Jetblue Airbus A320 Photo: JetBlue

MIAMI — JetBlue Airways reported a $4 million net profit for the first quarter of 2014, or $0.01 cents per diluted share, down sharply from a net profit of $14 million in Q1 2013. The New York based carrier pinned the current quarter’s slide to steeply rising labor costs, as well as the massive impact of the poor winter weather. JetBlue, whose network is heavily concentrated in the Northeast, was forced to cancel 4,100 flights due to abnormal winter weather. This had a $50 million impact, and reduced operating profit by nearly $25 million.

Passenger revenues rose 3.8% year over year (YOY) from the first quarter of 2013 to $1.35 billion. Passenger revenue grew 3.6% to $1.23 billion, while other operating revenues jumped 5.9% to $119 million.  Average per passenger revenue grew 3.2% YOY to $167.69, and yields ticked up 1.8%. And ancillary revenue per customer grew 9.9% YOY to $24. Total ancillary revenue increased roughly 9% YOY to $175 million, and the Even More offering is on track to generate $190 million for the full year. These factors played a part in driving a 0.9% YOY increase in passenger revenue per available seat mile (PRASM) to 11.80 cents on 2.7% growth in capacity as measured in available seat miles (ASMs), and 1.8% growth in demand as measured in revenue passenger miles (RPMs).

Revenue-wise, one of the key product side initiatives on the part of JetBlue is the introduction of Fly-Fi, JetBlue’s in-flight WiFi system. CEO David Barger had some color to offer on Fly-Fi during the quarterly conference call:

“We are on track to complete installations of Fly-Fi, JetBlue’s in-flight connectivity product, on our Airbus A320 fleet by the end of 2014. With 36 aircraft equipped with Fly-Fi today, initial customer feedback has been very positive. On certain long-haul flights, over 80% of customers are connecting to Fly-Fi. We believe offering true broadband speeds in-flight will be a key differentiator for JetBlue, particularly in the long-haul markets. We expect to share more details of our plans to monetize Fly-Fi later this year.”

JetBlue also noted that its airline partnership revenues continue to rise, hitting $120 million in revenues in 2013 ($50 million incremental). JetBlue expects partnership revenues to grow 50 – 60% in 2014, even with the loss of feed from American airlines. As an example of the power of its partnerships, the carrier cited Boston – Detroit as a route where on average 30 passengers are connecting onto JetBlue’s service from airline partners at Boston.

The increase in revenues was surpassed by worrisome increases on the expense side of the ledger, with operating expenses increasing an alarming 5.5% to $1.31 billion.  Fuel expenses dropped slightly, 0.8% YOY to $464 million on a 4.4% to $3.14, while aircraft rent and maintenance slid 3.1% and 17.8% YOY to $31 million and $94 million, respectively – the only areas in which costs decreased.

These expense reductions were singlehandedly obliterated, however, by a 17.7% YOY increase in labor costs. The carrier, facing an aging and more experienced workforce that continues to command higher salaries, wages, and benefits, spent about $49 million more on labor in Q1 2014 than it did in Q1 2013. The recent unionization of JetBlue’s pilots under ALPA, along with the spillover to other work groups such as the flight attendants, is expected to drive up costs even further. Accordingly, cost per available seat mile (CASM) rose 2.6% to 12.55 cents YOY, though more tellingly CASM excluding fuel jumped a sharp 6.3% YOY to 8.10 cents.

In terms of maintenance expense, JetBlue managed to reverse the massive cost increases that had seized its MRO operation mostly due to the winter weather. Its aircraft flew fewer cycles and thus scheduled maintenance was pushed forward into the second quarter and beyond. While the dip in maintenance costs was nice, it simply was not a sustainable one.

On the cost side, the key initiative on the part of JetBlue to manage CASM remains its fleet of larger A321s, which have yielded CASM savings of 10-15% versus the current A320 fleet according to CEO David Barger.

Part of that is certainly the maintenance honeymoon enjoyed by aircraft at the beginning of their economic life, but it is still a nice boost nonetheless. We expect to see JetBlue continue to shift to the larger A321 for trunk routes as its labor costs rise over the next few years, and increase its A321 order book relative to A320s. Barger also noted that the installation of sharklets has led to a 3-4% improvement in fuel efficiency on transcontinental routes.

JetBlue ended the quarter with $771 million in cash, cash equivalents and short term investments, and total debt of $2.64 billion for a net debt of $1.87 billion. The carrier plans to use a portion of the proceeds from its sale of LiveTV subsidiary to prepay between $200 million and $300 million worth of debt. Its operating profit for the quarter was $41 million, yielding an operating margin of 3.1% (down from 4.5% in Q1 2013). It is important to note that adjusted for weather impact, JetBlue would have recorded a $76 million operating profit and a 5.4% operating margin.

Looking forward into the second quarter, JetBlue expects to grow capacity by 5.5 – 7.5% YOY thanks to nearly 20% growth in Caribbean and Latin American flying. April PRASM is expected to increase by 9.5 – 10.5% YOY due to the shift of Easter and Passover into April. May PRASM growth is expected to be in “the mid-single-digits year-over-year.” CASM in the second quarter is projected to rise 4.5 – 6.5%, with 40 – 60% of the increase coming from salaries, wages, and benefits.

Much as is the situation at fellow hybrid (network & LCC) carrier Southwest Airlines, the most significant challenge facing JetBlue is the precipitous rise it faces in labor costs. Like Southwest, JetBlue has seen a decline in capacity growth as its “low hanging fruit” opportunities were steadily filled.

So it can no longer simply use growth to manage CASM. Thanks to pilot unionization, and the expected unionization of its remaining employee groups, JetBlue is staring down a future in which its labor costs will rise even more precipitously (and the ceteris paribus case wasn’t exactly frugal either). So the number one challenge for JetBlue is going to be revenue generation to offset labor costs (as it is at Southwest).

Ancillary revenues and airline partnerships are part of the puzzle, but the real opportunities in the longer run are to add checked baggage fees, and to go aggressively international from Boston and Fort Lauderdale using the A321neo.