SkyWest, Inc.
Q2 2017 Earnings Call Transcript

Published: 27 Jul 2017

[Operator:]

Good day and welcome to the SkyWest Incorporated Second Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Rob Simmons, Chief Financial Officer. Please go ahead.

[Rob Simmons:]

Thanks everyone for joining us on the call today. As the operator indicated, this is Rob Simmons, SkyWest’s Chief Financial Officer. On the call with me today are Chip Childs, President and Chief Executive Officer; Wade Steel, Chief Commercial Officer; Eric Woodward, Chief Accounting Officer; Mike Thompson, SkyWest Airlines Chief Operating Officer; and Terry Vais, ExpressJet Airlines Chief Operating Officer. I would like to start today by asking Eric to read the Safe Harbor, then I will turn the time over to Chip for some comments. Following Chip, I will take us through the financial results then Wade will discuss the fleet and related flying arrangements. Following Wade, we will have the customary Q&A session with our sell side analysts. Eric?

[Eric Woodward:]

Today’s discussion contains forward-looking statements that represent our current beliefs, expectations and assumptions regarding future events and are subject to risks and uncertainties. We assume no obligation to update any forward-looking statements. Actual results will likely vary and may vary materially from those anticipated, estimated or projected for a number of reasons. Some of the factors that may cause such differences are included in our 2016 Form 10-K and other reports and filings with the Securities and Exchange Commission. Chip?

[Chip Childs:]

Thank you, Rob and Eric. For the second quarter, we continue with good progress on our overall business and fleet plans as demonstrated by the resulted outlined in the press release. The quarter also brought about plant increases and total production as we prepared for peak summer months and both airlines delivered strong reliability overall. I want to thank our more than 18000 employees for their great work during the quarter. There’s a lot of noise about airlines this year and our employees have done a great job focusing on strong service and reliability. I appreciate the dedicated efforts of our people to deliver a very good – competitive -- in a very competitive environment. The number of flights our two entities operate across North America is very significant and together we operate more than 280,000 flights during the quarter. Operational reliability for our airlines was as follows; SkyWest continues its exceptional operating liability with 99.94% adjusted completion in the second quarter even with increased total departures in June. ExpressJet also delivered strong 99.85% adjusted completion for the quarter. Both of our airlines have great reliability and have been top performers in United’s portfolio for over two years. During the second quarter, SkyWest Airlines secured a four year extension to its existing pilot contract with a new agreement through mid 2022. We believe it’s important to continue to invest in our people and while we don’t disclose the details of these agreements it delivers competitive compensation within the industry and positions us well to continue to attract and retain exceptional professionals. Importantly securing these agreements provides a solid foundation which to pursue opportunities within the market place. Pilot staffing is a central issue across the airline industry and it’s a challenge we continually monitor at each of our entities. During the second quarter, we experienced reduction attrition at both of our entities and each remained well staffed. From an industry perspective however, there is no question that it’s a challenge that will become more achieved. We are focussed on proactively addressing the issue and ensuring we continue to provide exceptional pilot carriers. Also during the quarter we continued progress on our fleet plan, which Wade will cover in detail in just a minute. To date we have a 103 E175 on property and expect to have 104 by year end. We have nearly completed our CRJ700 transitioned from the United to our Delta and American Operations and remove 50-seat aircraft from unprofitable contracts as we previously discussed. Demand for all aircraft had from each of our core partners remain very strong. It’s been a very dynamic few years in the regional space and our proactive evolution has helped us continue to meet our partner’s needs. We have built and maintained very strong relationships and credibility with each of four cores and that remains a key focus going forward as we continue to adapt and respond to what we are seeing as strong demand for solid, efficient and reliable operations. And we’ll say that operational performance has been somewhat of a challenge in certain areas of ExpressJet operation and we continue to work towards evolving that entity towards the building. As we have stated in previous quarters over the past couple of years, the long term success of ExpressJet requires significant change as we make progress for a smaller, more efficient and productive airline, and we are increasingly optimistic about that progress, as we successfully evolve and move forward the stability and long term outlook at ExpressJet model continue to improve. Overall, we continue to see strong demand for our product. Our objective is to ensure we are in the best position to meet the industry’s demand better than anyone else. Again I want to thank our more than 18,000 professionals for their work across our operations during the quarter and everyday. Rob

[Rob Simmons:]

Today we've reported net income of $50 million or $0.95 per share for the second quarter of 2017 up from net income of $40 million or $0.77 from Q2, 2016. Our pretax income increased 22% year-over-year to $81 million. Revenue was $810 million in Q2, 2017 up $9 million from Q2, 2016. With fewer aircraft in service, but with an improving mix, the moderate increase in revenue included the net impact of 47 additional E175 aircraft less the removal of 51 ERJ145, 18 CRJ200 and 7 CRJ700s from service compared to a year ago. We expect to put one more E175 into service during Q4 of 2017 to bring our total fleet of E175s to 104 by year end. We also completed the transition of 49 CRJ700s from other partners to American under a previously announced multiyear agreement further mitigating our financing tail risk on those aircraft. Wade will provide some color on the fleet in a minute. The tax provision rate for the quarter was just a little under 38% and benefitted slightly from the new equity accounting rules that went into effect starting with Q1. Our future provision rate may vary based on the timing and amount of stock option exercises, restricted share vesting, stock priced performance and other factors. Generally we anticipate a future effective tax rate between 38% to 39% in Q3 and Q4 and between 37% to 38% for all of 2017. Our total fuel cost per gallon averaged $1.89 during the second quarter up from $1.69 per gallon in Q2, 2016. The increased fuel cost per gallon cost us about $2 million or $0.03 reduction in EPS from a year ago under our pro rate business model. You can see in our release that the expense line item for aircraft maintenance is up about $10 million year-over-year. This increase largely relates to a higher percentage of our engines now being covered by long term powered by the hour maintenance agreements including the 47 new E175s in our fleet since last year of this time. We believe our engine powered by the hour agreements significantly reduced volatility in future engine maintenance costs. The vast majority of our engines are now covered either by long term agreements or our direct to expense tax rate to our partners. Let me say a couple of things about our balance sheet, a critical point of differentiation in our models. We ended the quarter with cash of $635 million up from $586 million last quarter and $513 million last year at this time. We issued $227 million in new long term debt during Q2 to finance the 10 new E175s delivered during the quarter with total debt increasing by $146 million net of debt service. Total debt as of June 30, 2017 was $2.8 billion up from $2.6 billion last quarter. SkyWest also used $21 million in Q2, 2017 for other CapEx along with $40 million in cash and deposits towards the acquisition of the 10 new E175. Absent new investment opportunities, non-aircraft acquisition capital spending in the second half of the year should continue to run in the $20 million to $30 million per quarter range with only one remaining E175 aircraft left in this order by year end. Debt again, absent additional aircraft orders is likely at a near term peak. With little CapEx in the second half, we continue to expect strong cash flow ahead. We ended the second quarter with $365 million of pre paid aircraft rents under our long term lease agreements. We anticipate this asset will amortize over the next several years as a non-cash rent expense that will contribute to our operating cash flows and will enhance the cash flow quality of our earnings. During Q2, we did not refer just any stock under our three year $100 million repurchase program authorised by our board in Q1. We have $90 million in authorisation remaining under this program and expect to fully utilize it. And finally, none of the items mentioned earlier by Chip and the ongoing transitions we would expect Q3 earnings to be slightly better than Q2. Wade?

[Wade Steel:]

Thanks, Rob. We continue to execute on our strategy of removing aircraft from unprofitable agreements and transitioning our fleet to larger new aircraft as well as redeploying aircraft with extended flying terms to mitigate financing risk. From March 31, 2017 to June 30, 2017 we moved from a total of 632 aircraft to 626 aircraft in our fleet. During the second quarter, we added ten new E175s to our fleet including five E175s under our United agreement for a total of 65 under contract with United, and five E175s under our delta agreement for a total of 18 under contract with Delta. This brought our E175 aircraft count to 103 at quarter end. We expect to put one more E175 into service during December of 2017 to bring our total fleet of E175 to 104. We recently signed an agreement with Alaska for five additional E175 that we expect we will be delivering during 2018. During 2016, we signed agreements to redeploy 50 SkyWest airlines CRJ700s from the United to other major partners, 38 to American and 12 to Delta. As of July, 37 of the 38 aircraft were in service under our American contract, we expect the remaining one will be redeployed during Q1, 2018. All 12 Delta CRJ700 aircraft were operating within our delta system. As we discussed, these redeployments essentially mitigate any financing risk on our CRJ700s through 2019. As yearend 2016 we announced our plan to remove 46 CRJ200s from the ExpressJet fleet. In accordance with their natural contract explorations and as part of our plan to move ExpressJet CRJ operation to dual class. As of June 30, 20 of the 46 have been removed from contract. We anticipate that the remaining 26 aircraft will be removed during the third and fourth quarter. We anticipate the majority of these aircraft will be returned to the lessor [ph] under natural lease expirations this year while the remaining will be sold through other third parties. ExpressJet also placed two additional CRJ700 into service for American during the quarter. These two aircraft bring the total to 12 CRJ700s operating for American under a multiyear agreement as we move ExpressJet CRJ operation to primarily to dual class. We also made changes to our ERJ145 fleet during the second quarter. We removed 13 ERJ145s from our fleet. Seven of which were removed from an unprofitable united contract and six from our American contract. As we previously discussed United has exercised its first one year option to extend our ERJ145s contract at modestly improved rate through 2018. Our conversations with United are ongoing and productive. And we are optimistic about the opportunity to secure a positive long-term solution. Demand for our remaining 50-seat aircraft remains very strong and we are working with each of our major partners to meet their ongoing 50-seat needs. We have recently added 17 CRJ200s with United under a contract with SkyWest Airlines. These aircraft will be placed into service by the end of the third quarter. We continue to execute on our strategy of removing unprofitable, redeploying aircraft with other partners and placing larger new aircraft into service to minimize our risk and continue to deliver on our commercial agreements. Okay, Drew, we’re ready for Q&A now.

[Operator:]

We will now begin the question and answer session. [Operator Instructions] The first question comes from Michael Linenberg of Deutsche Bank. Please go ahead.

[Michael Linenberg:]

In the press release you call out some financing type to 10 E175, I guess there’s some cash up front, there’s some debt financing. That’s for the same 10 airplanes, right?

[Chip Childs:]

That’s right. We take delivery of 10 airplanes during the quarter, Mike and that was -- we’ve raised $227 million of new debt against those deliveries.

[Michael Linenberg:]

Okay, great. That’s helpful. And then, I believe you're taking your last E175 this year, and I just I am curious when we saw what I thought was an updated fleet plan from Alaska. Look like that they were another five E175s coming from you in the 2018/2019 timeframe. And I wasn't sure if that was incremental to your current fleet or if you had E175s coming out of one partner agreement and moving over to Alaska, a year and half, two years from now? What’s the status of those?

[Wade Steel:]

Yes. Mike, this is Wade. So, we recently signed a new agreement with Alaska to add new, five new E175s to the agreement and they will be delivered during 2018.

[Michael Linenberg:]

Okay. Okay, great. So is that something that’s coming in the earlier part of the year or later part of the year?

[Wade Steel:]

Later part of the year.

[Michael Linenberg:]

Okay. Okay, good. And then just last question, with all the talk on the reauthorization and maybe corporatizing or privatizing air traffic control. I mean it really comes down to just FAA reauthorization of what they want to put this plan. I know that there's an effort to try to put in some language to help the pilot situation. And it just seems like that I'm not sure is that it not going to go anywhere or its going to have to get striped out because this whole privatization of ATC isn’t going to happen. Is there anything that your people in DC or the RAA is telling you that we could see that we should expect release maybe some measures that will help really mitigate the situation because it is – its starting to show up at a lot of different fronts.

[Chip Childs:]

Michael, this is Chip. I’m impressed how much detail you know about this. I mean, from the perspective of how it impacts, but I don’t think you an extremely smart guy but I think that to see the last month or so I’ve been living there, its a little bit in DC and talk a lot of people about FAA reauthorization bill, and in our view, look we love the concept of it, but from our perspective it falls short in two distinct areas. One, it does not address the pilot issue, and fundamentally from our perspective -- I hate to speculate. I will tell you that if we look at the data it is absolutely positively clear if we’re really going to move the dial on what is in very emotional safety issue. If we really want to look at concrete data to enhance safety relative to the situation we have to address it through additional training program and modify the pathway. I’m actually for 1500 hours, but I'm also for alternate programs that clearly need to be evolutionary towards safety. And I don’t think anybody who has looked at the data or is going to look at the data could argue that there is not some significant opportunity there. Second of all, we’re a big concern about some of the funding model as it goes into reauthorization for a privatization of ATC and we’re optimistic and we’re very supportive of the overall process, but in its current form today I can tell you is falling short of what we think that several local communities both with the pilot issue and the funding issue, many local communities throughout America are going to have a bit impact if this is not addressed in this bill.

[Michael Linenberg:]

Yes. I agree. All right. Well, thanks for that update. Thanks Chip.

[Operator:]

The next question comes from Helane Becker from Cowen & Company. Please go ahead.

[Helane Becker:]

Hi. Thanks operator. Hi, guys. Thanks for the time. I just have a few questions. The first question is just a modeling question. I’m not exactly sure why salaries went down in the June quarter. And I didn’t hear you talk about that specifically on the earnings call?

[Chip Childs:]

Helane, salaries are correlated with production and as you can see were down about 5% year-over-year and block hour production.

[Helane Becker:]

Okay. Thanks. That’s helpful. And then my other question. I’m sorry, go ahead.

[Chip Childs:]

I’ll add one more thing. This is Chip. On per unit basis I think it’s up slightly. But when you take that much production out on the gross basis that shows down, but it -- I think that -- I think on a unit basis we were up a bit which is in a balance where we want to be, we want to make sure we’re taking care of right way.

[Helane Becker:]

Got you. Okay. And obviously I haven’t done all that work yet. So the other question is with the return in the CRJ200s to the West source, is there going to be maintenance cost provisions that we should be aware of?

[Wade Steel:]

Helane, this is Wade. Most of those costs are covered under either our capacity purchase agreement that we have with our major partners or they have substantially been accrued for.

[Helane Becker:]

Okay. Perfect. And then my last question is on the five new aircraft from Alaska that were going in next year. Is there room to add additional aircraft beyond these five?

[Wade Steel:]

Helane, this is Wade again. We continue to work with all of our major partners on their demands, Alaska is a great partner. We continue to have discussions with them around their needs and what they want to do in the future. So, yes, so stay tune.

[Helane Becker:]

Okay. Fair enough. Thank you.

[Wade Steel:]

Thanks, Helane.

[Operator:]

The next question comes from Savi Syth of Raymond James. Please go ahead.

[Savi Syth:]

Hey, good afternoon. Just a couple of quick follow-up, just on the United CRJ, the new aircraft that you prepared, is that fixed or prorate?

[Rob Simmons:]

Those are under capacity purchase agreement. So that’s a top contract.

[Savi Syth:]

Okay. Got it. And then just, its great to see deal with SkyWest Airlines pilot and having that visibility. Any update on the extra ship pilot side?

[Chip Childs:]

Yes. Helane, this is Chip. We continue with all work on ExpressJet to have active dialogue about new contracts. We have both pilot groups come due at the end of this year. Our fundamental strategy as we talked about in script I think its necessary for us to be transparent and provide some good long term vision about a longer term fleet strategy with ExpressJet and then entering to those dialogue more substantially. So I can tell you right now that the dialogue that we have with the past that ExpressJet is fantastic. There is good engagement and good collaboration on long term success of that entity.

[Savi Syth:]

Okay. And then just a little bit of strategic question, I mean, I think the team in general has done a great job of managing pretty complex fleet transition here. And I think maybe majority they have listing as coming towards, little bit of the end at least in the sense of kind of moving thing around you still have the 50 seat fleet, I’m trying to figure that one out. As you kind of get though the big E175 deliveries and getting into the second half and looking to 2018, where is the focus like, what’s kind of strategically does anything change and are they kind of new direction that you look to focus on?

[Rob Simmons:]

So, Sav, it’s Rob here. So I would say that it’s sort of more of what we’ve been talking about that we feel like there are still a number of opportunities from the legacy side of our fleet to make improvements in terms of turning pink squares to green in our presentation model. I mean, I think there’s still lot of opportunities to do that. And so I think growth can still come from a number of different areas, but we feel like we’re far from the end at this point.

[Savi Syth:]

Thanks.

[Operator:]

The next question comes from Steve O'Hara of Sidoti and Company. Please go ahead.

[Steve O'Hara:]

Yes. Thank you.

[Chip Childs:]

Hi, Steve.

[Steve O'Hara:]

How you’re doing? Thanks for taking the question. I guess, so just looking at the quarter was sequentially going into 3Q. I see you -- it looks like I think you put down the guidance for ASMs and I didn’t check the block hours relative to your prior forecast. Can you just talk about what that was that just aircraft coming out sooner than expected?

[Chip Childs:]

So, the question is just on the block hours came down slightly from our prior guidance on block hours. There’s just been some as we’re taking down some of the 46 CRJ200, some of those are coming out probably a little quicker than we had originally anticipated which is fine and stays within our model.

[Steve O'Hara:]

Okay. And I guess just on the and maybe you mentioned this, I apologize, but on the maintenance line, I mean it looks like a pretty decent jump year-over-year and I’m just wondering was that aircraft coming out that had to be maintained or just what happen there?

[Chip Childs:]

Steven, so it sort of hit that in my script, but I think again a lot of it has to do with when you’re looking year-over-year. We have 47 new E175s that are in there and they all have power by the hour maintenance agreement on their engines and so like a bigger percentage of our fleet year-over-year are under those powered by the hour agreements where you accrue it as you go. And so that explains the bulk of it.

[Steve O'Hara:]

Okay. So that number should be kind of something a good number for block hour, something like that going forward I guess that?

[Chip Childs:]

Yes. Like we say, like right now, like virtually all of our engines are under either long term powered by the hour tight maintenance agreement or our past through expense to our customers.

[Steve O'Hara:]

Okay. Okay. All right. Thank you.

[Chip Childs:]

Thanks Steve.

[Operator:]

This concludes our question and answer session. I would like to turn the conference back over to Chip Childs, President and Chief Executive Officer for any closing remarks.

[Chip Childs:]

Thank you. And again, we want to thank everybody for your continued interesting SkyWest. We continue our long term evolution and progress and we’ll talk to you next quarter. Thank you.

[Operator:]

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