SKYW

Business Context and Reporting Period

Company: SkyWest, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2011
Business Overview: SkyWest operates the largest regional airline in the United States through subsidiaries SkyWest Airlines, Atlantic Southeast Airlines, and ExpressJet Airlines. The company provides contract and pro-rate flying services for major carriers including Delta, United, Continental, and AirTran. As of March 31, 2011, the fleet consisted of 713 aircraft with approximately 4,000 daily departures.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Operating revenues increased 37.0% year-over-year, driven primarily by the November 2010 acquisition of ExpressJet, which added 244 aircraft and increased capacity by approximately 49%.
• Profitability Decline: Despite revenue growth, the company reported a net loss of $11.1 million compared to a net income of $15.0 million in the prior year. Operating income collapsed from $42.4 million to $0.2 million.
• Expense Increases:
  • Fuel: Fuel expenses rose 72.4% to $126.7 million due to higher fuel prices ($3.33/gallon vs. $2.52/gallon) and increased volume.
  • Maintenance: Maintenance costs increased 52.8% to $163.2 million, attributed to the larger fleet and higher-than-expected costs on scheduled and unplanned events.
  • Salaries: Salaries and wages increased 60.3% to $286.1 million due to a 44.4% increase in full-time equivalent employees.
• Operational Disruptions: Severe weather in Q1 2011 caused approximately 5,000 additional flight cancellations compared to Q1 2010, negatively impacting passenger revenues by an estimated $5.1 million.
• Contract Rate Adjustments: Negotiated rate adjustments with Delta resulted in $7.7 million lower passenger revenues than would have been realized under prior rates.

Outlook, Risks, and Contingencies

• Outlook: Management plans to acquire four additional regional jets and lease eight used CRJ700s in 2011. SkyWest also agreed to operate five CRJ700s for Alaska Airlines. The company expects to fund these acquisitions through operating leases and debt financing.
• Legal Contingencies:
  • Delta Dispute: A long-standing dispute regarding the allocation of liability for irregular operations (IROP) expenses continues. Delta has withheld approximately $25 million (pretax) since 2007. SkyWest has recognized $31.7 million in revenue associated with these withheld funds. Litigation is ongoing in Georgia State Court.
  • ExpressJet Litigation: Shareholder class action suits regarding the ExpressJet merger were settled and dismissed with prejudice in April 2011.
• Market Risks:
  • Fuel: The company bears fuel price risk on pro-rate operations. A hypothetical 25% increase in fuel prices would have increased expenses by $6.1 million for the quarter.
  • Interest Rates: Approximately 35.7% of long-term debt is variable rate. A 1% increase in rates would increase interest expense by $1.7 million, though most of this is passed through to major partners as revenue.
• Liquidity: The company maintains a $25 million line of credit with no outstanding balance. Management believes current working capital is sufficient for the next 12 months.

Investor Verification Checklist

• ExpressJet Integration: Verify the realization of synergies and cost efficiencies from the ExpressJet merger, as operating expenses grew faster than revenue excluding fuel and engine overhauls.
• Delta Dispute Resolution: Monitor the status of the IROP expense litigation with Delta, as the outcome could materially impact cash flows and revenue recognition.
• Fleet Financing: Confirm the terms and availability of financing for the planned acquisition of 12 new aircraft (4 purchases, 8 leases) in 2011.
• Weather Impact: Assess the extent to which Q1 2011 results were skewed by severe weather cancellations versus structural cost increases.
• Contract Rate Stability: Review the impact of the "second-lowest rate" provision in Delta agreements on future revenue margins.