SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

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

 

For the quarterly period ended June 30, 2006

 

OR

 

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

 

For the transition period from                    to

 

Commission file number 0-14719

 

SKYWEST, INC.

 

 

444 South River Road
St. George, Utah 84790
(435) 634-3000

 

Indicate by a check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes        x        No        o

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

Large accelerated filer x     Accelerated filer o     Non-accelerated filer o

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.

 

 

 

SKYWEST, INC.

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

 

PART I		Financial Information:
Item 1.		Consolidated Balance Sheets as of June 30, 2006 (unaudited) and December 31, 2005		3
		Condensed Consolidated Statements of Income (unaudited) for the three and six months ended June 30, 2006 and 2005		5
		Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2006 and 2005		6
		Notes to Condensed Consolidated Financial Statements		7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		14
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		25
Item 4.		Controls and Procedures		26
PART II		Other Information:		26
Item 1.		Legal Proceedings		26
Item 1A.		Risk Factors		26
Item 4.		Submission of Matters to a Vote of Security Holders		34
Item 6.		Exhibits		35
		Signature		36
Exhibit 31.1		Certification of Chief Executive Officer
Exhibit 31.2		Certification of Chief Financial Officer
Exhibit 32.1		Certification of Chief Executive Officer
Exhibit 32.2		Certification of Chief Financial 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, 2006			December 31, 2005
		(unaudited)
CURRENT ASSETS:
Cash and cash equivalents		$	239,715		$	140,614
Marketable securities		167,939			159,054
Restricted cash		22,100			24,823
Income tax receivable		3,835			12,534
Receivables, net		53,766			28,267
Inventories		74,195			68,611
Prepaid aircraft rents		208,898			178,762
Deferred tax assets		39,978			41,012
Other current assets		56,395			39,955
Total current assets		866,821			693,632
PROPERTY AND EQUIPMENT:
Aircraft and rotable spares		2,777,657			2,727,595
Deposits on aircraft		36,569			90,235
Buildings and ground equipment		157,187			150,426
		2,971,413			2,968,256
Less-accumulated depreciation and amortization		(474,929		)	(415,734		)
Total property and equipment, net		2,496,484			2,552,522
OTHER ASSETS
Intangible assets, net		31,874			33,043
Other assets		55,390			41,449
Total other assets		87,264			74,492
Total assets		$	3,450,569		$	3,320,646

 

See accompanying notes to condensed consolidated financial statements.

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LIABILITIES AND STOCKHOLDERS’ EQUITY

 

		June 30,			December 31,
		2006			2005
		(unaudited)
CURRENT LIABILITIES:
Current maturities of long-term debt		$	243,985		$	331,145
Accounts payable		112,494			95,283
Lines of credit		—			60,000
Accrued salaries, wages and benefits		56,909			53,105
Accrued aircraft rents		26,656			26,279
Taxes other than income taxes		24,948			18,224
Other current liabilities		50,486			31,881
Total current liabilities		515,478			615,917
OTHER LONG-TERM LIABILITIES		36,704			33,829
LONG-TERM LINE OF CREDIT		—			30,000
LONG-TERM DEBT, net of current maturities		1,470,741			1,422,758
DEFERRED INCOME TAXES PAYABLE		243,608			225,068
DEFERRED AIRCRAFT CREDITS		85,009			79,876
STOCKHOLDERS’ EQUITY:
Preferred stock, 5,000,000 shares authorized; none issued		—			—
Common stock, no par value, 120,000,000 shares authorized; 70,483,245 and 65,509,631 shares issued, respectively		480,683			364,535
Retained earnings		652,740			582,620
Treasury stock, at cost, 6,794,056 shares		(32,551		)	(32,551		)
Accumulated other comprehensive loss		(1,843		)	(1,406		)
Total stockholders’ equity		1,099,029			913,198
Total liabilities and stockholders’ equity		$	3,450,569		$	3,320,646

 

See accompanying notes to condensed consolidated financial statements.

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SKYWEST, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars and Shares in Thousands, Except per Share Amounts)
(Unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Operating revenues:
Passenger		$	784,332		$	378,243		$	1,518,758		$	713,799
Ground handling and other		6,072			5,800			14,501			10,536
		790,404			384,043			1,533,259			724,335
Operating expenses:
Flying operations		442,731			208,356			841,197			386,372
Customer service		99,390			55,984			199,066			111,761
Maintenance		73,779			34,349			152,090			66,381
Depreciation and amortization		47,262			21,611			92,751			42,642
General and administrative		37,621			19,147			75,671			38,136
		700,783			339,447			1,360,775			645,292
Operating income		89,621			44,596			172,484			79,043
Other income (expense):
Interest income		4,225			3,381			7,132			6,343
Interest expense		(28,519		)	(7,392		)	(57,062		)	(14,037		)
Other		13			—			(1,084		)	—
		(24,281		)	(4,011		)	(51,014		)	(7,694		)
Income before income taxes		65,340			40,585			121,470			71,349
Provision for income taxes		26,054			15,828			47,596			27,826
Net income		$	39,286		$	24,757		$	73,874		$	43,523
Basic earnings per share		$	0.62		$	0.43		$	1.21		$	0.75
Diluted earnings per share		$	0.62		$	0.42		$	1.19		$	0.75
Weighted average common shares:
Basic		62,970			57,671			61,044			57,670
Diluted		63,759			58,323			62,088			58,260
Dividends declared per share		$	0.03		$	0.03		$	0.06		$	0.06

 

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,
		2006			2005
NET CASH PROVIDED BY OPERATING ACTIVITIES		$	175,304		$	71,958
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities		(13,476		)	(265,696		)
Sales of marketable securities		4,154			275,709
Acquisition / Disposition of property and equipment:
Aircraft and rotable spare parts		(40,673		)	(166,265		)
Deposits on aircraft		(416		)	(56,998		)
Buildings and ground equipment		(6,761		)	(6,267		)
Proceeds from sales of aircraft		7,322			11,734
Increase in other assets		(12,571		)	(2,487		)
NET CASH USED IN INVESTING ACTIVITIES		(62,421		)	(210,270		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment on lines of credit		(90,000		)	—
Tax benefit from exercise of common stock options		1,328			—
Proceeds from issuance of long-term debt		7,093			140,980
Return of deposits on aircraft and rotable spare parts		7,573			23,941
Principal payments on long-term debt		(46,270		)	(18,018		)
Net proceeds from issuance of common stock		110,097			2,714
Payment of cash dividends		(3,603		)	(3,513		)
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES		(13,782		)	146,104
Increase in cash and cash equivalents		99,101			7,792
Cash and cash equivalents at beginning of period		140,614			113,020
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	239,715		$	120,812
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest, net of capitalized amounts		$	56,312		$	14,419
Income taxes		$	1,284		$	1,663
NON-CASH INVESTING AND FINANCING ACTIVITIES
Deposits applied to delivered aircraft		$	—		$	22,043
Debt transferred to operating lease		$	—		$	55,375

 

See accompanying notes to condensed consolidated financial statements.

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SKYWEST, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Note A — Condensed Consolidated Financial Statements

     The condensed consolidated financial statements of SkyWest, Inc. (“SkyWest, “we” or “us”) and its wholly-owned subsidiaries, SkyWest Airlines, Inc. (“SkyWest Airlines”) and Atlantic Southeast Airlines, Inc. (“ASA”) 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 have been condensed or omitted pursuant to such rules and regulations, although we believe 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. We suggest that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005 and our Current Report on Form 8-K dated September 7, 2005.  The results of operations for the three and six month periods ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006.

Note B — Acquisition of ASA

     On September 7, 2005, we completed our acquisition of all of the issued and outstanding capital stock of ASA.  ASA is a regional airline with primary hub operations in Atlanta, Salt Lake City and Cincinnati.

     Pursuant to the terms of the Stock Purchase Agreement entered into between us, Delta Air Lines, Inc. (“Delta”), and ASA Holdings, Inc. (“ASA Holdings”) we paid $421.3 million in cash for ASA, plus $5.3 million of transaction fees.  Additionally, as part of the purchase, we assumed approximately $1,251.3 million in long-term debt which combined with the amounts paid at closing, resulted in an aggregate purchase price of approximately $1,677.9 million. The purchase price of ASA has been adjusted to reflect certain post-closing adjustments related to ASA’s working capital as of September 7, 2005.

     In connection with the acquisition of ASA, SkyWest Airlines and Delta entered into an Amended and Restated Delta Connection Agreement with Delta for SkyWest Airlines and entered into a Second Amended and Restated Delta Connection Agreement (collectively, the “Delta Connection Agreements”) with Delta for ASA, whereby SkyWest Airlines, ASA, Delta agreed to provide regional airline service in the Delta flight system through SkyWest Airlines and ASA.  Among other provisions, the Delta Connection Agreements provide for the transfer of certain ownership and lease rights among SkyWest Airlines, ASA, Delta and Comair Inc., a wholly-owned subsidiary of Delta (“Comair”).  As part of the Delta Connection Agreements, SkyWest Airlines, ASA, Delta and/or Comair, as applicable, have terminated two master sublease agreements with respect to ten Canadair CRJ200 Regional Jets (“CRJ200s”) and transferred to Delta ten CRJ200s financed in part by an affiliate of Bombardier, and ASA and Delta entered into a sublease agreement whereby ASA will sublease the ten CRJ200s from Delta.

     Under the terms of the Stock Purchase Agreement, Delta and ASA Holdings have agreed to indemnify us, and we have agreed to indemnify Delta and ASA Holdings from damages suffered due to breaches of representations, warranties or covenants made in the Stock Purchase Agreement.  Recoveries under the indemnification provisions of the Purchase Agreement are subject to certain minimum losses per event, and an aggregate minimum for all losses.  Recoveries are also subject to an aggregate cap on all losses.

     The acquisition value of ASA was accounted for using the purchase method of accounting.  Accordingly, the aggregate purchase price was assigned to the assets acquired and liabilities assumed based on fair market values at the respective purchase date.  We recorded an intangible of approximately $33 million relating to the acquisition of ASA.  The intangible is being amortized over fifteen years under the straight-line method.

Note C — Stock Compensation

     Effective January 1, 2001, we adopted two stock option plans: the Executive Stock Incentive Plan (the “Executive Plan”) and the 2001 Allshare Stock Option Plan (the “Allshare Plan”).  These plans replaced our Combined Incentive and Non-Statutory Stock Option Plans (the “Prior Plans”); however, as of June 30, 2006, options to purchase approximately 940,000 shares of our common stock remained outstanding under the Prior Plans. The Executive Plan originally provided for the issuance of options to purchase up to

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4,000,000 shares of common stock to officers, directors and other management employees of which 3,696,477 options had been issued as of June 30, 2006. The Allshare Plan originally provided for the issuance of options to purchase up to 4,000,000 shares of common stock to our employees, of which 2,508,961 options had been issued as of June 30, 2006. Our Board of Directors has adopted amendments that reduce the total number of shares issuable under the Executive Plan and the Allshare Plan to 3,700,000 and 2,510,000 shares, respectively.  As of June 30, 2006, 3,523 shares and 1,039 shares remained available for issuance under the Executive Plan and the Allshare Plan, respectively.

At our annual meeting of shareholders held on May 2, 2006, our shareholders approved the adoption of the SkyWest, Inc. Long-Term Incentive Plan, which provides for the issuance of up to 6,000,000 shares of common stock to our directors, employees, consultants and advisors (the “2006 Incentive Plan”).  The 2006 Incentive Plan provides for awards in the form of options to acquire shares of common stock, stock appreciation rights, restricted stock grants and performance awards.  The Long-Term Plan is administered by the Compensation Committee of our Board of Directors (the “Compensation Committee”) who is authorized to designate option grants as either incentive or non-statutory. Incentive stock options are granted at not less than 100% of the market value of the underlying common stock on the date of grant. Non-statutory stock options are granted at a price as determined by the Compensation Committee.

     Prior to January 1, 2006, we applied Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans.  Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, requires pro forma information regarding net income and net income per share as if we had accounted for its stock options under the fair value method.  We did not record any stock-based compensation expense related to stock options for the year ended December 31, 2005.

     The following table contains the pro forma disclosures and the related impact on net income and net income per share (in thousands, except per share information) relating to stock-based compensation:

 

 

     Effective January 1, 2006, we adopted the fair value recognition provisions of SFASB No. 123(R), Share-Based Payment (“SFAS No. 123(R)”), using the modified-prospective-transition method.  Under the modified-prospective-transition method, compensation cost recognized during the three and six months ended June 30, 2006 includes compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123(R).  Results for prior periods have not been restated.

     The fair value of stock options has been estimated as of the grant date using the Black-Scholes option pricing model.  During the three months ended June 30, 2006 we granted 377,303 stock options to employees.  The following table shows the assumptions used and weighted average fair value for grants in the three months ended June 30, 2006 and for the years ended December 31, 2005 and 2004.

 

 

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     As required by SFAS 123(R), we recorded share-based compensation expense only for those options that are expected to vest.  The estimated fair value of the stock options is amortized over the vesting period of the respective stock option grants.

     During the three months ended June 30, 2006, we granted 317,901 shares of restricted stock to our employees under the 2006 Long Term Incentive Plan.  The restricted stock has a three year vesting period, during which the recipient must remain employed with SkyWest or our subsidiaries.  Additionally, we granted 12,600 fully-vested shares of restricted stock to our directors.  The fair value of the stock on the date of grants made during three months ended June 30, 2006 was $23.80 per share.

     During the three and six months ended June 30, 2006, we recorded pre-tax equity based compensation expense of $3.1 million and $4.7 million, respectively, related to the adoption of SFAS No. 123(R) and due to the issuance of restricted stock under the SkyWest, Inc. 2006 Incentive Plan.  As a result of adopting SFAS No. 123(R) on January 1, 2006, our net income for the three and six months ended June 30, 2006 was $1.6 million and $2.9 million lower, respectively, than if we had continued to account for share-based compensation under Opinion 25.  Basic and diluted earnings per share for the three months ended June 30, 2006 were $0.03 and $0.02 lower, respectively, than if we had continued to account for share-based compensation under Opinion 25.  Basic and diluted earnings per share for the six months ended June 30, 2006 were $0.05 and $0.04 lower, respectively, than if we had continued to account for share-based compensation under Opinion 25.

     Prior to the adoption of SFAS No.123(R), we presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Statement of Cash Flows.  SFAS No.123(R) requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.  The $1.3 million excess tax benefit for the six months ended June 30, 2006 classified as a financing cash inflow would have been classified as an operating cash inflow if we had not adopted SFAS No.123(R).

     We had $17.1 million of total unrecognized compensation cost related to non-vested stock options and non-vested restricted stock grants.  Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.  We expect to recognize this cost over a weighted average period of 1.5 years.

     We received approximately $14.7 million in cash from option exercises during for the six months ended June 30, 2006.

Note D — Marketable Securities

     Our investments in marketable debt securities are deemed by management to be available for sale and are reported at fair market value with the net unrealized appreciation or depreciation reported as a component of accumulated other comprehensive loss in stockholders’ equity. At the time of sale, any realized appreciation or depreciation, calculated by the specific identification method, is recognized in other income in our operating results.  Our position in marketable debt securities as of June 30, 2006 and December 31, 2005 was as follows (in thousands):

		June 30, 2006						December 31, 2005
Investment Types		Cost			Market Value			Cost			Market Value
		(Unaudited)
Bonds and bond funds		$	166,666		$	163,700		$	155,192		$	152,929
Asset backed securities		4,332			4,239			6,167			6,125
		170,998			167,939			161,359			159,054
Unrealized depreciation		(3,059		)	—			(2,305		)	—
Total		$	167,939		$	167,939		$	159,054		$	159,054

 

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     Marketable securities had the following maturities as of June 30, 2006 (in thousands):

 

 

     We classified all marketable securities as short-term since we have the intent to maintain a liquid portfolio and the right to redeem the securities within the next year.

Note E — Passenger and Ground Handling Revenue

     We recognize passenger and ground handling revenues when the service is provided.  Under our contract and pro-rate flying agreements with Delta and United revenue is considered earned when the flight is completed.  In the event that our contractual rates have not been finalized at quarterly or annual financial statement dates, we record revenues based on a prior period’s approved rates, adjusted to reflect management’s current estimate of the results of the then-current contract negotiations.

     On September 7, 2005, we completed our acquisition of all of the issued and outstanding capital stock of ASA from ASA Holdings, Inc. a subsidiary of Delta.  ASA is a regional airline with primary hub operations in Atlanta, Salt Lake City and Cincinnati.  In connection with the acquisition of ASA, SkyWest Airlines and ASA entered into Delta Connection Agreements with Delta which became effective September 8, 2005.  On September 14, 2005, Delta filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code.  With the approval of the U.S. Bankruptcy Court charged with administration of Delta’s reorganization proceedings, Delta assumed the Delta Connection Agreements on October 6, 2005.

     Each of the Delta Connection Agreements provides for a fifteen-year term, subject to early termination by Delta or SkyWest Airlines or ASA, 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 major events, including certain labor-related events, that prevent SkyWest Airlines or ASA from performance for certain periods, and (iii) the right to terminate each of the ASA Delta Connection Agreements if SkyWest Airlines or ASA fails to maintain competitive base rate costs, subject to certain adjustment rights.  In addition to the termination rights, Delta has the right to extend the term of the Delta Connection Agreements upon the occurrence of certain events or at the expiration of the initial term.  SkyWest Airlines and ASA have the right to terminate their respective Delta Connection Agreements upon the occurrence of certain breaches by Delta, including the failure to cure payment defaults.  SkyWest Airlines and ASA 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 us for our direct costs associated with operating the Delta Connection flights, plus a payment based on block hours flown.  However, among other changes, the SkyWest Airlines Delta Connection Agreement established a multi-year rate reset provision.  Under the terms of the ASA Delta Connection Agreement, Delta agrees to compensate ASA for its direct costs associated with operating the Delta Connection flights, plus, if ASA completes a certain minimum percentage of its Delta Connection flights, an additional percentage of such costs.  Additionally, ASA’s Delta Connection Agreement provides for the payment of incentive compensation upon satisfaction of certain performance goals.  Under the ASA Delta Connection Agreement, excess margins over certain percentages must be returned or shared with Delta, depending on various conditions.  The parties to the Delta Connection Agreements make customary representations, warranties and covenants, and the agreements contain other provisions typical of agreements of this kind, including with respect to various operational, marketing and administrative matters.

     The SkyWest Airlines and ASA Delta Connection Agreements also provide a weekly payment for an amount per aircraft designed to reimburse us for certain aircraft ownership costs. In accordance with Emerging Issues Task Force No. 01-08, Determining Whether an Arrangement Contains a Lease, the we have concluded that a component of its revenue under the Delta Connection Agreements is rental income, inasmuch as the Delta Connection Agreements identify the “right of use” of a specific type and number of aircraft over a stated period of time. The amounts deemed to be rental income under the Delta Connection Agreement for the three months ended June 30, 2006 and 2005 were $71.1 million and $18.9 million, respectively.  The amounts deemed to be rental income under the Delta Connection Agreement for the six months ended June 30, 2006 and 2005 were $138.7 million and $37.7 million, respectively.  These amounts were recorded in passenger revenue on our consolidated statements of income.

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     Effective July 31, 2003, SkyWest Airlines entered into the United Express Agreement, which sets forth the principal terms and conditions governing our 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 United Express Agreement also provides a monthly reimbursement for an amount per aircraft designed to reimburse us for certain aircraft ownership costs. In accordance with EITF 01-08, we have concluded that a component of our revenue under the United Express Agreement is rental income, inasmuch as the United Express Agreement identifies the “right of use” of a specific type and number of aircraft over a stated period of time. The amounts deemed to be rental income under the United Express Agreement for the three months ended June 30, 2006 and 2005 were $48.8 million and $41.7 million, respectively.  The amounts deemed to be rental income under the United Express Agreement for the six months ended June 30, 2006 and 2005 were $98.5 million and $79.2 million, respectively.  These amounts were recorded in passenger revenue on our consolidated statements of income.  The United Express Agreement contains certain provisions pursuant to which the parties could terminate the agreement, subject to certain rights of the other party, if certain performance criteria are not maintained.

     Our revenues could be impacted by a number of factors, including changes to our code-share agreements with Delta and United, contract modifications resulting from contract re-negotiations and our ability to earn incentive payments contemplated under our code-share agreements.

     The preparation of financial statements in conformity with accounting principals generally accepted in the United States of America 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 could differ from those estimates.

Note F — 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, 2006 and 2005, options to acquire 1,265,000 and 3,770,000 shares, respectively, were excluded from the computation of Diluted EPS as their impact was anti-dilutive.  During the six months ended June 30, 2006 and 2005, options to acquire 633,000 and 3,775,000 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,
		(unaudited)						(unaudited)
		2006			2005			2006			2005
Numerator
Net Income		$	39,286		$	24,757		$	73,874		$	43,523
Denominator
Weighted average number of common shares outstanding		62,970			57,671			61,044			57,670
Effect of outstanding stock compensation		789			652			1,044			590
Weighted average number of shares for Diluted net income per common share		63,759			58,323			62,088			58,260
Basic earnings per share		$	0.62		$	0.43		$	1.21		$	0.75
Diluted earnings per share		$	0.62		$	0.42		$	1.19		$	0.75

 

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Note G — Comprehensive Income

     We report comprehensive income in accordance with SFAS No. 130, Reporting Comprehensive Income, which establishes standards for reporting and displaying comprehensive income and its components in financial statements. Comprehensive income includes charges and credits to stockholders’ equity that are not the result of transactions with shareholders.  Also, our comprehensive income consisted of net income plus changes in unrealized depreciation on marketable securities, net of tax, for the periods indicated (in thousands):

 

		Three months ended June 30,						Six months ended June 30,
		(unaudited)						(unaudited)
		2006			2005			2006			2005
Net Income		$	39,286		$	24,757		$	73,874		$	43,523
Unrealized appreciation (depreciation) on marketable securities, net of tax		(206		)	600			(437		)	(211		)
Comprehensive income		$	39,080		$	25,357		$	73,437		$	43,312

 

Note H — Long-term Debt and Lines of Credit

Long-term debt consisted of the following for the periods indicated (in thousands):

 

		June 30, 2006			December 31,  2005
		(Unaudited)
Notes payable to banks, due in semi-annual installments, variable interest based on LIBOR, or with interest rates ranging from 4.16% to 6.23% through 2012 to 2020, secured by aircraft		$	645,151		$	666,758
Notes payable to a financing company, due in semi-annual installments, variable interest based on LIBOR, or with interest rates ranging from 3.51% to 7.01% through 2006 to 2021, secured by aircraft		640,584			643,831
Notes payable to banks, due in semi-annual installments plus interest at 6.06% to 7.18% through 2021, secured by aircraft		289,883			297,624
Notes payable to a financing company, due in semi-annual installments plus interest at 5.78% to 6.23% through 2019, secured by aircraft		89,149			93,327
Notes payable to banks, due in monthly installments plus interest of 6.05% to 7.38% through 2020, secured by aircraft		30,436			31,406
Notes payable to banks, due in semi-annual installments, plus interest at 3.72% to 3.86%, net of the benefits of interest rate subsidies through the Brazilian Export financing program, through 2011, secured by aircraft		12,337			13,546
Notes payable to a bank, due in monthly installments interest based on LIBOR through 2012, interest rate at 7.9% secured by building		7,186			7,411
Long-term debt		$	1,714,726		$	1,753,903
Less current maturities		(243,985		)	(331,145		)
Long-term debt, net of current maturities		$	1,470,741		$	1,422,758

 

     At June 30, 2006, the three-month and six-month LIBOR rates were 5.48% and 5.59%, respectively.   At December 31, 2005, the three-month and six-month LIBOR rates were 4.54% and 4.70%, respectively.

 

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The aggregate amounts of principal maturities of long-term debt as of June 30, 2006 were as follows (in thousands):

 

     As of December 31, 2005, we had $30 million outstanding under a $40 million line-of-credit facility with a bank. As of June 30, 2006, we repaid the borrowings under the facility.  The facility expires on January 31, 2007 and bears interest at a rate equal to prime less 0.25%.  Additionally, as of December 31, 2005, we had $60 million outstanding under another borrowing facility with a financing company.   As of June 30, 2006, we repaid the borrowings under the second facility and the facility was terminated.

     During the six months ended June 30, 2006, ASA refinanced six Canadair CRJ700 Regional Jets from short-term financing arrangements facilities into long-term financing facilities with the same financing company.

As of June 30, 2006, we had $36.4 million in letters of credit and surety bonds outstanding with various banks and surety institutions.

Certain of our long-term debt arrangements contain limitations on, among other things, the sale or lease of assets and ratio of long-term debt to tangible net worth.  As of June 30, 2006, we were in compliance with all debt covenants contained in our long-term debt agreements.

Note I — Commitments and Contingencies

     We lease 258 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 we pay taxes, maintenance, insurance and certain other operating expenses applicable to the leased property.  We expect that, in the normal course of business, leases that expire will be renewed or replaced by other leases.  The following table summarizes future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of June 30, 2006 (in thousands):

 

     On June 30, 2006, we had commitments of approximately $463 million to purchase 17 Canadair CRJ900 Regional Jets (“CRJ900s”), four CRJ200s and related flight equipment.  We currently anticipate that we will take delivery of these aircraft from July 2006 through April 2007.  We have also obtained options to acquire another 70 CRJ aircraft that can be delivered in either 70 or 90-seat configurations.  We presently anticipate that delivery dates for these aircraft could start in May 2007 and continue through April 2010; however, actual delivery dates remain subject to final determination as agreed upon by us and our code-share partners.

     In January 2003, the FASB issued Interpretation No. 46, or (FIN 46), Consolidation of Variable Interest Entities, which requires the consolidation of variable interest entities. The majority of our leased aircraft are owned and leased through trusts whose sole purpose is to purchase, finance and lease these aircraft to us; therefore, they meet the criteria of a variable interest entity. However, since these are single owner trusts in which we do not participate, we believe that we are not at risk for losses and are not considered the primary beneficiary. As a result, we are not required to consolidate any of these trusts or any other entities in applying FIN 46. We believe that our maximum exposure under these leases is the aggregated amount of the remaining lease payments.

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We have leveraged lease agreements that typically require us to indemnify the equity/owner participant against liabilities that may arise due to changes in benefits from tax ownership of the respective leased aircraft.  The terms of these contracts range up to 18 years.   We have not accrued any liability relating to these indemnification obligations to the equity/owner participants because we believe the probability of material claims arising under the indemnification provisions is remote.

Note J — Capital Transactions

     On April 17, 2006, we completed a public offering of 4,000,000 shares of common stock at a price of $26.05 per share. We received approximately $99.3 million in net proceeds which were used to pay off two revolving lines of credit, to provide working capital and for general corporate purposes.

Note K — Legal Matters

     We are subject to certain legal actions which we consider routine to our business activities.  As of June 30, 2006, our 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 our financial position, liquidity or results of operations.

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

     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, 2006 and 2005. Also discussed is our financial position as of June 30, 2006 and 2005. You should read this discussion in conjunction with our consolidated financial statements, including the notes thereto, appearing elsewhere in this report or incorporated herein by reference.  This discussion and analysis contains forward-looking statements. Please refer to the sections of this Report entitled ‘‘Cautionary Statement Concerning Forward-Looking Statements’’ and “ Risk Factors” for discussion of the uncertainties, risks and assumptions associated with these statements.

Overview

     Through our wholly-owned subsidiaries, SkyWest Airlines, Inc. (“SkyWest Airlines”) and Atlantic Southeast Airlines, Inc. (“ASA”), we operate the largest regional airline in the United States.  As of June 30, 2006, SkyWest Airlines and ASA offered scheduled passenger and air freight service with approximately 2,464 total daily departures to 285 destinations in the United States, Canada, Mexico and the Caribbean.  Additionally, we provide ground handling services for approximately ten other airlines throughout our system.  As of June 30, 2006, our consolidated fleet consisted of 231 Bombardier CRJ200 Regional Jets (“CRJ200s”) (66 assigned to United Air Lines, Inc. (“United”) and 165 assigned to Delta Air Lines, Inc. (“Delta”), 92 Bombardier CRJ700 Regional Jets (“CRJ700s”) (52 assigned to United and 40 assigned to Delta), 62 Embraer EMB-120 Brasilia turboprops (“Brasilia turboprops”) (50 assigned to United and 12 assigned to Delta), and 12 Avions de Transport 72-210 turboprops (“ATR-72 turboprops”) (all assigned to Delta).  We believe our success in attracting multiple contractual relationships with major airline partners is attributable to our delivery of high-quality customer service with an all cabin-class fleet at a competitive cost structure.  For the month of June 30, 2006, approximately 57.7% of our aggregate capacity was operated under the Delta code and approximately 42.3% was operated under the United code.

     SkyWest Airlines has been a partner with Delta in Salt Lake City and United in Los Angeles since 1987 and 1997, respectively.  In 1998, SkyWest Airlines expanded its relationship with United to provide service in Portland, Seattle/Tacoma, San Francisco and additional Los Angeles markets.  In 2001, SkyWest Airlines expanded its operations to serve as the Delta Connection in Dallas/Fort Worth.  Effective January 31, 2005, however, SkyWest Airlines re-deployed all its Delta Connection flights to Salt Lake City as a result of Delta’s decision to “de-hub” its Dallas/Fort Worth operations.  In 2004, SkyWest Airlines expanded its United Express operations to provide service in Chicago.  As of June 30, 2006, SkyWest Airlines operated as a Delta Connection carrier in Salt Lake City, and as United Express carrier in Los Angeles, San Francisco, Denver, Chicago and the Pacific Northwest, operating approximately 1,630 total daily flights.

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     On September 7, 2005, we completed the acquisition of ASA from Delta for $421.3 million in cash.  Additionally, as part of the purchase, we paid $5.3 million of transaction fees and ASA assumed approximately $1.25 billion in long-term debt.  In addition, we returned to Delta $50 million in deposits that Delta had previously paid on future ASA aircraft deliveries.  We believe the combination of SkyWest Airlines and ASA presents us with new opportunities for growth through our two geographically-focused regional airline platforms — SkyWest Airlines in the Western United States and ASA in the Eastern United States.  We now provide the vast majority of regional airline service for Delta in Atlanta, its most important eastern hub, and Salt Lake City, its most important western hub.  In connection with our acquisition of ASA in September 2005, we have established new, separate, but substantially similar, long-term fixed-fee Delta Connection Agreements with Delta for both SkyWest Airlines and ASA.  We also obtained control of 26 gates in the Hartsfield-Jackson International Airport located in Atlanta, from which we currently provide service to Delta.  Delta has committed to provide to us opportunities to utilize 28 additional regional jets in our fleet by the end of 2007.  Delta has also agreed that, starting in 2008, ASA is guaranteed to maintain its percentage of total Delta Connection flights that it has in 2007, so long as its bid for additional regional flying is competitive with other regional carriers.

     ASA has been a code-share partner with Delta in Atlanta since 1984.  ASA expanded its operations as a Delta Connection carrier to also include Cincinnati/Northern Kentucky and Salt Lake City in September 2002 and April 2003, respectively.  ASA operates approximately 830 daily flights, all in the Delta Connection system.

     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 our controlled or “pro-rate” flying and contract flying.  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 the completed block hours, flight departures and other operating measures.  On pro-rate flights, we control scheduling, ticketing, pricing and seat inventories and receive a pro-rated portion of passenger fares.  Since August 1, 2003, substantially all of our ASM production was generated by contract flights.  As of June 30, 2006, essentially all of our Brasilia turboprops flown for Delta were flown under pro-rate arrangements while approximately 64% of our Brasilia turboprops flown in the United system were flown under contractual arrangements, with the remaining 36% flown under pro-rate arrangements.

     In September 2005, Delta filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Prior to the date of Delta’s bankruptcy filing, each of SkyWest Airlines and ASA entered into an amended Delta Connection Agreement which provides for a 15-year term, subject to certain termination and extension rights.  Delta received all necessary approvals from the U.S. Bankruptcy Court and the Delta Connection Agreements were assumed by Delta on October 6, 2005.  Under the terms of its Delta Connection Agreement, SkyWest Airlines is compensated primarily on a fee-per-completed-block hour and departure basis, is reimbursed for fuel and other direct costs, and is paid a margin based on completed block hours.  Under its Delta Connection Agreement, ASA is compensated primarily on a fee-per-completed-block-hour basis, is directly reimbursed for fuel and other costs, and is paid a margin based on performance incentives. Notwithstanding the assumption by Delta of the Delta Connection Agreements, Delta’s bankruptcy filing could still lead to many other unforeseen expenses, risks and uncertainties for SkyWest Airlines, ASA or both.

     Although Delta has reported that it intends to reorganize and emerge from its ongoing Chapter 11 bankruptcy proceeding, it could convert its reorganization proceeding to a liquidation proceeding under the U.S. Bankruptcy Code or liquidate some or all of its assets through one or more transactions with third parties.  Such events could jeopardize our Delta Connection operations, leave us unable to efficiently utilize the additional aircraft which we are currently obligated to purchase, or result in other outcomes which could have a material adverse effect on our operating results or financial condition.

     Although a plan of reorganization has been confirmed in United’s bankruptcy proceedings, which became effective on February 1, 2006, there is no assurance that United’s plan will ultimately succeed.  Among other uncertainties, United’s order of confirmation is subject to a pending appeal.  There is no assurance that United will be able to operate successfully under the terms of its plan.  In the event United is not able to perform successfully under the terms of its plan, our United Express operations could be jeopardized, which could have a material adverse effect on our operating results or financial condition.

     On February 4, 2005, we announced that SkyWest Airlines had been selected by United to operate 20 new CRJ700s in its United Express operations, and that SkyWest Airlines had placed a firm order for these CRJ700s with Bombardier.  Deliveries of these aircraft began in the third quarter of 2005 and these deliveries were completed in March 2006.  Our total firm aircraft orders and commitments, as of June 30, 2006, consisted of orders for 17 Bombardier CRJ900 Regional Jets (“CRJ900s”) and commitments to lease four CRJ200’s from Delta.  Total expenditures for these aircraft and related flight equipment, including amounts for contractual price escalations are estimated to be approximately $463 million through April 2007.  Additionally, our agreement with Bombardier includes options for another 70 aircraft that can be delivered in either 70 or 90-seat configurations.  We presently anticipate that

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delivery dates for these aircraft could start in January 2007 and continue through April 2010; however, actual delivery dates remain subject to final determination as agreed upon by us and our code-share partners.

Cautionary Statement Concerning Forward-Looking Statements

     Certain of the statements contained in this Quarterly Report on Form 10-Q 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 the benefits of our acquisition of ASA, including our future financial and operating results, our plans for SkyWest Airlines and ASA, 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, or any applicable filings materializes, or any other underlying assumptions prove incorrect, our actual results may vary materially from those anticipated, estimated, projected, or intended.  These risks and uncertainties include, but are not limited to, those described below in Item 1A., Risk Factors, and the following:

·              our ability to achieve anticipated potential benefits with respect to our acquisition of ASA;

·              our ability to obtain and maintain financing necessary for operations and other purposes;

·              our ability to maintain adequate liquidity;

·              the impact of high fuel prices on the airline industry;

·                                          the impact of global instability, including the continued impact of the United States military presence in foreign countries, the September 11, 2001 terrorist attacks and the potential impact of future hostilities, terrorist attacks or other global events;

·              our ability to attract and retain code-share partners;

·              changes in our code-share relationships;

·              the cyclical nature of the airline industry;

·                                          Competitive practices in the airline industry, including significant fare-restructuring activities, capacity reductions and bankruptcy and other airline restructurings by major and regional carriers, including Delta and United;

·              global and national economic conditions;

·              labor costs;

·              security-related and insurance costs;

·              weather conditions;

·              government legislation and regulation;

·              unfavorable resolution of negotiations with municipalities for the leasing of facilities;

·              relations with ASA’s unionized employees and the impact and outcome of labor negotiations;

·              unionization efforts among SkyWest Airlines’ employees; and

·              other risks and uncertainties listed from time to time in our reports filed with the SEC.

 

     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.

Critical Accounting Policies

     Our significant accounting policies are summarized in Note 1 to our consolidated financial statements for the year ended December 31, 2005, which are presented in our Annual Report on Form 10-K filed with the SEC on March 14, 2006.  Critical accounting policies are those policies that are most important to the preparation of our consolidated financial statements and require management’s subjective and complex judgments due to the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies relate to revenue recognition, aircraft maintenance, aircraft leases and impairment of long-lived assets and intangibles as discussed below. The application of these accounting policies involves the exercise of judgment and the use of assumptions as to future uncertainties and, as a result, actual results will differ, and could differ materially from such estimates.

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Adoption of SFAS No. 123(R)

     Prior to January 1, 2006, we applied Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans.  Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, requires pro forma information regarding net income and net income per share as if we had accounted for our stock options under the fair value method.  We did not record any stock-based compensation expense related to stock options for the year ended December 31, 2005.

     Effective January 1, 2006 we adopted the fair value recognition provisions of SFAS No. 123(R), Share-Based Payment, using the modified-prospective-transition method.  Under that modified-prospective-transition method, compensation cost recognized during the three months ended June 30, 2006 includes compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123(R).  Results for prior periods have not been restated.

     The fair value of stock options has been estimated as of the grant date using the Black-Scholes option pricing model.  During the three months ended June 30, 2006 we granted 377,303 stock options to employees.  The following table shows the assumptions used for grants in the three months ended June 30, 2006 and for the years ended December 31, 2005 and 2004.

 

 

     As required by SFAS 123(R), we recorded share-based compensation expense only for those options that are expected to vest.  The estimated fair value of the stock options is amortized over the vesting period of the respective stock option grants.

     During the three months ended June 30, 2006, we granted 317,901 shares of restricted stock to our employees under the SkyWest, Inc. 2006 Long Term Incentive Plan.   The restricted stock has a three year vesting period, during which the recipient must remain employed with SkyWest or our subsidiaries.  Additionally, we granted 12,600 fully-vested shares of restricted stock to our directors.  The fair value of the stock on the date of grants made during three months ended June 30, 2006 was $23.80 per share.

     We had $17.1 million of total unrecognized compensation cost related to non-vested stock options.  Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.  We expect to recognize this cost over a weighted average period of 1.5 years.

Revenue Recognition

     Passenger and ground handling revenues are recognized when service is provided. Under our contract and pro-rate flying agreements with our code-share partners, revenue is considered earned when the flight is completed. In the event that our contractual rates have not been finalized at quarterly or annual financial statement dates, we record revenues based on a prior period’s approved rates, adjusted to reflect management’s current estimate of the results of the then-current contract negotiations. Our agreements with our code-share partners contain certain provisions pursuant to which the parties could terminate the respective agreements, subject to certain rights of the other party, if certain performance criteria are not maintained. Our revenues could be impacted by a number of factors, including changes to the code-share agreements, contract modifications resulting from contract renegotiations and our ability to earn incentive payments contemplated under applicable agreements.

Maintenance

     We use the direct-expense method of accounting for our regional jet aircraft engine overhaul costs. Under this method, the maintenance liability is not recorded until the maintenance services are performed, thus substantially reducing significant estimates and judgments inherent under the accrual method. We use the “deferral method” of accounting for our Brasilia turboprop engine overhauls, which provides for engine overhaul costs to be capitalized and depreciated over the estimated useful life of the engine. For leased aircraft, we are subject to lease return provisions that require a minimum portion of the “life” of an overhaul be remaining on the engine at the

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lease return date. With respect to engine overhauls related to leased Brasilia turboprops to be returned, we adjust the estimated useful lives of the final engine overhauls based on the respective lease return dates. With respect to SkyWest Airlines, a third-party vendor provides our long-term engine services covering the scheduled and unscheduled repairs for engines on our CRJ700s. Under the terms of the agreement, we pay a set dollar amount per engine hour flown on a monthly basis and the third-party vendor assumes the obligation to repair the engines at no additional cost to us, subject to certain specified exclusions.

Aircraft Leases

     The majority of SkyWest Airlines’ aircraft are leased from third parties, while ASA’s aircraft are primarily debt-financed on a long-term basis. In order to determine the proper classification of our leased aircraft as either operating leases or capital leases, we must make certain estimates at the inception of the lease relating to the economic useful life and the fair value of an asset as well as select an appropriate discount rate to be used in discounting future lease payments. These estimates are utilized by management in making computations as required by existing accounting standards that determine whether the lease is classified as an operating lease or a capital lease. All of our aircraft leases have been classified as operating leases, which results in rental payments being charged to expense over the terms of the related leases. Additionally, operating leases are not reflected in our condensed consolidated balance sheet and accordingly, neither a lease asset nor an obligation for future lease payments is reflected in our condensed consolidated balance sheet.

Impairment of Long-Lived and Intangible Assets

     As of June 30, 2006, we had approximately $2.5 billion of property and equipment and related assets.  Additionally, as of June 30, 2006, we had approximately $31.9 million in net intangible assets.  In accounting for these long-lived and intangible assets, we make estimates about the expected useful lives of the assets, the expected residual values of certain of these assets, and the potential for impairment based on the fair value of the assets and the cash flows they generate.  We recorded an intangible of approximately $33.8 million relating to the acquisition of ASA.  The intangible is being amortized over fifteen years under the straight-line method.  As of June 30, 2006, we had recorded $1.9 million in accumulated amortization expense associated with the ASA intangible.  Factors indicating potential impairment include, but are not limited to, significant decreases in the market value of the long-lived assets, a significant change in the condition of the long-lived assets and operating cash flow losses associated with the use of the long-lived assets.  On a periodic basis, we evaluate whether the book value of our aircraft is impaired in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”  Based on the results of the evaluations, our management concluded no impairment was necessary as of June 30, 2006.  However, there is inherent risk in estimating the future cash flows used in the impairment test.  If cash flows do not materialize as estimated, there is a risk the impairment charges recognized to date may be inaccurate, or further impairment charges may be necessary in the future.

Results of Operations

Three Months Ended June 30, 2006 and 2005

     Operating Statistics.   The following table sets forth our major operational statistics and the percentage-of-change for the quarters identified below.

 

 

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     Our total available seat miles, or ASMs generated during the quarter ended June 30, 2006 increased 99.9% from the quarter ended June 30, 2005.  The increase in ASMs was primarily a result of increasing the size of our aircraft fleet, including our acquisition of ASA, from 223 aircraft as of June 30, 2005, to 397 aircraft as of June 30, 2006.  On the date we acquired ASA, ASA’s fleet consisted of 149 aircraft (35 CRJ700s, 102 CRJ200s and 12 ATRs).  In addition to the aircraft acquired in connection with the acquisition of ASA, we took delivery of 2 CRJ 200s during the three months ended June 30, 2006.  Both aircraft delivered during the three months ended June 30, 2006 were financed under operating leases.

     Net Income.  Net income increased to $39.3 million, or $0.62 per diluted share, for the quarter ended June 30, 2006, compared to $24.8 million, or $0.42 per diluted share, for the quarter ended June 30, 2005.  Factors relating to the change in net income are discussed below.

     Operating Revenues.  Operating revenues increased 105.8% for the quarter ended June 30, 2006, compared to the quarter ended June 30, 2005.  The increase in total operating revenues was primarily due to the acquisition of ASA.  Airline operating and interest expenses, excluding fuel charges, per ASM decreased 3.2% to 9.2¢ for the quarter ended June 30, 2006, from 9.5¢ for the quarter ended June 30, 2005.  The primary reason for the decrease in cost per ASM, excluding fuel charges, was due to increased operating efficiencies obtained from increased stage lengths flown by the regional jets.

     Passenger Revenues.  Passenger revenues, which represented 99.2% of consolidated operating revenues for the quarter ended June 30, 2006, increased 107.4% to $784.3 million for the quarter ended June 30, 2006, from $378.2 million, or 98.5% of consolidated operating revenues, for the quarter ended June 30, 2005.  Our passenger revenues, excluding fuel reimbursements from major partners, increased 90.1% for the quarter ended June 30, 2006 compared to the quarter ended June 30, 2005.  The increase in passenger revenues excluding fuel was primarily due to a 99.9% increase in ASMs, principally as a result of our increase in operating aircraft to 397 aircraft as of June 30, 2006, from 223 aircraft as of June 30, 2005.  Revenue per ASM increased 3.3% to 15.6¢, from 15.1¢ for the quarter ended June 30, 2006, primarily due to an increase in fuel reimbursements from our major partners.  Passenger revenues include an amount designed to reimburse us for aircraft ownership costs.  The amount deemed to be rental income for the three months ended June 30, 2006 was $119.9 million.

     Passenger Load Factor.  Passenger load factor increased to 80.0% for the quarter ended June 30, 2006, from 75.3% for the quarter ended June 30, 2005.  The increase in load factor was due primarily to the further development of our relationships with United and Delta, whereby we supplement mainline service in previously established and developed markets.  Additionally, we believe passenger acceptance of our regional aircraft has increased from the comparable period of 2005.

     Ground Handling and Other Revenue.  Total ground handling revenue for the quarter ended June 30, 2006 increased approximately 4.7% from the same period of 2005.  The increase was primarily related to additional service provided under ground handling contracts with United and Delta, whereby we perform the ground handling for several other regional airlines.

     Total Airline Expenses Excluding Fuel.  Total airline expenses for the quarter ended June 30, 2006, excluding fuel charges (which are substantially reimbursable by our major partners), increased approximately 93.0% from the same period of 2005.  The increase was primarily a result of a 99.9% increase in ASMs (which resulted principally from the acquisition of ASA).  Total operating expenses for the quarter ended June 30, 2006 increased at a lower rate than ASM growth, primarily due to the increased operating efficiencies obtained from increased stage lengths flown by the regional jets.

     Operating and Interest Expenses. Operating and interest expenses increased 110.3% to $729.3 million for the quarter ended June 30, 2006, compared to $346.8 million for the quarter ended June 30, 2006.  The increase in total operating and interest expenses was due principally to our acquisition of ASA.  As a percentage of consolidated operating revenues, total operating and interest expenses increased to 92.3% for the quarter ended June 30, 2006, from 90.3% for the quarter ended June 30, 2005.  The increase in operating and interest expenses as a percentage of consolidated operating revenues was primarily due to significant increases in fuel costs quarter-over-quarter.

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     The following table sets forth information regarding our operating expense components for the quarters ended June 30, 2006 and 2005.  Operating expenses are expressed as a percentage of operating revenues. Individual expense components are also expressed as cents per ASM.

		Three months ended June 30,
		2006							2005
		Amount			Percentage of Revenue		Cents per ASM		Amount			Percentage of Revenue		Cents Per ASM
		(in thousands)							(in thousands)
Salaries, wages and employee benefits		$	165,850		21.0	%	3.3		$	85,749		22.3	%	3.4
Aircraft costs		117,587			14.9	%	2.3		68,974			18.0	%	2.7
Maintenance		51,576			6.5	%	1.0		23,977			6.2	%	0.9
Fuel		263,868			33.4	%	5.2		105,639			27.5	%	4.2
Other airline expenses		101,903			12.8	%	2.0		55,108			14.3	%	2.2
Interest		28,518			3.6	%	0.6		7,392			1.9	%	0.3
Total airline expenses		$	729,302				14.4		$	346,839				13.7

 

     The cost per ASM for salaries, wages and employee benefits decreased to 3.3¢ for the quarter ended June 30, 2006, compared to 3.4¢ for the quarter ended June 30, 2005.  The average number of full-time equivalent employees increased 79.7% to 13,335 for the quarter ended June 30, 2006 from 7,421 for the quarter ended June 30, 2005.  The increase in number of employees was due, in large part, to our acquisition of ASA and addition of personnel required for the new regional jet flying and ground handling operations within our United Express operations.  Additionally, during the three months ended June 30, 2006, we recorded $3.1 million pre-tax ($2.2 million after tax) of equity based compensation expense related to the adoption of SFAS No. 123(R) and due to the issuance of restricted stock grants under the SkyWest, Inc. 2006 Long Term Incentive Plan.

     The cost per ASM for aircraft costs, including aircraft rent and depreciation, decreased to 2.3¢ for the quarter ended June 30, 2006, from 2.7¢ for the quarter ended June 30, 2005.  The decrease in cost per ASM was primarily due to the addition of ASA’s regional jet fleet and the addition of 25 CRJ700s, which have a lower operating cost per ASM than our existing CRJ200 and turboprop fleets.

     The cost per ASM for maintenance expense increased to 1.0¢ for the quarter ended June 30, 2006, compared to 0.9¢ for the quarter ended June 30, 2005.  The increase was primarily related to the timing of certain maintenance events during the quarter ended June 30, 2006.  Under our United Express Agreement, specific amounts are included in the rates and charges for mature maintenance on regional jet engines that we record as revenue.  However, consistent with the change to a direct expense maintenance policy, we record maintenance expense on our CRJ200 engines as it is incurred.  As a result, during the quarter ended June 30, 2006, we collected and recorded as revenue $6.9 million (pretax) under the United Express Agreement to compensate us for future engine maintenance overhauls, with no corresponding expense relative to CRJ200 engine maintenance overhauls.  Because the “Maintenance” line in the table above does not include salaries, wages and employee benefits associated with our maintenance operations (those costs are stated separately in the table), the maintenance expense line in the above table differs from the maintenance line in our Condensed Consolidated Statements of Income.

     The cost per ASM for fuel increased 23.8% to 5.2¢ for the quarter ended June 30, 2006, from 4.2¢ for the quarter ended June 30, 2005.  This increase was primarily due to the average price of fuel increasing to $2.26 per gallon during the quarter ended June 30, 2006, from $1.87 per gallon for the quarter ended June 30, 2005.

     The cost per ASM for other expenses, primarily consisting of landing fees, station rentals, computer reservation system fees and hull and liability insurance, decreased 9.1% to 2.0¢ for the quarter ended June 30, 2006, from 2.2¢ for the quarter ended June 30, 2005. The decrease was primarily related to the increase in stage lengths flown by our regional jets.

     Interest expense increased to approximately $28.5 million during the quarter ended June 30, 2006, from approximately $7.4 million during the quarter ended June 30, 2005.  The increase in interest expense was primarily due to the addition of ASA’s aircraft which are primarily financed with long-term debt.

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Six Months Ended June 30, 2006 and 2005

     Operating Statistics.   The following table sets forth our major operational statistics and the percentage-of-change for the periods identified below.

 

     Our total ASMs generated during the six months ended June 30, 2006 increased 105.0% from the six months ended June 30, 2005.  The increase in ASMs was primarily a result of increasing the size of our aircraft fleet, including our acquisition of ASA, from 223 aircraft as of June 30 2005, to 397 aircraft as of June 30, 2006.  On the date we acquired ASA, ASA’s fleet consisted of 149 aircraft (35 CRJ700s, 102 CRJ200s and 12 ATRs).  In addition to the aircraft acquired in connection with the acquisition of ASA, we took delivery of 15 CRJ 700s and 2 CRJ 200s during the six months ended June 30, 2006.  All aircraft delivered during the six months ended June 30, 2006 were financed under operating leases.

     Net Income.  Net income increased to $73.9 million, or $1.21 per diluted share, for the six months ended June 30, 2006, compared to $43.5 million, or $0.75 per diluted share, for the six months ended June 30, 2005.  Factors relating to the change in net income are discussed below.

     Operating Revenues.  Operating revenues increased 111.7% for the six months ended June 30, 2006, compared to the six months ended June 30, 2005.  The increase in total operating revenues was primarily due to our acquisition of ASA.  Airline operating and interest expenses, excluding fuel charges, per ASM decreased 4.0% to 9.5¢ for the six months ended June 30, 2006, from 9.9¢ for the six months ended June 30, 2005.  The primary reason for the decrease in cost per ASM, excluding fuel charges, was the effect of increased operating efficiencies obtained from increased stage lengths flown by the regional jets.

     Passenger Revenues.  Passenger revenues, which represented 99.1% of consolidated operating revenues for the six months ended June 30, 2006, increased 112.8% to $1.52 billion for the six months ended June 30, 2006, from $713.8 million, or 98.5% of consolidated operating revenues, for the six months ended June 30, 2005.  Our passenger revenues, excluding fuel reimbursements from our major partners, increased 94.0% for the six months ended June 30, 2006 compared to the six months ended June 30, 2005.  The increase in passenger revenues excluding fuel was primarily due to a 105.0% increase in ASMs, principally as a result of our increase in operating aircraft to 397 aircraft as of June 30, 2006, from 223 aircraft as of June 30, 2005.  Revenue per ASM increased 3.3% to 15.7¢, from 15.2¢ for the six months ended June 30, 2006, primarily due to an increase in fuel reimbursements from our major partners.  Passenger revenues include an amount designed to reimburse us for aircraft ownership costs.  The amount deemed to be rental income for the six months ended June 30, 2006 was $237.2 million.

     Passenger Load Factor.  Passenger load factor increased to 78.8% for the six months ended June 30, 2006, from 74.3% for the six months ended June 30, 2005.  The increase in load factor was due primarily to the further development of our relationships with United and Delta, whereby we supplement mainline service in previously established and developed markets.  Additionally, we believe passenger acceptance of our regional aircraft has increased from the comparable period of 2005.

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     Ground Handling and Other Revenue.  Total ground handling revenue and other revenue for the six months ended June 30, 2006 increased approximately 37.6% from the same period of 2005.  The increase was primarily related to contracts with United and Delta, whereby we perform the ground handling for several other regional airlines.

     Total Airline Expenses Excluding Fuel.  Total airline expenses for the six months ended June 30, 2006, excluding fuel charges (which are substantially reimbursable by our major partners), increased approximately 96.8% from the same period of 2005.  The increase was primarily a result of a 105.0% increase in ASMs (which resulted principally from the acquisition of ASA).  Total operating expenses for the six months ended June 30, 2006 increased at a lower rate than ASM growth, primarily due to the increased operating efficiencies obtained from increased stage lengths flown by the regional jets.

     Operating and Interest Expenses. Operating and interest expenses increased 115.0% to $1.42 billion for the six months ended June 30, 2006, compared to $659.3 million for the six months ended June 30, 2005.  The increase in total operating and interest expenses was due principally to our acquisition of ASA.  As a percentage of consolidated operating revenues, total operating and interest expenses increased to 92.5% for the six months ended June 30, 2006, from 91.0% for the six months ended June 30, 2005.  The increase in operating and interest expenses as a percentage of consolidated operating revenues for the six-months ended June 30, 2006 was primarily due to significant increases in fuel costs compared to the six-months ended June 30, 2005.

     The following table sets forth information regarding our operating expense components for the quarters ended June 30, 2006 and 2005.  Operating expenses are expressed as a percentage of operating revenues. Individual expense components are also expressed as cents per ASM.

 

		Six months ended June 30,
		2006							2005
		Amount			Percentage of Revenue		Cents per ASM		Amount			Percentage of Revenue		Cents Per ASM
		(in thousands)							(in thousands)
Salaries, wages and employee benefits		$	331,175		21.6	%	3.3		$	169,162		23.4	%	3.5
Aircraft costs		231,424			15.1	%	2.4		133,553			18.4	%	2.8
Maintenance		106,754			7.0	%	1.1		45,719			6.3	%	1.0
Fuel		488,531			31.9	%	5.0		187,057			25.8	%	3.9
Other airline expenses		202,892			13.2	%	2.1		109,800			15.2	%	2.3
Interest		57,061			3.7	%	0.6		14,038			1.9	%	0.3
Total airline expenses		$	1,417,837				14.5		$	659,329				13.8

 

     The cost per ASM for salaries, wages and employee benefits decreased to 3.3¢ for the six months ended June 30, 2006, compared to 3.5¢ for the six months ended June 30, 2005.  The average number of full-time equivalent employees increased 81.1% to 13,207 for the six months ended June 30, 2006 from 7,291 for the six months ended June 30, 2005.  The increase in number of employees was due, in large part, to the acquisition of ASA and addition of personnel required for the new regional jet flying and ground handling operations within our United Express operations.  Additionally, during the six months ended June 30, 2006, we recorded $4.7 million pre-tax ($3.5 million after tax) of equity based compensation expense related to the adoption of SFAS No. 123(R) and due to the issuance of restricted stock grants under the SkyWest Inc. 2006 Long Term Incentive Plan.

     The cost per ASM for aircraft costs, including aircraft rent and depreciation, decreased to 2.4¢ for the six months ended June 30, 2006, from 2.8¢ for the six months ended June 30, 2005.  The decrease in cost per ASM was primarily due to the addition of ASA’s regional jet fleet and the addition of 25 CRJ700s, which have a lower operating cost per ASM than our existing CRJ200 and turboprop fleets.

     The cost per ASM for maintenance expense increased to 1.1¢ for the six months ended June 30, 2006, compared to 1.0¢ for the six months ended June 30, 2005.  The increase was primarily due to the timing of certain maintenance events during the six months ended June 30, 2006.  Under our United Express Agreement, specific amounts are included in the rates and charges for mature maintenance on regional jet engines that we record as revenue.  However, consistent with the change to a direct expense maintenance policy, we

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