Buffett gives highs and lows of his bizav units

 - May 15, 2008, 5:34 AM

Insight into the competitive performances of FlightSafety International and Executive Jet can be found in a candid and personal letter by Berkshire Hathaway CEO Warren Buffett to shareholders in his company. In the midst of the financial data, he singles out the leaders of these two divisions, Al Ueltschi and Richard Santulli.

Revenues from FSI and EJ last year increased $284 million, or 12.4 percent over 2000. About 83 percent of the increase in revenues was attributed to Executive Jet, which produced “significant increases” in revenues from both flight operations and aircraft sales, according to Buffett. Revenues from FlightSafety also increased, approximately 7.7 percent last year compared with 2000, reflecting both increased training revenues and product (simulator) sales.

Combined operating profits of FSI and EJ fell $27.1 million last year–a drop of 12.8 percent from 2000. Increased operating profits at FlightSafety were more than offset by reduced operating profits at Executive Jet. Executive Jet’s results for the past two years reflect operating losses related to expansion into Europe, as well as significantly higher operating costs incurred to “ensure that a premier level of safety, security and service is maintained.” The increases in safety and security costs were exacerbated by September 11.

Buffett wrote: “All of the income for Berkshire Hathaway’s flight services division last year ‘and a bit more’ came from FlightSafety.… Its earnings increased 2.5 percent, though return on invested capital fell slightly because of the $258 million investment we made last year in simulators and other fixed assets. My 84-year-old friend [Ueltschi] continues to run FlightSafety with the same enthusiasm and competitive spirit that he has exhibited since 1951, when he invested $10,000 to start the company. If I line Al up with a bunch of 60-year-olds at the annual meeting, you will not be able to pick him out.”

After September 11, training for airline pilots fell, and today it remains depressed. “However, training for business and general aviation, our main activity, is at near-normal levels and should continue to grow.” This year the company expects to spend $162 million for 27 simulators, “a sum far in excess of our annual depreciation charge of $95 million. Those who believe that EBITDA [earnings before interest, taxes, depreciation and amortization] is in any way equivalent to true earnings are welcome to pick up the tab.”

‘Small Loss’ at NetJets

Buffett said, NetJets “sold a record number of airplanes last year and also showed a gain of 21.9 percent in service income from management fees and hourly charges. Nevertheless, it operated at a small loss versus a small profit in 2000. We made a little money in the U.S., but these earnings were more than offset by European losses. Measured by the value of our customers’ airplanes, NetJets accounts for about half of the industry. We believe the other participants, in aggregate, lost significant money.

“Maintaining a premier level of safety, security and service was always expensive, and the cost of sticking to those standards was exacerbated by September 11,” Buffett said. “No matter how much the cost, we will continue to be the industry leader in all three respects.”

Buffett also praised Executive Jet CEO Santulli. An “uncompromising insistence on delivering only the best to his customers is embedded in the DNA of Rich Santulli. I’m delighted with his fanaticism on these matters for both the company’s sake and my family’s: I believe the Buffetts fly more fractional-ownership hours (in excess of 800 annually) than does any other family. In case you’re wondering, we use exactly the same airplanes and crews that serve NetJets’ other customers.”

NetJets experienced a spurt in new orders shortly after September 11, but its sales pace has since returned to normal. Per-customer usage declined somewhat during the year, probably because of the recession. “Both we and our customers derive significant operational benefits from our being the runaway leader in the fractional-ownership business. We have more than 300 airplanes constantly on the go in the U.S. and can therefore be wherever a customer needs us on very short notice. The ubiquity of our fleet also reduces our positioning costs below those incurred by operators with smaller fleets.”

These advantages of scale, and others Buffett said the company has, give NetJets “a significant economic edge over the competition. Under the competitive conditions likely to prevail for a few years, however, our advantage will at best produce modest profits.” (The investment mogul’s remarks about EJ’s profit forecast come amid contract negotiations with the NetJets pilot union. Speculation is that the pilot group is asking for an 80- to 100-percent pay hike.)

And a profit opportunity is being planned to coincide with the Berkshire Hathaway annual meeting in Omaha on May 4. Speaking to shareholders, Buffett said, “We will have the usual array of aircraft from NetJets available for your inspection. If you buy what we consider an appropriate number of items [from Berkshire Hathaway-owned companies] during the weekend, you may well need your own airplane to take them home. And if you buy a fraction of an airplane, we might even throw in a three-pack of briefs or boxers…assuming our Fruit of the Loom purchase has closed by May 4.”

Berkshire Hathaway A stock (BRK/A), the company’s primary stock, was selling for about $70,000 per share before September 11. Like the rest of the stock market, it fell dramatically–to a 52-week low of $59,000–but quickly bounced back. In mid-March it was trading in the $71,000 to $72,000 range.�