SKYWEST INC - Quarter Report: 2013 September (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

 

For the quarterly period ended September 30, 2013

 

OR

 

 

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.

 

 

 

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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, 2013 (unaudited) and December 31, 2012	3
		Consolidated Statements of Comprehensive Income (unaudited) for the three and nine months ended September 30, 2013 and 2012	5
		Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2013 and 2012	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	30
	Item 4.	Controls and Procedures	30
PART II	OTHER INFORMATION:		31
	Item 1.	Legal Proceedings	31
	Item 1A.	Risk Factors	32
	Item 6.	Exhibits	32
		Signatures	33
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)

 

 

 

		September 30, 2013			December 31, 2012
		(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	267,746		$	133,772
Marketable securities		440,468			556,117
Restricted cash		19,559			19,553
Receivables, net		94,806			130,102
Inventories, net		132,871			113,581
Prepaid aircraft rents		335,379			325,999
Deferred tax assets		160,974			124,320
Other current assets		27,799			30,596
Total current assets		1,479,602			1,434,040
PROPERTY AND EQUIPMENT:
Aircraft and rotable spares		4,049,227			3,997,926
Deposits on aircraft		35,629			—
Buildings and ground equipment		279,164			274,085
		4,364,020			4,272,011
Less accumulated depreciation and amortization		(1,699,768		)	(1,561,015		)
Total property and equipment, net		2,664,252			2,710,996
OTHER ASSETS
Intangible assets, net		15,560			17,248
Other assets		105,980			92,353
Total other assets		121,540			109,601
Total assets		$	4,265,394		$	4,254,637

 

See accompanying notes to condensed consolidated financial statements.

 

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SKYWEST, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands)

 

		September 30,			December 31,
		2013			2012
		(unaudited)
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt		$	174,962		$	171,454
Accounts payable		231,380			222,671
Accrued salaries, wages and benefits		126,677			121,352
Accrued aircraft rents		8,725			12,745
Taxes other than income taxes		20,761			22,353
Income tax payable		405			1,255
Other current liabilities		41,247			39,595
Total current liabilities		604,157			591,425
OTHER LONG-TERM LIABILITIES		75,544			57,422
LONG-TERM DEBT, net of current maturities		1,349,209			1,470,568
DEFERRED INCOME TAXES PAYABLE		725,613			657,620
DEFERRED AIRCRAFT CREDITS		83,419			90,427
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Preferred stock, 5,000,000 shares authorized; none issued		—			—
Common stock, no par value, 120,000,000 shares authorized; 77,322,304 and 76,713,154 shares issued, respectively		617,701			609,763
Retained earnings		1,191,265			1,147,117
Treasury stock, at cost, 26,095,636 and 25,280,364 shares, respectively		(382,950		)	(371,211		)
Accumulated other comprehensive income		1,436			1,506
Total stockholders’ equity		1,427,452			1,387,175
Total liabilities and stockholders’ equity		$	4,265,394		$	4,254,637

 

See accompanying notes to condensed consolidated financial statements.

 

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SKYWEST, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

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

(Unaudited)

 

 

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2013			2012			2013			2012
OPERATING REVENUES:
Passenger		$	836,890		$	848,578		$	2,448,883		$	2,671,568
Ground handling and other		13,850			16,681			44,474			52,079
Total operating revenues		850,740			865,259			2,493,357			2,723,647
OPERATING EXPENSES:
Salaries, wages and benefits		306,887			297,106			904,625			878,596
Aircraft maintenance, materials and repairs		176,822			163,825			515,506			510,610
Aircraft rentals		80,928			82,592			245,330			251,438
Depreciation and amortization		61,135			62,703			183,309			191,200
Aircraft fuel		49,656			71,477			146,139			372,471
Station rentals and landing fees		29,473			45,336			100,559			133,523
Ground handling services		30,541			28,414			98,235			93,344
Other		59,124			58,832			177,363			170,228
Total operating expenses		794,566			810,285			2,371,066			2,601,410
OPERATING INCOME		56,174			54,974			122,291			122,237
OTHER INCOME (EXPENSE):
Interest income		567			2,053			3,164			6,049
Interest expense		(16,999		)	(19,474		)	(52,490		)	(58,641		)
Other, net		4,625			(4,638		)	10,477			(9,305		)
Total other expense, net		(11,807		)	(22,059		)	(38,849		)	(61,897		)
INCOME BEFORE INCOME TAXES		44,367			32,915			83,442			60,340
PROVISION FOR INCOME TAXES		17,973			11,982			33,094			23,129
NET INCOME		$	26,394		$	20,933		$	50,348		$	37,211
BASIC EARNINGS PER SHARE		$	0.51		$	0.41		$	0.97		$	0.73
DILUTED EARNINGS PER SHARE		$	0.50		$	0.40		$	0.96		$	0.72
Weighted average common shares:
Basic		51,881			51,241			51,841			51,022
Diluted		52,610			52,153			52,551			51,608
Dividends declared per share		$	0.04		$	0.04		$	0.12		$	0.12
COMPREHENSIVE INCOME:
Net income		$	26,394		$	20,933		$	50,348		$	37,211
Proportionate share of other companies foreign currency translation adjustment, net of taxes		67			(375		)	67			(264		)
Net unrealized appreciation (depreciation) on marketable securities, net of taxes		363			88			(137		)	536
TOTAL COMPREHENSIVE INCOME		$	26,824		$	20,646		$	50,278		$	37,483

 

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
		2013			2012
NET CASH PROVIDED BY OPERATING ACTIVITIES		$	251,406		$	244,167
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities		(328,442		)	(513,574		)
Sales of marketable securities		443,950			428,195
Proceeds from the sale of equipment		270			3,630
Acquisition of property and equipment:
Aircraft and rotable spare parts		(70,246		)	(35,164		)
Deposits on aircraft		(35,629		)	—
Buildings and ground equipment		(8,847		)	(3,341		)
Decrease (Increase) in other assets		12,948			(739		)
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES		14,004			(120,993		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on long-term debt		(117,850		)	(113,502		)
Tax benefit (deficiency) from exercise of common stock options		(150		)	206
Net proceeds from issuance of common stock		4,510			4,076
Purchase of treasury stock		(11,739		)	(902		)
Payment of cash dividends		(6,207		)	(6,120		)
NET CASH USED IN FINANCING ACTIVITIES		(131,436		)	(116,242		)
Increase in cash and cash equivalents		133,974			6,932
Cash and cash equivalents at beginning of period		133,772			129,526
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	267,746		$	136,458
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid (received) during the year for:
Interest, net of capitalized amounts		$	50,479		$	54,858
Income taxes		$	2,509		$	(1,440	)

 

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

 

Basis of Presentation

 

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, 2012.  The results of operations for the three and nine-month periods ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.

 

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, the Company’s subsidiary, ExpressJet Airlines, Inc., a Delaware corporation, was merged into the Company’s subsidiary, Atlantic Southeast Airlines, Inc., a Utah corporation, with the surviving corporation named ExpressJet Airlines, Inc. (the “ExpressJet Combination”).  In these notes to condensed consolidated financial statements, “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.

 

Recent Accounting Standards

 

Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income

 

Recently issued accounting guidance revises the reporting of items reclassified out of accumulated other comprehensive income and is effective for fiscal years beginning after December 15, 2012. We adopted this guidance during the quarter ended March 31, 2013, and have determined that the balance and the activity during the three and nine- month periods ended September 30, 2013 in accumulated other comprehensive income was not material.

 

Note B — Passenger and Ground Handling Revenues

 

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”), 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. Other ancillary revenues commonly associated with airlines such as baggage fee revenue, ticket change fee revenue and the marketing component of the sale of mileage credits are retained by the Company’s major airline partners on flights that the Company operates under its code-share and pro-rate agreements.

 

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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 that were activated during 2010 and are scheduled to continue each fifth year thereafter. In addition to its 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.

 

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 the 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 rates 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.

 

During 2012, the Company reached an agreement with Delta to add 34 additional used dual-class Bombardier regional jet aircraft that were previously operated for Delta by other regional carriers in exchange for the early termination of 66 Bombardier CRJ200 regional jet aircraft (“CRJ200s”) under the SkyWest Airlines and ExpressJet Delta Connection Agreements. The 34 additional dual-class aircraft are subleased from Delta for a nominal amount. The 34 additional dual-class aircraft consist of 29 Bombardier CRJ900 regional jet aircraft (“CRJ900s”) and five Bombardier CRJ700 regional jet aircraft (“CRJ700s”). As of September 30, 2013, the Company had taken delivery of 29 CRJ900s and five CRJ700s. The Company anticipates that all 66 CRJ200 aircraft will be removed from service under 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, and are scheduled to be returned to Delta without obligation to the Company.

 

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).

 

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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 May 16, 2013, SkyWest Airlines and United entered into a United Express Agreement to operate 40 new Embraer E175 dual-class regional jet aircraft. Under the agreement, it is anticipated that the 40 aircraft will be introduced into service in the second quarter of 2014, with deliveries continuing to mid-2015. The United Express Agreement has a 12-year term for each of the aircraft subject to the agreement, and other terms which are generally consistent with the SkyWest Airlines United Express Agreement.

 

On February 1, 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 for each of the aircraft subject to the agreement, and other terms which are generally consistent with the SkyWest Airlines United Express Agreement.

 

On December 1, 2009, ExpressJet Delaware and United 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 during the term of the agreement, the Company calculates the incentives achieved during the month and recognizes revenue accordingly.  As of September 30, 2013, ExpressJet operated 22 Embraer 145  ERJs under the United Express Agreement, which is scheduled to expire in April 2015.

 

United Capacity Purchase Agreement

 

Effective November 12, 2010, ExpressJet Delaware entered into a Capacity Purchase Agreement with Continental Airlines, Inc. (“Continental”), to which United became a party pursuant to its merger with Continental in 2010 (the “United CPA”). Pursuant to the United CPA, ExpressJet Delaware agreed to provide regional airline service in the Continental (now United) flight system. Under the terms of the United CPA, to which ExpressJet succeeded as a party through the ExpressJet Combination, ExpressJet operates 229 aircraft in the United flight system and United 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 United CPA. Additionally, ExpressJet may earn incentive compensation upon achievement of certain operating performance criteria, but is subject to financial penalties if it fails to achieve minimum operating performance criteria. At the end of each month during the term of the agreement, the Company calculates the incentives achieved during the month under the United 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 during the term of the agreement, 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

 

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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 during the term of the agreement, the Company calculates the incentives achieved during the quarter from the US Airways Express Agreement and recognizes revenue accordingly.

 

American Agreement

 

In September 2012, SkyWest Airlines and ExpressJet each entered into a Capacity Purchase Agreement with American (collectively, the “American Agreements”), which sets forth the terms and conditions governing the American Eagle operations conducted by SkyWest Airlines and ExpressJet, respectively. SkyWest Airlines placed 12 CRJ200s into service for American on November 14, 2012, and ExpressJet placed 11 CRJ200s into service for American on February 14, 2013. The aircraft flown under the American Agreements have been removed from flying contracts SkyWest Airlines and ExpressJet had with another major partner. The term of each American Agreement is four years. The American Agreements provide for SkyWest Airlines and ExpressJet to be compensated primarily on a fee-per-completed-block hour and departure basis and to be reimbursed for fuel and other costs. The American Agreements also provide for SkyWest Airlines and ExpressJet to receive incentive compensation upon each airline’s achievement of certain performance criteria, but also impose financial penalties if the airline fails to achieve minimum performance criteria. The incentives are defined in the American Agreements as being measured and determined on a quarterly basis. At the end of each quarter during the term of the agreement, the Company calculates the incentives achieved during the quarter from the American Agreements and recognizes 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 its major partners, 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. Other revenue primarily consists of revenue attributed to ground handling services the Company provides for other airlines.

 

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, 2013, the Company granted options to purchase 173,558 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, 2013.

 

Expected annual dividend rate		1.21		%
Risk-free interest rate		0.92		%
Average expected life (years)		6.0
Expected volatility of common stock		0.446
Forfeiture rate		0.00		%
Weighted average fair value of option grants		$	5.04

 

During the nine months ended September 30, 2013, the Company granted 284,026 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, 2013, the Company granted 27,492 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 $13.24 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.  For each of the three-month periods ended September 30, 2013 and 2012, respectively, the Company recorded pre-tax share-based compensation expense of $1.1 million. For each of the nine month periods ended September 30, 2013 and 2012, respectively, the Company recorded pre-tax share-based compensation expense of $3.6 million.

 

Note D — Net Income Per Common Share

 

Basic net income per common share (“Basic EPS”) excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share (“Diluted EPS”) reflects the

 

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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 per common share.  During the three months ended September 30, 2013 and 2012, options to acquire 3,164,000 and 3,945,000 shares, respectively, were excluded from the computation of Diluted EPS as their impact was anti-dilutive. During the nine months ended September 30, 2013 and 2012, options to acquire 3,300,000 and 3,963,000 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,
		2013			2012			2013			2012
		(Unaudited)						(Unaudited)
Numerator
Net Income		$	26,394		$	20,933		$	50,348		$	37,211
Denominator
Weighted average number of common shares outstanding		51,881			51,241			51,841			51,022
Effect of outstanding share-based awards		729			912			710			586
Weighted average number of shares for diluted net income per common share		52,610			52,153			52,551			51,608
Basic earnings per share		$	0.51		$	0.41		$	0.97		$	0.73
Diluted earnings per share		$	0.50		$	0.40		$	0.96		$	0.72

 

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 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. The following table sets forth the Company’s segment data for the three-month periods ended September 30, 2013 and 2012 (in thousands).

 

		Three months ended September 30, 2013
		SkyWest Airlines		ExpressJet		Other		Consolidated
Operating revenues		468,517		381,749		474		850,740
Operating expense		409,320		382,583		2,663		794,566
Depreciation and amortization expense		38,845		22,290		—		61,135
Interest expense		10,812		5,274		913		16,999
Segment profit (loss)(1)		48,385		(6,108	)	(3,102	)	39,175
Identifiable intangible assets, other than goodwill		—		15,560		—		15,560
Total assets		2,711,009		1,554,385		—		4,265,394
Capital expenditures (including non-cash)		21,977		8,891		—		30,868

 

		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)		11,579		4,601		—		16,180

 

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

 

The following table sets forth the Company’s segment data for the nine-month periods ended September 30, 2013 and 2012 (in thousands).

 

		Nine months ended September 30, 2013
		SkyWest Airlines		ExpressJet		Other		Consolidated
Operating revenues		1,380,930		1,109,085		3,342		2,493,357
Operating expense		1,236,003		1,128,757		6,306		2,371,066
Depreciation and amortization expense		116,309		67,000		—		183,309
Interest expense		33,535		16,099		2,856		52,490
Segment profit (loss)(1)		111,392		(35,771	)	(5,820	)	69,801
Identifiable intangible assets, other than goodwill		—		15,560		—		15,560
Total assets		2,711,009		1,554,385		—		4,265,394
Capital expenditures (including non-cash)		66,339		28,242		—		94,581

 

		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)		47,933		13,141		—		61,074

 

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

 

Note F — Commitments and Contingencies

 

As of September 30, 2013, the Company leased 571 aircraft, as well as airport facilities, office space, and various other property and equipment under non-cancelable operating leases which are generally on a long-term net rent basis where the Company pays taxes, maintenance, insurance and certain other operating expenses applicable to the leased property.  The Company expects that, in the normal course of business, such operating leases that expire will be renewed or replaced by other leases.  The following table summarizes future minimum rental payments required under operating leases that had initial or remaining non-cancelable lease terms in excess of one year as of September 30, 2013 (in thousands):

 

October through December 2013		$	113,776
2014		381,088
2015		326,777
2016		255,287
2017		192,853
Thereafter		722,172
		$	1,991,953

 

Commitments.  On May 21, 2013, the Company announced that it entered into an agreement with Embraer for the purchase of 100 new E175 dual-class regional jet aircraft. Of the 100 aircraft, 40 are considered firm deliveries and the remaining 60 aircraft are considered conditional until the Company enters into capacity purchase agreements with other major airlines to operate the aircraft.  The Company anticipates taking delivery of the 40 firm aircraft in March 2014 and has scheduled delivery of the remaining aircraft covered by the order through August 2015. The table below summarizes the Company’s firm commitments as of September 30, 2013, which primarily relate to the acquisition of aircraft and related spare engines that are considered firm deliveries (in thousands):

 

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2014		$	569,640
2015		591,368
2016		9,972
		$	1,170,980

 

Note G — Fair Value Measurements

 

The Company holds certain assets that are required to be measured at fair value in accordance with United States 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, 2013 and December 31, 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, 2013
		Total			Level 1			Level 2			Level 3
Marketable Securities
Bond and bond fund		$	440,270		$	—		$	440,270		$	—
Asset backed securities		198			—			198			—
		440,468			—			440,468			—
Cash, Cash Equivalents and Restricted Cash		287,305			287,305			—			—
Other Assets (a)		2,245			—			—			2,245
Total Assets Measured at Fair Value		$	730,018		$	287,305		$	440,468		$	2,245

 

		Fair Value Measurements as of December 31, 2012
		Total			Level 1			Level 2			Level 3
Marketable Securities
Bonds and bond funds		$	552,289		$	—		$	552,289		$	—
Commercial paper		3,514			—			3,514			—
Asset backed securities		314			—			314			—
		556,117			—			556,117			—
Cash, Cash Equivalents and Restricted Cash		153,325			153,325			—			—
Other Assets (a)		3,844			—			—			3,844
Total Assets Measured at Fair Value		$	713,286		$	153,325		$	556,117		$	3,844

(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, 2013.  The Company’s policy regarding the recording of transfers between levels is to record any such transfers at the end of the reporting period.

 

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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, 2013 (in thousands):

 

Fair Value Measurements Using Significant Unobservable Inputs

(Level 3)

 

		Auction Rate Securities
Balance at January 1, 2013		$	3,844
Total realized and unrealized gains or (losses)
Included in earnings		—
Included in other comprehensive income		(71		)
Transferred out		—
Settlements		(1,528		)
Balance at September 30, 2013		$	2,245

 

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 $1,574.6 million and $1,744.2 million as of September 30, 2013 and December 31, 2012, respectively, as compared to the carrying amounts of $1,524.2 million and $1,642.0 million as of September 30, 2013 and  December 31, 2012, respectively. .

 

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, 2013, the Company’s investment balance in TRIP was $19.1 million. In connection with the investment in TRIP, the Company entered into a put option agreement with the majority shareholder of TRIP that allowed 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 is prohibited from transferring the TRIP shares until all 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 for financial reporting purposes. As a result, the Company intends to 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, 2013, the Company had received the first two installment payments totaling $26.2 million. These payments were recorded as an “Other Long-Term Liability” on the Company’s consolidated balance sheet. The third installment payment is due July 12, 2014 for an amount of $16.8 million. The last installment payment 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 the financial performance of Trip Investimentos in its financial statements.

 

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. During the three months ended September 30, 2013, the Company sold its shares of Air Mekong.  In conjunction with the sale of its shares, the Company recognized a gain of $5.0 million, which is reflected in other income in the Consolidated Statements of Comprehensive Income.

 

Note I — Legal Matters

 

The Company is subject to certain legal actions which it considers routine to its business activities. As of September 30, 2013, management believed, after consultation with legal counsel, that the ultimate outcome of such legal matters is not likely to have

 

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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 (now ExpressJet), and has disputed subsequent billings for IROP expenses. 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. 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. As of September 30, 2013, the Company had recognized a cumulative total of $31.7 million of revenue associated with the funds withheld by Delta prior to July 1, 2008.

 

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 has concluded. On July 19, 2013, the parties filed cross motions for partial summary judgment. SkyWest Airlines and ExpressJet filed a motion for partial summary judgment on their claim for voluntary payment. Delta filed a motion for partial summary judgment on all of SkyWest’s and ExpressJet’s claims, for partial summary judgment on the issue of damages, and for spoliation sanctions. Briefing of the cross motions is complete, but the State Court has not yet set a hearing date for the motions. SkyWest and ExpressJet intend to oppose Delta’s motions and continue to vigorously pursue their claims set forth in the State Court Complaint.

 

As of September 30, 2013, the Company’s estimated range of reasonably possible loss related to the dispute was $0 to $25.8 million.

 

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, 2013 and 2012. Also discussed is our financial position as of September 30, 2013 and December 31, 2012. You should read this discussion in conjunction with our condensed consolidated financial statements for the three and nine-month periods ended September 30, 2013, 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

 

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“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 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 our outlook, the revenue environment, our contract relationships, and our expected financial performance.  These statements include, but are not limited to, statements about our future growth and development plans, including our future financial and operating results, our plans for SkyWest Airlines and ExpressJet, our 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 our existing beliefs about present and future events outside of our 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, our 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 we are 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.  We assume 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, 2013, 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, 2013, we operated a combined fleet of 756 aircraft consisting of the following:

 

		CRJ200		ERJ145		ERJ135		CRJ700		CRJ900		EMB120		Total
United		92		242		9		70		—		35		448
Delta		129		—		—		60		60		8		257
American		23		—		—		—		—		—		23
US Airways		11		—		—		—		4		—		15
Alaska		—		—		—		5		—		—		5
Subleased to an un-affiliated entity		2		—		—		—		—		—		2
Unassigned		6		—		—		—		—		—		6
Total		263		242		9		135		64		43		756

 

For the nine months ended September 30, 2013, approximately 60.8% of our aggregate capacity was operated for United, approximately 34.0% was operated for Delta, approximately 2.4% was operated for American, approximately 1.6% was operated for US Airways, and approximately 1.2% was operated for Alaska.

 

Under a fixed-fee flying arrangement, the major airline generally pays the regional airline a fixed fee for each departure, with additional incentives based on completion of flights, on-time performance and baggage handling performance. In addition, the major and regional airline often enter into an arrangement pursuant to which the major airline bears the risk of changes in the price of fuel and other such costs that are passed through to the major airline partner. Regional airlines benefit from a fixed-fee arrangement because they are sheltered from many of the elements that could cause volatility in airline financial performance, including variations in ticket prices, passenger loads and fuel prices. However, regional airlines in fixed-fee arrangements do not benefit from positive trends in ticket prices, passenger loads or fuel prices and, because the major airline absorbs many of the costs associated with the regional airline flight, the margin between the fixed fees for a flight and the expected per-flight costs tends to be smaller than the margins associated with revenue-sharing arrangements.

 

Under our fixed-fee arrangements, two compensation components have a significant impact on comparability of revenue and operating expense for the periods presented in this Report. One item is the reimbursement of fuel expense, which is a directly-reimbursed expense under all of our fixed-fee arrangements. Our major partners reimburse us for fuel expense incurred under each respective fixed-fee contract, and we record such reimbursement as passenger revenue. Thus, the price volatility of fuel and the volume of fuel expensed under our fixed-fee arrangements during a particular period will impact our fuel expense and our passenger revenue during the period equally, with no impact on our operating income.  Over the past few years, some of our major airline

 

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partners have purchased an increased volume of fuel directly from vendors on flights we operated under our flying contracts, which also impacts the comparability of revenue and operating expense for the periods presented in this Report.

 

The second item is the compensation we receive for engine maintenance under our fixed-fee arrangements. Under our United, American, US Airways and Alaska flying contracts, a portion of our compensation is based upon fixed hourly rates, which is intended to compensate us for engine maintenance costs (“Fixed-Rate Engine Contracts”). Under the compensation structure for our Delta Connection and United CPA flying contracts, our major partner reimburses us for engine maintenance expense when the expense is incurred (“Directly-Reimbursed Engine Contracts”). We use the direct-expense method of accounting for our CRJ200 regional jet aircraft engine overhaul costs and, accordingly, we recognize engine maintenance expense on our CRJ200 engines on an as-incurred basis. Under the direct-expense method, the maintenance liability is recorded when the maintenance services are performed (“CRJ200 Engine Overhaul Expense”).

 

Because we use the direct-expense method of accounting for our CRJ200 engine expense, and because we recognize revenue using the applicable fixed hourly rates under our Fixed-Rate Engine Contracts, the number of engine maintenance events and related expense we incur each reporting period under the Fixed-Rate Engine Contracts has a direct impact on the comparability of our operating income for the presented reporting periods.

 

Because we recognize revenue at the same amount and in the same period when we incur engine maintenance expense on engines operating under our Directly-Reimbursed Engine Contracts, the number of engine events and related expense we incur each reporting period does not have a direct impact on the comparability of our operating income for the presented reporting periods.

 

We have an agreement with a third-party vendor to provide long-term engine maintenance covering scheduled and unscheduled repairs for engines on our CRJ700s operating under our Fixed-Rate Engine Contracts (a “Power by the Hour Agreement”). Under the terms of the Power by the Hour Agreement, we are obligated to pay a set dollar amount per engine hour flown on a monthly basis and the vendor assumes the obligation to repair the engines at no additional cost to us, subject to certain specified exclusions. Thus, under the Power by the Hour Agreement, we expense the engine maintenance costs as flight hours are incurred on the engines and using the contractual rate set forth in the agreement. Because we record engine maintenance expense based on the fixed hourly rate pursuant to the Power by the Hour Agreement on our CRJ700s operating under our Fixed-Rate Engine Contracts, and because we recognize revenue using the applicable fixed hourly rates under our Fixed-Rate Engine Contracts, the number of engine events and related expense we incur each reporting period does not have a direct impact on the comparability of our operating income for the presented reporting periods. The table below summarizes how we are compensated by our major partners under our flying contracts for engine expense and the method we use to recognize the corresponding expense.

 

Flying Contract		Compensation of Engine Expense		Expense Recognition
SkyWest Delta Connection		Directly-Reimbursed Engine Contracts		Direct Expense Method
ExpressJet Delta Connection		Directly-Reimbursed Engine Contracts		Direct Expense Method
SkyWest United Express (CRJ200)		Fixed-Rate Engine Contracts		Direct Expense Method
SkyWest United Express (CRJ700)		Fixed-Rate Engine Contracts		Power by the Hour Agreement
SkyWest United Express (EMB120)		Fixed-Rate Engine Contracts		Deferral Method
ExpressJet United Express (CRJ200)		Fixed-Rate Engine Contracts		Direct Expense Method
ExpressJet United Express (ERJ145)		Fixed-Rate Engine Contracts		Power by the Hour Agreement
ExpressJet United CPA		Directly-Reimbursed Engine Contracts		Power by the Hour Agreement
Alaska Agreement		Fixed-Rate Engine Contracts		Power by the Hour Agreement
American Eagle Agreement (CRJ200)		Fixed-Rate Engine Contracts		Direct Expense Method
US Airways Express (CRJ200)		Fixed-Rate Engine Contracts		Direct Expense Method

 

Historically, multiple contractual relationships with major airlines 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, 2013, 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 $850.7 million for the three months ended September 30, 2013, a 1.7% decrease, compared to revenues of $865.3 million for the three months ended September 30, 2012. We had a net income of $26.4 million, or $0.50 per diluted share,

 

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