Mesa Air Group, Inc.
Q3 2008 Earnings Call Transcript

Published: 19 Aug 2008

[Operator:]

Welcome to the Mesa Air Group’s third quarter earnings conference call. (Operator Instructions) I would now like to turn the meeting over to your host for today’s conference, Jonathan Ornstein.

[Jonathan Ornstein:]

Let me start by reading the forward-looking statement, please. This conference call will contain various forward-looking statements that are based on management’s beliefs as well as assumptions made by and information currently available to management. Although the company believes that the expectations reflect in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Such statements are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those anticipate, estimate, projected, or expected. The company does not intend to update these forward-looking statements made in the call prior to the next filing with the Securities and Exchange Commission. Okay, again I would like to thank everyone for taking time out of your day to join us on this earnings call. As always we appreciate your interest and we will get to all the information and then ask for any questions. On a high level earnings overview, on a consolidated basis we posted net income of $1.8 million or $0.07 per diluted share from continuing operations on operating revenues of approximately $353.9 million. On a pro forma basis net loss from continuing operations was $2.5 million, or $0.09 a share. The company compares to a $6.9 million gain or $0.23 per diluted share in the third quarter of fiscal 2007. Pro forma net adjustments on an after tax basis were the following, a $4.5 million gain on extinguishment of debt which includes $3.6 million gain on the sale of 14 Beech 1900 Aircraft to the lien-holder and a $900,000 gain on convertible debt, $1.3 million gain from a settlement made with Big Sky on the return of aircraft, a $1.2 million gain on securities, a $800,000 gain on investments and a $200,000 gain on disposal of assets. Pro Forma losses included $1.9 million from a settlement with a code share partner, legal expenses at go! 800,000 and 700,000 costs associated with the Chinese joint-venture and $300,000 in net lease return costs. As we stated in the prior call, we have now designated our Air Midwest operations as discontinued operations, thus the previously stated financial results exclude Air Midwest. Air Midwest was $5.6 million after tax in the third quarter of 2008. Additionally, as of June 30, the company’s cash and cash equivalents and restricted stocks and marketable securities were approximately $60.1 million of which $46.7 million was unrestricted. During the third quarter there was quite a bit going. On March 28, Delta notifies the company of its intent to terminate the Delta connection agreement regarding ERJ-145 alleging failure to maintain the specified completion rate with respect to its ERJ-145 Delta Connection flights during three months of the six-month period ending February 2008. Following Delta termination notification the company filed a complaint on April 7, 2008 in the United States District Court of Northern District of Georgia, seeking declaratory and injunctive relief. An evidentiary hearing was held on May 27 through May 29 following the hearing; the Court ruled in the company’s favor and issued a preliminary injunction against Delta. The effect of this ruling is to prohibit Delta from terminating the Delta Connection agreement and pending a final trial at a date to be determined by the Court. On June 27, 2008 Delta filed a notice of appeal, on July 15, 2008 Delta filed a motion requesting that the appeal be heard on an expedite basis. The company has responded to Delta’s motion in accordance with the applicable rules. The outcome of Delta’s motion will determine the timing of subsequent deadlines. Prior to the Courts ruling, Delta plan to remove from service a significant portion of the aircraft in early June 2008, and all aircraft in July 2008 and forward. Delta did not immediately reverse its plans based upon the Court’s ruling. Following the Court’s ruling the company and Delta reached an interim financial understanding, subject to the mutual reservation of rights in which Delta will reimburse the company for a certain cost and the majority of the ERJ-145 aircraft remain out of service until October 2008. On August 5, 2008 the company issued a press release announcing that on August 1, Delta had notified the company of its election to immediately terminate the Delta Connection Agreement for CRJ-900 aircraft dated March 13, 2007. This notice states that Delta is terminating the 900 Agreement as a result of Freedom’s alleged failure to maintain specified on-time arrival rate and completion rate with respect to the Delta Connection flights during the four months of March, April, May and June in 2008. The notice issued by Delta is accompanied by proposed temporary agreement pursuant to which Freedom will continue to provide 900 flying, while the parties discuss the terms of a transition agreement. As of August 2008, the Company operated seven 900’s for Delta pursuant to the agreement different from all of our other code share agreements Mesa Air did not own of any long-term lease agreements, the aircraft are in fact sublet from Delta for $1 per month. The 900 agreement contributed 4% and 2.6% of the company’s revenues for the three months and nine month ending June 30, 2008 respectively. Go! We’ll go a little bit more into this further on, go! increased capacity in Hawaii and its operation to meet the markets decrease in supply. Available Seat Miles increased 61% from the prior quarter with an average of $11.3 million to an average $18.1 million; operating revenue increased $9.4 million for the same period in the prior year. Mesa's operates 7, CRJ-200’s in the Hawaiian Island under the go! brand name during the quarter. The sum was also reached with Hawaiian Airlines concerning the lawsuit over Mesa's inter-island flight services operated under the go! brand name. In the second quarter Mesa received $37.5 million previously posted under a Bond. Air Midwest, in the fourth quarter of fiscal 2007 the company committed to plan to sell Air Midwest or certain assets thereof. Air Midwest consist of Beech 1900D turboprop operations which includes the Mesa independent operations Midwest airlines and U.S. Airways code share operations. In connection with this decision the company began soliciting bids for the sale of the twenty 1900D aircraft and began to take the necessary steps to exit the EAS markets it served. We exited all markets on or before June 30, 2008. All assets and liabilities result to the operation of the financial and operational data associated with these assets has been presented at discontinued operations separate from continuing operations. Air Midwest ceased operations on June 30, 2008 in all markets. On May 16, the company sold 14 of its 34 Beechcraft 1900 aircraft to Raytheon Aircraft Company and Raytheon Aircraft Credit, pursuing to an agreement reached between the parties regarding such aircrafts. The company sold the aircraft as it is, made a payment of $500,000 and in return Raytheon eliminated approximately $28 million of long-term debt due to Raytheon associated with the aircraft. This transaction resulted in net gain of $5.8 million, which was recorded in gain on extinguishment of debt in the condensed consolidated statement of operations. On May 12, company reached an agreement with MAIR Holdings a parent company of Big Sky in relation to the early return of ten Beechcraft 1900D leased to Big Sky, following Big Sky’s announcement that it was ceasing operation and liquidating its assets. The net gain on the settlement was approximately $2.1 million as recorded in other income in the condensed consolidated statement of the operations. In China, the company entered into a Letter of Intent with Shenzhen Airlines. The agreement details the company’s intent to sell its interest in Kunpeng, the Chinese joint-venture to Shenzhen Airlines, the majority owner. As a result of the Letter the company wrote down its investment in the Kunpeng by approximately $1.3 million to reflect the terms of the Letter of Intent. Kunpeng will continue to lease the five regional jets currently flying in China from Mesa Airlines. As discussed previously, operating income fell $16.8 million from an income of $13.6 million in Q3, 2007 to a loss of $3.2 million in Q3, 2008. On the revenue side the quarter ending June 30, 2008 net operating revenue increased $13.5 million or 4% to $353.9 million from $340.4 million in the previous year. Primarily due to contract revenue increase of $3.6 million, this is due to fuel pass-through and the go! increase in revenue of $9.2 million. Fuel expense increased by $32.6 million or 28% to $149.2 million from a $116 million in the quarter ending June 30, approximately 94.5% of our fuel is reimbursed by our code-share partners. The go! segment reported a pretax loss of $7.4 million for the third quarter of that we are going to go through some numbers here. go! expenses included $0.5 million in lease return costs, $1.3 million in legal expenses, 900,000 for unscheduled engine overhaul, $700,000 of cost to swap out the aircraft, which were all being return up of short-term lease. Looking ahead on go! I’d just like to run a few more numbers through. We carry as we report publicly approximately 80,000 to 85,000 passengers a month. I can tell you that our average fair is up approximately $9 over the previous quarter and our fuel prices are down approximately $0.60 at this point over last quarters average fuel and we burned approximately 600,000 gallons per month. Okay, in addition we have approximately $400,000 allocation per month to go! that includes about 200,000 of non-cash depreciation and $200,000 of corporate overhead. I think if you add those numbers up you can draw some conclusions as to why we continue to move forward and are committed to the go! operation. Total Available Seat Miles for the third quarter of fiscal 2008 decreased 10.9% from the third quarter of 2007, primarily due to a decrease in the number of Aircraft flown from 199 to 161 as of June 30, 2008. At June 30, Mesa’s 2008 operating fleet comprised of 80 50-seat regional jets, 38, 86-seat regional jets, 76-seat regional jets those are the affirmation Delta jets, 20, 66-seat regional jets and 16, 37-seat turboprops. Under the U.S. Airways contract, the Company operators 51 regional jets and six turboprops, United 46 regional jets and ten turboprops and 41 regional jets at Delta. We also were flying seven regional jets in Hawaii, we are currently had six regional jets in Hawaii. For the quarter ended June 30, the company’s controllable completion factor was 98.5% and I would like to talk a little bit about some of the challenges we faced going forward and then open up for questions. Clearly, Mesa is not without issues, we probably face issues that we have never face before, certainly the high fuel prices, while most of our fuel is pass-through effected us pretty significantly. In go! last year for example our average fuel price was 230 a gallon, this year it was approximately 412 a gallon. You can imagine that that’s a pretty big hit to the operations. We had seen some moment downwards at the rest of the industry as I said we’re now around the 355 range, we have seen some improvement, hopefully continue to see that. Clearly, another big issue we faced has been the whole situation with Delta, we’re very fortunate to one injunction, we do have to go to Court on that and we remain confident not only in our position, but in the strength of the injunction that are position will be at held. We also are contesting the cancellation of this CRJ-900 contract, again we feel that the interpretation that Delta is used is inaccurate and incorrect and we believe that ultimately we will prevail on this situation as well. Of course as we are with all of our partners we would prefer to work these things out amicably, I remain open to do that, but we also feel that we have defend our right and we’ll do so to extent necessary. I think the other significant challenge that we face, I think most of you know particularly in the finance community, because we have a large amount of debt coming due in early part of next year and we continue to look at way to solve that rather complex issue. There are number of things that we done, the last time we had some of the bonds come due, we were able to roll them for a short period of time. Clearly, the company does not have the money to pay those bonds, so we will have to be creative, but again we thing that it everyone’s interest income to a reasonable solution, so that the company can continue to move forward and return to sustain profitability. I would like to thank all of our employees who continue to do an excellent job in the field in spite of what is a very difficult operating environment. I would like to thank our partner for their continued support U.S. Air and United in particular have been just terrific. They have been helpful of working through these issues with us. I would like to thank all the folks there and certainly I would like to also send out our appreciation to our many vendors and suppliers, the aircraft manufactures who’ve also been helpful Mesa has got a long history, this is our 26 year of operation. We have faced challenges before and we’ve come through and I remained confident that we will be able do the same here as we move forward. With that, I would like to open up the call to any questions and I’ll do the best, I have few other people in the room, we can all help to answer them as best possible.

[Operator:]

(Operator Instruction) Your first question comes from Michael Lindenberg - Merrill Lynch.

[Michael Lindenberg:]

When you talked about the agreement that you reached with Delta on compensation for the 145, when we think about that and how we model. Does that assume, because you aren’t running the operation and there is obviously cost associated with it, but a lot of variable cost is out, based on the rate that they are paying you, does that result in a breakeven number for the company, and is it a loss. How should we think about that?

[Jonathan Ornstein:]

I think you can look at that as no worse than a breakeven.

[Michael Lindenberg:]

With those planes, maybe they grounded maybe not, may be you are able to use them in charter or backfill for Delta, because they are out of the schedule until October. Do you run into any issues with pilot time and making sure that the pilots are on those planes remain current?

[Jonathan Ornstein:]

We have been doing some ad hock work for Delta and so, no we don’t see it as an issue and there is 12 aircraft going back into service in September. I am not sure, I may have misspoke but they all go back in October, but we start in September. So, there is no time out, there is no issues we’ll be find.

[Operator:]

Your next question comes from Bob McAdoo - Avondale Partners

[Robert McAdoo:]

What the line it says loss from discontinued operations, the $5.5 million loss for Air Midwest. Fuel costs are involved, any fuel cost increases or any fuel that relates to Air Midwest is in that because that’s that is the net of that expanding expense there?

[Jonathan Ornstein:]

Yes, that’s correct.

[Robert McAdoo:]

Could you tell us how much on the go! side, what your fuel went up, into your fuel bill win up on the go! side year-over-year? Is there a way to get to that?

[Jonathan Ornstein:]

Its $3.8 million.

[Robert McAdoo:]

That’s the year-over-year increase in fuel?

[Jonathan Ornstein:]

That’s just on the rate Bob. That’s not volume, that’s just rate, and since then and Keith correct if I am wrong, we’ve seen approximately a $1.2 million decline based on today’s prices versus last quarter, on a quarterly basis?

[Robert McAdoo:]

Again, this is a rate variance only it doesn’t talk about adjusting volumes.

[Jonathan Ornstein:]

That’s correct, and average fares and I think it is reasonably good news for Hawaii. Average fares were only up about $9, but we do carry something in the 250,000 range in terms of people per quarter.

[Robert McAdoo:]

Okay, when you talk about $9 up, is that versus prior year or versus sequential quarter?

[Jonathan Ornstein:]

Versus this quarter that we’re reporting.

[Robert McAdoo:]

Is this at the June quarter versus the March quarter or is that the June quarter versus the June quarter year ago?

[Jonathan Ornstein:]

No, that is the June quarter versus where we are today.

[Robert McAdoo:]

That’s since the June quarter?

[Jonathan Ornstein:]

Yes, I’m sorry.

[Robert McAdoo:]

That’s kind of what its currently running at now, the last week or so versus the quarter that you’re reporting here.

[Jonathan Ornstein:]

That’s correct. It’s about more than the week, about the last six weeks.

[Robert McAdoo:]

Last six weeks, versus the June quarter?

[Jonathan Ornstein:]

Yes

[Robert McAdoo:]

Okay, and all of that list of lease returns and legal and all of that is meant to give us a clue as to how to go back and take that $7 million loss that’s in the front page of the papers over there and sale it back to get us something as to…

[Jonathan Ornstein:]

Where we think we are, and we had a lot of what we viewed as one-time expenses, we’d like to think that hopefully at some point we will not be dealing with legal expenses as we have been, and we do have about $200,000 of non-cash depreciation and about $200,000 of corporate overhead, which we can all look at that number one way or another I’m not sure that, if that number would necessarily go away, if we weren’t flying in Hawaii. So, we’re sort of doing that analysis to determine the viability of go! going forward, and at this point we still feel confident that with any help from fuel primarily, I think we’re in recently reducing shape.

[Robert McAdoo:]

In terms, kind of the ongoing go! capacity, what's the kind of level that you are at now?

[Jonathan Ornstein:]

We went from seven aircraft down to six and we do plan a seasonal pull down also to accommodate maintenance in September. So we will be going down a little bit again in September not unlike the other carriers in the island after the summer season, things do slow down and everyone pulls down some capacity just to reflect the demand levels, and then following that for next summer or the spring is things start to move back up again and obviously depend upon general economic conditions and where we are with fuel, we would look to add back that capacity..

[Robert McAdoo:]

Okay and on the Chinese venture, this Letter of Intent that’s been put together, will that get you out of everything over there except the fact that they would continue to lease some airplanes on our some kind of reasonable rate basis?

[Jonathan Ornstein:]

Yes, the biggest part of going into that operation was that the fine homes for aircraft. Unfortunately, our view at this point is again 50-seaters are difficult to make work. They are moving into larger aircraft, which hopefully will provide them better results, but the fact matter is this will generate, not an insignificant amount of cash for us at this point and I would say that if we’re able to successfully complete this transaction, which no clearly has a way to go from LOI with that cash would add some value to us right now that otherwise, if we’re in the different situation may be we would have a different view, but I think the fact of matter is that we made this investment in a couple of years ago to get back the bulk of our cash may make its one of the better airline investments over the last couple of years. Clearly it’s not the big hit that we’d hope for, but unfortunately there have been a lot of changes in the industry, lots of changes within China and its stock market and the opportunity to potentially liquefy that investment and just we felt that if we had the opportunity to generate some cash that might make some sense right now.

[Robert McAdoo:]

These are owned aircraft?

[Jonathan Ornstein:]

No, these are aircraft that are sublet.

[Robert McAdoo:]

Okay and is the $1.3 million that you took. Is that kind of the end of it, or is that if this transaction moves alone there will be another hit, somewhere down to road?

[Jonathan Ornstein:]

I don’t believe so, the people hear are shaking their head. So, I think that that...

[Robert McAdoo:]

Is that head up down, or side to side.

[Jonathan Ornstein:]

No, we think that, that will adequately covered but again remember this is only in LOI and it is been challenging in our operations in China for sure.

[Operator:]

Your next question comes from Jim Parker - Raymond James

[Jim Parker:]

Jonathan a couple of questions, so I think everyone talk for a while China would be a great market and now it isn’t so, what’s going wrong there?

[Jonathan Ornstein:]

Well I think that from the cost side equation, I mean their fuel is more control than it is here, the aircraft have operated as we expected. I think the biggest issue has been, we had relied on our partners there obviously a much better understanding of the marketplace and we do and I think that what they have found is that while there yields have been reasonably good that their load factors have just not been more they need to be in may just mean that there is a longer developed cycle, they don’t quite have the same level of sophistication in terms of distribution and I have a sense that unlike Untied States where it gets merely distributed through, literally dozens of channel over there it just takes more time. Our view is again that the cash is probably worth more to us and I will also add that, I think that it’s just been difficult managing the operation at such a distant and it’s just become such that, while we do have a revenue guarantee effectively where we are only responsible for a small portion of losses, I could tell you that has worth very much in our favor because it was a conservative approach. We decided to take shot at it, but the numbers have just not been I think where we had hoped or the Chinese had anticipated and at this point in time it may just be a little bit more long-term than we have the ability to stomach and frankly the cash right now is valuable to us.

[Jim Parker:]

Okay, Jonathan more of a big picture question. You mentioned Mesa’s been in business for 26 years I think you’ve been there for about 18 of them, this maybe the most difficult point in that timeframe. What is the future for the regional airline business for investors, will regional airlines be would of investment in the future, what you’re thinking?

[Jonathan Ornstein:]

Well, I think it’s a great question and its something that we’ve all been asking ourselves, because the bottom line is with fuel reaching upwards to 450 a gallon not too long ago I don’t think anyone could make sense of 50 seat aircraft. There has been a somewhat of shift I see among our partners and there is a difference of opinion among some of the partners in that. If you are going to fly a network maybe even though the 50 seater is not the most sufficient if you just sort of hunkering down maybe you continue to fly the small aircraft until such times turnaround, United for example move pretty aggressively on the capacity side internally and they’ve also come to us, and said what can we do to help them and certainly we wanted to do everything we can. The smaller aircraft, with the fueled level where it is make the difficult. I think going forward Mesa still has the option and we continue to pursue the option, where we will swap out 700s, 500s, 200s or 700s. We are talking to our leaseholds and manufacturers by potentially giving us more flexibility with the 50-seat fleet, and we have to wait for what I think is going to be a general industry recovery before we see any significant growth opportunities. I mean when you look at the losses being generated in the industry this year, even compared to those at 9-11, this has been far more damaging and its puts everyone in sort of a hold certainly in terms of any kind of growth opportunities and I just think that we have to just sort of bear through it is as best we can. We have immediate challengers, and we are fortunate that we’ve got partners who have been very supportive at U.S. Air and at United, because clearly there were times that they knew that the level of difficulty we had, and I think they could have treated much differently. They chose not to, they viewed us a long-term partner and it was very helpful, and now we are looking at ways that we can be of assistance to them as well with what is unfortunately limited capability, but nonetheless maybe some flexibility in terms of the fleet. So, I think it’s a tough situation, and clearly the most meaningful challenge we have determined whether Mesa is quite investor worthy or from our perspective, we obviously have the bond to deal with and that is going to take some work no doubt and some creativity. Clearly, we don’t have the cash to pay them in cash, we do have the ability to give them stock, but I think, we are looking to be a little more creative that we can all see some benefits to hopefully in improving environment certainly lead by hopefully fuel prices continuing lower, but at this point in time, I think that’s with the industry being where it is, and where Mesa is in particular, we still face some pretty serious challenges.

[Operator:]

There are no further questions.

[Jonathan Ornstein:]

Thank you for taking time out of your day. It has been a very busy time here as you can imagine, we’ve got a lot of good people here working in Phoenix to try to resolve these issues. We’ve got thousands of great people out in the field they are continuing in some very tough environment out they’re doing, what I considered to be an excellent job. We are all working very hard to see the company return to sustain profitability, as it had been for pretty much most of its history and certainly over the last 10 years. So, I appreciate everyone’s patience, if you have any additional questions, please feel free to call us and we’ll do the best we can. Thank you very much. Have a great day. Bye, bye.