Republic Airways Holdings Inc. (RJET) Q2 2019 Earnings Report, Transcript and Summary

Welcome, and thank you all for standing by. [Operator Instructions]. This call is being recorded. If you have any objections, you may disconnect at this point. And now I will turn the meeting over to your host, Jonathan Ornstein, You may begin.

Thank you, Kirby. Thanks, everyone, for joining us on the call today. As the operator indicated, this is Jonathan Ornstein. I'm the Chairman and Chief Executive Officer of Mesa Airlines. On the call with me today is Mike Lotz, President and Chief Financial Officer; Brian Gillman, Executive VP and General Counsel; a new addition to our call, Brad Rich, Chief Operating Officer; and Darren Zapfe, Vice President of Finance. I'd like to ask Brian to read the safe harbor statement please.

Thanks, Jonathan. Before the presentation comments begin, Mesa would like to remind you that some of the statements and responses to your questions in the conference call today may include forward-looking statements. As such, they are subject to future events and uncertainties that could also affect our actual results to differ materially from those statements. Also, please note the company undertakes no obligation to update or revise these forward-looking statements. Any forward-looking statements should be considered in conjunction with the cautionary statements in our press release and the risk factors included in our filings with the SEC, which Mesa encourages you to read. In addition, please refer to our press release in the Investor section of Mesa's website to find additional disclosures and reconciliations of non-GAAP financial measures that will be used on today's call.

Okay. Thank you, Brian. Okay. We had a pretty nice quarter. We continue to execute our plan to increase block hour production on our existing fleet. As a result, block hours were 112,030 for Q2 fiscal '19, which represented a 14.5% increase from the same quarter last year. We're also providing guidance for third quarter. We believe the block hours will be about a 115,203, which is an 11.9% increase from the same quarter last year. Given our partner's desire of increased block hour production and to position ourselves for future growth opportunities, we have continued to overstaff, hiring more pilots than we are losing. We continue to see excellent results on our pilot recruiting front and attrition has been stable to slightly lower than anticipated. Our quarter two fiscal '19 adjusted earnings before taxes, were $21 million, which compares to $3 million for the same quarter last year. However, earnings before taxes were $4 million lower than our previous quarter, primarily due to the timing of heavy maintenance events, engine, C-checks and landing gear. As you know, our earnings are very sensitive to the timing of these major heavy maintenance events since we expense these costs in the period they occur. On March 6, we finalized our purchase agreement with GECAS for 10 CRJ-700 aircraft, current leased from them and operating at United. Upon completion of the transaction and financing closing, we will have reduced the number of leased aircraft with third parties to 18 out of our total fleet. For United, we continue to have productive discussions in United related to the 20 CRJ-700 standard, which we just purchased. That agreement is scheduled to expire later this year. I know this has been an ongoing topic for longer than any of us anticipated, but we remain highly confident on a CPA extension on the 20 CRJ-700s. As noted above, the CRJ-700s that we are purchasing off lease from GECAS are currently flying at United. We hope to have something to announce in the next few weeks. Beyond our existing business, we continue to explore potential expansion that includes CPA flying increases and other opportunities as previously discussed, including new partnerships and cargo. On the cargo front, we believe we have made some progress towards that goal. All in all, we continue to focus on operational excellence and believe as the low-cost regional airline operator, we're well positioned to take advantage of these opportunities. Brad Rich, who many of you will know from his days at SkyWest and later at United, will now walk through some of our operational performance.

Thank you, Jonathan. First of all, having been here less than two months, my comments will be very brief today. But let me start by saying, first of all, how impressed I am with the talent and the capabilities of the Mesa operational team. Having recently come from United, I'm familiar with the regional carriers, and I believe Mesa is very well positioned in the industry. I've been working very closely with both America and United. I may know many of their senior leaders personally from my time both at SkyWest and United. And I'm confident that Mesa can and will do everything possible to meet and exceed their expectations. As an example, during the second quarter of fiscal '19, we had a controllable completion factor of 99.6% compared to 98.8% for the same period in the prior year. That's a significant improvement. So far, for Q3 in fiscal '19 to date, we're at 99.6%. Our total completion factor, which includes weather and other uncontrollable cancellations was 97.4% in Q2 compared to 96.4% for the same period in the prior year. I mentioned just a few of those metrics has an indication of the improvements that were making. And again, I'm confident that we can be successful in the future. Let me now turn the time over to Mike Lotz, who will now walk through some of the financial details.

Thanks, Brad. So for the second quarter, we reported pretax income of $17.3 million, excluding a onetime adjustment for the loss on the extinguishes -- extinguishment of debt, the adjusted pretax income was $21 million for the quarter. This is a significant increase over the same quarter last year where we reported pretax earnings of $3 million. Our earnings are down from our pretax income of $25 million from the first quarter, and as Jonathan had pointed out, this is primarily due to the timing of our heavy maintenance events. Additionally, we reported $4.1 million of income tax expense for net income of $13.2 million or $0.38 per share. Excluding the onetime adjustment, our adjusted net income was $16 million or $0.46 per share. Also, from an income tax perspective, although we reflect the income tax expense of $4.1 million for accounting purposes, we do not pay any cash taxes, and we still have approximately $415 million in NOLs; this is up from last year's NOL of about $300 million. And we believe based on our current projections, that we will not be a cash taxpayer until 2024 or 2025. Our adjusted EBITDA was $53.7 million and adjusted EBITDAR was $67.8 million. Again, these are significant increases from the same quarter last year when adjusted EBITDA and adjusted EBITDAR were $32 million and $50.3 million, respectively. On the revenue side, we reported contract or CPA revenue excluding pass-through items of $169.8 million, which is an 8.5% increase over the same quarter last year of $156.5 million. Also included in revenue is pass-through revenue, which is reimbursement of certain expenses on a dollar-for-dollar basis, which have no P&L impacts. For quarter two, we reported pass-through revenue of $7.4 million compared to $11.1 million for the same quarter last year. On the expense side, as Jonathan pointed out to position Mesa better to take advantage of potential growth and our partner's desire for increased block hours, we continue to hire more pilots than the associated attrition levels would require. To put this into context, during the quarter, we averaged approximately 188 pilots in training each month, which is down from the same quarter last year where we were at about 268. But still, we're about 100 pilots more than required if we were just to offset for attrition. As a result, we believe pilot training expense will decline over time, but we do not believe they will decline as rapidly as we had previously anticipated. That being said, we believe this is a strategic investment in our long-term future. The added expense of increased pilots and training is approximately $3.5 million to $5 million per quarter. Our engine expense was $5.6 million for the quarter compared to $10.8 million for the same quarter last year. As we have said, our engine expense, although predictable, can vary significantly quarter-to-quarter and year-over-year. We did provide guidance for Q3 with engine expense projected at $8.7 million. Also, as we talked about on our last call, we have retimed some of our C-check events based on revised C-check time limits and also to accommodate our partner's request for having maximum number of aircrafts available during the summer. As a result, the C-check expense for Q2 was $3 million higher than in Q1. We expect this to continue for Q2 -- for Q3 rather, and then drop off in Q4, which is actually our summer quarter. Again, like engines, this is more of a timing issue and not a structural cost issue. Also, Jonathan mentioned the purchase of 10 CRJ-700s from GECAS. This will have a positive impact on earnings as we transition from lease accounting to ownership accounting. And we expect about $3 million to $4 million per year over the next few years and increased earnings as a result of that transaction. From cash and liquidity standpoint, we ended the quarter at $77.7 million in cash, which is down $45.5 million from $123.2 million that we reported at the end of September 2018. This reduction of cash was primarily driven by executing on two of the key IPO initiatives that totals $51 million. One of them was for $26 million that we paid down in connection with refinancing our spare engine facility at lower interest rates and $25 million to pay down our full line of credit. Total debt on the balance sheets for the quarter was $844 million, down $71 million from the $915 million as of September 2018. As to other CapEx for the remainder of fiscal 2019, we will have the 10 purchased CRJ-700s, which will be $70 million. We have one additional engine that we're purchasing for roughly $5 million, and then we're looking at roughly about $10 million to $12 million in additional CapEx on maintenance-related items. Lastly, on cash, we do still have our full revolver available to us of $35 million, and we anticipate extending and expanding that over the next few months. I'd like to now turn it back over to Jonathan who can open it up for questions.

Thanks, Mike, that was a good review. Before we open up for questions, I would like to update you on the conferences that Mesa will be attending. We are going to be at the Bank of America Merrill Lynch 2019 Transportation and Industrials Conference, which is actually next week in Boston on May 14, and we will be -- I believe, we are presenting there. Is that correct, Mike?

Yes.

Okay. All right. So with that, we'd like to open up the floor to questions.

[Operator Instructions]. The first question is from the line of Michael Linenberg of Deutsche Bank.

Brad, welcome aboard. Welcome back. Anyway, Jonathan, can you just give us your thoughts on how you think about -- I know you made without recently with this CRJ-550 concept. Thoughts on it? I think there's a view out there that taking a 70-seater and putting 50 seats on it that -- it undermines the economics of the aspect. And maybe we have to think a little bit harder about how it's being utilized, and maybe it's going to be in markets that are premium heavy -- premium -- revenue-premium heavy. Thoughts on it? And whether or not something like that would potentially make sense for you guys?

Sure. Thanks, Mike. Yes. I'm actually very excited about the concept. As these aircraft get older and they become depreciated, there are some cost benefits obviously that accrue to us as a result of that. From United's perspective, as you know, they are somewhat scope-restrained in the larger regional jets, which has put them at a strategic disadvantage in regard to total first class seats available. And the revenue impact is not insignificant. If you want to fly from Wichita to London and you're going to buy a ticket on business or first, you can't do it on United Airlines. I don't think Wichita is an example, but these other carriers would have more. Large regional jets can offer first class ticket, and in fact, connecting long-haul traffic where United is being penalized. I think that it obviously will take a special cost structure. I'm very pleased that I think Mesa is one of just a couple of carriers that could potentially do that. And I think it opens up the door for us for a significant amount of opportunity, not the least of which is why I've been as confident as I have been and we've been in regarding to our 700s to either be operated in the 70-seat configuration or in a 50-seat configuration. So I'm very excited about it. I think it will certainly be very well received from the passenger's standpoint. I've looked at the LOPA, the seat arrangements on the aircraft. It's going to be incredible airplane. I mean it's probably as close as you can fly to a private aircraft in the commercial world. And I think that Mesa's cost structure will allow us to operate that plane profitably for United as well as for ourselves.

Okay. Very good. And then just a second question on cargo. You mentioned, I think, it was a sentence or so on cargo, and you indicated that there was progress toward a goal but that you still had a few more steps. Can you elaborate on that? I mean the opportunity -- and is that a 2019 opportunity? Or is this putting in something structurally for an opportunity in 2020, 2021? Any detail on that would be great.

Sure. I mean, we've -- since I've served on the Board at southern, cargo is kind of interesting to us because it's so similar to our business. There are some nuances to it regarding how the contracts are structured, but there's advantages and disadvantages. We think it's very interesting. Again, given our cost structure, we think we are very well positioned. It's a simple operation in terms of -- you don't have this sort of complex networks and utilization that you have in the current major airline partner relationships. You just have to operate reliably. And I think that this is something that we'd be looking out. Clearly, it would be more of a 2020-type opportunity. It's not a game-changer by any stretch. We actually would start very small. We think it's helpful, not only from the standpoint that it diversifies our business and gives us a new revenue stream and opportunity on the net income side, but more importantly, probably is the fact that it helps us in terms of attraction and retention of pilots. You can come to Mesa and start by flying a regional jet and end up flying a narrowbody or bigger, I think that is a really big, big benefit, and I think that helps our partners as well. So we're excited about it. We think that there's some real opportunities. Most of you on this call certainly follow what's going on in the cargo world. And I think there's definitely room for a low-cost operator, like ourselves, to enter the cargo business in a way that is beneficial to all parties.

So Jonathan, just reading between the lines, if I heard you right, it would sound like that you would be flying, in the cargo business, bigger airplanes than regional jets. Is that the right interpretation?

Well, I think that we are looking at regional jets for sure. I mean everybody is trying to figure out what to do with these 50 seaters that are out there. And there's a lot that are out there part, but we're looking across the whole spectrum. It's just that can you make the 50 seaters work, and if not, obviously, then we would be looking at larger aircraft.

The next question is from the line of Savi Syth of Raymond James.

And actually, if I might -- Brad, it's nice to have you back. And just kind of wondering, leaving United, coming to Mesa, what attracted to you? And what you see is kind of key important things to get done in the first 18 months?

Well, thank you, Savi. First of all, look, the positioning of Mesa is one of the primary reasons I'm here. I've known Mike and Jonathan, of course, for many years. In fact, Jonathan and I joke about the fact most of those years we've been competitors and then partners for United. And so I've known the team for a long time. And look, I see a lot of opportunity, both in the positioning of the cost structure, which obviously can't be -- I don't think we get overemphasized how important that is as well as the operational capability when we consistently produce high reliability, which is my highest priority right now then, of course, we think there are a lot of opportunities with our major partners. And so that's the primary reason I'm here and my priority is consistent reliability.

Got it. And if I might ask on the American contract, I think starting April, you're under the kind of the new performance metrics, and just wondering if you can provide an update on how that's progressing with kind of that extra spares now?

Brad, do you want to take a shot at that? Or would you like me to talk about it?

Well, I, first of all, ask you to repeat the question, please?

Sure. Just wondering about the American contracts that was kind of revised with new performance metrics? And I think part of the contract allowed you to have a couple of more spares as well as kind of made some changes to help kind of improve operations. I was wondering how you're executing kind of to the new targets?

Okay. Well, so first of all, I think we should just say, I mean, the contract amendment is an interesting amendment. I mean it's one that certainly motivates us to produce at a higher level, and it's also certainly in the best interest of American. And -- but by the way, I'm perfectly fine with that because our relationship with American is going to do nothing but improve and get better and stronger as we adhere to and comply with the amendment. So -- and I'm confident that we can achieve the metrics. Yes, there are some things that we're looking at and restructuring and looking at different ways of doing some things everywhere from a schedule to just fundamental operating procedures. And I think all of that will be -- that's when things really work in strength and relationships is when things work both for the regional partner and the major airline. And so, look, I'm confident that we can be successful with the new amendment. And look, there are other things that we're doing, I mean, some strategic investments that we are willing to and need to make in the operation to just create this really high sustainable reliability that our partners expect. So I'm confident we can do that.

Yes, and if I could add, I mean, I think that the proof is in the pudding. We knew that in the last year, 18 months, I mean, we were hamstrung by the fact that we had expanded a lot, we needed more pilots, we got hung up a little bit in pilot training, maintenance became more difficult in terms of qualified maintenance people. And we're just sort of finally putting all that together. And as I mentioned, the proof is in the pudding. We ran a completion rate, almost a full point, higher than we did last year. That is not an insignificant number. So we think we've made the improvements necessary. We have more to go. But that being said, I think when you look at the standpoint of how we operate, where we operate and at the cost at which we operate, it's a pretty compelling product. And that's what we just continue to focus on providing the best product at the best cost.

And Jonathan, just a follow-up on that. So I'm guessing then the increment came on the American side because I think that's where -- because United, you're already performing at a high level. Is that fair?

Yes. I would say, for sure, that the bulk of that came on the American side, and you know, American has been very helpful, too. They have given us some focus. Some of their real high quality people have been involved with us that we enjoy interacting with, particularly some of the people on the maintenance side have been incredibly helpful. And so I think that we have seen some very significant improvement there. And again, we continue to do things like our maintenance space in Dallas, which we're really pleased that we now have the maintenance capability, overnight capability in Dallas, for example. I think it will all make really big difference. And I think you're seeing it in those numbers because we're seeing improvement across the board in our operational performance at American, in particular.

The next question is from the line of Helane Becker of Cowen.

And Brad, I'll add my welcome back comments to you as well, nice to hear you again. So here's my two questions. One is, we noticed that G&A was higher and I was wondering if you can talk about that or is that just spread salary? And the other question is your -- some thoughts on profitability for the rest of the year, given the higher pilots, more than you were thinking. So two questions with respect to that one. Greater number of pilots than you were thinking and then maintenance moving around a little bit. Obviously, you're heading into the peak, so you would normally want to have your maintenance done before the peak. So how should we think about that? And then finally, maybe I don't know, Jonathan or Mike, you can answer this question, with respect to -- I mean, I know Jonathan you mentioned this cargo potential operation in response to Mike's question about when it would start out, which would be next year, and possibly larger aircraft. What would you do for training these pilots? Like, I assume you would take existing Mesa pilots who are more senior and offer them that opportunity, especially if it's a bigger jet. How should we think about the potential for training costs? And where you would get some time to do that? Sorry, I think that was more than two, but it was all bundled in one.

No problem. It's fine Helane. Mike, why don't you go over the G&A issue first?

Yes, I can hit a couple of them, the G&A issues. Brad's employment agreement is confidential. So I can't discuss any of those details. However, I can assure you, it's not the variance in G&A.

Okay. Just joking.

So on the G&A, it's just one of the nuances of our SEC reporting and our capacity purchase agreement. So included in our G&A are property taxes on the aircraft and hull and liability insurance. And those two costs combined and it's primarily the property -- increase in property tax rates based on where we fly. That's what's driving the majority of the increase in G&A. And so it will be offset in the pass-through revenue as well. So there's not been a structural cost change on the G&A side. It's really related to those two items, the property taxes and the hull and liability -- passenger liability and hull insurance that's included in those items. As for the -- having the additional pilots, we talked about that. That's just something we think is a good investment. Again, it's going to run $4 million to $5 million more per quarter than we had originally anticipated, where we did some of our earlier modeling. So it's going to be consistent going forward with what it was last quarter. I think this quarter was a little bit lower because we had lower block hours, but that's -- it's not going to come down until probably the fourth quarter. In terms of our maintenance, we will have a big maintenance quarter. We had a big maintenance quarter. Q2 and Q3 will also be for us because that's our June quarter, so April, May and June, but then we'd be doing a lot of maintenance ahead of time to free up the aircraft for the July, August peak summer schedules. As for cargo and training pilots, we're not close to that yet, but we would -- depending upon which aircraft flight it would be, if it was an aircraft that we don't not operate today, we would outsource that pilot training to FlightSafety or CAE-type company down the road. But it would likely be done by some of our pilots. Some of our senior pilots would upgrade into that aircraft if it was a bigger aircraft, and we would get new hire FOs off the street. And as Jonathan alluded to, that is part of the benefit we see of a cargo operation, whether it's the front end of cargo with turboprops using our existing regional jets, or on the other end, getting bigger jets. Across the board, we look at it as a way to attract pilots and retain them as well. And I think that it should be -- we should note to that, we're talking about a very, very small number to start. I mean, you're talking about a very low utilization out and back trip. And that -- even the size operation that we're contemplating would require probably somewhere around, call it, 20 to 25 pilots. So not a big number. And that's why we continue -- because we think of this growth opportunity plus other growth opportunities that we feel are in hand that we have made this investment in hiring what is now -- we have literally over 100 pilots more than we need in training all the time to be able to accommodate the growth opportunities. As well as to give our partners the opportunity to fly the aircraft more. I mean, both of our partners want to fly aircraft more, and we just keep hiring pilots so that we can do that, because not only do you want to be able to fly the planes more but you want to be able to fly them more and be able to react to irregular operations and all those kinds of situations where having few pilots on the bench can be very helpful. And that's the goal that we're looking to when we spend this money to hire more pilots and what we would need to actually operate the schedule.

The last question is from the line of Joseph DeNardi of Stifel.

Just to start, Mike, just to make sure on the same page in terms of your expectations around the flight ops expense line. I mean, it's been running 10% higher than maybe you guys had expected. Should we assume 2020 is kind of back in line with expectations? Or is it just higher but not as high as it's been?

Yes. No. I think, by 2020, we'll be back to our previous run rates, maybe a point or two higher. We did put a new pilot contract inquiry if you're looking back at fiscal year '17 or '18. But yes, by 2020 -- again, it's -- if we were to get some additional growth and had to start prehiring for that. Whenever we have growth, like we've had it over the last five years, is that buildup of expenses prior to the aircraft coming online and getting position for them, but if we were to get no growth and just keep the same fleet size by 2020, we would be back.

Okay. And then Jonathan, you talked about the United aircraft, obviously. Can you just remind us how many aircrafts are on contract kind of coming up for expiration out of this year or next? And what your expectation would be in terms of, I guess, the contract?

Sure. I mean, the key is the 700s, so we have 20 700s that start coming out, I believe, in August according to the plan. I think most of you would probably be familiar with airline scheduling and know that as this close in, those are aircraft already scheduled. So again, we have confidence that those planes will remain in the fleet. And I think that those are the ones that -- obviously, I think people are -- have their concerns about. We do have some of 175 contracts that technically come off just because they were five year deals and they get renewals. But again, I think that we've been assured by United that all those -- the Embraers are going to be renewed as well. So we feel very confident about that.

Okay. That's helpful. And then, Mike, just in terms of free cash flow for the year, you walked us through the CapEx. It still seems like you guys will generate pretty, pretty strong free cash. What are your priorities in terms of deploying that. Is it kind of just deleveraging?

Yes. I think our primary focus on our cash is to use it for growing the company. We really are out talking to various partners about increasing our business, and if we were to get just say 20 aircraft, you're talking about $50 million to $60 million in down payments that we would have to make and that probably would be the best use of our cash.

Got it. And then Jonathan, just going through the proxy and kind of your compensation and what drives it, it seems like, based on the most recent one, it's a little bit subjective between you and the Board. As you mature as a public company, should we expect that the metrics that drive executive comp will be a little bit more formalized? And what metrics do you think are most relevant in determining kind of your incentive compensation?

Yes. I mean we do reviews all the time. And just -- I mean, it's sort of a joke in the company. I've never been to a compensation committee meeting in my history. I just -- I'm not one that lobbies for pay. And I think that when you look at the most recent one, I mean, a lot of that had to do with the stock that was granted and you know the IPO. Because I wondered, like, where do all my money go, and I realized that it's all paid. Half of it went out in taxes just because the stock is all vested, but we're going to continue...

Jonathan, I can add a little bit to it, also, that when we were private, it was less structured in terms of -- there was little bit more subjectivity to it. But since we've been public and since we've had our last compensation committee meeting with the Board, one of our objectives is to put a little bit more structure into what types of things we would measure and a little bit more structure into what those payouts would look like. And we're obviously looking at companies like SkyWest and how they would do it, and we plan on putting that in place if not during this year, certainly, for next year.

[Operator Instructions].

There's one other point that I forgot to make. I'd like to make that the reason why we are so excited about this concept of 50-seat 700s is, it really opens up the door for 700s at United to be downguaged into 50-seat aircraft, and what that creates is opportunities for more 70-seat aircrafts to replace those 70 seaters that are now going to 50 seats. And we believe that if it wasn't for the constraint of pilots, that literally every 700 could be downguaged into 50 seaters creating more backfill opportunities. And that Mesa is, by far, best position in terms of cost and operation capability to fulfill those requirements. The other thing that it has done, it did sort of opened up the eyes. The whole industry has looked at what other opportunities exist, whether it's taking 76-seat aircraft and putting them into 70-seat configuration; or American, for example, has the opportunity to take a 70 or 76-seat aircraft and convert it into a 65-seat airplane, not a 50-seat, but a 65-seat airplane, which only gets counted as if it was a 50-seat airplane. So this whole downgauge movement has been, I think, for us, could open up a real big opportunity going forward. So we are going to do everything we can if we've given the opportunity to prove that, that thesis works in real life. It's a really big opportunity for Mesa.

We don't have questions on queue. [Operator Instructions]. No questions on queue. Speakers, you may continue.

Okay. Well, everyone, if there is no further questions, we'd like to thank you for taking time out of I know your busy day to talk to us and hear about Mesa in our earnings for this quarter. We continue to do everything we can to enhance shareholder value, work as hard as we can to provide the best performance for our partners, and again, do everything we can to provide best work environment for our people. So thank you very much. We look forward to talking to you for the next quarter.

Thank you. And that concludes today's conference. Thank you all for joining. You may now disconnect.