Flying Agreements Revenue and Lease, Airport Services and Other Revenues

3 Months Ended

Mar. 31, 2020

Flying Agreements Revenue and Lease, Airport Services and Other Revenues

Flying Agreements Revenue and Lease, Airport Services and Other Revenues

Note 3 — Flying Agreements Revenue and Lease, Airport Services and Other Revenues

The Company recognizes flying agreements revenue and lease, airport services and other revenues when the service is provided under its code-share agreements. Under the Company’s fixed-fee arrangements (referred to as “capacity purchase agreements”) with Delta Air Lines, Inc. (“Delta”), United Airlines, Inc. (“United”), American Airlines, Inc. (“American”) and Alaska Airlines, Inc. (“Alaska”) (each, a “major airline partner”), the major airline partner generally pays the Company a fixed-fee for each departure, flight hour (measured from takeoff to landing, excluding taxi time) or block hour (measured from takeoff to landing, including taxi time) incurred, and an amount per aircraft in service each month with additional incentives based on flight completion and on-time performance. The major airline partner also directly pays for or reimburses the Company for certain direct expenses incurred under the capacity purchase agreement, such as fuel, airport landing fees and airport rents. Under the capacity purchase agreements, the Company’s performance obligation is met when each flight is completed and is reflected in flying agreements revenue. The transaction price for the capacity purchase agreements is determined from the fixed-fee consideration, incentive consideration and directly reimbursed expenses earned as flights are completed over the agreement term. For the three months ended March 31, 2020, capacity purchase agreements represented approximately 85.9% of the Company’s flying agreements revenue.

Under the Company’s revenue-sharing arrangements (referred to as a “revenue-sharing” or “prorate” arrangement), the major airline partner and the Company negotiate a passenger fare proration formula, pursuant to which the Company receives a percentage of the ticket revenues for those passengers traveling for one portion of their trip on a Company airline and the other portion of their trip on the major airline partner. Under the Company’s prorate flying agreements, the performance obligation is met and revenue is recognized when each flight is completed based upon the portion of the prorate passenger fare the Company anticipates that it will receive for each completed flight. The transaction price for the prorate agreements is determined from the proration formula derived from each passenger ticket amount on each completed flight over the agreement term. For the three months ended March 31, 2020, prorate flying arrangements represented approximately 14.1% of the Company’s flying agreements revenue.

Lease, airport services and other revenues primarily consist of revenue generated from aircraft and spare engines leased to third parties. Of the Company’s $5.4 billion of property and equipment, net as of March 31, 2020, $154.1 million of regional jet aircraft and spare engines was leased to third parties under operating leases as of March 31, 2020. The Company mitigates the residual asset risks of these assets by leasing aircraft and engine types that can be operated by the Company in the event of a default. Additionally, the operating leases typically have specified lease return condition requirements paid by the lessee to the Company and the Company typically maintains inspection rights under the leases. The following table summarizes future minimum rental income under operating leases primarily related to leased aircraft that had remaining non-cancelable lease terms as of March 31, 2020 (in thousands):

April 2020 through December 2020	$	23,484
2021		27,849
2022		27,606
2023		24,704
2024		24,396
Thereafter		87,235
	$	215,274

Additionally, lease, airport services and other revenues includes airport agent services, such as gate and ramp agent services at applicable airports where the Company provides such services. The transaction price for airport customer service agreements is determined from an agreed-upon rate by location applied to the applicable number of flights handled by the Company over the agreement term. The following represents the Company’s airport and customer service and other revenue for the three months ended March 31, 2020 and 2019 (in thousands):

	For the three months ended March 31,
	2020		2019
Airport customer service revenue	$	9,896	$	14,635
Operating lease revenue		10,546		9,058
Lease, airport services and other	$	20,442	$	23,693

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 agreements.

The following table represents the Company’s flying agreements revenue by type for the three-month periods ended March 31, 2020 and 2019 (in thousands):

	For the three months ended March 31,
	2020		2019
Capacity purchase agreements revenue: flight operations	$	366,409	$	386,545
Capacity purchase agreements revenue: aircraft lease revenue		242,734		207,381
Prorate agreements revenue		100,351		106,075
Flying agreements revenue	$	709,494	$	700,001

A portion of the Company’s compensation under its capacity purchase agreements is designed to reimburse the Company for certain aircraft ownership costs. The consideration for aircraft ownership costs varies by agreement but is intended to cover either the Company’s aircraft principal and interest debt service costs, its aircraft depreciation and interest expense or its aircraft lease expense costs while the aircraft is under contract. The consideration received for the use of the aircraft under the Company’s capacity purchase agreements is reflected as lease revenue, inasmuch as the agreements identify the “right of use” of a specific type and number of aircraft over a stated period of time. The lease revenue associated with the Company’s capacity purchase agreements is accounted for as an operating lease and is reflected as flying agreements revenue on the Company’s consolidated statements of comprehensive income. The Company has not separately stated aircraft rental income and aircraft rental expense in the consolidated statement of comprehensive income since the use of the aircraft is not a separate activity of the total service provided.

The Company’s capacity purchase and prorate agreements include weekly provisional cash payments from the respective major airline partner based on a projected level of flying each month. The Company and each major airline partner subsequently reconcile these payments to the actual completed flight activity on a monthly or quarterly basis. In the event a flying agreement includes a mid-term rate reset to adjust rates prospectively and the contractual rates under the Company’s flying agreements have not been finalized at quarterly or annual financial statement dates, the Company applies the variable constraint guidance under ASU No. 2014-09, “Revenue from Contracts with Customers, (Topic 606)” (“Topic 606”), where the Company records revenue to the extent it believes that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

In several of the Company’s agreements, the Company is eligible to receive incentive compensation upon the achievement of certain performance criteria. The incentives are defined in the agreements and are measured and determined on a monthly or quarterly basis. At the end of each period during the term of an agreement, the Company calculates the incentives achieved during that period and recognizes revenue attributable to that agreement accordingly, subject to the variable constraint guidance under Topic 606.

The following table summarizes the significant provisions of each code-share agreement SkyWest Airlines has with each major airline partner:

Delta Connection Agreements
Agreement	Aircraft type	Number of Aircraft	Term / Termination Dates
Delta Connection Agreement (capacity purchase agreement)	• CRJ 200 • CRJ 700 • CRJ 900 • E175	55 8 43 62	• Individual aircraft have scheduled removal dates from 2020 to 2029
Delta Connection Prorate Agreement (prorate arrangement)	• CRJ 200	27	• Terminable with 30-day notice

United Express Agreements
Agreement	Aircraft type	Number of Aircraft	Term / Termination Dates
United Express Agreements (capacity purchase agreement)	• CRJ 200 • CRJ 700 • E175	70 19 69	• Individual aircraft have scheduled removal dates from 2022 to 2029
United Express Prorate Agreement (prorate arrangement)	• CRJ 200	31	• Terminable with 120-day notice

American Agreements
Agreement	Aircraft type	Number of Aircraft	Term / Termination Dates
American Agreement (capacity purchase agreement)	• CRJ 700	61	• Individual aircraft have scheduled removal dates from 2022 to 2025
American Prorate Agreement (prorate arrangement)	• CRJ 200	7	• Terminable with 120-day notice

Alaska Capacity Purchase Agreement
Agreement	Aircraft type	Number of Aircraft	Term / Termination Dates
Alaska Agreement (capacity purchase agreement)	• E175	32	• Individual aircraft have scheduled removal dates from 2027 to 2030

In addition to the contractual arrangements described above, SkyWest Airlines has entered into capacity purchase agreements with Delta, American and United to place additional new and used Embraer E175 dual-class regional jet aircraft (“E175”) into service. The Company is coordinating with its major airline partners on the timing of upcoming fleet deliveries under previously announced deals in response to COVID-19 schedule reductions. The anticipated future delivery dates summarized below are subject to change.

As of March 31, 2020, the Company was scheduled to acquire and place into service six new E175 aircraft in connection with its agreement with Delta. The delivery dates for these six new E175 aircraft are currently scheduled to be completed during 2020. Additionally, the Company is scheduled to add three used E175 aircraft that are financed by Delta under the Delta agreement during 2020. SkyWest Airlines also entered into an agreement with Delta to place one Canadair CRJ900 regional jet aircraft (“CRJ900”) that is financed by Delta under a nine-year capacity purchase agreement in 2020.

As of March 31, 2020, the Company was scheduled to acquire and place into service 20 new E175 aircraft in connection with its agreement with American. The delivery dates for the new E175 aircraft were originally scheduled to be completed by 2021. The Company is currently coordinating with American and the manufacturer on revised delivery dates due to COVID-19-related schedule reductions. Additionally, SkyWest Airlines has a flying contract with American to operate a total of 70 used Canadair CRJ700 regional jet aircraft (“CRJ700s”), of which 61 aircraft were under contract at March 31, 2020. The Company is also coordinating with American on in-service dates for the remaining nine aircraft.

The Company anticipates its American Prorate Agreement on seven CRJ200 aircraft will terminate in 2020 as a result of COVID-19-related passenger demand reductions. The Company may have further reductions in the number of CRJ200 aircraft operating under prorate agreements with its other major airline partners throughout 2020.

During the three months ended March 31, 2020, SkyWest Airlines placed four used E175 aircraft financed by United under a capacity purchase agreement with United. As of March 31, 2020, SkyWest Airlines was scheduled to add 21 used E175 aircraft that were financed by United under the United agreement throughout 2020 and 2021.

As of March 31, 2020, the Company’s capacity purchase agreement with Delta included 55 CRJ200 aircraft that are scheduled to expire in increments during the remainder of 2020 and are not expected to be extended as a result of the decreased demand caused by the COVID-19 pandemic. The Company leases 19 of the 55 aircraft from Delta and anticipates returning the leased aircraft to Delta in 2020. The Company owns the remaining 36 CRJ200 aircraft and anticipates parking the 36 CRJ200 aircraft following removal from service. The Company has no outstanding financing obligations on the 36 owned CRJ200 aircraft. The Company reduced the estimated useful lives of these 36 CRJ200 aircraft to align with each aircraft’s anticipated removal dates, which resulted in approximately $15.0 million of incremental depreciation expense during the three months ended March 31, 2020. The Company anticipates it will incur $29.1 million of additional depreciation expense from April to December 2020 resulting from the shorter estimated useful lives of the 36 owned CRJ200 aircraft.

When an aircraft is scheduled to be removed from a capacity purchase agreement, the Company may, as practical under the circumstances, negotiate an extension with the respective major airline partner, negotiate the placement of the aircraft with another major airline partner, return the aircraft to the lessor if the aircraft is leased and the lease is expiring, place owned aircraft for sale, or pursue other uses for the aircraft. Other uses for the aircraft may include placing the aircraft in a prorate arrangement, leasing the aircraft to a third party, using aircraft parts and engines as spare inventory or leasing spare engines to a third party. In the event practical alternative uses for the aircraft removed from service are not available, the Company may park and store the aircraft.

The Company’s operating revenues could be impacted by a number of factors, including the impact of the COVID-19 pandemic on the demand for air travel and associated reduction in flight schedules, changes to the Company’s code-share agreements with its major airline partners, contract modifications resulting from contract renegotiations, 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 airline partners.

Allowance for credit losses

The Company monitors publicly available credit ratings for entities for which the Company has a significant receivable balance. As of March 31, 2020, the Company had gross receivables of $42.0 million in current assets and gross receivables of $76.7 million in other long-term assets. The Company has established credit loss reserves based on publicly available historic default rates issued by a third party for companies with similar credit ratings, factoring in the term of the respective accounts receivable or note receivable. During the three months ended March 31, 2020, the credit ratings were lowered on certain entities for which the Company has outstanding accounts receivable or notes receivable, which was the primary driver for the increase in the Company’s credit loss reserve when benchmarked against historic default rates of similarly rated companies during the three months ended March 31, 2020.

The following table summarizes the changes in allowance for credit losses:

	Allowance for
	Credit Losses
Balance at January 1, 2020	$	15,388
Additions to credit loss reserve		3,756
Write-offs charged against the allowance		—
Balance at March 31, 2020	$	19,144