SkyWest, Inc. (SKYW) Q2 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the SkyWest Second Quarter 2013 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions) We please ask that any employees of SkyWest Airlines, Atlantic Southeast Airlines, and ExpressJet Airlines listen to today’s presentation via the webcast. After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Mr. Bradford Rich. Mr. Rich, please go ahead.

Thank you very much. And good morning and welcome to all of you who are participating with us this morning. We are excited to be able to have the opportunity to get on and to review the performance and the events from the quarter. I’ll begin this morning by first of all just introducing who’ll be participating. I have with me here at SkyWest Inc. headquarters, Chip Childs, President and Chief Operating Officer of SkyWest Airlines; I have Brad Holt with us this morning, President and Chief Operating Officer of ExpressJet, Mike Kraupp, our Chief Financial Officer and Treasurer, as well as Eric Woodward, our Chief Accounting Officer, as well as other members of our staff here in St. George. We would like to begin our discussion today by turning the time to Mike Kraupp, who will read the Safe Harbor on forward-looking statements.

Okay. Thank you, Brad. We will be making statements during this conference call which are considered forward-looking, such statements are based on our beliefs, expectations, and assumptions regarding future events and are subject to risks and uncertainties. Words such as expects, intends, believes, anticipates, should, likely and similar expressions identify forward-looking statements. All forward-looking statements expressed in this call are made as of the date hereof and are based on information available to us. At this time we assume 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, including those discussed in today’s press release or expressed during this conference call or set forth in our 2012 form 10-K another reports and filings with the Securities and Exchange Commission.

Okay. Thank you very much, Mike. Okay, we’ll now proceed as follows. I would give just a few brief overall comments, then I will turn the time to Mike to review specifically and then in more detail the financial performance and some of the just a review of the numbers, and then we will turn it over to questions and you will have our whole team here available to participate in the Q&A. First of all then I would refer you to the press release that we put out this morning. We reported net income of $20.7 million, which is $0.39 and fully diluted earnings per share. That compares to $17 million in net income and $0.33 in fully diluted EPS for the same quarter, the second quarter of last year. That represents good improvement quarter-over-quarter and I would just assure you that we remain very focused on our returns and on continued margin improvement. The quarter has been a very busy and a productive quarter. And I want to review at least from my perspective some of the highlights of the quarter. First of all, we completed the deliveries of the 34 dual-class aircraft. They are part of the Delta transaction that we have been talking about for several quarters now. All of those dual-class airplanes are now in and flying. And, of course, those airplanes as you recall from previous discussions are a combination of 700/900, so we’re glad to have all of those aircraft in now and flying. That is a transaction, which you remember and that also involves the termination of 66 CRJ200, so beginning this fall we’ll be the first retirements or terminations of those airplanes from the system. During the quarter, we also announced back in May 21, we announced a new CPA with…

Okay, thank you, Brad. And I’d also like to thank all of those who are participating on the call with us today. We do appreciate your interest in the company and your time that you take. My comments actually this morning are going to be very brief and I’m just going to sort of follow or highlight some things within the press release. As Brad had said just a minute earlier, this morning we reported net income of $20.7 million or $0.39 per diluted shares for the quarter ended June 30, 2013. This compares favorably to reporting net income of $17 million or $0.33 for the same period last year. We also reported net income of $24 million or $0.46 per diluted share for the six months ended June 30, 2013, and that compares to $16.3 million or $0.32 per diluted share for the six months ended June 30, 2012. Consistent with our comments and reporting for the previous three quarters regarding how our major partners are currently purchasing the majority of fuel for our contract flights, we continue to experience a reduction in our operating revenues and operating expenses. Due to these changes, we experienced a reduction of $106.8 million in our top line revenues as a result of these fuel purchases. During the quarter ended – just ended, we also experienced $11.1 million decrease in engine overhaul costs that are considered pass-through costs under our contract that also resulted in a reduction to our top line revenues. I will make you aware by way of information that this quarter should be the last quarter where we’ll see the significant reductions in top line revenues. In the third quarter of this – the upcoming third quarter, you’re going to see a significant mitigation, again, on those top line revenues…

Okay, thank you, Mike. Operator, well we go ahead and open up the line, so we would happy to address a few questions.

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question is from Duane Pfennigwerth with Evercore. Go ahead please. Jeff Reisenberg – Evercore: Hey, good morning. This is Jeff Reisenberg in for Duane today. Quick question on expansion opportunities at American, when do you think the emerged entity will be at a position to do another CPA? And in addition to the timing maybe help us aside what’s the opportunities associated with that would be?

Okay. That’s a very good question. I wish we knew the answer to the question. Probably even if we did, that would be something that American needs to address, the new American and their leadership need to address. What I can say is that from our previous discussions, I should say pervious and ongoing, I mean, we are doing the best we can to keep in regular contact with that leadership team. Certainly, the transition affects timing, but as we understand that, we think there will be a meaningful regional, a large dual-class opportunity there for someone. And we keep in regular contact, we were doing the best we can to position ourselves to win and be awarded a portion of that flying. But as to the timing and as to the volume and which types and which parts they’ll do at what times, we just are not in a position at all to give any clarity to that. I wish we had better answers, but that’s more up to them to describe the market. Jeff Reisenberg – Evercore: Okay, thanks. And one more quick question. Given the fleet growth, when do you think, you’ll be in a position to buyback stock again?

Okay. So very good question. Our first priority relative to stock assuming that all of our analysis and numbers indicate that it’s a good investment. Our first priority is to buy enough shares to offset current year dilution. So that’s the equity type of programs and the equity comp programs and those things. So as we said before, our first priority there is to just make sure we’ll find enough – that to offset the current year dilution, and that still remains our objective. Above and beyond that, we have some things here that we are making sure that we get some good clarity to relative to capital that will be required and liquidity that will be required for expansion. We are at a very critical time where we think there are some opportunity not just for the American, we just see there were some other opportunities kind of sort themselves out here. So we’re at a critical time I think for the next six or nine months, where we would like to see a little more clarity to some of these opportunities, which will make it – give us additional clarity on our liquidity and how much capital will be required for opportunity, and then put that in the equation and then make a recommendation to our board relative to the further start buyback. Jeff Reisenberg – Evercore: Great. Thank you for taking the questions.

You’re welcome.

Our next question comes from Jim Parker with Raymond James. Go ahead please. Jim Parker – Raymond James: Good morning to all.

Good morning, Jim. Jim Parker – Raymond James: Mike, would you give us the revenue and pre-tax year-to-year for the second quarter on pro-rate?

We can hardly hear you there, but I think you… Jim Parker – Raymond James: I’m sorry, Mike. I asked about pro-rate, what was the revenue year-to-year on pro-rate?

Okay. You have revenue, year-to-year, we recorded $88 million for this quarter just ended and we had $80 million from the quarter a year ago. Jim Parker – Raymond James: And pre-tax?

Jim, we are not going to go down that road. You remember in general, we typically don’t breakout things on a contract basis and we sort of feel the pro-rate fits in a very similar category. Jim Parker – Raymond James: So you are saying, as Brad said, it was up nicely year-to-year, is that correct?

We did have good solid year-over-year margin improvement. Jim Parker – Raymond James: Okay. Now what was the profitability in the quarter of ExpressJet?

Again, I’ll let you look at all of the details of that when we file the Q later this week. I’ll just say in general, ExpressJet did have a small operating profit, which means let’s say, a significant portion of the total net income came from the SkyWest Airlines operation. Jim Parker – Raymond James: So ExpressJet continues to lag apparently substantially continues to lag the profitability of SkyWest. And so what is being done to improve the profitability at ExpressJet?

There are a number to things being done Jim. Very specific and continued focus on the cost side of that operation is one part. We’re at a critical time with our labor groups, where we have essentially open contracts in the negotiating process on all of the contract labor agreements. So we need to get some clarity to those and need to see where our total labor costs will come out. And then as we have said before, we have some just contract rate issues, but need to be – I mean, we’ve got to figure out a way to get some improvement in the rates, because part of this equation is cost, the other part is rate. Now, in the legacy express side of the deal that operation as groups of airplanes naturally terminate, we would expect to do one of three things either extend aircraft at rates that are back to market rates, or replace their planes as they terminate with a different aircraft type, which we would expect to be at market rates or just eliminate that flying from that fleet, which would reduce the amount of aircraft flying in subpar performing contracts. And at the same time, we need to I mean, just continually work as the best we can in general improvement. In the first few groups, aircraft that have come up for natural termination, I will not allow to go into much specific, I’ll just say in general, we have had some success at ending aircraft at improved rates. Jim Parker – Raymond James: Okay. Brad now, one other question here, it looks like over the next several years, actually the size of your fleet, the number of aircraft may shrink. Have you replaced 50-seaters with 76-seaters? Okay, that may imply that you have a redemption in labor force, which means that your average labor costs are going to go up just because of more senior people. So how do you counterbalance, how do you offset those cost increases and labor with no growth and shrinkage in the labor force?

Okay. Well, first of all, keep in mind Jim, this is happening at a time when there is a lot of uncertainty relative to the impact of the some these and some regulations and new flight and duty, which all indications would indicate. Well, there are two things; first of all, there is a lot of talk in the industry about the general pilot shortages, okay. So yeah, for example, in the ExpressJet fleet, we just brought in the additional dual-class airplanes in the Delta transaction then we will lose some of the CRj-200. When you put that in context with, that’s happening at a time where there are predicted pilot shortages and increased requirement or demand for pilots because of the new flight and duty, that’s not an entirely bad situation to have at this particular time. So we are going to take all of these factors including the new flight and duty, I mean, all of these things together, and then do the best we can to mange that issue. But when you look at it in context the timing here of some of these issues actually we think is working out very well. Jim Parker – Raymond James: Okay. Thank you.

You are welcome.

(Operator instructions) And our next question is from Glenn Engel with Bank of America. Glenn Engel – Bank of America Merrill Lynch: Good morning. Can you go over the – you get typically service bonuses in a quarter for delivering on reliability measures, how did you do this year versus last year?

Okay. So I’ll address that one generally, and I’ll just say – and by the way, I’m just going to do the best I can to answer the question. I certainly don’t want my answer to come across as excuses or anything for subpar performance. The fact of the matter is, we are not achieving levels, and then by the way, Glenn, this has been two components, right. It’s either performance incentives that we may forego because of reliability, and in some contracts, it actually is the payment of penalties for less than expected performance, right. So when we put all of that together in a bucket, either increases in penalties paid quarter-over-quarter or same quarter this year versus last year or lost incentives, it has been almost – we’ve either lost revenue or paid penalties at almost twice the level that we did the same quarter last year. So our performance has not been as good. Now, one of the reasons for that is the extreme level of weather-related cancels. And although weather is generally excluded from the performance metrics, the downline or secondary impact of this challenging and difficult weather creates a tremendous amount of pressure on the rest of the system, simply having airplanes out of positions, pilots out of positions, and those sorts of things, which although not directly coded weather cancels, put an extreme amount of pressure on the system. And we had almost three times the level of weather cancellations that we had the same period last year. And so look, again, I’m not trying to make excuses for them. I’m just trying to say, there has been an extreme amount of pressure on these systems due to this difficult weather period that we have had and that’s, I would say, the primary cause for the increase in lost incentives or paid penalties. Glenn Engel – Bank of America Merrill Lynch: So the margin improvement happened despite the fact that your service performance bonuses were less?

That is exactly right. And so in spite of some significant headwind in the quarter, we had good margin improvement. Glenn Engel – Bank of America Merrill Lynch: Can you talk about employee turnover? You mentioned main line guys started to hire a little bit more. Are you starting to see turnover increase?

Let’s have Chip Child to address that one.

At least on the SkyWest Airlines, in fact, we have not seen a significant impact on the air. We keep a very closed eye what’s out there in the future and what (inaudible). But at least on our side, the SkyWest side, we have technically some of the lowest turnover we’ve had in a long time, but we are very astute to see what the risk may be going forward. Glenn Engel – Bank of America Merrill Lynch: And finally, can you give any very, very broad views on 2014 capacity?

At this time, Glenn, let me answer that. We just barely started into the – planning process for next year, so unfortunately we don’t have that at this point. We will have that in the third quarter when we produce.

Yeah, I mean, but I think in general, when you look at the mix of flying and we’ve got the dual-class airplanes in, some 200s going out, overall, we’ll have the dual-class in at the front end, but 200 down in the back end, and overall, I mean, if we’re looking at a relatively flat, production year from 2013 to 2014. Glenn Engel – Bank of America Merrill Lynch: And the fleet itself will end up being low at the end of 2014 and the end of 2013 because of the 200’s dropping?

So Glenn, I think at this point, we’re just kind of projecting flat. Total block hour production, but again a lot – I mean the two drivers of this, of course, are the fleet itself, but then just utilization and the scheduled by the majors has a tremendous impact on the overall production. So a small change in daily utilization can have a material impact on total production. So with the variable we know is the fleet. The variable we don’t know is the scheduled utilization. So at this point the best we know is that those factors would be fairly close to flat. Glenn Engel – Bank of America Merrill Lynch: Thank you very much.

You’re welcome.

The next question is from Mike Linenberg with Deutsche Bank. Go ahead please. Michael Linenberg – Deutsche Bank: Yeah, good morning, everyone. I have a couple here, Brad, you talked about the 40 ERJ 175’s that you’re going to be taking delivery for United, and then you said you had maybe commitments that upwards got you closer to 200. When do those airplanes start delivering and when do you start, paying your initial delivery deposits? How does that CapEx ramp up over the next couple of years?

Okay. So the initial 40 airplanes, they start in April of 2014, in general. So those are first deliveries. The actual service dates, that actual date has not been determined and we will work cooperatively with United to actually determine the first in-service dates. But it will be shortly thereafter April. So the airplanes come in and we basically have 20 in 2014 and 20 in 2015, pretty evenly from April through the end of 2015. Okay, so that’s the timing of the aircraft coming in. So relative to a CapEx – from a CapEx perspective, of course, there is a lot of time and some money being spent now just in the certification process. The hard dollars and ramp up of CapEx, I mean, first of all, let’s put it in perspective. We’re somewhere around $50 million worth of CapEx spend on that fleet. And I would think, I mean, we’ll have an initial spend to get stock for parts and tooling and that sort of thing prior to the April deliveries. But of course, some of that’s done on a per-aircraft basis and will be done as the airplanes come, as the airplanes deliver. So there will be probably half of that will be upfront before April and then the other half, I think we could assume would be spread out as the aircraft deliver. Michael Linenberg – Deutsche Bank: Okay, good. And then going back to the pilots, I know you mentioned the new duty and flight and duty rules going to affect, and I guess that was August 1. What about the – I don’t know if we had an official start date where to have an air transport pilot license, the minimums are going to go from 250 to 15,000. And I know that’s out there, and I’m not sure they actually set the date, although I thought it was actually in August as well. Is that in effect now and so as a consequence, I guess for both of those, what are the staffing requirements look at SkyWest over the next 6 to 12 months? And if you look at your current rooster pilots, how many more pilots, do you have to just put on the payroll to meet the new duty and flight rules?

Okay. Good questions, Mike. First of all, I’ll have Brad Holt give us some color to that as it affects the ExpressJet operation. And then by the way the answer might be slightly different between entity. So we’ll have Brad Holt to address the first and then Chip can add on.

Okay, great.

Mike, I’ll just start with the ATC requirement that did go into effect August 1. Michael Linenberg – Deutsche Bank: Okay.

And all carriers required to have, of course, with ATPs. The 117 are the flight and duty rule goes into the effect in January. So we’ve not had to deal with that yet. In general industry wide and this is a very general statement, the pilot workforce to deal with those rules will be somewhere between 5% and 9% increase in overall pilot. So it is going to be a bit of a strain on the system with the increase flight time requirements of pilots that went into effect August 1. But we are not seeing a big problem yet. We also do have some buffer in that we have aircraft go in a way this fall and winter. And so those pilots can be used to cover the 117 rule. As far as turnover goes, we have not seen a lot of turnover to this point with the normal turnover, but the majors will start higher in this fall, so there will be some of that. Michael Linenberg – Deutsche Bank: Okay. Okay, that’s helpful. And then just if I can squeeze…

Mike, let’s let Chip – I think Chip…. Michael Linenberg – Deutsche Bank: Sure.

Chip has something to add as it relates specifically to SkyWest Airlines.

Mike, I mean, just a real quick, I think what Brad has identified along the same minds that we are seeing in SkyWest. I think at the end of the day though, we’ve got some good estimates out there. We are still trying to get candidly and I think golf carriers are a lot more feedback from the FAA relative to those. There is still a lot of things where even their documentation is not entirely finalized to help us get specific to that. But what Brad has indicated is the impact that’s consistent across the board. Michael Linenberg – Deutsche Bank: Okay, great. And then if I could just squeeze in one last one, I want to go back to the question on performance. And I know you had discussed it with Glenn. You had, a one-point improvement in op margin and yet, there were some operational issues. And you’ve talked about weather cancellations and I know some of that you’re on the hook for. I mean, it was a pretty sizable impact. Brad, is there any way, can you quantify, those cancellations or, whether it was the lack of, whether you didn’t receive – you got less incentive payments or you had to pay the penalties. I mean how much of a margin impact was there on the quarter? Was that a point or more? And I realize that it may actually be a bigger number when you start including in all of the accommodation issues and moving crews around and airplanes being in the wrong airports, at particular times because of these. I mean, how much of a margin point headwind did you have from all of this, because these were some big numbers.

Yeah, they are some big numbers. It’s a very good question, Mike. I’m going to be very general, but I’ll at least try to give you some perspective. Michael Linenberg – Deutsche Bank: Okay.

And by the way some of this, I will acknowledge up front is very hard to quantify. What we do know is, is what lost block hours amount to as far as lost revenue. So if you look at the volume – and I’m going to give you a reference point that is just the number above and beyond a typical run rate of weather, because look, we know we’re always going to have weather and we’ve always got to deal with weather and we’ve got to be prepared to react and get the system back running as efficiently and as quickly as possible when it happens. So that’s our responsibility to manage and lead through normal weather conditions. I mean, it just happens. This has been admittedly very unusual. The revenue loss only, just at ExpressJet in the six-month period to-date through June, is approximately $6 million in lost revenue simply from those lost block hours. And as you’ve astutely pointed out, there is a corresponding number that just is the secondary impact of the weather on the system that affects your costs. And that number, although hard to pinpoint, it could be as high as dollar for dollar of lost revenue, which would be a corresponding increase in costs. So you have I mean, the number at a minimum we think is $6 million, the number – the total impact could be as high as $12 million. Okay we have not paid much attention to it and so you ask the questions, because we don’t want to make excuses, we don’t want to, we just want to report, give you confidence that we have those things that are controllable, under control and that we have a good strong grasp on what’s happening in our systems. But look admittedly there is a material impact both in the revenue loss and the corresponding increase in costs. Some people think, well, shoot you, yes, there is a weather cancel, but you didn’t fly the flight, so you must have saved costs. Okay, that is not what happens, and especially when it happens to this extent. Okay, the other part of this that has cost us, I will just say generally as we talked about before, either in lost incentives, lost markup, or paid penalties, that number has also been several million dollars year-to-date. Michael Linenberg – Deutsche Bank: Okay, great. That’s great color. Thanks, Brad, I appreciate it.

You’re welcome.

Our next questions is from Bob McAdoo, Imperial Capital. Go ahead please. Bob McAdoo – Imperial Capital LLC: Hi. Just a couple of questions on these 40 United airplanes that are coming in. First, are those new incremental units for united that you’re flying, or are any of those replacing some of the old continental X jet stuff that might be disappearing that was probably lower margin stuff? And secondly, in terms of your relationship with Embraer, with these airplanes, are there terms between under which these aircraft are purchased, are those driven by negotiations between United and Embraer or between you and Embraer or a combination of the two? How does that relationship work between you guys and United and Embraer in a situation like that?

That’s a very good question. Let me deal with the last question first. So in this particular case, the discussions were specifically very separate transactions. I mean, we did a large transaction on the current version of the 175 that could be as many as 200 aircraft. I mean, in firm and options, okay. When I say as many as, I mean, I want to make it very clear that although we have hundreds of airplanes under contract, we are not speculating on aircraft, okay. So we do have some contingencies in there that are based on securing CPAs to fly the airplanes. But when you look at our total fleet and the fleet of the industry and look at the amount of replacement that’s going to need to be to happen, we think it very strategically and wise and prudent for us to position ourselves to, for a very material fleet replacement. And that’s what we’ve done. Now, the discussions between us and Embraer were very separate and distinct from what United did in the 30 that they announced, where they went direct to Embraer. No coordination or discussion amongst those parties at all, just very separate and distinct transactions. Okay, now, the first question you asked was are these airplanes in United system incremental growth aircraft or are they replacement? Okay, so unfortunately, I have to tell I don’t know exactly the answer to that question. I think in general, United has made statements, again I don’t want to in anyway appear to be or represent that I’m a United spokesperson, I’m not. I think they have made some general statements in the market indicating that they are either limited or will be very careful at incremental growth in the total regional system. But we’re not the only ones in that regional system and so how they manage these airplanes relative to their total fleet, we honestly don’t know exactly. So I mean, some of these could be temporarily incremental aircraft, but we don’t know the exact answer to how this plays into their overall regional fleet management. Bob McAdoo – Imperial Capital LLC: So you are still flying the same number of ex-continental lines of flight roughly that you did when you took over we would when you too over next step?

Yes. Bob McAdoo – Imperial Capital LLC: Okay. All right. And aren’t those some of the lower margin flights?

That’s correct. Bob McAdoo – Imperial Capital LLC: Yeah, okay. All right. So that’s some of the ones that Jim Parker was talking about earlier.

Yes. Bob McAdoo – Imperial Capital LLC: If you think in your response to him then, they are still out there.

Yes. Bob McAdoo – Imperial Capital LLC: Okay. Very good. Thanks a lot.

You’re welcome.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Brad Rich for any closing remarks.

Okay, we have nothing further to add other than again to express appreciation to all those participated with us today. We respect your time. We appreciate your interest. And as we have discussed in this call we feel very good about our improvement. We feel very good about our strategic positioning. We have had some challenges during the quarter and some real difficult conditions to operate in, not just weather, but general operating conditions, issues of aircraft, and look the overall things and acknowledgment needs to go to our – to all of the employees of each companies. We as a leadership team are very grateful for all of those efforts and for the commitment of our people. And with that, we’ll conclude the call. Thank you very much.

The conference is now concluded. Thank you for attending today’s presentation. Please disconnect your lines.