SkyWest, Inc.
Q2 2008 Earnings Call Transcript

Published: 6 Aug 2008

[Operator:]

Welcome to the SkyWest Airlines Q2 2008 earnings call. (Operator Instructions) I would like to turn the conference over to Bradford Rich, SkyWest, Inc. Executive Vice President and Chief Financial Officer.

[Bradford Rich:]

First of all, let me just begin with some introductions of those participating with us this morning on the call. I have with me here at SkyWest is Chip Childs, President and Chief Operating Officer of SkyWest Airlines; also participating via phone line will be Brad Holt, President and Chief Operating Officer at Atlantic Southeast Airlines. I also have Michael Kraupp, our Vice President Finance and Treasurer; Eric Woodward, our Vice President and Controller with me here at SkyWest, as well as other members of our staff. Before we begin, I’ll turn some time to Mike Kraupp to read our forward-looking statement.

[Michael Kraupp:]

In addition to historical information, this 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 expect, intends, believes, anticipates, 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 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.

[Bradford Rich:]

This morning, I really am going to try to keep my prepared remarks very brief. As usual, I will try to use the script and stick pretty close to the press release that went out this morning. I’m assuming that most, if not all of you that are participating on the call, have seen our announcement this morning. As I said, I’ll try to keep my remarks brief and leave as much time as we can for question and answers. This has been a quarter that has been I think one of the most unusual quarters that I’ve seen in quite awhile in my experience at SkyWest just from a standpoint of so much activity in a lot of different areas going on within the industry. Everybody I think is certainly well aware of the challenges that are prevalent in our industry, as well as just market activity in general. So it’s been busy. It’s been a challenging quarter. It’s one in which our results, as you see them reported this morning, are not exactly what we expected; but in light of market conditions and the challenges that we faced, we actually are quite pleased with the results. As you can see from the release, reported operated revenues of $950.8 million for the quarter, we reported $36.4 million in net income, which is $0.63 in diluted earnings per share. That compares to $40.6 million of net income and $0.62 per diluted share for the same period last year. In looking at things on a year-to-date basis for the six months, end of June 30, we reported $1.82 billion in revenue; $65.6 million at $1.10 per diluted share. That compares to $75.4 million of net income and $1.15 per diluted share for the same six months a year earlier. Some of the significant items affecting our performance, certainly our production as measured by block hours is a key indicator and a metric that we look at very closely as indicated in the release. For the first time in a lot of quarters, we had reduction in our block hours of 1.3%. A few comments relative to production from just a high level

[Operator:]

(Operator Instructions) Your our first question comes from Lily Ng - Merrill Lynch.

[Lily Ng:]

My first question is related to your prorate flying. Brad, do you think you could give us an update on what’s going on there because there was quite a bit of talk last quarter of that part of the business, and I was just surprised you didn’t give us as much update this time around.

[Bradford Rich:]

Certainly our prorate flying is a factor in our financial performance. I’ll just give you some general numbers here. We were over our plan by 4.4 million in prorate fuel, which we have full risk; and we were also a little under plan by approximately $1 million in our prorate revenue generated. So in total, relative to our plan, we were under plan pre-tax, $5.5 million to $6 million in our prorate flying. I think that we have and in total, that’s relative to plan, we had planned a small loss for our prorate flying. So although it’s a relatively small portion of the business, you’re asking a very good question. It did have a fairly meaningful impact on our financial performance for the quarter. A lot of people will say, “Well, what are you doing to mitigate the impact of that?” Without getting into a whole lot of the specifics, we do have very specifically some plans in process that I think will mitigate those losses going forward. We’re very optimistic that we can get our prorate flying back very near to a break-even, which I think would be a good success in this environment.

[Lily Ng:]

My second question is back to your dispute with Delta. I was just wondering, they have obviously resolved some of the issues they have with several other regional partners. Have you seen any changes in the attitude, and this is mainly regarding out-of-court conversations that you have with them, not the stuff that you have that’s going on in court. Have you seen a change in attitude? Are they more willing to work with you or would you still characterize the relationship as being maybe more difficult than it was [inaudible] standard?

[Bradford Rich:]

I think I can answer that very concisely. What we have, a very clear agreement on with Delta is that we’re going to compartmentalize this dispute, set it off to the side, and let our respective legal teams deal with this. I can tell you our position, our attitude about this has not changed. We’ve agreed with Delta to set it aside. Let our legal teams deal with this. There aren’t any out-of-court discussions relative to that dispute going on. On the other side, we have very productive and cordial discussions going on with Delta just relative to our systems. As I’d mentioned earlier in my remarks, we’ve got to be more proactive on creating value-driven solutions to our partners, including Delta, and we’re having those discussions. On the one hand, the discussions are very productive. We’ve just compartmentalized this dispute off to the side and it’s just running its course.

[Operator:]

Your next question comes from Duane Pfennigwerth - Raymond James.

[Duane Pfennigwerth:]

Just in terms of your production in the second quarter, can you speak to where you were relative to minimums and just the second part of that relative to the guidance that you’ve put forth. What does that assume relative to your block hour minimums and what does that also assume about Midwest?

[Bradford Rich:]

Some of you may know this already just by your own reviews of our contract that’s publicly filed. There is some latitude for Delta to move at certain times below the minimums, as long as they bring them back. So we have seen, particularly at ASA, we’ve seen the block hour utilization split below the minimums at certain times and then it’ll pop back up to the minimum, so that has been happening. The projections going forward are assuming, first of all, through September the estimates just include the schedules that we’ve seen through September. Then beyond September, we’re just taking what information we have from our partners; what information we’ve gathered from Delta where I think we’re assuming; there’s a high likelihood that beyond September, they could take us below our minimums. So that’s what we’ve assumed there. Then on the Midwest side, we’ve just assumed schedules moving forward with nine aircraft scheduled out of the system.

[Duane Pfennigwerth:]

So regarding those minimums, at what point do you bill for the minimum even if you fly below the minimum?

[Bradford Rich:]

So once there’s, for lack of a better way to describe it, a more permanent schedule that takes us below the minimums. Then at that point, by contract, then our block hour rates need to be modified. I don’t think that we have any disagreement with Delta relative to that.

[Jim Parker:]

It appears that you’re not enforcing your contract with Midwest, and I want to know why not given that Midwest is owned by parties that have very substantial resources meaning Northwest and TPG. You’re not enforcing your contract, so it appears. Are you enforcing it or not? Are they breaking the contract? Are they violating the terms of the contract?

[Bradford Rich:]

So to be very specific, they are in default of the contract. We have sent them Notice of Default, which are just the normal things that you would expect us to do to protect our rights under the contract. Now having said that, the fact that they have defaulted and we’ve sent them notice; and they haven’t [inaudible], obviously gives us a termination right, if we choose. So we can either terminate or we can try to work out an acceptable solution. Jim, what we don’t want to have is we don’t want to enforce the contract to the point where we’re doing flying that just plain and simply isn’t wanted and then becomes counter-productive to their overall strategy to survive. So we’re trying to work out an acceptable solution here that works for them and works for us, that’s more appropriately configured to their particular needs at this point, given the situation they’re in. So whether right or wrong or whether that’s enforcing or not enforcing, that is what we’re doing.

[Jim Parker:]

Now you spent $90 million, I think, buying back stock in the first half, is that correct?

[Bradford Rich:]

Yes.

[Jim Parker:]

Why won’t you spend another $90 million in the second half of the year or will you?

[Bradford Rich:]

As I said, we’re going to continue to look at market conditions. We’re going to continue to evaluate other alternatives. Jim, you know how this works, I mean we plain and simply are looking at the value created from repurchasing versus the value created from other alternatives. The uncertainty in this market is that always a factor in our alternatives becomes general market and industry conditions and with the uncertainty of, as you’ve just mentioned our Midwest contract; the uncertainty around what our block hour utilization’s going to be; the uncertainty about 50-seaters. Certain of our partners have indicated they want fewer 50-seaters. To give us the financial flexibility to work through many of those uncertainties, we feel at this point it’s very important to put more emphasis on the accumulation of cash than it is a very aggressive program in repurchasing. But I’m telling you our thinking today, as some of these uncertainties become clearer based on market conditions that may change.

[Operator:]

Your next question comes from Bob Mcadoo - Avondale Partners.

[Bob Mcadoo:]

Just a little bit on the 22 airplanes; have you laid out or described anywhere or are you willing to talk about how you plan on financing those? What’s your plan? What’s the cash that you would require for that?

[Bradford Rich:]

Well, I can tell you. I’ve got to be a little careful here. Let me put it this way. We feel very confident in our ability to secure very attractive debt financing.

[Bob Mcadoo:]

This would be with Canadian Export people?

[Bradford Rich:]

That’s certainly one source. As I’ve already said, our financial position, our creditworthiness still puts us right at the top of the regional industry relative to our financing rates, and that has not been compromised. So we still feel very good about our credit rating and our ability to finance at attractive rates. So as a worst-case scenario, we have the ability to debt finance all of the airplanes. I’m probably not going to tell you exactly what the advance rate will be on that, in those financings, but it will certainly be well within industry standards of what that advance rate would be. Then we also have some productive discussions going on with certain equity participants, which we’re very pleased with, as those of you following the financial market and the financial community relative to aircraft financing know that equity investors into these aircraft have been hard to find lately. We have some productive discussions going on there, so I would expect that a portion of the airplanes will be leased, a portion will be debt financed; and as a worst-case scenario, we have the ability to debt finance all of them.

[Bob Mcadoo:]

Then just the other half of that is the 23-turbo props that you’re going to retire. What’s the market for those like now, and are these currently owned and paid for airplanes or what’s the status there?

[Bradford Rich:]

Again, I’ll talk somewhat generally about this. We have some of the aircraft are owned. Some of them are leased. Some of the leases are coming up for expiration. All of the leases will expire within relative very short periods of time. So we have really no material tail-risk exposure on any of the leases. The aircraft that are owned, we’ve seen the market go full circle on the value of Brasilias. A year ago, the values were pretty depressed; but we all know that as fuel prices go up, turbo prop value seems to go up with them because of their fuel efficiency. That’s what we’ve seen in Embraer. So the market actually is as good as we’ve seen it in a long time for disposing of owned Brasilias.

[Bob Mcadoo:]

What range do you see out there, not necessarily that you think you’re necessarily going to get that but what are some recent transactions you might have seen out there in terms of people buying these things?

[Bradford Rich:]

Are you talking about what prices we’ve seen in aircraft sale?

[Bob Mcadoo:]

Yes, on 120s, yes.

[Bradford Rich:]

First of all, be cognizant of the fact that the conditions of the engine, when you’re talking about a roughly $2 million airplane, the conditions of the engines is a very material issue; but with mid-time engines that are in average condition [we’re having some discussion about that]. They’re a little under $2 million.

[Bob Mcadoo:]

So just under $2 million with half-time engines.

[Bradford Rich:]

Yes.

[Operator:]

Your next question comes from Keith Weissman - Calyon Securities.

[Keith Weissman:]

Have you thought about, especially in light of Delta looking to cut back below minimum levels, cutting back on the prorate flying since it obviously seems to be a money-losing operation for you at this point?

[Bradford Rich:]

The question is, are we planning reductions in the prorate flying?

[Keith Weissman:]

Or just wiping it all out for the time being, at least, when the oil price environment’s more favorable.

[Bradford Rich:]

I’ll give a very quick response that just comes to mind. I’ll let Chip Child, if he wants to fill in here with any more color on it. We have to keep and be cognizant of number one, the needs of our major partners and their desire to have the code. Now certainly, we’re not going to be completely philanthropic about this and just provide the major’s code in environments or in operations that lose money for us on a sustained basis, but we are trying to be cognizant of our major partners desires and needs for the prevalence of the code in certain markets. Also, keep in mind that these are markets where you go in, you develop and you establish loyalty, code and brand loyalty and you’re in today and out tomorrow and then back in when conditions change. These are markets that you make pretty good commitments; and once you make those kinds of in and out decisions, you’re making some long-term decisions generally. So we’re trying to factor all of that in as I previously mentioned with some things that we have in the works to significantly mitigate the losses or get this back to break even, and then we’re really trying to be sensitive to the needs and wishes of our major partners with the code in these markets. But, Chip, I don’t know if you want to give more color on that.

[Chip Childs:]

I think the other thing is if you look at some of the other smaller communities that we serve with this flying, we have, as oil has been increasing during the spring months, and we have directly communicated to several of these markets and said, “Look, this is a big economic problem here. Oil is doing this. The value, our service is increasing into your community and we’ve met with local and state and government officials about that issue; and we’ve been very impressed with the response with that.” The RAA is also out working with small communities under the circumstances, and these small communities do not want to lose this service. So we’ve been able to be pretty creative with this type of flying to be able to provide value to the communities; make sure there’s value out there for employees to continue to have right domiciles in place and with all that combined with working with the major partners that Brad said early on in the call, this is something that we’re committed to and something that we think is going to be able to provide some good value going forward to the community and to shareholders as well.

[Keith Weissman:]

You had made a comment once this permanent schedule changed that you would go back and re-negotiate block hour rates. What is the definition of a permanent schedule change versus doing it for two or three quarters? What’s the tipping point where it becomes considered permanent?

[Bradford Rich:]

What I’m referring to is just the way that our contract works. The terms of our agreement with Delta basically just say that if there’s a reduction that lasts longer than two months with block hour utilization below the required minimums, then there will be a change, a re-negotiated block hour rate. So to us, a permanent change is beyond two months.

[Keith Weissman:]

So the rates have been changed already or they will be shortly?

[Bradford Rich:]

No, we have not had at either airline schedules that had block hours reductions below the two-month requirement yet; but I’m just saying, we certainly won’t, with what we’re hearing, that is more likely to happen in future schedules than it has so far.

[Keith Weissman:]

But beyond September, you think it’s possible?

[Bradford Rich:]

Yes.

[Operator:]

There are no further questions.

[Bradford Rich:]

I hope that we have been thorough and responsive to your questions. I would feel a bit remiss as I walked through our operational performance and the improvements that have been made, our DOT rankings, both airlines now are in the top five in operation reliability. We owe a lot of thanks and gratitude to all of the men and women of SkyWest, Inc. companies that are making that happen now everyday and appreciate all of their efforts. I continue to believe that in spite of the difficult circumstances and in the difficult environment we’re in, when you combine the operational strength of our entities and combine that with the financial strength that we have, we really are well positioned here in this market to take advantage of opportunities that are presented. So we feel very bullish and optimistic about our future. Thanks to all of our employees, thanks to all of you participating this morning and for your time with us on the call. Thank you very much.