SkyWest continues rocky period with minuscule profit on nearly USD1 billion in revenues

The situation is so serious that it prompted Chair and CEO Jerry Atkin to weigh in to assure the company had a battle plan for turning the situation around. Mr Atkin, the only post-deregulation founding father to remain in place, usually does not comment, but it is clear the company is bringing all forces to bear to arrest what can easily be called a train wreck when compared to decades of outstanding growth and profitability.

One thing is clear: just as the legacy and low-cost carriers have completely restructured, they are now forcing regional carriers to do the same.

President Brad Rich echoed Mr Atklin assuring that executives have a strong action plan that will return it to “meaningful and sustained profitability.”

Ominously, it remains in the red for 2011 having lost USD9.3 million compared to a profit in the first nine months of 2010 when it earned USD59.1 million. However, the large swings in its revenues and expenses are expected to moderate in the fourth quarter and in 2012 as the company has stabilized its hiring and training issues that cost it USD9.7 million in the third quarter just as it did in the first two quarters.

CFO Mike Kraupp reported the cost savings anticipated in the third quarter were, indeed, met but were offset by other cost challenges resulting in a USD2.2 million pre-tax loss compared to USD29.2 million of pre-tax income for 3Q2010.

The market is growing impatient with the losses, questioning whether contract provisions need to be enforced. But the market has also applauded the quarterly results of the offending mainline carriers, especially on their capacity discipline. One member of the public rightly suggested Delta was using SkyWest to flex their capacity seasonally, which is wreaking havoc with the regional company’s profitability. SkyWest’s statement described a USD5.3 million drop in revenues as the result of “applications of provisions” in the CPA contract.

“You have described the problem well,” said Mr Atkin in response to the suggestions about Delta’s actions. “The utilisation on the smaller aircraft is a challenge that is not defined extremely well in the contracts about how those rates change when the utilisation moves. We are talking to our partners about alternatives to that which would allow some flexibility”

On the operational side, there seems there is little the company can do. “There are some things you can do within a range in terms of vacations and the way we manage the labour force but when the difference between the high and low months is greater than 15% you’ve got carrying costs because of training to get people from the left seat to the right seat. It is a question of whether it is worth it in the time frame you might need them. That takes about two to three months and then you need them back. It is a practical problem that we have not solved yet and we are talking with our major partners. We know what needs to be done but it could be a persistent challenge for the future.”

See related story Delta aggression on capacity cuts earns kudos, to bring CASM to 2010 levels

Fleet renewal underway

In a surprise, SkyWest, which has consistently said it thinks there is still life for 50-seat aircraft, said it is currently negotiating with regional aircraft manufacturers to upgrade its fleet. This was first mention of the plans for what will likely be a large order although the company would not detail the aircraft or the timing. It did say it issued its RFP in Jan-2011. Some 506 of its 724-aircraft fleet are 50-seat aircraft, including 264 CRJ 200s and 242 ERJ 145s.

Mr Rich indicated the RFP was prompted by the timing of its CPA contract expirations and/or the underlying financial obligations on the aircraft. The company has always tried to time lease or financial obligations to the expiration of CPA contracts.

“We have to begin now to plan a very significant fleet replacement,” he said. “This will be a seven-to-eight year project. We’ve been working diligently and aggressively on this program but we are not ready for a firm decision because we are still in negotiation with the manufacturers.”

However, he then offered up an intriguing hint of what SkyWest was doing with its fleet replacement. Noting the size of the fleet needing to be replace, he suggested that might provide leverage for the airline in negotiations. In addition, he said, “there are things we are trying to do that we think different than what is currently being done in the market. We want a complete change of the model in how we buy and maintain aircraft.”

Rising maintenance costs have been plaguing the airline for some time and the third quarter was no different when it incurred USD10.7 million in additional United CRJ 200 engine overhaul costs. It incurred another USD6.7 million in additional maintenance costs related to aircraft paint, parts and airframe heavy checks. The increased paint expense is related to the change of livery after the Delta/Northwest and United/Continental merger.

Problems outlined

The magnitude of the company’s problems were outlined by Mr Atkin, who said it was a combination of over confidence in its ability to both acquire an airline, ExpressJet, and run both Atlantic Southeast Airlines (ASA) and ExpressJet with high operational fidelity.

“The timing for ASA as the acquirer was less than ideal and stretched its capability,” he said. “Having said that both ASA And ExpressJet have steadily improved and have been operating at a  high level for the past three months.”

The staffing and utilisation problems resulted in all three airlines missing performance targets meaning the company also missed on the performance incentives forcing it to leave money on the table.

The company is expecting between USD60-65 million in total synergy savings from the integration and has now realized about USD30 million in annual, run-rate savings. However, achieving additional savings is dependent on the single operating certificate (SOC) as well as hammering out collective bargaining agreements that could take some time. The same stumbling block is hampering the Southwest/AirTran and United/Continental mergers. For that reason, Mr Atkin said the full integration will probably take a year longer than anticipated.

While the company is still on track to gain its SOC, expected on 15-Nov, the fastest process of this type in the industry, said Mr Rich, the integration will also cost more than originally anticipated. Even so, it expects to begin operating ASA and ExpressJet as ExpressJet on 1-Jan-2012.

Mainline partners causing major problems

Besides the integration and operational problems, Mr Atkin also pointed to problems with its mainline partners that have forced higher costs and lower utilization. While trying to remain diplomatic, the company seemed to be shifting its stance with respect to partners.

SkyWest has always rolled with whatever punches partners threw its way. Their message was, given unanticipated changes, they just had to align costs to those changes. However, observers were signaling it was time for a little push back, especially toward Delta.

Mr Kraupp noted the USD5.3 million decline in revenues resulted from Delta imposing its second lowest rate provision in its Delta contract.

Delta has been hammering all its regional partners since 2008 but Delta is still a large part of SkyWest Airlines' business. SkyWest Airlines serves 95 points for Delta with 548 daily departures. Still its United Express operation is larger at 171 destinations and 1,098 daily departures. ASA, with 829 daily departures, does not break out its individual CPA points and daily departures but Delta is by far its major partner. Nor does it break out the size of ExpressJet’s CPAs but the vast majority of its service, if not all, serves Continental at its main hubs at Houston, Newark, Chicago and Cleveland with 1,217 departures.

Diversifying the portfolio

The acquisition of ExpressJet, which Mr Atkin called a strategic move which continues to hold promise, then gives balance to the Atlanta subsidiary and, perhaps, even some leverage as SkyWest Airlines, Inc negotiates. The goal in acquiring ExpressJet was to diversify its CPA portfolio and it seemed to do just that by adding Continental to the mix. Ironically, is is back to two major partners with the United/Continental merger and its new business with US Airways and Alaska also part of that effort. However, those contracts are minuscule by comparison and is continues to need diversification.

Acquiring American Eagle, which is being divested by AMR, would seem to meet that goal but, with the acquisition and integration problems surrounding ExpressJet, this is hardly an auspicious time to add to the problems at the company.

In talks with partners

The company is renegotiating some issues and has even dropped 12 CRJ 700 Delta Connection flying when the five-year contract expired. That business transferred to GoJet. That included four lines of SkyWest Airlines flying and eight at ASA. Mr Rich indicated that renewing the contracts at the same rate, which he delicately described as “not the been most productive contract,” was not appropriate.

“One of the things we need to do is exercise more discipline on fleet decisions rather than just going after the business and this was one of those times,” he said.

Key goals in its action plan is increasing aircraft utilisation, according to Mr Rich. He explained the bid rates used in contracts include a grouping of expenses that the company views as controllable costs amounting to about USD2 billion annually. That means it is focused on reducing those expenses as well as increasing the utilisation of all its assets, particularly aircraft.

That, however, cannot be done on its own and needs the cooperation of codesharing partners which is expected to make negotiations very challenging.

“There is a direct correlation between crew-related issues and the impact on operational performance and realization of incentive dollars,” he said. “Stabilising the crew and issues relative to unplanned growth of SkyWest Airlines, will address that issue but there is nothing we can do other than improve operational performance which has already been done given the significant improvement in September and October.” 

Offsetting the loss of the business that went to GoJet is a new agreement with US Airways. The new flying includes 15 CRJ 200s, set to begin 1-Dec-2011. It is sourcing the aircraft internally.

“The second issue is accommodating our major partners at a time of higher fuel with lower daily utilization in off peak which still quite high in peak season,” Mr Atkin told analysts. “The lower and greater variation in utilization caused higher costs that weren’t anticipated in our current rate arrangement and we are working on ways to mitigate that short fall.”

Crew costs and training smoothing out

The third issue facing the company is related to the second and deals with preparing for northern hemisphere summer 2011. “We increased our flying capacity aggressively going into the summer at all three companies and relied on more overtime and more aggressive training to keep up, which added more costs than normal for late spring and early summer. We have mostly caught up and we’ll plan better and more smoothly in the future. We’ve booked some business that will continue for some time.”

The USD9.7 million cost of the crew training issues are expected to moderate in the fourth quarter compared to 3Q2011 now that the hiring binge to meet higher than expected current and forecast block-hour production is over. Maintenance is also expected to moderate in the fourth quarter as CRJ 200 engine overhauls go down. Also, costs related to ASA and ExpressJet integration are expected to drop as they achieve a single operating certificate. Mr Rich indicated a key goal was eliminating the negative variances in crew-related costs.

The issue has been an ongoing problem this year and last, but ASA President Brad Holt reported the companies are now staffed up from the flight crew standpoint and is now running normally. “The associated costs with the training will normalise in the fourth quarter and we don’t expect that to differ in 2012. The turnover in other departments tapered off toward the end of the spring and we are in good shape now.”

Mr Atkin told analysts that the 2012 results will be better than in 2011 but not until the second half. However, he anticipates a notable improvement in 2013 over 2012. Part of that can be attributed to the end of the mismatch in maintenance expenses, which will end in 2013.

The mounting headwinds which began in 2010 and, this year, conspired to create its first quarterly loss since 1987, has seriously impacted the stellar reputation of one of the nation’s oldest and best run airlines. It has gone from an airline consistently making between 8-10% margins to where it is today and Mr Atkin acknowledged that.

“I have high confidence in our team and believe we are making significant progress in improving our financial results while remaining in the strongest position in the regional airlines industry,” he concluded, noting that many of the factors contributing the 2011 performance were a surprise to the company. “I’m confident we can execute on our plan and leadership is focused on the right priorities and certainly wiser and more capable than a year ago.”

Hits keep coming

Operating revenues increased substantially up from USD686.9 million posted in 3Q2010, before ExpressJet was acquired in Nov-2010 which contributed USD243.1 million.

This year has not been good for SkyWest as it restructures operations. It also incurred USD10.7 million in addition engine overhaul costs for a total cost of USD28.2 million compared to the USD17.5 million in the year-ago period. The costs were incurred on its aging United Express 50-seat CRJ 200 fleet and also resulted in USD6.7 million in additional maintenance related to aircraft paint, parts and airframe heavy checks. The painting resulted from new liveries from both United and Delta and will largely be complete in the first half of 2012. However, the company was reimbursed approximately USD9.6 million and USD8.5 million under its CPA with United in the third quarter of 2011 and 2010, respectively.

It is integrating ExpressJet into Atlantic Southeast Airlines and incurred a USD7 million pre-tax loss from ExpressJet operations. At the same time, it recorded a USD5.7 million downward adjustment to the ExpressJet acquisition accounting in connection with the preparation of the 2010 tax return.

In addition, its investment in Trip Linhas Aereas and Mekong Aviation Joint Stock Company, known as Air Mekong, resulted in USD4.8 million in losses. Previously, SkyWest cited the start up losses for Air Mekong but this time it said Trip was also incurring losses on its aggressive growth rate, according to CFO Mike Kraupp, who said the investments lost USD3.8 million for Trip and USD1.7 million coming from Air Mekong. 

Mr Rich noted Trip’s growth rate was higher than expected and it is aggressively taking additional aircraft and ramping up growth. “The financial results were less than expected but the other issue you have to keep in mind is Trip is very seasonal,” he said. “We will continue to evaluate these operations and contract provisions make it easy to make changes. We’ll do that if we think it is appropriate.”

Amidst all the grim news was a USD6 million increase in its pre-tax results from its pro-rate operations which has been gaining in strength in the last year. It has a total of 57 aircraft in the operation including 21 CRJ 200s and 36 Embraer 120 Brasilias.

Mr Rich cited not only operational improvement but financial improvement, noting it is becoming an increasingly important part of the company. He added the unusual flexibility with its aircraft mitigates the financial risk it takes on the operation.

Results

The company also cited an increase in operating revenues for additional fuel and engine overhaul cost reimbursements from mainline partners. Revenues also benefited from increases in its ground handling and other revenues from USD9.9 million in the third quarter of 2010 to USD19 million. 

SkyWest Airlines, Inc, with its three subsidiaries, SkyWest Airlines, ExpressJet and Atlantic Southeast Airlines, flew 8.6 billion available seat miles, up 53% on the addition of ExpressJet. Load factor grew 0.6% to 81.4% just over passenger break-even load factor which rose 4.3 points to 80.3%. For the fourth quarter it expects its subsidiaries to produce 8.95 billion available seat miles (ASMs), down from the nearly 10 billion produced in the third quarter.

Yield dropped 9.8% to 11.9 cents while revenue per available seat mile (RASM) declined 9.2% to 9.9 cents. However, cost per available seat mile (CASM) also declined, 4.9% to 9.80 cents on a 21.4% increase in fuel cost per available seat mile to 10.7 cents. Block hours rose 54.3% to 575,145 on the addition of ExpressJet.

Total airline expenses increased 45.9% to USD928.5 million during the quarter owing to the addition of ExpressJet which generated USD249.9 million in additional expenses.

It finished the quarter with USD724.2 million in cash and marketable securities, down from the USD804.9 million at the end of 2010. It cited USD56.2 million in stock buy backs and prepaid aircraft lease amounts and charges equalling USD19.5 million.

Long term debt was USD1.63 billion at the end of the quarter, down from USD1.74 billion at the end of 2010. The company has significant off-balance-sheet, long-term lease obligations that are not recorded on its balance sheets. At a 6.2% discount rate, it put the current value of these obligations at USD1.9 billion at the end of the third quarter.

It cited fleet changes including the addition of two new CRJ 700s and three used CRJ 200s as well as the removal of two ERJ 145s and one CRJ 200. Its fleet now consists of 727 aircraft compared to the 466 in the 2010 third quarter before ExpressJet was acquired in Nov-2010.