SkyWest, Inc. (SKYW) Q3 2015 Earnings Report, Transcript and Summary

Good day. And welcome to the SkyWest Incorporated Third Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Chip Childs. Please go ahead.

Thank you, Andrew, and thank you for participating on our call today. We're grateful for your interest and let me give a brief outline of who is here on the call with us today and then we’ll also going to brief outline how the call will proceed. Today I’d like to introduce our team here, as well as an outline of our call, here today we have Rob Simmons, our Chief Financial Officer, Wade Steel, our Chief Commercial Officer, Eric Woodward, our Chief Accounting Officer, Mike Thompson, SkyWest Airlines, COO, Terry Vais, Terry Vais is our ExpressJet COO as well. We'll proceed on the call as follows; Eric Woodward will take care of some housekeeping with the forward-looking statement disclosure; Rob Simmons will give the financial results, Wade Steel will give a brief fleet and commercial update and I will provide some key updates on our strategy and progress and then open up for questions afterwards. So, Eric to you.

Thank you, Chip. We will be making statements on today’s 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. All forward-looking statements expressed in today's call are based on the information available to us at this time. We assume no obligation to update any forward-looking statement. 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 2014 Form 10-K and other reports and filings with the Securities and Exchange Commission. Rob?

Thanks Eric. Today we reported net income of $36 million or $0.71 per diluted share for the third quarter of 2015. Our Q3 operating income of $78 million increased 32% year-over-year. Additionally, our operating income margin was 9.9% in the quarter up from 7.1% in Q3 of 2014. Consistent with last quarter, the improvement in our year-over-year operating income was driven by our operating leverage in three areas. One, the change in our aircraft mix under our fleet transition plan, two, the use of our capital strength to add accretive new aircraft to our system, and three, solid operating performance and related operating efficiencies. 2016 for us is expected to be a year of continuing transition as we prepare to bring new aircraft into service and continue to work on improving the economics of the unprofitable and less profitable portion of our legacy fleet. 2017s anticipated growth will be enhanced by a full year of our 2016 deliveries, a full year impact of any 2016 fleet renewals and a partial year impact from the remaining aircraft deliveries in 2017 first half. In addition to the schedule the E175 growth, our opportunity to continue to improve the profitability for our other aircraft is fully played out at this point. For the next couple of years, we expect to deploy the cash being generated from our model to invest in the new flying we have announced that significantly enhances our enterprise value. We expect the 15% equity tranche as each new E175 delivery to be entirely funded by internally generated capital with the 85% balance funded by external VAT. Once the deliveries end in mid-2017, we expect to again begin to accumulate cash generated from the model starting in late 2017 and beyond. Looking at 2016 given the volume of E175 deliveries anticipated for the second half of 2016, we may experience higher crew training and other costs in year-over-year Q2 comparisons leading into the second half of 2016 aircraft deliveries. Separately, we possibly have some fleet transition noise in 2016 as we evaluate improved economic opportunities with our existing fleet. And as we have been signaling for some time, we may have non-cash or cash charges from existing certain lease obligations on a portion of our CRJ fleet. In terms of our capital deployment, we anticipate using our internally generated capital to invest in the great growth opportunities we have announced for 2016 and 2017 and build shareholder value through earnings accretion. Once we hit 2018, you will likely see us again consider share repurchase opportunities. At this point, we will continue our practice of not providing specific EPS guidance but let me provide a little color. For Q4, last year we had each earnings per share of $0.42 excluding special items. For next quarter we would expect year-over-year EPS to show modest improvement and we also expect year-over-year growth for the full year of 2016 in the 10% ballpark, excluding the noise from any potential fleet related charges and the caveats I mentioned earlier about Q2 training and other expenses. As I said earlier, we see 2016 as a transition year preparing for the growth story that emerges in Ernest in 2017 and 2018 as this new accretive fleet spins up into production and we fill the effects of any successful fleet renewals. Also on last quarter’s earnings call, we mentioned an interim goal of achieving 10% operating margin. Although we essentially achieved that in Q3, the third quarter is typically our seasonally best quarter. We aspire to achieve low double digit operating margins on an annual basis by 2017. In terms of year-over-year changes to our revenue and operating expenses, the theme for the third quarter is relatively consistent with the second quarter. As outlined in the release, the anticipated revenue decrease from a reduced fleet size and scheduled production was partially offset by incremental revenue from our E175 aircraft accretive 50 seat aircraft additions, contract rate improvements under various agreements, improved flight completion rates and higher contract performance incentives earned. Combined our revenues decreased by $41 million from the third quarter of 2014 with a better mix. Over the same period, the reduced fleet size and related lower production combined with operating efficiencies from improved performance and various cost initiatives resulted in a decrease in operating expenses of $60 million from the third quarter of 2014 netting a year-over-year improvement in pretax income of $19 million. In the third quarter of 2014, we completed the sale of our equity investment in TRIP Airlines, which resulted in a pretax gain of $25 million last year, which was reflected as other income and we've outlined it as a special item for 2014 for comparison purposes. Our 10-Q will include our operating segment information that we anticipate filing in early November. I will point out now that ExpressJet had a pretax segment loss of $6 million during the quarter compared to a $10 million loss in the third quarter of 2014. With respect to our cash and liquidity position, we ended the quarter with $570 million in cash and marketable securities up about $65 million over last quarter after deploying $20 million toward ownership for the five E175s delivered during the quarter. We are forecasting to use $8 million in the fourth quarter as ownership toward two E175 aircraft purchases. We anticipate our other capital expenditures will be approximately $20 million in Q4. I'll turn the time now to Wade.

Thanks Rob. With respect to key changes in our fleet over the past year, at September 30, 2014 we had 740 aircrafts schedule for service. Over the last 12 months we have removed 69 ERJ145 from our United contract, 36 CRJ200s from various contracts and 36 EMB120turboprops, which totaled the 141 removals or 19 % of our September 2014 operating fleet. This aircrafts were operating under unprofitable or less profitable agreements. Over the same period we added the following aircraft to our fleet, which have been accretive to our earnings. 26 new E175 under our United agreement, three new E175 under our last year agreement, 16 ERJ145 under our American agreement, and 12 CRJ200s under our Delta agreement, which totaled 57 additions or 9% of our September 2015 operating fleet of 656 aircraft. During the last three months of 2015, we anticipate removing 13, 50 seat aircraft from various contracts. On June 15, we announced that SkyWest Airlines will place eight additional E175 aircraft into service with Alaska Airlines for a total of 15 E175s. As of September 30, SkyWest has taken delivery of three of the 15 aircraft and its schedule to take delivery of the remaining 12 between Q4 2015 and Q4 2016. As of September 30 2015, we have taken delivery of 40 E175 from our United contract. During the third quarter we announced SkyWest Airlines was awarded 18 additional E175s for United. We anticipate placing seven of these aircraft in service during 2016 and 11 during 2017. We also announced that SkyWest Airlines was awarded 19 E175s for Delta. We anticipate placing 13 of these aircraft in service during 2016 and six during 2017. Go back to Chip.

Thanks Wade and Rob. SkyWest Inc. carries solid third quarter as we continued executing our strategy with both focused and discipline. Though we remain in transition with ongoing execution of our fleet optimization plan, the strategy is producing meaningful improvement and we’re pleased with the results. Third quarter is generally our strongest in terms of production and both operating entities delivered solid operational performance and improved operating incentives for the quarter. Strong predictable operating performance and exceptional reliability remains a top priority. The product we deliver is a crucial part of our competitive position and we are focused on delivering on our commitments to our partners across all of our operations. SkyWest and ExpressJet continue to produce strong operational performance with ExpressJet producing 99.8% and SkyWest producing 99.4% in adjusted completion for the quarter. Notably, both ExpressJet and SkyWest continue to show strong year-over-year improvement in every metric and ExpressJet led in the largest improvement for fewest complains on the latest D02 report. Both carriers are also top tier in Delta and United's regional portfolios. As we have discussed for the quarter we removed additional unprofitable aircraft resulting in a better fleet mix and improved profitability over fewer block hours. The fleet is key to our strategy and it will continue to transition throughout 2016. Since June of this year, we have announced a number of flying agreements including 18 175s for United, eight additional 175s for Alaska and 19 E175s for Delta Airlines. Our immediate focus is positioning ExpressJet for a competitive and profitable future. This includes potential extensions on aircraft to improve profitability. As we have previously disclosed, we expect ExpressJet to lose money in 2016. However, we are in discussions with our partners to move forward with more sustainable contracts. Demand for the ExpressJet product is strong and the airline is delivering exceptional operational performance on the foundation we've worked to build over the past 18 months. That's a huge credit to the ExpressJet people and their leadership however it's important to take the next task with labor and our partners in securing a predictable model as we seek to retain and grow profitable flying at ExpressJet. SkyWest Airlines continues to perform. For 2016 SkyWest we are focused on preparing for and executing on current and new flying arrangements. As Rob mentioned, we anticipate 2016 should reflect modern improvement from 2015. We continue to look to our fleet transition and could potentially have some noise later this year or 2016 with respect to potential aircraft related cash or non-cash special charges. To summarize we are pleased with the third quarter's continued momentum. Looking into 2016, we remain focused on executing our fleet strategy to improve profitability, delivering strong operating performance and ensuring we remain positioned to deliver the best of what our major airline partners need. The 20,000 professional over-crossed our operation with very hard to deliver solid product to our partners and passengers. Our people are the foundation of what we do and the reason we are successful. My many thanks to them for working very hard every day, to be the very best in the industry. Andrew, we'll now open it up for questions.

[Operator Instructions] The first question comes from Michael Lindenberg of Deutsche Bank. Please go ahead.

Good afternoon everybody. I want to touch on the ExpressJet year-over-year performance. When you look at - it is less than what it is last year but it looks like its very modest the improvement and I want to go back and Chip you mentioned about the potential extension on the aircraft to improve profits. Is it that - the fleet - the way some of these agreements are currently constructed that those agreements need to be redone in order to have a more meaningful improvement in year-over-year earnings at ExpressJet, is that where we are like we've gotten as far as we’ve gotten so that we can get, look for addressing the fleet. Why not a bigger improvement on a year-over-year basis is what I am getting to.

Thanks Michael. Again this is Chip, and you did kind of answer your own questions just a little bit. We are looking for more meaningful revenue improvement relative to these contracts and let me express our optimism because what we have generated we knew we had to do this first. We had to make sure that it had absolutely top reliability to be a part of the conversation for increased demand on a product. We can represent today that there is a lot of demand for the ExpressJet product today and as I said in my opening statements, we need to turn that demand into – I think to make the model more reliable with those good productive conversation with the major carriers which we are having, as well as continuing to make some improvements on reliability internal to the company as well. But to a certain extent, that’s exactly where we are and we are optimistic about where those conversations are going.

Okay, great. And then just my second question as it relates to pilots. Overall I think you guys have done fairly well with respect to retention of pilot and procuring pilots. Although we now are seeing a lot of airlines, a lot of regional carriers, other small carriers as well start to establish programs where they set up basically seater systems, whether it's with university or flying clubs or maybe establishing aviation type programs. Is that a topic you've gone down as a company or is that something that you don’t need to pursue given where you are with your pilot retention efforts.

Great question, Michael. Let me first state with some clarity that we are certainly not imminent to the industries challenges. The main thing we do is we monitor our models consistently and modify all of our plans accordingly and there is wide range of plans including fleet management, as well as recruiting efforts, though there are some of the program that you have talked to about we certainly see a model where we want to continue to attract the best aviation professionals out there. So, we are as much in it full, [indiscernible] anybody else says to make sure that we’ve got all of the right programs underlying the development of pilots out there as much as anybody else. We are not immune to it but we think that part of what we need to be very best that is managing the pilot issue from the very, very beginning to managing the promises we are making on the backend with the fleet.

Perfect, great. Thank you.

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

Thanks very much Operator. Hi guys, thanks for the time. Are you – when the network airlines, legacy airlines talk too, are they looking to continue to replace those 50 seaters or have they started to think about keeping some of them in service longer with your cost down so much?

I would tell you that the dynamic is certainly evolved over the last 24 months to where I would say today that the majority of our conversation is retaining the 50 seat fleet that we have. As Wade pointed out in the last 15 to 18 months we pulled a lot of 50 seaters but that's - I think in my view and our view and strategy turning the quarter where we see significant demand on our entire fleets and the products at both airline. So, we are seeing a little bit of that dynamic change and we’re strategically aligning ourselves to make sure that we work with our partners to deliver what they want within that fleet.

Okay. I asked because it looks like there was six more aircraft in under the quarter then maybe we were expecting but also the fourth quarter I think and then you're so expecting the same amount of block hour guidance and the guidance hasn't changed, I guess even there is more aircraft so are they replacing other aircraft?

Helane, this is Eric. In terms of the fleet counts that we put in some of the prior earnings releases, we are looking at a snapshot fleet counted each quarter and day. So the production and the block hour estimates those are very close in terms of the actual fleet count at a specific date. There is going to be some fluctuation so we are trying to compare a snapshot of a fleet and the better focus in on the block hour production.

Okay. And then I'm not sure why salary is declined when didn’t some of your pilots get pay rate increases?

Yes Helane. I think what you’re looking at, when you look at the total amount overall we had a significant reduction in the overall business model with the fleet coming out. So, the salaries has declined, we certainly are keeping things in line with what has been the past and even there has been some appreciation in all those levels of compensation relative to that. But you have to reconcile that with the declining number of block hours and operating fleet at the same time.

Okay, great. Thank you for your help.

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

Hi, good afternoon everyone. Just on the ExpressJet 135, 145 fleet I think earlier the expectation was per house maybe 68 retirement this year, and it looks like maybe just backing into it maybe looks like 61 is that a timing issue or a huge kind of planning is it another discussion with United to maybe reduce less than anticipated previously.

This is Wade, Savi. We are in current discussions with all of our major partners specifically on the 145 we are in discussion with United about some potential opportunities that might be out there and so some of those aircraft may continue to operate. We’re just working with our major partners around from additional opportunities that are out there.

So you’re still thinking maybe another 20 next year or how should we think about next year is going to retirements out of that unprofitable.

Right now there is a lot of fleet renewal opportunities out there. Like I said we are working with all of our major partners, we are working with them on the opportunities to keep on flying planes at improved economic. And so right now, it's difficult to say what is exactly going to happen but the suite renewal discussions are in active dialogue and we are continuing to work with our major partners on some potential fleet extensions out there.

And Wade if I may ask you just on the 14 aircraft that were retired this quarter, were they all from contract lines and were they all from ExpressJet or SkyWest side?

There was a combination of both SkyWest and ExpressJet but it was from all contract lines.

Okay, great. And then if I can touch on the comments Rob you made on those acceleration for low double digit margin by 2017, what do you need to see from today to get there. Is it just more retirement, the retirement plans get to there, do you need incremental improvement in some of the sign or is what you have today gets you there, a little bit more color on how you might get to that double digit number by 2017.

Sure. I think Savi, as we said that 2016 is a year for us kind of positioning ourselves to take the maximum advantage of the growth and profitable flying that's out there. So, I think that as we look at 2016 as a transition year, I think from a margin standpoint again as Wade sort of intimated, we’ve got fleet renewal opportunities that represent potential upside to our model out there but I think if you look at our basic scenario that’s something that’s achievable just with the core strategy that we’ve been articulating for some time that we’re going to continue to shrink the unprofitable flying as much as possible and we’re going to add accretive new plans to our mix as the opportunity provide itself. So, obviously with respect to our delivery schedules most of those deliveries begin in Earnest in mid-2016 and runs really primarily through the fourth quarter period comprising the second half of 2016 and the first half of 2017, that’s when the bulk of that flying is going to be - the new flying will come online. So margins will be correlated with the timing of the new airlines, the new aircraft, as well as the timing of any and all fleet kind of renewal discussions that we are able to successful book in the upcoming year. So I think margin improvement is definitely part of our core strategy with again some potential upside out there based on conversations with our partners.

Thanks Rob. And if I may, just one last question on the 3Q 2015, as I think about if you do no other – where there incremental improvements in contracts this quarter that will carry through even if there is going to be no other improvement as you look out in some of the next few quarters.

Yes. So as you look at Q3 there is definitely some aircraft that we have added into the system that should continue on for the next foreseeable future obviously. So, we anticipate some of these aircraft to continue on.

So that’s the new aircraft but not necessarily like current contracts that got improved.

There were no current contracts that got improved during the quarter.

Okay, helpful. All right, thank you very much.

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

Thank you, Andrew. Again we really appreciate your interest in SkyWest Inc. And more importantly its – certainly how many represents the 2000 professional of both airlines that were part to continue to make our progress. I think as you can hear from our dialogue today, we had a great quarter, we are optimistic about our future. We have a clear plan in place and its going to take a lot of work from a lot of parties but we feel like we’ve got some very good objectives out there for the next year and beyond to continue to make improvement. With that, we’ll give our thanks and end the call. Back to you, Andrew.

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