Republic Airways (RJET) Chairman, President and CEO Bryan Bedford gave a lesson in regional airline economics, in his candid and often provocative remarks at the recent Merrill Lynch Global Transportation Conference. He also showed why his high-flying airline is a case study in how to run profitable routes.

Notably, the always-quotable airline insider asserted that network aircraft replacement would benefit regionals, adding that it is too early in the game to predict the future of 70- to 90-seat regional jets. "There is a pent-up demand at US Airways (LCC), Northwest (NWACQ) and Delta (DALQ) who are looking at larger capacity products," Bedford said, "but it is uncertain whether any of the low cost carriers will enter this space to build out their networks. The travel patterns in domestic North America show that 80 percent of all departures leave with fewer than 100 passengers aboard; over 50 percent depart with fewer than 50 passengers. If you want to match the machine to the mission - capacity to demand - there is an overwhelming requirement for products in the sub-100 seat space. Clearly we think the market has a lot of opportunity in it and not a lot of providers to satisfy demand."

Bedford thinks the industry is entering a cycle in which network carriers want to pursue fleet replacement. He predicted they would use their resources on wide-body aircraft, because they can be used in higher yield international routes with built in barriers to entry driven by bilateral treaties. "Airline capital has been constrained over the last five years," he said. "They have to be judicious in how they allocate their resources. I expect them to outsource the large capital requirements for smaller planes to regional carriers that can buy and finance those planes for them."

He does not put much stock in the lower labor agreements network carriers have hammered out. "I've seen the strategy of lower labor costs associated with operating smaller jets come and go and apparently it is not played out yet," he said. "Mainline labor has never been welcoming to what we would call a 'B scale.' "

He added that, over the long term, even if network carriers obtain lower costs to operate smaller capacity aircraft, those agreements would not sustain themselves. "Outsourcing is the best model," he said. "Simplifying their fleet equals lower costs and outsourcing helps that. Operating fewer fleet types is key and complicating that with larger regional jets, I don't think, is value added to them compared to outsourcing. You also have to maintain market discipline and once you make a decision to bring those operations in house, you are essentially negotiating with yourself versus maintaining a competitive market dynamic by negotiating with various regionals."

Bedford recounted recent changes in scope clauses and noted the positive impact scope relief has had on network carriers. "Scope is a visceral issue for both management and labor," he continued. "Labor doesn't want to give it up and management wants to get rid of it. We've seen the experience of both United (UAUA) and US Airways which have achieved scope relief and followed it on with orders for larger capacity jets for the mainline carrier. I expect that to happen at Delta and Northwest."

He pointed out that management has no reason to negotiate scope flexibility if it doesn't intend to satiate demand. "Right now, there is a pent-up demand for larger capacity regional jets that will be let loose over the next few quarters," he said. "Delta has amended its pilot scope agreement increasing by 100 its ability to operate larger regional RJs. Northwest received relief for an additional 90, 55 of which can be outsourced."

He said a longer view of the network is needed. "If you focus on the narrow body jet demographic, specifically those that are 15 to 30 years old and reaching their economic obsolescence, there is a need of 1,072 aircraft," he said. "I'm not saying all of them will be replaced by 70- to 90-seat RJs, but there will be many and our strategy is to position ourselves for the replacement cycle and win our fair share of the business."

He did not discount the possibility of breaking RJET's philosophy of having a simple fleet focused on Embraer products. "We have three operating subsidiaries that can operate three fleet types and still maintain our single aircraft mantra," he said. However, he drew the line at returning to turboprops and suggested that there is an oversupply of smaller jets, although it is not as bad as pundits suggest and probably worse than some regional carriers would admit.

"You used to get on turboprops and let's face it, you hated it," he said. "They were cruel and unusual punishment. People thought they were loud, noisy and unsafe. Customers didn't like it and that prompted them to drive to get on a jet. The evolution to the 50-seat jet happened because the customer wanted a faster, smoother, quieter ride and now the passenger has it."

Bedford described his airline as little more than an "outsourcing business that happens to fly airplanes," adding that RJET has been able to grow revenues from $150 million to $900 million at a time when the rest of the airline industry has experienced its worse financials since Kitty Hawk.

"We have been challenged," he said. He indicated, however, that while these challenges have been risky they have also brought opportunities that made his airline so successful. "We have personally experienced just about every network carrier's distressed bankruptcy, reorganization or workout," he said. "I don't know how we managed to miss Northwest's bankruptcy but we went through US Airways one and two, American West, TWA's liquidation, American's workout in 2003 and, of course United. Our results speak for themselves. We've been profitable for 24 consecutive quarters, have a well capitalized balance sheet and have grown revenues over 40 percent year over year."

Bedford attributed the airline's success to copying the Southwest approach - isolating one aircraft type, concentrating assets geographically, maintaining a low overhead, having a positive employee culture and "incentivizing" partners to use assets productively.

Unlike other airlines that contract with multiple network carriers, RJET keeps its assets in a single geographic area in order to use human and equipment resources across all contracts, going as far as to "neutrally brand" aircraft. "This drives out cost so we can use the savings to competitively [pursue] growth opportunities," he said. That growth has resulted in a compound annual growth rate in excess of 70 percent in terms of fleet, stalling growth of small regional jets in favor of larger capacity 70- to 90-seat jets.

"Growth for growth's sake is not what we are about," he said. "We maintain a 47 percent annual growth rate on revenue. We have a strategy of diversifying our revenue stream and like the idea of flying for multiple partners. We allocate our overhead across many different carriers and that gives us 'best-in-class' economy as we compete for new business."

Given the airline's experience with its partners' bankruptcies, it seemed like an understatement for him to say that revenue diversity is important. "Ideally, no one carrier should provide more than 25 percent of revenues," he said. "I'm not saying we are there but we have plans in place to accomplish that over the next two to three years. Our risk is operationally driven. If we don't fly we don't get paid so reliability has to be built into the business model. The result is, we obtain a predictable revenue stream off our code sharing partners."

In response to a question concerning fuel price impact on regional carriers, Bedford said they do not negatively impact regionals.

"Fuel prices impact everyone especially when passengers decide to drive or not take a trip at all," he told the investment community. "If you believe you reach a point where prices have to increase to compensate for the high cost of oil, that generally means lower demand and where there is lower demand, you want to operate a smaller capacity aircraft. Why would you want to pay for a 150-seat aircraft when all you need is a 70-seat airplane? I think fuel prices stimulate what we do as opposed to oppress us. Clearly, the regional segment of the business is not cyclical. We grow in good times and we grow more in bad times. When times are tough, that is when the national carriers are really trying to keep coming through the hubs at the lowest possible cost and that is when they outsource. In fact, we grow less rapidly in good times when network carriers can make money with larger capacity aircraft on routes that might otherwise be operated by regionals."

RJET: Flying High in May

Republic Airways Holdings (RJET) reported a 51.8 percent increase in traffic for May when it generated 570 million revenue passenger miles (RPMs). At the same time available seat miles (ASMs) increased to 758 million, a 41.7 percent increase over May 2005. Block hours numbered 45,785, up 16.7 percent and load factor jumped five points to 75.2 percent. It flew 1,105,148 passengers during the month. Year to date, RPMs totaled 2.4 billion, up 46.3 percent while ASMs are up 39.1 percent to 3.4 million. Load factor was up 3.6 points to 72.2 percent while passengers carried rose 30.8 percent to 4,681,827.