SkyWest, Inc. (SKYW) Q4 2014 Earnings Report, Transcript and Summary

Good morning and welcome to the SkyWest, Inc. Fourth Quarter 2014 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Chip Childs, President of SkyWest, Inc. Please go ahead, sir.

Thank you, Dan. Good morning and welcome everyone to our 2014 fourth quarter earnings call. This quarter had, obviously, some significant items, but in general we are very pleased with what we believe is meaningful progress toward our broader strategic goals. To start with, I’d like to introduce our team here as well as on outline for our call. With me here today is Wade Steel, our Executive Vice President; Eric Woodward, our Chief Accounting Officer; Mike Thompson, Chief Operating Officer of SkyWest Airlines; and Alex Marren, Chief Operating Officer at ExpressJet. The outline of our call today will go as follows: we’ll have Eric Woodward take care of some housekeeping with the forward-looking statement disclosure; Wade Steel will then give a brief explanation of our earnings and the special charge we are taking; Eric Wood will then give liquidity and fleet update; and then I’ll provide some key updates on our strategy and progress and then open it up for questions. So with all that, Eric let me turn over to you.

Thank you, Chip. Good morning everyone. We will be making statements during this conference call which are considered forward-looking. Such statements are based on our current beliefs, expectations and assumptions regarding future events and are subject to risks and uncertainties. Words such as expect, intend, believe, anticipate, should, likely and similar expressions identify forward-looking statements. All forward-looking statements expressed in this call are based on information available to us at this time. We assume no obligation to update any forward-looking statement. Actual results may vary and may vary materially from those anticipated, estimated, projected, or expected for a number of reasons, including those discussed in today's press release or expressed during this conference call or set forth in our 2013 Form 10-K and other reports and filings with the Securities and Exchange Commission.

Thanks, Eric. Excluding special items, SkyWest’s pre-tax income was $33.5 million for the fourth quarter of 2014, which is an increase of $18.4 million over the fourth quarter of 2013. Our diluted earnings per share excluding special items was $0.30 per share. SkyWest’s GAAP net loss including special items was $27.9 million or $0.54 per diluted share for the December 2014 quarter compared to net income of $8.6 million or $0.17 per diluted share for December 2013 quarter. That were primarily four items affecting SkyWest profitability in the fourth quarter. First, the revenues excluding pass-through items increased by approximately $19 million during the quarter. The revenue improvement was primarily due to certain contract renewals and modifications, improved operational performance at ExpressJet and the delivery and operation of additional E175 aircraft at SkyWest Airlines. Second, crew related cost decreased by $1 million for the quarter. These costs included labor, hotels, per diem and simulator costs. This is a significant improvement from prior quarters, primarily due to better planning related to the new flight in duty rolls and a decrease in flying at ExpressJet. Third, total operating expenses excluding pass-through items remained essentially flat during the quarter due to the following reasons. Cost reduction initiatives, we have made and continue to make investments in our maintenance planning and infrastructure, fleet makeup modifications. We were able to remove older aircraft from our fleet. We removed 26 ERJ145s from contract during 2014. The fourth item affecting our profitability during the fourth quarter was a special charge. The fourth quarter includes a one-time special charge of $70 million associated with the removal of the EMB-120 aircraft and modifications to the term of the ExpressJet's ERJ145 contract. Of the $70 million, approximately $60 million consisted of non-cash write-down of asset values. Of this $60 million non-cash write-down, $48 million relates to the EMB-120s, primarily reducing the aircraft and engine values and approximately $12 million relates to the ERJ145s, primarily in spare engines and spare aircraft parts to its estimated fair market value. The other $10 million consist of obligations resulting from the accelerator removal of lease aircraft from service. For 2014, SkyWest pre-tax income, excluding special items and TRIP gain that was recorded in the third quarter, was $34.9 million. However, our pre-tax income excluding special items and the TRIP gain for the last six months of 2014 was $78.3 million. This is a significant improvement compared to the first months of 2014.

Thank, Wade. Eric?

Thanks, Chip. In regard to our cash and liquidity position, SkyWest ended the fourth quarter with $559 million in cash and marketable securities, which was consistent with the cash position at September 30. During the fourth quarter, SkyWest invested approximately $25 million in cash as ownership towards the six E175 aircraft that were delivered during the quarter. Additionally during the fourth quarter, SkyWest used $17 million to purchase spare aircraft parts and related equipment, of which approximately $4 million was specific to the E175 aircraft. In regards to the fleet and looking forward into 2015 for the E175 deliveries, we anticipate taking delivery of nine aircraft in the first quarter, nine aircraft in the second quarter, five aircraft in the third quarter, and two aircraft in the fourth quarter, for a total of 25 E175 aircraft deliveries in 2015. We currently anticipate using debt to finance the 2015 E175 deliveries. If we use debt financing, we anticipate using $36 million in cash during the first quarter of 2015, and $21 million in the second quarter as ownership payments towards the aircraft. Net of approximately $19 million in return aircraft deposits. For 2015, we also anticipate using $25 million for capital expenditures in the first quarter and $25 million in the second quarter. We currently anticipate the capex requirements will decrease in the second half of 2015. Additionally under our combined aircraft lease arrangements, we are scheduled to make approximately $16 million in prepaid lease payments during the first quarter of 2015. However, the increase in the lease prepayments relating to the first quarter will be significantly reduced in the second and third quarter, simply due to the timing of scheduled semiannual lease payments. Our earnings release includes the 2015 scheduled contract renewals for the ERJ145 and ERJ135 aircraft that we operate under our United code share agreement. Such ERJ aircraft are sub-leased from United and will be returned to United after renewal of contract service. As you can see in the release, we have several anticipated fleet changes scheduled for 2015. For reference, the fleet and production forecast included at the end of the earnings release is based on aircraft scheduled for operations and reflects the various anticipated fleet changes we’ve outlined in the release. So with that, I’ll turn the call back to Chip.

Thank you, Eric, Wade, appreciate it. So in sum, while the fourth quarter results indicate strong improvement in the right direction, I think it’s very important that we recognize we still have a lot of work to do to improve profitability, which was represented in a number of notable areas in the fourth quarter. First of all, ExpressJet’s operational improvement remains very noteworthy. We maintain strong momentum in ExpressJet’s operations with 99.6% adjusted completion, representing another strong improvement over the previous quarter and a five point improvement over the same quarter last year. Strong reliability has been a top priority and represented some of the improved financial results for the quarter. This was accomplished with continued process improvement and communication improvements across the organization, which will be key to deliver what our partners and passengers expect in the future. SkyWest continued to perform well financially in the fourth quarter. Though the airline did experience some operational challenges, they did produce strong profitability. We won't get into details on this call relative to the profitability of our segments, but we would refer you to the 10-K that will be filed sometime next week for further details on those elements. We continued to execute on our strategy to increase flexibility within our fleet, to reduce unprofitable flying and simplify the fleet during the quarter. I will address specifically what's going on with each of the entities separately here. As outlined in the release, SkyWest Airlines took delivery of six E175 aircraft during the quarter under its flying arrangement with United for a total of 20 deliveries in 2014. The remaining 20 deliveries will happen throughout the first three quarters in 2015. Additionally, SkyWest reached an agreement with Alaska to operate seven new E175 and those will begin delivery in the third quarter of this year and will go throughout the first quarter of 2016. Finally, SkyWest also reached an agreement to operate 12 additional used CRJ200s that started delivery in 2014 and scheduled to continue through the second quarter of 2015. And these are being from Delta. Regarding [indiscernible] previously discussed with our special Judge, SkyWest Airlines began its transition to an all-jet fleet and is expected to be complete in May, with the final removal of the EMB-120. With the one-time write-off has been discussed, that was realized in the fourth quarter, and the successful execution of the transition, we expect the overall cost savings and associated improvement to be realized in about May of 2015 or May of this year. On the ExpressJet side, ExpressJet moved 10 ERJ145 aircraft in the quarter and has continued to simplify its network and support operations to reflect these changes. Additionally, consistent with what we've announced in the previous quarters, 59 ERJ145s and nine ERJ135s are scheduled to be removed from service throughout the rest of 2015. Also on the ExpressJet side, we've reached an agreement with American to operate 15 used 145 aircraft that will be leased from American. Looking forward, pilot resources continue to be a key focus across the US industry, while SkyWest Inc. and our NDs are able to fill new higher classes today, each remains very focused, proactive efforts to maintain the strong pipeline as the major carriers increase hiring and new regulation to restrict access to new pilots. We are very focused on addressing this issue as proactively as possible and make sure that we're able to take good care of our people and continue to attract the top industry professionals. So in summary, while the fourth quarter provided strong traction and movement in a positive direction, overall we continue to expect 2015 will still continue to be a very large year of transition. We expect to evaluate our fleet in light of profitability improvement from sustainability. Our focus is to execute our strategy to focus on solid reliable operations, simplify our total fleet make-up and ensure we are positioned to deliver the best of what major carriers expect from us. Finally and most importantly, I would like to thank the nearly 20,000 SkyWest, Inc. employees across the country for their continued work every day to deliver a fantastic product. They are clearly the key to our success and our continued ability to evolve and meet the needs of our partners. That concludes our written comments. With that, Dan, I'll turn it back to you for the Q&A session.

[Operator Instructions] And our first question comes from Savi Syth of Raymond James.

This is Lana Parker actually, I’m covering for Savi. And I apologize if you covered this already, but related to United contract, do you still expect to return 23 ERJ145s and nine ERJ135s in the first half of 2015?

Hold on one second, Eric, do you have those numbers?

I do. That’s very close to the schedule that we currently anticipate, yes.

My follow up is how many ERJ145s are expected to be removed in 2016 under the new agreement?

Under the new agreement, there is probably about 20.

There are 20 that are scheduled to be removed in 2016.

Our next question comes from Michael Linenberg of Deutsche Bank.

It’s [Richie Towar] filling in for Mike. So just a couple of questions from me. First, you’ve done a very good job bringing the business back to profitability at least on an ex special basis over the last two quarters, despite having what we think are still bunch of assets that resume a drag on financials. I’m just wondering if you can quantify how much of the headwind those assets are for us, particularly I’m talking about the ERJ145s and 135s, as well as the EMB-120s that you’re looking to remove from the fleet this year? In other words, what would your profit have been if those aircraft had already been removed from the system?

That’s a very interesting and kind of a difficult question. We appreciate it. There is a couple of things I think respond to the question. I think what you’re asking is if we did not have those assets in for 2014, what would the picture look like? We’re not really prepared to kind of do that analysis, but I will back up and give you the strategy of why we’ve done what we have done and what we can expect in the future. Part of what we’ve talked about in previous quarters is that we’ve got a strategy where we need to be the right size to be able to deliver what our partners need. So first and foremost, while we can feel retrospectively what this would have done in 2015 we are trying to do in 2015 and 2016 is make sure we’ve got the bandwidth of fleet that approximates with the needs of our partners are. And from that perspective, we’ve had a lot of issues such as pilot – pending pilot shortage and some various fleet exposures. And what we’ve done with the fleet to try to shrink it a bit to try to make sure that when we execute on what we think that we can actually do for our partners that we can deliver on it. We just have been too big and we’ve been too spread out and by consolidating them into a – we’ve already closed a couple on the ExpressJet side, and as we can clearly do that, it makes us significantly more efficient. We know that this is working because as what we said earlier on the call related to the operational reliability, and we had to shrink the fleet to get to the operational reliability that we ended up with and at the end of the day, we think that that is going to continue to hopefully evolve into more efficient cost, more efficient deliverability to all partners and be able to manage it a lot better than what we have had. So I know that’s not exactly probably the answer that you want, but it’s certainly the strategy of what we’ve been trying to do over the past six or seven months to position us for the future.

Got it, that’s really clear, Chip. So just to confirm, the run rate EPS that we should be expecting will be better than what you did in the fourth quarter you would assume, right, once we get all your decks in the row regarding your strategy?

I would caveat that a bit, I would turn you probably more to what we’ve done over the last six months of the year and certainly applied some seasonality and difficulty index for what usually happens in the first six months of the year and discount that a bit. But again, there is a lot of variables, we are not – we've never really given strong guidance to the street, 2015 is still such a transitional year, I probably look to kind of what's happened overall in the back half of the year, look at the fact that we have a great reliability on our side this time going into 2015 and kind of discounting for some of the seasonality that we have in the first half of the year.

And then secondly, you did work through a lot of the contracts and mandates that you have won, but we also noticed that there are some large regional mandates that other operators had won, so I was curious if you were out there actively bidding for a lot of the business and if you still see opportunity to pursue deals this year?

I would say that we are actively out bidding for a fair amount of business today, certainly with what the industry looks like today, there is a lot of chaos within fleets across the entire regional spectrum. So we are engaged in all of our partners and meeting their needs, some are formal RFPs, some are just conversations and we are optimistic about some of the things we are working on. We fundamentally – our primary focus again is on back to making sure that we can deliver the best product in our set. I think that we have got great moment to do that, we've seen what's happened with other carriers and some of those we've been participating, and in some we haven't. But I think where our focus has been over the last six months and what we're seeing on the result on the operating side, it's going to give us a lot of good opportunities here within the next year or two, hopefully to secure some more larger grip.

Our next question comes from Duane Pfennigwerth of Evercore.

This is Jeff Eisenberg in for Duane. Wondering with your down levels, have you seen any increased demand for your products from their partners? And if so, do you have the pilots for that demand?

So I think it's the unique picture with [indiscernible] around the $50, we've seen what I would suggest and this is not to surprise anybody, probably more viability in the smaller aircraft, it didn't obviously translate to what the Brasilio operation was doing, we still felt the need to continue to put that fleet down, but we have seen a bit of a resurgence from a 50 seat perspective as is evidenced in taking more 50 seaters on both the SkyWest flight and ExpressJet flight for their partners. So we do see a little bit of increased demand on the 50 seat side with that and as what we committed so far today, we believe that we've got the pilots to deliver, otherwise you wouldn't be committing to us. That's something we are taking serious with our partners is that when we are looking at new growth opportunities, we intend to deliver on what we are committing to.

And then just a quick modeling question, on the first quarter 2014, I think you call that about $30 million in pretax income hit, can you discuss how much of that is revenue and how much of that is sticky cost as we think about modeling that is a tailwind into Q1 2015?

So Q1 of 2014, we did call it about $30 billion. That was divided primarily – there were two sides, there was the revenue side and a cost side, a lot of it was related to the weather, we were not able to complete some flights due to that. We are very optimistic that Q1 of 2015 will not have that level of reduction in revenue and the increased cost. So we are feeling very good about Q1.

[Operator Instructions] Our next question comes from Bob McAdoo of Imperial Capital.

Just a couple of quick questions, you said you closed some hubs, which ones have you closed? Or is it related to the old stuff, whether Wade you’d been saying that’s been expanding or dragging you all over the place and now you want to go back to where you were, is that really what we’re calling on that?

We have closed two bases currently in Dallas, which winds down for us at the end of March and we also announced a closure in December. That will allow us a lot of operational efficiencies and improvements, obviously we consolidate both from a crew and maintenance perspective and working very closely with our partners in coordinating that transition wise for our customers.

One other thing that was a layer to the disclosure talking about shortening the life of one of the agreements which I assume is probably the old Continental agreement related to that, United, is that in fact – how much was it shortened and what is the nature of the other kinds [indiscernible] what are the kinds of other things that you got modified in that contract so that it seems to me that were last year or two that's been one that you guys have discussed as a counter problem to that contract [indiscernible] change really did happen there.

It's a great question, Bob, and let me address it in a couple of ways. First and foremost, we did shorten the term of the agreement and there was a couple of reasons why we did that. And then the other thing that we did is we put just a couple of other high-level enhancements within the agreement on some various, what we termed to be, market reimbursements, mostly enhancements relative to items of an Iraq situation or that type of stuff. So in total, the reason why we went and shortened the term of the agreement is that we had to have a situation where we needed to have some visibility and flexibility sooner than later. And I think that there were some value in that to both United and us, it certainly was a contract negotiation where we wanted to make sure that we both were getting significant value out of it. The elements of the contract negotiation I will tell you were largely minimized by outstanding performance. We spent a lot of time with United in the conversations that we wanted to achieve long-term with that. And at the end of the day, we think that we are developing and delivering a product that they are very happy with, I think that their reliability has been the best today than it's ever been since we've owned ExpressJet. And there is some of these things at the end of the day that we wanted to make sure we were delivering what their expectations are, because we simply haven't been doing that. And some of that clarity enabled us to make some investments in the entity. And even though that we have shortened the term of the agreement, it is fully our intention to continue to work with them to get contracts extensions and continued to fly for them under the arrangement with some extensions and renewals for a very, very long time.

Over the last several quarters, there have been disclosures that basically said that the ExpressJet entity as a whole was a cash burn problem. Has that now stopped with all these changes?

It is not entirely stopped, but I will say that it’s been significantly mitigated primarily with outstanding performance.

And one last thing, [incremental] pro-rate business now?

No, we are getting out of the pro-rate business and in the process we’re putting that fleet down, but we still have probably approximately, well, after the turboprops are out, there’ll still be around 30 to 40 CRJs that are in under a pro-rate arrangement.

So we still have 30 to 40 in any given point of the year that are still under pro-rate.

I assume with these kind of fuel prices, that’s working better now?

It does help, yes.

Is it making a nice contribution or are you just kind of hanging in there?

It’s nice to hanging in there, how is that?

Nice to hanging in there, okay. Thanks.

This concludes our question-and-answer session. I would like to turn the conference back over to Chip Childs for any closing remarks.

Thank you, Dan. I think that the quarter from our perspective is still a stepped process where we still have some very strong long-range goals that we need to achieve throughout 2015. We’re very comfortable with the momentum that we have, but we also have a very healthy respect for what we still need to do to accomplish in 2015 to set both of these outstanding entities up for a very, very strong future. With that, again, we want to thank all of the people and all the professionals throughout both entities. We couldn’t be doing it without you and we appreciate your ability to evolve and continue to meet the needs of our partners. And with that, we’ll close the call.

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