SkyWest, Inc. (SKYW) Q2 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to SkyWest, Inc. Second Quarter 2012 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Bradford Rich. Please go ahead, sir.

Thank you, operator, and thank you to all of you for taking the time to join us this morning. On our call, we’re always very appreciative of your interest in the company and the time that you’re willing to spend with us. Before we get into the details of the call this morning, let me just introduce those here at headquarters that will be participating with us today. First of all, we have Chip Childs, the President and Chief Operating Officer of SkyWest Airlines. We have Brad Holt, the President and Chief Operating Officer of ExpressJet. Mike Kraupp, our Chief Financial Officer; Eric Woodward, our Chief Accounting Officer, as well as other members of our staff that are here with us this morning. I always feel very important to begin our calls with our expressions of gratitude for our people. We recognize the significance of their contributions. We recognize as well, in these times particularly, that in these times that we need to rely even stronger on our employees who are making such a significant difference. We also -- I have just been reminded by Mike, we need to -- also, before we get into the details of our call, read our forward-looking statement -- our Safe Harbor on forward-looking statements. So I’ll turn the time to Mike to do that.

Okay. Thank you, Brad. In addition to historical information, this release and conference call may contain forward-looking statements. SkyWest may, from time to time, make written or oral forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements encompass SkyWest’s beliefs, expectations, hopes or intentions regarding future events. Words such as expects, intends, believes, anticipate, should, likely, and similar expressions identify forward-looking statements. All forward-looking statements included in this release and conference call are made as of the date hereof and are based on the information available to SkyWest as of such date. SkyWest assumes no obligation to update any forward-looking statement. Actual results will vary and may vary materially from those anticipated, estimated, projected or expected for a number of reasons.

Okay. So with that, let’s go ahead and get into the call, into the details of the quarter, our results. Kind of the agenda for the call this morning, I will give just some brief introductory comments. I will then turn the time to Mike to go through the details of the financials for the quarter and then we’ll make sure that we leave plenty of time for questions and answers at the end. First of all, we are very pleased with the significant improvements that we’ve reported in the quarter, both in our financial and the operational improvements that have happened during the quarter. The $17 million of net income is not only a material improvement from the same quarter of last year, but also a significant improvement from the first quarter of this year. I think probably of most significance in these results is that we really believe that it’s indicative that the aggressive return to profitability program and initiatives that we’ve been executing at the company are, in fact, working. We have spent a significant amount of time and put a tremendous amount of focus both on revenue enhancement. That revenue enhancement is a function of several factors. Our operational performance is obviously very important in revenue enhancement as we have a significant portion of our operating revenues that are dependent upon operational incentives. We are trying to get better utilization out of all of our assets. We also have some things in the intricacies of some of our contracts from an administrative standpoint that are also significant for us to pay attention to. All of those things we have been doing and I think the results are indicative that those things are working. At the same time, an extremely important part of that return to profitability plan is our focus on cost reduction. As a result show both reductions over the same quarter of last year, the second quarter of last year, as well as cost reductions from the first quarter of this year of 3% and 4.9% respectively. So the cost reduction initiatives that we’ve been focusing on are also working. So you put the 2 together: revenue enhancement initiatives as well as cost reduction focus and programs and initiatives and we believe that we still have a lot of work to do and we still remain very focused, but the results of the quarter, we believe, are indicative that these programs are working and that we are well on our way to return and sustained profitability. Our operational performance has been excellent during the quarter at both entities. Mike will go through the details of those issues and the dollar amounts of impact. But just the impact of operational performance and the increase in operational incentives during the quarter has been a significant contributor to the improved results. Our pro-rate operation at SkyWest Airlines has also shown significant improvement during the quarter. We have, just for your information, about 6% of our total block hours are in the pro-rate environment. But we’ve had significant improvement in that again both as compared to the second quarter of last year as well as compared to the first quarter of this year. In addition to some of the revenue enhancement and cost control things that we feel have been very effective, it has also been a very busy and a significant quarter from a number of other aspects. We have some achievements and some milestones that we’ve reached during the quarter. First of all, we negotiated the sale of TRIP -- of our TRIP investment. We negotiated it during the quarter. It actually -- once we got regulatory approvals and so forth, the transaction actually closed -- it closed on the 12th of July. That transaction will result in the recognition of a gain of approximately $20 million on that investment. That’s a gain from the net book value of the investment. I will say that we’re still working with our accountants and so forth to figure out the timing of the recognition of that gain. But the overall transaction has been -- we consider it a successful transaction, but we have negotiated and completed the sale of that investment. We also announced an agreement with Mitsubishi during the quarter for the acquisition of 100 Mitsubishi regional jets. We feel that’s a significant transaction for both us and Mitsubishi regional aircraft for a number of reasons. For us, we believe it’s indicative of some creativity and some very hard work to create a relationship with an aircraft manufacturer that is different in many respects than the traditional way of buying and managing aircraft assets that we believe will create some significant economic advantages. At the same time, we think it positions us in a significant way for the fleet replacement that we are going to have to do out into the next 5 and 10 years. So a very significant transaction from our standpoint. We also announced just recently what we consider to be a very productive and material transaction with Delta, in which we’ll bring in an additional 34 dual class aircraft into the SkyWest, Inc. operation with a term that goes through December of 2022 on those 34 aircraft. It also will involve the reductions of 66 CRJ200 50-seat aircraft, which will be removed from the system. I think as we highlighted in the press release and the announcement of that transaction, of those 66 aircraft coming out, 41 of those aircraft are Delta-owned aircraft, which will be -- they are in contract today. And so we have agreed to allow those aircraft to come out of our contract operations and they will be returned to Delta with no obligation to SkyWest. Of the 25 SkyWest aircraft that we’re responsible for, I think our statement there is that we have been working and continue to work very aggressively to find opportunities for those airplanes. We feel very confident in our opportunity to place those airplanes to materially mitigate any risk of idle aircraft and we feel very confident about our ability to do that. As far as the 34 dual-class airplanes that are coming in, the way we’re really viewing this transaction is for a period -- we’re still working with Delta on some of the exact timing of the removals of the 66 aircraft. As far as the 34 additional aircraft coming in, there will be a time of approximately about a year where the 34 aircraft will be -- I guess term it as incremental or net new additions to the fleet. And then as we -- over time the aircraft will come out. But the way, we’re viewing the transactions for a short period of time, we have an incremental growth in the 34 dual-class airplanes that will come in that we feel will be very productive and accretive to our EPS. And then over time, some of the 200s will come out. But we are, in effect, over a long-term replacing less productive assets with higher productive assets. And so, we believe it’s significant to us from that standpoint. And at the same time, it’s significant from the standpoint that I think it demonstrates that our ability to be creative and to work through productive and cooperative solutions with major partners, in this case Delta, on a transaction which will benefit both Delta as well as SkyWest, Inc. I think that that -- that’s an important transaction and an important message in and of itself. With that, I will go ahead and conclude my remarks and turn the time to Mike.

Okay. Thank you, Brad. Also I want to echo a couple comments that Brad just mentioned as well. I certainly want to thank each and every one of you for taking the time to be on the call with us today and for your continued interest in SkyWest. I’d also like to thank all of our employees for the very hard work that they did this quarter and being diligent in helping to make the cost reductions and improvements in our operations. It was a great result from a great effort. It’s also nice to see the progress that we’re making in achieving this year. And I would highlight that by saying that, what we’ve accomplished so far this year has been a little bit beyond our expectations, so good things that are happening there. This morning we reported operating revenues of $937.2 million compared to $933.7 million for the same period last year. That’s a net increase of $3.5 million. But as Brad had said earlier, we did experience some increases in our revenue of about $14 million from a combination of escalation in our contract rates as allowed under our agreements with major partners as well as from our increased margin and markup from incentives, as a result of better completion factors and on-time performance. We also received a reimbursement from a major partner of about $3.2 million for costs that we incurred when moving a significant portion of our ERJ fleet from Houston to Chicago about a year ago. We had previously incurred those costs in connection with the move and they were recorded in our financial statements last year. The increased revenues were also offset by about $14 million in reductions of our pass-through expenses for fuel and engine overhauls, which we record as revenues. Together, these items resulted in a slight net increase in our operating revenues. We had also had a planned reduction of about 7% in our pro-rate block hours produced, but actually generated an improvement in the pre-tax income from that operation of about $2.5 million. That was based on slightly lower fuel costs and then higher yields or pricing that we’re getting. Overall, our block hours were in essence flat on a year-over-year basis. We generated 577,884 block hours for the second quarter of 2012 compared to 574,372 for the same period last year. This is actually significant when looking at the reduction of about $24.2 million in our operating expenses. When looking at just the absolute dollars in these operating expense categories, the reductions were primarily the result of lower engine overhaul costs of about $9.3 million. We also experienced lower crew costs and maintenance costs on a combined basis of about $14 million. On a combined basis, we also recorded $0.7 million of losses in our share of losses from our ownership in TRIP and Air Mekong compared to about $2.9 million for the same period last year. That’s the result of some slight improvement in the operations of Air Mekong as well as a positive adjustment from an accounting change in how they account for some of their maintenance reserves. As a result of these things, we produced pre-tax income of $28.6 million compared to pre-tax loss of $1.8 million for the same period last year. That’s a positive change of $30.4 million. Our operating margin was 5% compared to 2% for the same period last year. And net income was $17.0 million, compared to a net loss of $0.7 million for the same period last year. On an entity level basis, SkyWest Airlines increased its pre-tax income by about $8.5 million and ExpressJet experienced increase in its pre-tax income of about $19.9 million. There’ll be more details on that as we file our 10-Q later this week. With regards to the balance sheet, we did end the quarter with $629.5 million in cash and marketable securities. That was an increase of $46.2 million from the quarter ended March 31, 2012. We also generated $111 million in cash from operations during the quarter just ended. I will also note that our cash is down slightly from our year end number by about $17 million, and that’s primarily the result of our prepaid lease payments, which occur from payments that are made early in the year. A couple of other interesting numbers, our book value per share is $26.51 and cash and marketable securities per share is $12.36. Of note also, we additionally refinanced $40 million in balloon payments for debt that were reported in our current maturities as of June 30, 2012, just after the end of the quarter. So that amount will actually move from 2 long-term debt in subsequent quarters. I also wanted to give you just a quick update on ASMs for the third and the fourth quarters. Based on the additional aircraft that are coming in, that Brad spoke of, these estimates are slightly revised primarily in the fourth quarter. But for the third quarter of this year, we expect to produce ASMs of $9.6 billion. And in the fourth quarter, we expect to produce ASMs of $9.2 billion. So, that one is up just a little bit. We’ll be up just a little bit on a year-over-year basis. And with that, Brad, I’ll conclude sort of the formal remarks and back to you.

Okay. Very good. We will go ahead and entertain some questions.

We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Michael Linenberg, Deutsche Bank.

A couple questions here. The 34 dual-class airplanes that you’re picking up, presumably those are used airplanes, and it seems like a large number of them may come from Comair. I think Comair had 28 700s and 900s. Where are the extra shells coming from or are they coming new from the manufacturer?

I think right now, Michael, we just need to leave it at they will be used airplanes. But that hasn’t been announced yet and we’re not in a position to announce it this morning. They will be used aircraft.

Okay. And then sort of as a follow up to that, we know that Delta is looking to pare a lot of 50-seaters. My sense is that that they’re done with you. They had their conversations. There is some changes here and there. But my sense is that we’re not -- we shouldn’t anticipate that they are going to come back to you and say, by the way, we need another 50 airplanes on the ground here and maybe we can work something out. I mean, is that fair? Or maybe it’s just -- there is some uncertainty there?

Well, so I think there is still just some uncertainty relative to exactly the timing of reductions that Delta may want and where they’re going to get them. I think the important thing for us, whether they’ll come back to us and want to try to work out some other kind of transaction that benefits both of us or not, the important part for you to understand is that, I mean, our airplanes with Delta are under contract. So we don’t have a lot of exposure to the fleet, so to speak. But, look, I mean, if Delta -- if there’s productive transactions that can be worked out that benefit both us and Delta, we’ll continue to have those discussions with them as we see them appropriate and as they create solutions for both of us. But the important thing to note is just that we don’t have a significant amount of risk of those airplanes given that they are in contract.

Okay. Good. And then, just -- if I can just squeeze one more in. There was that ongoing lawsuit with Delta tied to the irregular operations and I think it goes back, I want to say it goes back to '07 and the last that I checked I think it was in dispute; it was something like $26 million. Is that -- was this an opportunity to address that? Or is that still outstanding?

It’s still outstanding and still just progressing through the system. But I would say -- we’ve had, I think, what we’ve done is just kind of put that to the side and the various legal teams are working that issue. On the operational and kind of administrative side, we just continue to do business and try to find ways to operate that benefit us both and I mean, it’s -- that’s how it’s worked.

Brad, it is from 2007, right?

Yes.

Our next question is from Duane Pfennigwerth, Evercore Partners.

I just wanted to ask you around capital deployment. When do you feel like enough of the issues that have been impacting your performance are stable enough for you to begin buying back stock again?

That’s a very good question. So, as Mike walked through the results, talked about liquidity, we have had not only a very good quarter operationally and financially, but we also had some pretty significant improvements to our liquidity during the quarter. And by the way, we expect to generate positive cash flow throughout the remainder of the year. Another kind of important thing to note is that, that as we’ve been going through this very soft period, we kind of had what I just described as a couple of bell curves not only in some things like the timing of the very heavy period of maintenance, which has required some -- we just gone through kind of the peak in the bell on our maintenance expenses. But the way that we have had financed some airplanes and structured payments, we’ve gone through the heaviest period. And I’m not talking about within a 12-month period. I mean, if you look at and schedule out payments of both debt and prepayments of leases over like a 5 or 10-year period, we’ve just gone through a very significant peak in the bell on that as well. So, I mean, we are optimistic about our liquidity. We think we’re well positioned now to continue to generate fairly strong positive cash flows. I think that does position us to get back active in the repurchase environment. But I will just caution -- I mean, that is something that we just continue to evaluate based on market conditions. And maybe -- so, look, this is a big topic of conversation. I don’t think it’s -- I think our liquidity positions us very well to get back active.

Our next question is from Savi Syth, Raymond James.

On the United maintenance, it looks like there is a timing issue here. So what are you expecting in the second half? I think earlier the thought was that it will be, net-net neutral in the second half. But maybe now there will be a bit of a drag?

Mike, go ahead.

We’ve actually had a little bit of movement, Savi, in our numbers in moving it from previous quarters to now. Our estimates for the third and the fourth quarters if I can just give you that, we are targeting around $14 million in gross expenditures for Q3 and then $11 million in the fourth quarter. So, those are down in concert by about $10 million from the first half of the year, okay?

Okay.

So, I think to make sure we clarify, I mean, I think you indicated that there may be some drag on the fourth -- on the second half of the year, and I think the second half of the year relative to this issue will be better in the fourth quarter. Than it’s been in the -- in the last 6 months versus the first 6 months. It will be better.

Makes sense. And then on the Air Mekong, TRIP, are those all written off -- now the TRIP isn’t going away and is Air Mekong fully written off so we shouldn’t see any losses related to that going forward?

Mike, go ahead.

We actually still have a little bit of basis in our Air Mekong operation. So we’ll continue to record results as they come in from that entity. But, when we look at it, there’s again a basis of only about $2 million that could be additionally written down. So, not materially overall.

Okay. Great. And then just one last question. Great cost improvements that we’re seeing. I think you were targeting maybe with non-SOC related synergies and just other cost improvements maybe about $10 million for the year. Where are we in trying to get there and then how much of what you saw this quarter is repeatable?

Okay. So, I’m just trying to process your statement of $10 million in synergies. We think the number is higher. We don’t think the improvements we’ve seen this time are -- any kind of -- I mean, it’s not based on one-time type thing. I mean, the improvements that we’re putting in and the cost reductions are long term what we believe are sustainable and continuing reductions. And I think the number is actually a little higher than the $10 million that you stated.

Okay. And that’s non-SOC related items, correct?

Yes.

[Operator Instructions] Our next question is from Bob McAdoo, Imperial Capital.

I guess, just to -- I’m trying to understand a little bit more of what you’re saying about the surplus airplanes or the 50-seaters. I mean, if the 66 coming -- going out and 41 coming in, in terms of shells, I mean, there is something like 25 that still need a home. But, Brad, you kept using the word, all of our airplanes are in contract. Does that imply that these other 25 are -- that Delta is going to pay for them whether or not you fly them, or what are you trying to say there? And the other thing is kind of related to that. Over the last several years at various times you’ve made comments about how you had a large number or some number of 50-seaters that were on short-term leases that you could turn back to the lessors if you needed to or if something wasn’t working. I am curious, how many of those do you have left? Are they still around so that could be some of the cushion that you would use to take up surplus airplanes?

Okay. Very good question, Bob. So, first of all, I don’t want there to be any impression that the 25 -- that Delta has any obligation whatsoever on those 25 airplanes. They don’t. They are in contract. We’ve agreed to take them out. Okay. So we -- so of the 66, we don’t have an obligation on 41, but on the 25, we do. We do have all of those short-term, I would say very low risk. These are airplanes that have been used. Some of them that we’ve had have come off lease. Some have gotten into the secondary markets that have been repriced. They are not only short term, but most of them are relatively inexpensive relative to our total CRJ200 fleet. So, we still have all of those airplanes and we still have all of the fleet flexibility on those airplanes, meaning early termination rights. So that gives us a lot of ability to productively manage this 25 airplanes of risk. But that’s not our intention. Our intention is to continue working on opportunities to place those airplanes in productive service. That’s our first priority and that’s where we’re -- we believe we’re making some very good progress. Nothing to announce or anything like that, but I just have to leave it at we are very confident that we can still productively use those airplanes. But if that doesn’t materialize, we have those short-term airplanes as a backstop to manage the risk.

So the likelihood that you get stuck with 20 some airplanes -- 25 airplanes at a hundred and some thousand a month for an extended period of time is pretty slim?

We just think it’s very, very low risk.

This does conclude our question-and-answer. I would like to turn the conference back over to Bradford Rich for any closing remarks.

Okay. Looks like we’re getting through the call very expeditiously this morning. That’s good. And from a lot of perspectives, the results are the results. We’re very pleased with the results for the quarter as we’ve mentioned. And maybe just, by way of summary, the improvements that have come through the utilization of the assets through incentives that have come through operational performance, the cost reduction initiatives that we’re implementing that we think are in fact long-term continuing sustainable cost reductions, we feel very good about all of that. As those results are improving, our liquidity and our ability to generate strong and positive cash flows, we think, has significantly improved as well. But, having said all of that, we are pleased with the results. But let me assure you that we do remain extremely focused on our overall profit improvement initiatives. We still have more work to do. We know that. We remain focused and we’re very optimistic, not just in the current performance, both operationally and financially, and our focus on the return to profitability. We still just believe that when you put the strength of these operations together and the quality of the service and the breadth and depth of the operation and the quality of our people that are really making a difference, you put all of this together with our financial strength and credibility and we remain very, very well positioned to move productively into the future. And so, we feel very optimistic and bullish on the future, as I just said. And again, we express our appreciation to those of you on the call as well as our employees who make this all happen. And if there are no further questions, we’ll go ahead and conclude the call. Again, thank you very much.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.