through to Delta IROP expenses that were paid pursuant to Delta’s policies, and Delta accepted and reimbursed those expenses. Delta now claims it is obligated to reimburse only a fraction of those IROP expenses. As a result, Delta withheld a combined total of approximately $25 million (pre-tax) from one of the weekly scheduled wire payments to SkyWest Airlines and Atlantic Southeast during December 2007. Since December 2007, Delta has continued to withhold payments from the weekly scheduled wire payments to SkyWest Airlines and Atlantic Southeast, and has disputed subsequent billings for IROP expenses. As of September 30, 2012, the Company had recognized a cumulative total of $31.7 million of revenue associated with the funds withheld by Delta. Since July 1, 2008, the Company has not recognized revenue related to IROP expense reimbursements withheld by Delta because collection of those reimbursements is the subject of litigation and is not reasonably assured. On February 1, 2008, SkyWest Airlines and Atlantic Southeast filed a Complaint in the Superior Court for Fulton County, Georgia (“Superior Court”) challenging Delta’s treatment of the matter and seeking recovery of the payments withheld by Delta and any future withholdings related to this issue. Delta filed an Answer to the SkyWest Airlines and Atlantic Southeast Complaint and a Counterclaim against SkyWest Airlines and Atlantic Southeast on March 24, 2008. Delta’s Counterclaim alleged that SkyWest Airlines and Atlantic Southeast breached the Delta Connection Agreements by invoicing Delta for IROP expenses that were paid pursuant to Delta’s policies, and claims only a portion of those expenses may be invoiced to Delta.

 

After proceedings that included contested motions, document discovery, and depositions, Delta voluntarily dismissed its Counterclaim. Discovery in that action was not complete at the time of dismissal. On February 14, 2011, SkyWest Airlines and Atlantic Southeast voluntarily dismissed their claims in the Superior Court, and filed a new complaint (the “State Court Complaint”) in the Georgia State Court of Fulton County (the “State Court”). The claims continue to include breach of contract, breach of contract based on mutual departure, breach of contract based on voluntary payment, and breach of the duty of good faith and fair dealing. Delta moved for partial dismissal of the State Court Complaint, which motion was denied in its entirety. Discovery in the State Court lawsuit is not yet complete.

 

On October 18, 2011, Delta filed a counterclaim (the “Counterclaim”) against SkyWest Airlines and Atlantic Southeast. The Counterclaim contains claims for unjust enrichment and breach of contract related to alleged non-revenue positive space flying by SkyWest and Atlantic Southeast employees for non-Delta related business. Delta’s Counterclaim does not specify an amount of damages, but the Counterclaim alleges, on information and belief, that Delta’s damages exceed $4.5 million. SkyWest and Atlantic Southeast filed their reply to the Counterclaim on November 21, 2011, stating the allegations contained in the Counterclaim stand denied by operation of law and asserting SkyWest’s and Atlantic Southeast’s affirmative defenses. An estimated loss is accrued if the loss is probable and reasonably estimable. Because these conditions have not been satisfied, the Company has not recorded a loss in its consolidated financial statements with respect to the dispute. As of September 30, 2012, a range of reasonably possible loss is not determinable related to this Counterclaim.

 

During 2010, the Company and Delta began preliminary settlement discussions related to the dispute. Notwithstanding the legal merits of the case, the Company offered to settle the claim for approximately $5.9 million less than the cumulative total of revenue recognized related to this matter. Those settlement discussions were not successful; however, as a result of the settlement offer, the Company wrote off $5.9 million of related receivables as of December 31, 2010. As of September 30, 2012, the Company’s estimated range of reasonably possible loss related to the dispute was $0 to $25.8 million.

 

SkyWest Airlines and ExpressJet continue to vigorously pursue their claims set forth in the State Court Complaint and their defenses against Delta’s Counterclaim.

 

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ITEM 2:

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis presents factors that had a material effect on the results of operations of SkyWest, Inc. (“SkyWest” “we” or “us”) during the three and nine month periods ended September 30, 2012 and 2011. Also discussed is our financial position as of September 30, 2012 and December 31, 2011. You should read this discussion in conjunction with our condensed consolidated financial statements for the three and nine month periods ended September 30, 2012, including the notes thereto, appearing elsewhere in this Report.  This discussion and analysis contains forward-looking statements. Please refer to the section of this Report entitled “Cautionary Statement Concerning Forward-Looking Statements” for discussion of the uncertainties, risks and assumptions associated with these statements.

 

Effective December 31, 2011, our subsidiary, ExpressJet Airlines, Inc. was merged into our subsidiary, Atlantic Southeast Airlines, Inc., with the surviving corporation named ExpressJet Airlines, Inc. (the “ExpressJet Combination”).  In this Report, “Atlantic Southeast” refers to Atlantic Southeast Airlines, Inc. for periods prior to the ExpressJet Combination, “ExpressJet Delaware” refers to ExpressJet Airlines, Inc., a Delaware corporation, for periods prior to the ExpressJet Combination, and “ExpressJet” refers to ExpressJet Airlines, Inc., the Utah corporation resulting from the combination of Atlantic Southeast and ExpressJet Delaware, for periods subsequent to the consummation of the ExpressJet Combination.

 

Cautionary Statement Concerning Forward-Looking Statements

 

Certain of the statements contained in this Report should be considered “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements may be identified by words such as “may,” “will,” “expect,” “intend,” “anticipate,” “believe,” “estimate,” “plan,” “project,” “could,” “should,” “hope,” “likely,” and “continue” and similar terms used in connection with statements regarding SkyWest’s outlook, the revenue environment, SkyWest’s contract relationships, and SkyWest’s expected financial performance.  These statements include, but are not limited to, statements about SkyWest’s future growth and development plans, including SkyWest’s future financial and operating results, SkyWest’s plans for SkyWest Airlines and ExpressJet, SkyWest’s objectives, expectations and intentions, and other statements that are not historical facts.  You should also keep in mind that all forward-looking statements are based on SkyWest’s existing beliefs about present and future events outside of SkyWest’s control and on assumptions that may prove to be incorrect.  If one or more risks identified in this Report materializes, or any other underlying assumption proves incorrect, SkyWest’s actual results will vary, and may vary materially, from those anticipated, estimated, projected, or intended.

 

There may be other factors not identified above of which SkyWest is not currently aware that may affect matters discussed in the forward-looking statements, and may also cause actual results to differ materially from those discussed.  SkyWest assumes no obligation to publicly update any forward-looking statement to reflect actual results, changes in assumptions or changes in other factors affecting these statements other than as required by law.

 

Overview

 

Through SkyWest Airlines and ExpressJet, we operate the largest regional airline in the United States. As of September 30, 2012, SkyWest Airlines and ExpressJet offered scheduled passenger and air freight service with approximately 4,000 total daily departures to destinations in the United States, Canada, Mexico and the Caribbean. As of September 30, 2012, we operated a combined fleet of 739 aircraft consisting of the following:

 

		CRJ 200		ERJ 135/145		CRJ700		CRJ 900		EMB 120		Total
Delta		158		—		57		44		8		267
United Continental		92		249		70		—		34		445
US Airways		15		—		—		—		—		15
Alaska		—		—		5		—		—		5
Maintenance spare		1		—		—		—		—		1
Subleased to an un-affiliated entity		2		—		—		—		—		2
Subleased to an affiliated entity		—		—		—		4		—		4
Total		268		249		132		48		42		739

 

For the three months ended September 30, 2012, approximately 65.8% of our aggregate capacity was operated under United Express Agreements executed between United Airlines, Inc. (“United”) and each of SkyWest Airlines and ExpressJet and a Capacity Purchase Agreement between Continental Airlines, Inc. (“Continental”) and ExpressJet, approximately 31.2%  of our aggregate capacity was operated under Delta Connection Agreements executed between Delta Airlines, Inc. (“Delta”) and each of SkyWest Airlines and ExpressJet (as successor to Atlantic Southeast), approximately 1.4% of our aggregate capacity was operated under a capacity purchase agreement with Alaska Airlines (“Alaska”) and approximately 1.6% of our aggregate capacity was operated under a code-share agreement with U.S. Airways Group, Inc. (“US Airways”).

 

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SkyWest Airlines has been a code-share partner with Delta in Salt Lake City and United in Los Angeles since 1987 and 1997, respectively. In 1998, SkyWest Airlines expanded its relationship with United to provide service in Portland, Seattle/Tacoma, San Francisco and additional Los Angeles markets. In 2004, SkyWest Airlines expanded its United Express operations to provide service in Chicago. In May 2011, SkyWest Airlines entered into a capacity purchase agreement with Alaska. In November 2011, SkyWest Airlines entered into a code share agreement with US Airways. In September, 2012, SkyWest Airlines and ExpressJet entered into code share agreements (the “American Agreements”) with American Airlines, Inc. (“American”). As of September 30, 2012, SkyWest Airlines operated as a Delta Connection carrier in Salt Lake City and Minneapolis, a United Express carrier in Los Angeles, San Francisco, Denver, Houston, Chicago and the Pacific Northwest, an Alaska carrier in Seattle/ Tacoma and Portland and a US Airways carrier in Phoenix.

 

On November 17, 2011, Atlantic Southeast and ExpressJet Delaware consolidated their operations under a single operating certificate, and on December 31, 2011, Atlantic Southeast and ExpressJet Delaware completed the ExpressJet Combination. At the time of the ExpressJet Combination, Atlantic Southeast had been a code-share partner with Delta in Atlanta since 1984 and a code-share partner with United since February 2010. As of September 30, 2012, ExpressJet operated as a Delta Connection carrier in Atlanta and Cincinnati and a United Express carrier in Chicago (O’Hare), Washington, D.C. (Dulles International Airport), Cleveland, Newark and Houston.

 

Historically, multiple contractual relationships have enabled us to reduce reliance on any single major airline code and to enhance and stabilize operating results through a mix of contract flying and our controlled or “pro-rate” flying. For the three months ended September 30, 2012, contract flying revenue and pro-rate revenue represented approximately 90% and 10%, respectively, of our total passenger revenues. On contract routes, the major airline partner controls scheduling, ticketing, pricing and seat inventories and we are compensated by the major airline partner at contracted rates based on completed block hours, flight departures and other operating measures.

 

Third Quarter Summary

 

We had revenues of $865.3 million for the three months ended September 30, 2012, a 9.4% decrease, compared to revenues of $955.4 million for the three months ended September 30, 2011. Our operating income increased to $55.0 million for the three months ended September 30, 2012, or $28.2 million, from $26.8 million for the three months ended September 30, 2011.  We had a net income of $20.9 million, or $0.40 per diluted share, for the three months ended September 30, 2012, compared to $0.1 million of net income, or $0.00 per diluted share, for the three months ended September 30, 2011.

 

The significant items affecting our financial performance during the three months ended September 30, 2012 are outlined below:

 

Under certain of our flying contracts, certain expenses are subject to direct reimbursement from our major partners and we record such reimbursements as passenger revenue, including fuel and certain engine maintenance expenses. Our fuel expense and directly reimbursed engine expense decreased by $88.0 million and $6.0 million, respectively during the three months ended September 30, 2012 from the three months ended September 30, 2011, due primarily to United purchasing an increased volume of fuel directly from vendors on flights we operated under the United contract and due to a reduction in the number of engine events from the prior year.  Excluding the impact of the decrease in direct fuel and engine maintenance expense and associated reimbursements, our passenger revenues increased $6.2 million for three months ended September 30, 2012 compared to the three months ended September 30, 2011, which was primarily due to an increase in block hour production, which is a significant revenue driver under our flying contracts.

 

Under certain of our flying contracts, our major partners reimburse us a fixed hourly rate for engine maintenance costs, rather than directly reimbursing the expense.  Under the flying contracts, the number of engine events and related costs we incur each quarter directly impacts our operating income.  The engine expense subject to reimbursement under a fixed hourly rate decreased $15.1 million during the three months ended September 30, 2012 compared to the three months ended September 30, 2012.  The decrease in engine maintenance expense was primarily due to a reduction in the number of scheduled engine maintenance events.

 

Aircraft maintenance expense, excluding reimbursed engine overhauls and engine overhauls for our Bombardier CRJ200 regional jet aircraft (“CRJ200s”), which are reimbursed at fixed hourly rates, decreased $4.9 million, or 4.2%, during the three months ended September 30, 2012, compared to the three months ended September 30, 2011. The decrease in aircraft maintenance expense, excluding engine overhaul costs, for the three months ended September 30, 2012, compared to the three months ended September 30, 2011, was principally due to fewer scheduled maintenance events.

 

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Additionally, we experienced a $3.0 million reduction in other operating expenses, including new hire crew training related costs and simulator and lodging costs, during the three months ended September 30, 2012, compared to the three months ended September 30, 2011. Operating expense incurred during the three months ended September 30, 2011 were higher than the corresponding period of 2012, due primarily to crew training required to support incremental aircraft placed into service during the second half of 2011.

 

The items identified above were the principal factors that contributed to the significant improvement in our financial results during the three months ended September 30, 2012, compared to the three months ended September 30, 2011.

 

On August 2, 2012, we announced that we reached an understanding with Delta to add 34 additional used dual-class Bombardier regional jet aircraft in exchange for the early termination of 66 CRJ200 aircraft under our Delta Connection Agreements. The additional dual-class aircraft were previously operated for Delta by other regional carriers. The Company anticipates the 34 additional dual-class aircraft will be subleased from Delta for a nominal amount. The 34 additional aircraft consist of five Bombardier CRJ700 regional jet aircraft (“CRJ700s”) and 29 Bombardier CRJ900 regional jet aircraft (“CRJ900s”).  As of September 30, 2012, we had taken delivery of 13 CRJ900s and two CRJ700s. We anticipate that the remaining aircraft will be delivered by June 2013.  We anticipate that the all 66 CRJ200 aircraft will be removed from the Delta Connection Agreements by December 31, 2015. Of the 66 CRJ200s to be removed, 41 CRJ200s are subleased from Delta for a nominal amount, which are scheduled to be returned to Delta without obligation to the Company.  As of September 30, 2012, three of the 66 CRJ200 aircraft have been removed.

 

During the three months ended September 30, 2012, we signed the American Agreements, which provide for us to operate 23 CRJ200s.  We anticipate that the aircraft to be flown for American will be removed from existing contracts SkyWest Airlines and ExpressJet have with another major carrier.  We anticipate that our operations under the American Agreements will commence on November 14, 2012, with all 23 aircraft being placed in service by February 14, 2013.  We anticipate that 12 of the aircraft will be flown by SkyWest Airlines and 11 aircraft will be flown by ExpressJet. We also anticipate that the aircraft will be operated out of Los Angeles International Airport and Dallas/Fort Worth International Airport.

 

Total available seat miles (“ASMs”) for the three months ended September 30, 2012 increased 0.1%, compared to the three months ended September 30, 2011. During the three months ended September 30, 2012, we generated 9.70 billion ASMs, compared to 9.68 billion ASMs during the three months ended September 30, 2011.

 

Critical Accounting Policies

 

Our significant accounting policies are summarized in Note 1 to our consolidated financial statements for the year ended December 31, 2011, which are presented in our Annual Report on Form 10-K for the year ended December 31, 2011.  Critical accounting policies are those policies that are most important to the preparation of our consolidated financial statements and require management’s subjective and complex judgments due to the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies relate to revenue recognition, maintenance, aircraft leases, impairment of long-lived assets and intangibles, stock-based compensation expense and fair value. The application of these accounting policies involves the exercise of judgment and the use of assumptions as to future uncertainties and, as a result, actual results will differ, and could differ materially, from such estimates.

 

Results of Operations

 

Our Business Segments

 

For the three months ended September 30, 2012, we had two reportable segments which are the basis of our internal financial reporting: SkyWest Airlines and ExpressJet (which reflects the combined operations of Atlantic Southeast and ExpressJet Delaware). On December 31, 2011, we completed the ExpressJet Combination, which ended ExpressJet Delaware’s existence as a separate entity.

 

		2012			2011			$ Change			% Change
		Amount			Amount			Amount			Percent
Operating Revenues:
SkyWest Airlines Operating Revenue		$	475,662		$	524,286		$	(48,624	)	(9.3	)%
ExpressJet Operating Revenues		386,803			428,265			(41,462		)	(9.7	)%
Other Operating Revenues		2,794			2,874			(80		)	(2.8	)%
Total Operating Revenues		$	865,259		$	955,425		$	(90,166	)	(9.4	)%
Airline Expenses:
SkyWest Airlines Expense		$	438,803		$	502,647		$	(63,844	)	(12.7	)%
ExpressJet Expense		388,464			443,614			(55,150		)	(12.4	)%
Other Airline Expense		2,492			2,423			69			2.8	%
Total Airline Expense(1)		$	829,759		$	948,684		$	(118,925	)	(12.5	)%
Segment profit (loss):
SkyWest Airlines segment profit		$	36,859		$	21,639		$	15,220		70.3	%
ExpressJet segment loss		(1,661		)	(15,349		)	13,688			89.2	%
Other profit		302			451			(149		)	(33.3	)%
Total Segment profit (loss)		$	35,500		$	6,741		$	28,759		426.6	%
Interest Income		2,053			2,215			(162		)	(7.3	)%
Adjustment to purchase accounting gain		—			(5,711		)	5,711			N/A
Other		(4,638		)	(5,351		)	713			(13.3	)%
Consolidated Income (Loss) before taxes		$	32,915		$	(2,106	)	$	35,021		N/A

 

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