SkyWest, Inc.
Q3 2016 Earnings Call Transcript

Published: 28 Oct 2016

[Operator:]

Good afternoon, and welcome to the SkyWest Inc. Third Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note 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 CFO. 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 sellside analysts. Eric?

[Eric Woodward:]

Thank you, Rob. 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 2015 Form 10-K and other reports and filings with the Securities and Exchange Commission. With that I’ll turn the call over to Chip.

[Chip Childs:]

Thanks, Rob, and Eric. Appreciate that. I want to start the call today by identifying that throughout this past year we've discussed our progress on the execution of our business plan to three different phases. First was to evolve and transition our fleet, two is to re-disk our risk profile and third to build value through strong cash generation for our stakeholders all with the focus on best-in-class safety and reliable operations. The last a while in transition years and I want to begin with a big thank you to our 20,000 people across the organization for their continued commitment to delivering consistent exceptional reliability, service and safety. Our current strategy began in 2014 with a multiyear fleet transition plan. In the last two years we have removed the EMB120 Brazilian turboprop of our fleet. We invested in new E175 aircraft and we reduced our total 50 seat fleet by more than 120 aircraft. We continue to see positive outcomes from a successful fleet evolution which Wade will cover more in detail later. As a result of this evolution we've also successfully reduced our risk in a number of key areas. As we will discuss we've essentially mitigated the tail risk on our CRJ700 fleet through 2019 and our new E175 aircraft continue to provide significant improvement to our overall risk profile. By reducing or removing unprofitable aircraft from our fleet, we continue to minimize losses of ExpressJet which broke even in the second quarter and produced a small profit in the third quarter excluding early lease return charges. I want to note that while ExpressJet shown significant improvement in the seasonally strong second, third quarters, we expect that they will still lose money for the full year of 2016. Our ongoing focus on thought operating performance remains central to our ability to compete. Our two entities continue to deliver exceptional operating performance during the quarter. Specifically SkyWest Airlines continue to improve its adjusted completion performance moving from 99.4% in the third quarter last year to 99.9% in the third quarter of this year. ExpressJet also delivered solid operating performance with 99.8% adjusted completion for the quarter consistent with their strong performance in the same quarter last year. Both of our airlines are delivering top performance within our partner’s portfolio and that's very, very important for us. In fact one or both of the airlines have been the top performing carrier in United network for more than two years now. Together our two entities operated more than 300,000 flights in the quarter and continue to deliver consistent exceptional reliability and service. As we neared completion of our first two phases of our multi-year strategy, we expect to continue to build liquidity, improve cash generation and ensure we're best positioned for continued opportunities. We believe our ability to attract and retain top aviation professionals, as well as our capital strength sets SkyWest apart in our industry and continue to provide added value for our employees, our partners and our shareholders. I want to again thank our 20,000 professionals for their good work in the quarter and for continuing to deliver best-in-class product as we build our airlines for the future. Rob?

[Rob Simmons:]

Thanks Chip. Today we reported net income of $41 million or $0.79 per diluted share for the third quarter of 2016, up from net income of $36 million or $0.71 from Q3 2015. These GAAP results included the $9 million non-cash impact of early lease return charges on six CRJ700s. Excluding these charges adjusted earnings per share this quarter was $0.90. Pretax income for the third quarter was $67 million compared to $60 million last year, an improvement of 12%. This strong growth in year-over-year earnings continues to validate the fleet transition plan that we’ve executing against over the last two years. Our continued growth and profitability was driven by the addition of new flying with 11 new E175 planes placed under contracts this quarter, the removal of 18, 50 seat aircraft during the quarter and operating efficiencies realized through improved operating performance. Since Q3 2015 we've taken delivery of 24 additional E175s. We expect to put 19 more into service in Q4 of 2016 and an additional 18 in 2017. In addition to the $9 million lease return charges I referenced earlier, we expect to take a similar charge on 11 additional CRJ700s early lease returns in the neighborhood of $15 million to $17 million over the next six months if they are returned as scheduled. Looking ahead we expect Q4 2016 to be up slightly from Q4 2015 excluding special items. The expected Q4 results are slightly softer than our original plan as a result of higher training and pilot carried cost as SkyWest gears up for a heavy Q4 E175 delivery schedule and as we continue to transition 37, CRJ700s to American through early 2017. To provide some color the softer Q4 can be attributed to two factors that are positive for us over the long-term. Number one, pilot carry and training costs are up as pilot attrition has slowed, pilot hiring an increase and we position for delivery of 37 new E175s over the next few quarters. Earlier this year we anticipated higher pilot availability for Q4 and we were somewhat conservative in our Q4 flying commitments. We expect this pilot carrying cost to be temporary and will be corrected in early 2017 as we deploy pilot against new aircraft deliveries. Two, additionally we are in the process of transitioning 37 CRJ700s from United to American. During this transition there'll be some normal off-line time as these aircraft are painted and placed back into service under the new contract flying. Again this temporary inefficiency should be resolved by early 2017. This transition resolves the financing tail risk on these planes through 2019 and Wade will speak more to this in a minute. Our future outlook for 50 seat flying may evolve as we evaluate our partner’s long-term needs as part of our year end fleet planning process. Changing market conditions may impact our previous assumptions regarding the value of our 50 seat fleet. Total fuel cost per gallon averaged $175 during the third quarter, down from $2.02 per gallon in Q3 2015 and up from $1.69 per gallon in Q2 2016. Let me say a couple of things about our balance sheet. We ended the quarter with cash of $564 million, an increase of $51 million from last quarter. We issued $249 million in new long-term debt during Q3 to finance 11 new E175s delivered during the quarter with total debt increasing by $185 million net of scheduled debt service payments. Total debt as of September 30 was $2.2 billion from 1.9 billion as of December 31, 2015. Cash used for CapEx during the quarter was $61 million including $44 million in cash to buy the 11, E175s and $17 million in other equipment. We expect to be able to fund the cash investment for the 37 remaining E175 deliveries out of internally generated cash flow while maintaining the strong levels of liquidity we enjoy now. We expected to end 2016 with cash in the area of $500 million. Once this delivery cycle winds down next year we expect our cash position to grow unless new positive NPV investment opportunities present themselves. As you can see from our Q3 results, SkyWest continues to operate at an improved trajectory. Wade?

[Wade Steel:]

Thanks Rob. In a very busy third quarter we continue to execute on our strategy to remove 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. During the quarter we signed an agreement with American to redeploying 30, CRJ700s from our United fleet to our American fleet essentially mitigating any financing risk on our CRJ700s through 2019. These 30 aircraft are in addition to the seven previously announced aircraft for a total of 37, CRJ700s with American. As of September 30, 13 of the 37 CRJ700s have been placed into service in our American operation and we anticipate transitioning the remaining 24 aircraft through the middle of 2017. In addition to the CRJ700s we extended nine of our CRJ200s on short-term agreements with American during the quarter. To provide a little color on the fleet changes in the quarter, we removed seven ERJ145s from our United contract, 11 CRJ200s from various contracts and 16 CRJ700s from various contracts six of which were early lease return aircraft as previously discussed and 10 that were subsequently transitioned back into service with other partners during the quarter. We also added a number of aircraft our fleet during the quarter. We received and placed into service our first five new E175 our Delta agreement, added two new E175 under our United agreement and four E175s under our Alaska agreement. During the fourth quarter we anticipate removing 13 ERJ145s from our United contract as well as three CRJ200s under various contracts through the remainder of the year. Looking at 2000 1711 ExpressJet CRJ200s are scheduled to expire during the first quarter of 2017. We expect to replace these CRJ200 with dual class aircraft within our existing fleet. As discussed in previous quarters we expect to return a total of 20 CRJ700s under an early lease return agreement. We have removed the first nine of those 20 CRJ700s during the past six months and are scheduled to remove the remaining 11 CRJ700s during the next six months. As Rob discussed we anticipate additional lease return charges for these aircraft if they are returned as scheduled. We also expect delivery of 19 E175s during the fourth quarter. Of those 19 we plan to operate nine under United's contract, eight under Delta's contract, two under Alaska's contract with the scheduled delivery of 18 E175s in 2017. We expect 104 E175s in our fleet by the end of 2017. As demonstrated in Q3 execution of our fleet strategy continues to produce tangible results to our model and overall profitability. As we’ve discussed today we expect fleet transitions to continue during the fourth quarter and 2017 as we reduce unprofitable flying, redeploying aircraft with other partners and place larger new aircraft into service to deliver on our commercial agreements.

[Rob Simmons:]

Okay. Thanks Wade. Kate we're now ready for Q&A.

[Operator:]

[Operator Instructions] The first question comes from Steve O'Hara of Sidoti and Company. Please go ahead.

[Steve O'Hara:]

Hi, good afternoon. Thanks for taking my questions. Yes, I guess just on the tail risk, if you could talk about maybe it sounds like you guys are doing a good job kind of mitigating what's there and working that down, can you just talk about what remains for the rest of the fleet maybe as of right now? And then also you'd mentioned I think about changes and that may impact the value of your 50 seat fleet, I was just curious what that was alluding to? Thank you.

[Wade Steel:]

Steve thanks. This is Wade. So first of all just on the financing tail risk, so for the rest of 2016, 2017 and 2018 we don't have any meaningful and 2019 we don’t have any meaningful tail risk on our fleet, which means basically we matched up our contract expirations with the financing. After 2019 we do have some additional risk, but at that point in time we feel like we'll be able to cover it off with other flying arrangements.

[Steve O'Hara:]

Okay, great.

[Chip Childs:]

And then Steve, this is Chip. On the second point the impact on 50 seaters as you know we always are evaluating that. We've got quite a number of 50 seaters. Right now I can certainly say there's still interestingly enough very good strong current demand on our short-term profile for this stuff. Q4 is a time when we match up long-term fleet plans with our partner needs and as we continue to evaluate that in the fourth quarter, we're going to evaluate what some of the opportunities are with 50 seaters and there's some opportunities to replace some dual-class with that. So we're going to need let those partners give us a little bit more color on what their needs and desires are and hopefully in the fourth quarter come back with some good - better information with you to cover what that information may be long term.

[Steve O'Hara:]

Okay. Maybe just a follow-up, as you guys deployed E175s, I assume you don’t get maybe the full benefit until the 3Q of 2017, but I assume that going forward you should still see additional growth in your earnings may be offset by some of the transition costs you talked about. And then maybe the stress on the system for adding so many aircrafts and training et cetera, does that the right way to think about it?

[Chip Childs:]

So, Steve obviously Q4 is a very heavy delivery cycle with 17 new planes coming online. It continues through the first half of 2017, but the bulk of the deliveries will be done by the middle of 2017. So that's where we've been gearing up our infrastructure to be able to handle that. We're really gratified that the pilot situation is very strong as we head into this that the rest of this delivery cycle for the E175 product.

[Steve O'Hara:]

Okay. Thank you very much.

[Operator:]

The next question comes from Michael Linenberg of Deutsche Bank. Please go ahead.

[Michael Linenberg:]

I just have couple of questions here. Rob, just a clarification you mentioned that Q4 2016 should be up I guess modestly from Q4 2015. Does that Q4 2016, does that include any lease return charge in that number, is that excluding the impact of that?

[Rob Simmons:]

So when we talk about that up slightly over Q4 last year that would be excluding any of these special items including any lease returns that could head in Q4.

[Michael Linenberg:]

Okay, good. And then when I look at the debt that you put on balance sheet tied to the airplanes, it looks like you are putting down what about 15% into the airplanes and then financing 85% is that right?

[Rob Simmons:]

That's right. It's exactly right. It's roughly $4 million per airplane that we're investing and then financing the rest of it on a long-term basis.

[Michael Linenberg:]

Can you give us a feel for what that cost of debt was? I mean it is on a secured basis what ballpark or maybe you can give us something maybe the exact coupon on that that would be helpful.

[Rob Simmons:]

Sure, I mean obviously we've been closing on airplanes like virtually every week the last little while as the deliveries are starting to ramp up. But our long-term cost of debt for those is typically is running in the neighborhood of 3.6% plus or minus a few basis points.

[Michael Linenberg:]

Okay, very good. And then just lastly, there was a headline maybe a month to month and half ago, Delta considering a big regional jet order, I know they have a captive, but it- the size of the order sounded like it was something more than just for their own subsidiary. Anything with respect to that or how you think about that and does it make sense for - I think I know the answer to this one whether or not it makes sense for the major carriers to get more involved in owning regional jets, but just any thoughts on that, or how you would respond to that?

[Chip Childs:]

I think I mean specifically - Michael, this is Chip - it's good to hear from you too. Specifically relative to that I want to just put it in contact because I think that I want to make sure you know that on an ongoing basis we're always having conversations with our partners about potential in a new opportunity. I mean our number one strategy as I think we've demonstrated quite well lately is that we want to make sure that we're the carrier that has the pilots and the capital to give options to our partners. And it's rare in our space to be able to provide both the pilots and the capital to buy the airplanes. So we realized that we're in a bit of a unique niche and we can have good conversations with our partners. Without getting into detail I can say the conversation continues to be fluid and ongoing. Scope has lot to do with it. And we - in the end I can only say that we are very comfortable with our position and that we do have good conversation with all four of our partners. Our main focus is to be prepared when that event may take place where they’re ready to do something like what you've described.

[Michael Linenberg:]

Okay, great. Just one last quick one, the $9 million where is that, is that with line items, does that apparent, lease return charge?

[Chip Childs:]

That's hitting the ramp line items.

[Michael Linenberg:]

Okay, very good. Thank you.

[Operator:]

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

[Savi Syth:]

Hi, good afternoon. Just wanted to touch on the pilot side of things there and it's always difficult schedule and figure out the right sized, so wondering if you can provide a little bit more color, does that get right sized when summer flying or maybe the Easter flying charter to pick up and so that would be still a drag in 1Q as well? And then I'll ask another question after that.

[Chip Childs:]

Okay, perfect. Savi, it's Chip. Good to hear from you as well. I would present this as I think that we've ended up in a pilot situation today that's better than expected and I hope that goes to our respect of what the issue is with pilots. I think that we at both entities have a very, very aggressive and strong pilot recruitment program of both entities. And when we commit the flying we want to make sure that we deliver what our partners are signing up for. So we do exercise conservatism for that. But I'll also say relative to your timeline we have the ability with a strong demand of aircraft on a current and continual basis that we believe that we can recover from where we are today largely in Q1 by the partner asking us to licensing on short term. So it's not like we got to muscle through this for another six months or anything. We think that we can there's some demand that we can and our fleet flexibility allows us to respond quickly. Agility to the needs of our partners is a key, core competency for our philosophy. And then I think that the other thing is that we are not going to - we are fundamentally not going to pull our foot off rather than recruiting. We're fortunate to have an outstanding culture of both entities that have unbelievably solid operations and pilots are very, very smart. They see through the things, they think it has the biggest impact on their career and their development and who they want to fly for. And we are fortunate with that and we don’t intend to back off of that at all. By chance more opportunities come our way because we have pilots. We're going to continue to look for those opportunities. So it's not a long-term work through problems. If you call it a problem it's more short term, we think we are going to get back to in Q1.

[Savi Syth:]

Definitely high quality. To follow-up on that Chip, so we've seen some pretty big pay increases across the Board and more recently at some of the in-house subsidiaries, how is that dynamic impacting recruiting and it doesn’t sound like it has, but I was just curious it's still high to compare contract?

[Chip Childs:]

It really is difficult to compare contract and you’d have to get into a lot of granular detail because there's some attractive things that they're offering, there’s some attractive things we’re offering. It really is apples and oranges most of the time. But I can tell you from our experience because we’ve spent so much time on this in the last year that we fundamentally believe that the aviation professionals we’re recruiting today are extremely smart. It’s a lot about money. It’s not entirely about money. I think that they see within our entities that we do a couple of things for their careers progression. One is that we, like we said before we have outstanding solid safe operations. We have I would say best in industry training and things that we do to make sure that there are outstanding pilots and provide outstanding service. Plus the number one thing they I think have compared to a wholly-owned carrier might be that they have a lot of flexibility. I mean when you invest that much money and time into your career I fundamentally and we fundamentally feel like it’s you know good to have options to go to many different types of opportunities and we're very good strong in a great position to help our folks do that. That being said like I said I think that it's sometimes an apples and orange scenario and since some of these things have come out we really have not seen a significant impact in our recruiting efforts as of now. But again Savi, as you know we have a very strong healthy respect for this problem but we continue to work a lot of different things to make sure you know the core part of our business to have the best professionals that are out there.

[Savi Syth:]

That’s helpful. Thanks Chip. And if I may ask just one last question on the CRJ700, that the transition between United and American are those of kind of repainting costs and things covered in the contract or is that that kind of the sum (ph) as you transition.

[Wade Steel:]

You know as Rob – hey Savi this is Wade. But as Rob said in his script there is definitely some inefficiencies during the transition periods. Some costs are definitely covered but not a 100% of the costs are covered during the transition. And so it – there are definitely some of the inefficiencies during the transition that are going to hurt some of our Q4 as Rob said.

[Savi Syth:]

Makes sense. All right thank you.

[Operator:]

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

[Helane Becker:]

Thanks operator. Hi, guys thanks for the time. The first question I have is with respect to the lack of scope release that Delta seems to be negotiating with their pilots. Is that going to affect your future opportunities with them?

[Chip Childs:]

Helane this I Chip again and I think it’s a great question because as I said earlier we spent a lot time talking with partners about new band new airplanes. I think when you say what the impact on our growth model. I would probably categorize it into maybe two or three different things. One, I would say that we have still very strong opportunity even thought 2020 without new aircraft to transition our fleet and contracts within the existing fleet with some improved profitability. I’d say even as you look out ’16 to ‘17 we still have a good consistent trajectory in that effort and we continue to probably have some solid opportunities to keep this growth and earnings momentum going. One thing that we also are trying to do is reduce our overall risk that helps with that and then the other thing is that I think that as I said earlier we want to be positioned with pilot and capital when that opportunity comes. But it’s also not a bad thing when you’ve seen what we've done over the last couple of years. With all the context that I’ve just given to you a bit of a break in thinking new aircraft may not be such a bad idea for a little bit because we still have plenty to focus on like I said even through 2020. And a lot of the mainline contracts that are being negotiated today go through ‘18 and ’19. So to be candid we’re not nervous about the timeline. We have pilots and capital for the opportunity when they come and we’re also still even now in conversations with all of our partners about opportunities for this long-term in the future.

[Helane Becker:]

Okay. And then if I could just follow-up on the fourth quarter delivery schedule. Is it evenly spread throughout the quarter, is it front end loaded, back end, I mean, how are we – how should we think about that

[Wade Steel:]

So this is Wade. So the 19 deliveries that we have coming in Q4 is definitely weighted more towards the back end of the fourth quarter. The deliveries during the first half are even pretty evenly spread in 2017 and then we only have one aircraft that deliveries in the second half of 2017. So most of the deliveries are in the first half of 2017.

[Helane Becker:]

Right. And then most of the fourth quarter deliveries are more towards December.

[Wade Steel:]

Yes, they are.

[Helane Becker:]

Okay. Because I noticed you gave us the block hours and the ASMs for the quarter but not for the months so just.

[Wade Steel:]

That’s right. Most of that will show up in Q1.

[Helane Becker:]

Okay. Got you. All right. Okay, that’s all I have. Thank you.

[Operator:]

Next we have a follow-up from Savi Syth of Raymond James. Please go ahead.

[Savi Syth:]

Hi guys, thanks again. On the other line that’s been performing well in the last couple of quarters. I was just wondering that’s driving that?

[Eric Woodward:]

Savi this is Eric. The other revenue lines primarily ground handling and other services, various ground handling services we’re providing to third-parties and then just other revenues that we’re generating.

[Savi Syth:]

Is there something changed in there Eric or it’s just small numbers moving around?

[Eric Woodward:]

It’s a small number that’s just moving around so it’s primarily volume driven.

[Savi Syth:]

Okay. And then if I may also ask on the – how many aircraft do you guys have on the prorate fleet today.

[Wade Steel:]

Yes Savi this is Wade. We have approximately 50 aircraft in the prorate fleet.

[Savi Syth:]

Got it. And my last question. On the CRJ700s that are getting redeployed did the new contract terms line up with the financial obligations for those aircrafts or those some of the ones that have been in 2019 come up again?

[Rob Simmons:]

On the CRJ700 some of those financing still out there beyond 2019 and so there are still some other opportunities to redeploy those at the end of the contract with American.

[Savi Syth:]

Got it. All right thank you.

[Rob Simmons:]

Thank you, Savi.

[Operator:]

And next we have a question from Duane Pfennigwerth of Evercore ISI. Please go ahead.

[Raymond Wong:]

Hi, guys this is actually Ray filling in for Duane. Just wondering if there's been any developments in the discussions with United regarding those E145s?

[Wade Steel:]

Yes, Ray thanks for calling. I think in total terms relative to 145 fleet with ExpressJet with United we continue to have fluid conversations about what happens with that fleet long-term. We’re optimistic. I think the desire for everybody is very clear. We want to continue to fly it as long as we can. We obviously have some contractual business model things that we’ve got to close the gap on between the two of us. But I would certainly fundamentally think that as we continue to progress to Q4 and Q1 we should get some more progress on that beyond 2017 but I can say that the opportunities for us to expand and the desire I think from a partner on that is I think we’re aligned. It’s a matter of getting to work and seeing what’s going to work for both of us.

[Raymond Wong:]

Okay, great. Thanks a lot guys.

[Operator:]

And next we have a follow-up from Michael Linenberg of Deutsche Bank. Please go ahead.

[Michael Linenberg:]

Yes, I can squeeze in two here. Just prorate, how did that perform year-over-year, was it more profitable this year any color on that front would be fine.

[Wade Steel:]

Yes, so the prorate is very consistent year-over-year, not a lot of change between the years. It has performed seasonally is always better in Q3 and it was seasonally strong again.

[Michael Linenberg:]

Okay, good. And then just last on the DOT metrics. You gave us the raw completion factor, you gave us the adjusted completion factor. In each of your carrier contracts presumably is it the adjusted in every single one of them or them or does it differ by contact?

[Wade Steel:]

So Michael this is Wade. It differs by – there is different metrics in all of our contracts. The majority of our measuring adjusted completion, there are some on time metrics that we also, that were measured on but most of the significant incentive dollars are based on adjusted completion.

[Michael Linenberg:]

Okay, great. Thank you.

[Operator:]

There are no additional questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Chip Childs for any closing remarks.

[Chip Childs:]

Thank you, Kate. Appreciate everybody's interest in our evolution of this model. One more, thank you to the 20,000 professionals they are the best in the industry and work hard every day to make sure that we continue to evolve and have a strong and solid safe operating model. And thank you all for our interest in SkyWest as we continue our progress and we'll talk to you next quarter.

[Operator:]

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