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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

 

For the quarterly period ended June 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):

 

Large accelerated filer o		Accelerated filer  x
Non-accelerated filer o		Smaller reporting company  o
(Do not check if a smaller reporting company)

 

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

 

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PART I	FINANCIAL INFORMATION:		3
	Item 1.	Financial Statements	3
		Consolidated Balance Sheets as of June 30, 2013 (unaudited) and December 31, 2012	3
		Consolidated Statements of Comprehensive Income (unaudited) for the three and six months ended June 30, 2013 and 2012	5
		Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended June 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	28
	Item 4.	Controls and Procedures	28
PART II	OTHER INFORMATION:		29
	Item 1.	Legal Proceedings	29
	Item 1A.	Risk Factors	31
	Item 5.	Other Information	31
	Item 6.	Exhibits	31
		Signature	32
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

 

		June 30, 2013			December 31, 2012
		(unaudited)
CURRENT ASSETS:
Cash and cash equivalents		$	140,546		$	133,772
Marketable securities		505,516			556,117
Restricted cash		19,559			19,553
Receivables, net		86,892			130,102
Inventories, net		129,206			113,581
Prepaid aircraft rents		362,990			325,999
Deferred tax assets		168,033			124,320
Other current assets		23,350			30,596
Total current assets		1,436,092			1,434,040
PROPERTY AND EQUIPMENT:
Aircraft and rotable spares		4,029,501			3,997,926
Deposits on aircraft		24,200			—
Buildings and ground equipment		275,477			274,085
		4,329,178			4,272,011
Less accumulated depreciation and amortization		(1,651,377		)	(1,561,015		)
Total property and equipment, net		2,677,801			2,710,996
OTHER ASSETS
Intangible assets, net		16,123			17,248
Other assets		110,054			92,353
Total other assets		126,177			109,601
Total assets		$	4,240,070		$	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)

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

		June 30,			December 31,
		2013			2012
		(unaudited)
CURRENT LIABILITIES:
Current maturities of long-term debt		$	173,201		$	171,454
Accounts payable		217,647			222,671
Accrued salaries, wages and benefits		125,738			121,352
Accrued aircraft rents		11,587			12,745
Taxes other than income taxes		19,166			22,353
Income tax payable		1,480			1,255
Other current liabilities		37,133			39,595
Total current liabilities		585,952			591,425
OTHER LONG-TERM LIABILITIES		59,132			57,422
LONG-TERM DEBT, net of current maturities		1,382,849			1,470,568
DEFERRED INCOME TAXES PAYABLE		715,285			657,620
DEFERRED AIRCRAFT CREDITS		85,629			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; 77,178,934 and 76,713,154 shares issued, respectively		614,703			609,763
Retained earnings		1,166,921			1,147,117
Treasury stock, at cost, 25,295,636 and 25,280,364 shares, respectively		(371,407		)	(371,211		)
Accumulated other comprehensive income		1,006			1,506
Total stockholders’ equity		1,411,223			1,387,175
Total liabilities and stockholders’ equity		$	4,240,070		$	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 June 30,						Six Months Ended June 30,
		2013			2012			2013			2012
OPERATING REVENUES:
Passenger		$	826,122		$	920,633		$	1,611,993		$	1,822,989
Ground handling and other		13,008			16,581			30,624			35,399
Total operating revenues		839,130			937,214			1,642,617			1,858,388
OPERATING EXPENSES:
Salaries, wages and benefits		300,342			290,676			597,738			581,490
Aircraft maintenance, materials and repairs		171,528			167,150			338,684			346,786
Aircraft rentals		81,814			83,944			164,402			168,846
Depreciation and amortization		61,174			64,182			122,174			128,497
Aircraft fuel		46,802			153,544			96,483			300,994
Station rentals and landing fees		36,998			44,254			71,086			88,187
Ground handling services		33,117			29,615			67,694			64,930
Other		56,800			57,043			118,238			111,395
Total operating expenses		788,575			890,408			1,576,499			1,791,125
OPERATING INCOME		50,555			46,806			66,118			67,263
OTHER INCOME (EXPENSE):
Interest income		870			2,043			2,597			3,996
Interest expense		(17,526		)	(19,387		)	(35,491		)	(39,167		)
Other, net		(187		)	(815		)	5,852			(4,667		)
Total other expense, net		(16,843		)	(18,159		)	(27,042		)	(39,838		)
INCOME BEFORE INCOME TAXES		33,712			28,647			39,076			27,425
PROVISION FOR INCOME TAXES		12,992			11,687			15,121			11,147
NET INCOME		$	20,720		$	16,960		$	23,955		$	16,278
BASIC EARNINGS PER SHARE		$	0.40		$	0.33		$	0.46		$	0.32
DILUTED EARNINGS PER SHARE		$	0.39		$	0.33		$	0.46		$	0.32
Weighted average common shares:
Basic		51,881			50,944			51,822			50,912
Diluted		52,547			51,789			52,522			51,335
Dividends declared per share		$	0.04		$	0.04		$	0.08		$	0.08
COMPREHENSIVE INCOME:
Net income		$	20,720		$	16,960		$	23,955		$	16,278
Proportionate share of other companies foreign currency translation adjustment, net of taxes		—			141			—			448
Net unrealized appreciation (depreciation) on marketable securities, net of taxes		(563		)	35			(499		)	111
TOTAL COMPREHENSIVE INCOME		$	20,157		$	17,136		$	23,456		$	16,837

 

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)

 

		Six Months Ended June 30
		2013			2012
NET CASH PROVIDED BY OPERATING ACTIVITIES		$	129,277		$	109,347
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities		(294,649		)	(222,616		)
Sales of marketable securities		344,682			219,362
Proceeds from the sale of equipment		102			630
Acquisition of property and equipment:
Aircraft and rotable spare parts		(44,469		)	(27,555		)
Deposits on aircraft		(24,200		)	—
Buildings and ground equipment		(4,442		)	(3,252		)
Increase in other assets		(11,719		)	(9,397		)
NET CASH USED IN INVESTING ACTIVITIES		(34,695		)	(42,828		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on long-term debt		(85,971		)	(84,598		)
Tax benefit (deficiency) from exercise of common stock options		(175		)	73
Net proceeds from issuance of common stock		2,666			2,161
Purchase of treasury stock		(196		)	(897		)
Payment of cash dividends		(4,132		)	(4,070		)
NET CASH USED IN FINANCING ACTIVITIES		(87,808		)	(87,331		)
Increase (decrease) in cash and cash equivalents		6,774			(20,812		)
Cash and cash equivalents at beginning of period		133,772			129,526
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	140,546		$	108,714
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid (received) during the year for:
Interest, net of capitalized amounts		$	36,633		$	39,261
Income taxes		$	880		$	(1,477	)

 

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 six-months ended June 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 in the quarter ended March 31, 2013, and have determined that the balance and the activity during the period 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”), 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. 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 beginning in 2010 and continuing 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 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.

 

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 June 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 H 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

 

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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, the Company calculates the incentives achieved during the month and recognizes revenue accordingly.

 

United Capacity Purchase Agreement

 

Effective November 12, 2010, ExpressJet Delaware entered into a Capacity Purchase Agreement with 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, 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, 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 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

 

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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, 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 six months ended June 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 six months ended June 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 six months ended June 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 six months ended June 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.  During the three months ended June 30, 2013 and 2012, the Company recorded pre-tax share-based compensation expense of $1.1 million and $1.1 million, respectively. During the six months ended June 30, 2013 and 2012, the Company recorded pre-tax share-based compensation expense of $2.4 million and $2.4 million, respectively.

 

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 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 June 30, 2013 and 2012, options to acquire 3,298,000 and 3,952,000 shares, respectively, were excluded from the computation of Diluted EPS as their impact was anti-dilutive. During the six months ended June 30, 2013 and 2012, options to acquire 3,368,000 and 3,971,000 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 June 30,						Six Months Ended June 30,
		2013			2012			2013			2012
		(Unaudited)						(Unaudited)
Numerator
Net Income		$	20,720		$	16,960		$	23,955		$	16,278
Denominator
Weighted average number of common shares outstanding		51,881			50,944			51,822			50,912
Effect of outstanding share-based awards		666			845			700			423
Weighted average number of shares for diluted net income per common share		52,547			51,789			52,522			51,335
Basic earnings per share		$	0.40		$	0.33		$	0.46		$	0.32
Diluted earnings per share		$	0.39		$	0.33		$	0.46		$	0.32

 

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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 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 represents the Company’s segment data for the three-month periods ended June 30, 2013 and 2012 (in thousands).

 

		Three months ended June 30, 2013
		SkyWest Airlines		ExpressJet		Other		Consolidated
Operating revenues		463,068		375,588		474		839,130
Operating expense		411,917		374,431		2,227		788,575
Depreciation and amortization expense		38,839		22,335		—		61,174
Interest expense		11,227		5,362		937		17,526
Segment profit (loss)(1)		39,924		(4,205	)	(2,690	)	33,029
Identifiable intangible assets, other than goodwill		—		16,123		—		16,123
Total assets		2,656,855		1,583,215		—		4,240,070
Capital expenditures (including non-cash)		21,952		11,473		—		33,425

 

		Three months ended June 30, 2012
		SkyWest Airlines		ExpressJet		Other		Consolidated
Operating revenues		509,135		425,445		2,634		937,214
Operating expense		467,497		421,640		1,271		890,408
Depreciation and amortization expense		38,646		25,536		—		64,182
Interest expense		12,353		5,959		1,075		19,387
Segment profit (loss) (1)		29,285		(2,154	)	288		27,419
Identifiable intangible assets, other than goodwill		—		18,373		—		18,373
Total assets		2,604,012		1,634,798		—		4,238,810
Capital expenditures (including non-cash)		13,946		4,579		—		18,525

 

(1)                                  Segment profit is operating income less interest expense

 

The following represents the Company’s segment data for the six-month periods ended June 30, 2013 and 2012 (in thousands).

 

		Six months ended June 30, 2013
		SkyWest Airlines		ExpressJet		Other		Consolidated
Operating revenues		912,413		727,336		2,868		1,642,617
Operating expense		826,683		746,174		3,642		1,576,499
Depreciation and amortization expense		77,464		44,710		—		122,174
Interest expense		22,723		10,825		1,943		35,491
Segment profit (loss)(1)		63,007		(29,663	)	(2,717	)	30,627
Identifiable intangible assets, other than goodwill		—		16,123		—		16,123
Total assets		2,656,855		1,583,215		—		4,240,070
Capital expenditures (including non-cash)		44,362		19,351		—		63,713

 

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		Six months ended June 30, 2012
		SkyWest Airlines		ExpressJet		Other		Consolidated
Operating revenues		1,004,046		849,074		5,268		1,858,388
Operating expense		940,403		848,192		2,530		1,791,125
Depreciation and amortization expense		77,429		51,068		—		128,497
Interest expense		24,915		12,005		2,247		39,167
Segment profit (loss) (1)		38,728		(11,123	)	491		28,096
Identifiable intangible assets, other than goodwill		—		18,373		—		18,373
Total assets		2,604,012		1,634,798		—		4,238,810
Capital expenditures (including non-cash)		36,353		8,541		—		44,894

 

(1)                                  Segment profit is operating income less interest expense

 

Note F — Commitments and Contingencies

 

As of June 30, 2013, the Company leased 575 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 June 30, 2013 (in thousands):

 

July through December 2013		$	174,682
2014		378,877
2015		325,540
2016		254,928
2017		192,602
Thereafter		720,718
		$	2,047,347

 

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 these aircraft in April 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 June 30, 2013, which primarily relate to the acquisition of aircraft and related spare engines that are considered firm deliveries (in thousands):

 

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

 

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				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 June 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 June 30, 2013
		Total			Level 1			Level 2			Level 3
Marketable Securities
Bond and bond fund		$	505,293		$	—		$	505,293		$	—
Asset backed securities		223			—			223			—
		505,516			—			505,516			—
Cash, Cash Equivalents and Restricted Cash		160,105			160,105			—			—
Other Assets (a)		2,248			—			—			2,248
Total Assets Measured at Fair Value		$	667,869		$	160,105		$	505,516		$	2,248

 

		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		3,844			—			—			(a) 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 six months ended June 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.

 

The following table presents the Company’s assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at June 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		(68		)
Transferred out		—
Settlements		(1,528		)
Balance at June 30, 2013		$	2,248

 

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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 $1,651.4 million as of June 30, 2013, as compared to the carrying amount of $1,556.1 million as of June 30, 2013. The fair value of the Company’s long-term debt is estimated based on current rates offered to the Company for similar debt and approximated $1,744.2 million as of December 31, 2012, as compared to the carrying amount of $1,642.0 million as of December 31, 2012.

 

Note H — Legal Matters

 

The Company is subject to certain legal actions which it considers routine to its business activities. As of June 30, 2013, 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 (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 June 30, 2013, the Company had recognized a cumulative total of $31.7 million of revenue associated with the funds withheld by 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 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. 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 June 30, 2013, the Company’s estimated range of reasonably possible loss related to the dispute was $0 to $25.8 million.

 

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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 six-month periods ended June 30, 2013 and 2012. Also discussed is our financial position as of June 30, 2013 and December 31, 2012. You should read this discussion in conjunction with our condensed consolidated financial statements for the three and six-month periods ended June 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 “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 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 June 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 June 30, 2013, we operated a combined fleet of 760 aircraft consisting of the following:

 

		CRJ200		ERJ145		ERJ135		CRJ700		CRJ900		EMB120		Total
United		92		242		9		70		—		34		447
Delta		136		—		—		60		60		8		264
American		23		—		—		—		—		—		23
US Airways		15		—		—		—		—		—		15
Alaska		—		—		—		5		—		—		5
Subleased to an un-affiliated entity		2		—		—		—		—		—		2
Unassigned (a)		—		—		—		—		4		—		4
Total		268		242		9		135		64		42		760

 

---

(a)          We anticipate these aircraft will begin service with US Airways during the third quarter of 2013.

 

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For the six months ended June 30, 2013, approximately 61.0% of our aggregate capacity was operated for United, approximately 33.9% was operated for Delta, approximately 2.4% was operated for American, approximately 1.5% 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 most of the elements that 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 most 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.

 

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

 

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US Airways Express (CRJ200)

Fixed-Rate Engine Contracts

Direct Expense Method

 

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 June 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.

 

Second Quarter Summary

 

We had revenues of $839.1 million for the three months ended June 30, 2013, a 10.5% decrease, compared to revenues of $937.2 million for the three months ended June 30, 2012. We had a net income of $20.7 million, or $0.39 per diluted share, for the three months ended June 30, 2013, compared $17.0 million or $0.33 per diluted share, for the three months ended June 30, 2012.

 

The significant items affecting our financial performance during the three months ended June 30, 2013 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 $106.7 million and $11.3 million, respectively, during the three months ended June 30, 2013, from the three months ended June 30, 2012, due primarily to United purchasing an increased volume of fuel directly from vendors on flights we operated under our United Express Agreements and due to a reduction in the number of engine maintenance events. Excluding the impact of the decrease in direct fuel and engine maintenance expense and associated reimbursements, our passenger revenues increased $23.5 million for the three months ended June 30, 2013, compared to the three months ended June 30, 2012, which was primarily due to an increase in block-hour production.

 

Because we use the direct-expense method of accounting for our CRJ200 engines 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 operating under the Fixed-Rate Engine Contracts has a direct impact on the comparability of our operating income for the presented reporting periods. The CRJ200 Engine Overhaul Expense we incurred under the Fixed-Rate Engine Contracts decreased $3.2 million during the three months ended June 30, 2013, compared to the three months ended June 30, 2012. The decrease in CRJ200 Engine Overhaul Expense was primarily due to a reduction in the number of scheduled engine maintenance events during the three months ended June 30, 2013.

 

Other aircraft maintenance, materials and repairs increased $18.9 million, or 16.7%, during the three months ended June 30, 2013, compared to the three months ended June 30, 2012. The increase in aircraft maintenance expense excluding engine overhaul costs for the three months ended June 30, 2013, compared to the three months ended June 30, 2012, was primarily due to an increase in the number of  scheduled maintenance events at ExpressJet.

 

The items identified above were the principal factors that contributed to the significant improvement in our financial results during the three months ended June 30, 2013, compared to the three months ended June 30, 2012.

 

During 2012, we reached an agreement with Delta to add 34 additional used dual-class Bombardier regional jet aircraft to our operations 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. We have agreed to sublease the 34 additional dual-class aircraft from Delta for a nominal amount. The 34 additional aircraft consist of five CRJ700s and 29 CRJ900s. As of June 30, 2013, we had taken delivery of  all 34 additional aircraft. We anticipate that all 66 CRJ200 aircraft will be removed from the Delta Connection Agreements by December 31, 2015. Of the 66 CRJ200s scheduled to be removed, 41 CRJ200s are subleased from Delta for a nominal amount, and are scheduled to be returned to Delta without obligation to us.

 

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, we anticipate 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.

 

Critical Accounting Policies

 

Our significant accounting policies are summarized in Note 1 to our consolidated financial statements for the year ended December 31, 2012, which are presented in our Annual Report on Form 10-K for the year ended December 31, 2012.  Critical

 

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