SkyWest, Inc. (SKYW) Q4 2015 Earnings Report, Transcript and Summary

Good day and welcome to the SkyWest Incorporated Fourth Quarter 2015 Earnings Conference Call. [Operator Instructions] Please note today’s event is being recorded. I would now like to turn the conference over to Rob Simmons, Chief Financial Officer. Please go ahead, sir.

Thanks everyone for joining us on the call today. On the call with me here today are Chip Childs, President and Chief Executive Officer; Wade Steel, Chief Commercial Officer; Eric Woodward, Chief Accounting Officer; Mike Thompson, Chief Operating Officer of SkyWest Airlines; and we’re going to excuse Terry Vais, who is the Chief Operating Officer of ExpressJet who is unable to join us today. 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 our fleet and our flying partners. Following Wade, we will have the customary Q&A session with our sell side analysts. Eric?

Thank you, Rob. 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 information available to us at this time. 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 2014 Form 10-K and other reports and filings with the Securities and Exchange Commission. Chip?

Thank you, Eric and thanks everyone for your interest in SkyWest. As outlined in the press release, SkyWest had a solid fourth quarter and continued traction on our overall business plan. Operationally, we made strong improvements at both entities compared to the same quarter in 2014. I don’t want to thank the nearly 20,000 employees across our organization for their excellent work and the outstanding product that they provide. Not only have our people continued to evolve and adapt as we work through significant evolution, they have worked hard to deliver what our partners need better than anyone else in the industry. SkyWest and ExpressJet continue strong – to produce strong operating performance, with ExpressJet producing 99.88% and SkyWest producing 99.75% adjusted completion for the quarter respectively. Both ExpressJet and SkyWest continued strong year-over-year improvement in every metric. ExpressJet has been the strongest operator for reliability in United Express portfolio for 18 consecutive months, that’s a huge credit to the teams at ExpressJet for achieving and maintaining this outstanding caliber of operating performance. Both SkyWest and ExpressJet continued to produce top tier performance in Delta and United regional portfolios. While we remain in transition with ongoing execution of our fleet optimization plan, the strategy is producing meaningful improvement. We are pleased with the plan and its results in the fourth quarter. As Wade will discuss in more detail, during the quarter, we continued our strategy to reduce unprofitable aircraft and increase larger dual-class aircraft. This includes reducing unprofitable 50-seat flying and increasing the number of larger dual-class aircraft within our fleet. This resulted in improved profitability on fewer block hours. As we laid out in our press release today, by mid 2017, we expect to have a total of 99 E175 in service, 65 with United, 19 with Delta and 15 with Alaska. At both of our operating entities, we continue to execute. Overall, operating performance and profitability has improved. At SkyWest Airlines for 2016, we are focused on preparing for and executing on current and new flying arrangements with new aircraft continuing to join that fleet. Our primary focus at ExpressJet is to position that entity for a competitive and profitable future. As we have previously discussed, we expect ExpressJet to lose money in 2016. However, we remain focused on achieving stability in that entity through top operating performance, reducing unprofitable flying and achieving predictable, sustainable labor cost. We remain heavily engaged in discussions with our partners, including additional opportunities to reduce unprofitable flying, as well as to potentially extend current flying at improved rates. ExpressJet’s ability to lead its peers in operating performance is a key component in these discussions. Also during the past year at ExpressJet, we have removed 54 unprofitable ERJ145 aircraft and 22 CRJ200 aircraft from operations. We have also made good progress with labor, particularly the pilot groups at ExpressJet and expect to have an update on those conversations in the near future. With operating performance stabilized, we believe achieving those agreements will play a key role in extensions and terms of flying contracts at ExpressJet. In summary, both of our partners and our people, we remain focused on establishing a predictable and stable model at ExpressJet. As we have outlined stabilizing the model will take time, but we are optimistic about our progress and expect more updates on that progress later in the year. Throughout the enterprise, we anticipate that 2016 should reflect moderate improvement from 2015. As we have discussed over the past year, this transition evolves our overall fleet to more dual-class aircraft and to our 50-seat aircraft demands. The regional space continues to evolve and we have been executing a strategy for almost 2 years now to adapt. Demand for our product remains very strong and by the end of 2017, we expect 50% of our fleet to be dual-class. In conclusion, we are very pleased with the continued traction that we have gained over the fourth quarter. We are very focused on executing our strategies to improve profitability, deliver top reliable products and position ourselves to profitably deliver best what our major partners need. The 20,000 professionals across our operations work extremely hard to deliver a quality product to our partners and passengers. We continued to believe our people are our most important asset as we continue our transition and evolution many thanks to them for working hard everyday to be the industry’s best. With that, I will turn the mic over for Rob for a review of our financial summary for the quarter.

Okay, thanks, Chip. Today, we reported GAAP net income of $40 million or $0.78 per diluted share for the fourth quarter of 2015. Adjusted net income for the quarter excluding special items was $25 million or $0.49 per diluted share, up from adjusted EPS of $0.31 in Q4 of 2014. For the full year of 2015, we had adjusted EPS of $1.98 per diluted share, up from $0.14 adjusted EPS in 2014. Operating margin increased to 7.9% in Q4 2015, up from 6.2% in Q4 2014 on an adjusted basis. Consistent with our results throughout 2015, this quarter’s year-over-year improvement in profitability was driven by, one, the change in our aircraft mix under our ongoing fleet transition plan. Wade will speak more to this in a minute. Two, the effective deployment of our capital to bring new aircraft into service. And three, solid operating performance that drives related operating efficiencies and performance incentives. We continue to expect 2016 to be a year of transition as we bring new aircraft into our fleet and work on improving the economics of the unprofitable and less profitable portion of our legacy fleet. 2016 is the year that we hope to position ourselves to continue our growth story for 2017 and beyond. We expect to bring on 54 more E175s over the next 18 months, evolving our fleet and driving value creation. Over the same time, it is likely that we will continue to shrink the size of the loss-making component of our fleet and renegotiate contracts where possible to improve fleet economics. This three-pronged strategy to add new 175s to our fleet, to shrink our loss-making flying and renegotiate contracts where possible continues to be our plan for driving earnings growth, better returns on capital and creating value for our stakeholders. We had the opportunity this quarter to pay down a total of $128 million in higher rate debt for $94 million in cash. This helped us generate a $33 million gain this quarter. This gain and an $8 million contra revenue item related to the resolution of a flying contract matter, together $25 million in pre-tax income were excluded from the calculation of our adjusted EPS number of $0.49 per share. This $128 million debt reduction helps further strengthen our balance sheet at the front end of this next delivery cycle for 54 more E175s. This reduction in higher rate debt improves further the capacity of our balance sheet as we add new flying to our fleet mix. We expect the 15% or approximately $4 million equity tranche per each new aircraft to be funded by internally generated free cash flow, with 85% of the purchase price funded by external debt. Once this delivery/investment cycle ends in mid-2017, we expect again to begin accumulating cash generated from our model for either the next growth opportunity or for share repurchase, or both. As we discussed last quarter, we expect the first half of 2016 to have higher crew training and other costs relative to 2015, as we prepare for this wave of E175 deliveries. And as we have been saying in past quarters, we still expect that 2016 could have some fleet transition noise in the form of non-cash or cash charges, as we evaluate opportunities to exit certain lease obligations and position ourselves for better long-term profitability. We continue to focus on deploying capital more effectively and taking advantage of the growth opportunities that are out there for us as the strongest, largest and best capitalized regional airline. We will continue transitioning and evolving our fleet over the next 18 months and we are pleased that we have the balance sheet, the liquidity and the right team in place to take advantage of this window. At this point, we will continue our practice of not providing specific EPS guidance, but let me provide a little color. We generated EPS of $1.98 in 2015, excluding the $25 million net gain from special items in the fourth quarter. We would expect 2016 EPS to grow at a very low double-digit rate over 2015, excluding any special items with the bulk of the new E175 flying coming online in the second half of the year. By the time we exit 2017 and we are flying a total of 99 E175s and have taken action to improve fleet economics, we believe our ability to generate profits and cash flow should be greatly enhanced from where we now stand. With respect to our revenue and operating expenses in the quarter, our revenue was down approximately 6.5% year-over-year. The net revenue reduction was expected giving the removal of approximately 100 aircraft from service that operated under unprofitable flying arrangements. These reductions were partly offset by 25 E175 aircraft and 21 used 50-seat aircraft added to our fleet since December of 2014. Additionally, our solid operating performance generated an additional $6 million of performance incentives we earned under our contracts compared to Q4 of 2014. We anticipate continued year-over-year growth in our E175 operations at least through 2018. Excluding the special items in 2014, our operating expenses decreased by more than 8% year-over-year. The decrease in operating expenses was primarily due to the reduced fleet size and related 10% reduction in departures and block hours. Additionally during the quarter, our crew training and crew related costs increased approximately $12 million compared to 2014, primarily related to the growing fleet of E175s. We also had a net benefit of $7 million year-over-year from the combination of reduced fuel costs and higher airport costs incurred under our pro-rate operations. Wade?

Thanks Rob. Throughout 2015, we executed on our strategy to remove unprofitable flying and transition our fleet to larger aircraft. Our execution of this transition continues today. To highlight that progress, at December 31, 2014, we had 717 aircraft scheduled for service. During the last 12 months, we have removed 54 ERJ145s from our United contract, 22 CRJ200s from various contracts and 27 EMB120 turboprops from multiple partners. This totals 103 aircraft removals over 12 months or 14% of our December 2014 operating fleet. All removed aircraft were operated under unprofitable or less profitable agreements. During the same period, we added the following aircraft to our fleet, 20 E175s under our United agreement, five new E175s under our Alaska agreement, 16 ERJ145s under our American agreement and five CRJ200s under our Delta agreement. These additions totaled 46 aircraft or 6% of our 2015 operating fleet of 660 aircraft. During 2016, we expect to continue our fleet transition plan and are currently determining the specific removal dates of these aircraft. Our current estimated 2016 fleet forecast by quarters included at the end of today’s earnings release. And we do anticipate that the forecast will modify as the year progresses and plans are finalized. As noted in the release, we anticipate removing 20 ERJ145s from our United contract. However, we do have the opportunity to extend these aircraft based on crew availability. Additionally, we anticipate removing 20 CRJ200s from various contracts and 20 CRJ700s will be replaced by E175 flying. We also continue exercising our fleet flexibility and mitigating exposure through our fleet transition. As we address the tail risk we have previously discussed on the CRJ700 fleet, we have secured agreements to transition at least 20 CRJ700s from our United contract to various other partners. We anticipate these transitions and their associated costs will occur throughout 2016. These transitions address the majority of our aircraft tail risk for 2016. We also anticipate taking delivery of 37 E175s during 2016, 11 of which we will receive in the first part of the year. Of those 11, we anticipate operating seven under our United contract, four under our Alaska contract. We are scheduled to take delivery of 26 E175s during the second half of 2016 and 17 E175s in the first half of 2017. With completion of those deliveries, we anticipate a fleet of 99 E175s by mid-2017. Execution of our fleet strategy continues to produce tangible results to our model and overall profitability. As discussed, we expect fleet transitions to continue through 2016, as we will reduce unprofitable flying and execute on our new flying commitments.

Okay. Operator, we are now ready for Q&A.

Thank you, sir. [Operator Instructions] Our first question comes from Duane Pfennigwerth of Evercore ISI. Please go ahead.

Hi. Thanks guys. Good afternoon.

Hi Duane.

Can you talk about the impact from weather related cancellations on your business and how that might be different now versus some of the past structures you had?

Yes. Duane, this is Chip. I think that we have had some very good testing weather so far in the month of January and late part of December. We think that the impact is roughly the exact same impact economically as what we had in 2015, which as we have stated last year is also significantly better than what we had in 2014. Most of that related to the significantly increased performance at ExpressJet and their ability to manage through those tough situations. So given the storms in the winter that we have seen thus far, we think the impact is going to be relatively the same as it was in 2015.

Is there anything contractually different that gives you maybe more flexibility than you had in the past when you get severe weather?

Duane, this is Wade. Our contracts, we have modified some certain things, but there is not a lot of specifics that we are going to get to on this call, but it’s generally the same as it’s been in the past.

Okay. And then just with respect to your hiring needs as you complete this transition through the middle of ’17, can you put some numbers around that, what is the pilot recruiting pipeline look like today, how are training lead times tracking relative to your expectations. And despite all the press that we get and comments from bigger airlines about pilot shortage, I guess just your thoughts on how you would characterize the environment right now? Thank you.

Thanks Duane, that’s a great question. I think first, I would repeat, I think what we have said in the past as well and that we are not immune to the pilot issue. It’s something I think that the entire industry has felt and we are feeling it obviously as well. I think that the thing that we best manage this issue through is a couple of key points. One is making sure we have extreme discipline with our growth and extension opportunities given our fleet forecast and our pilot forecast. Two is that we have an unparalleled coordination with our mainline partners to make sure that we are being transparent and work with both of our business models to make sure that those demands are met and then we also have some good fleet flexibility. Our forecast that – I don’t want to get into too much specifics, we don’t give a lot of numbers with this stuff, but I think that the forecast and the guidance that Rob had given in his script, we have taken a look at all of those variables in putting that data out there and we continue to think that we can execute well on our plan, but it’s continuing to be a very fluid situation that I will say we have outstanding professionals at both entities that continued to want to deliver an outstanding product for our partners and our ability to be disciplined and be able to forecast is a key component of all of that.

Okay, thanks for your time.

And our next question comes from Steve O’Hara of Sidoti & Company. Please go ahead. Steve O’Hara: Hi, good afternoon.

Hey, Steve. Steve O’Hara: I was just curious just on maybe the pilot staffing and kind of following up on that as well. And in terms of the aircraft that you are taking out, I mean, how much does that help at SkyWest? And is there a point where that becomes maybe less – that option becomes less available and maybe hiring is adds more pressure. But it mean, I guess, from what you are saying is you are – you think you can deal with it and I am just wondering if you can add any color there? Thank you.

Yes. Thanks, Steve. I will add a little bit more color than what we gave previously. I would say that we have a lot of strong demand for our product under both enterprises. And I think that relative to the pilot availability and that type of stuff, we continue to be reasonably comfortable with what Rob had said relative to our forecasting. But I think that from our – the perspective that we try to continue to do is continue to work with the partners. We certainly are doing some things on a long-term basis with the long-term – longer term solutions that we have got I think accelerated this continues to evolve. Our fleet flexibility, as you have alluded to, is a pretty key component of that. Our objective is to make sure that we can have the ability to exceed those in every case possible. Wade alluded to that a bit in his components. So, from the perspective of continually have flexibility and shrinking the fleet, we are comfortable with where our position is throughout 2016 and think that we can meet those demands and most importantly try to exceed the expectations of our partners if at all possible. Steve O’Hara: Okay, thank you. And then just going back to ExpressJet quickly, I know you – I think you had said that you didn’t expect it to be profitable or you expected it to generate a loss in 2016. And I am just wondering I assume that the plan is for that to turn breakeven and then eventually show profit. And I am just wondering how you get there? Is it – can you get there by certainly just shrinking the fleet and removing unprofitable aircraft or does it have to include some sort of a new contract and then an expansion of flying at some point? Thank you.

Yes, Steve. I think it’s a two-pronged approach. One is that in 2016 we are going to continue to invest in the model, that’s a little bit why it’s still gong to be unprofitable in 2016. We are going to continue to make the right investments with the people there. And I think that the biggest windows that we see particularly at ExpressJet is that if you look at the contract exploration opportunities and extension opportunities, our objective with the fleet as long as we have the right crew members in place is to continue to see if we can extend what is going to be natural exploration starting in 2017. So, we are optimistic that the trend can turn here in the near future, but not in 2016. And those are two of the things that we are doing today to provide for some opportunities in likely ‘17 and ‘18 with ExpressJet. Steve O’Hara: Okay, thanks for the time.

Thank you, Steve.

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

Yes, hey, good afternoon everybody. I guess my first question for Rob. I want to go back to the extinguishment of the debt, the $128 million, what was the coupon on that? And how did that opportunity arise? It looks like you are able to take it out at a pretty significant discount? What – can you just give us some background on what went on there?

Yes, it was a unique sort of one-time opportunity that we had at the end of the year to do that to pay down a $128 million of junior notes on our capital stock. They were higher rate and they had various rates, but in general, it was higher cost tranche of capital for us that we were able to extinguish at a very, very favorable economics.

Was this – was it tied to aircraft or was it unsecured, what?

Well, it was tied to aircraft originally for many years ago. It was part of the financing structure that – it just represented a higher cost tranche of capital. And when we had the opportunity to take it out, we thought it made a lot of sense to create value for our shareholders and do that.

Okay, great. And then if I could just ask a question on ExpressJet, Chip you did mention that it looks like that 2016 will be another year of losses, although my sense is that we have seen these losses come down. Can you just give us how that has trended? And I know it will probably show up when you put out in the K, but what that loss was in ‘14 and how the loss in ‘15 is ExpressJet compared to the ‘14 loss?

Yes, Mike, I will be real simple with it. I think that – I think I will tell you that the trend is in a good direction. We are pleased with the trend. We will give you some of the specifics when we file the K. For us, it’s still a loss and that’s not a good thing. I think like I said a little bit earlier, we are going to do a little bit of investment in making sure the model is stable in ‘16 as well. And then I think that the trend in ‘17 and ‘18, we are optimistic about, but it is from ‘14 to ‘15, the trend was admittingly really well, really good so.

Okay, great. And just if I could squeeze in a third one, just with respect to your partner Alaska, you are putting a lot of airplanes, a decent amount of airplanes in at Alaska over the next year, they do have – Alaska themselves are obviously looking at potentially purchasing 76-seat airplanes. They have talked about the E175s, I have seen the CRJ, I think 900s have popped up. I mean, these are aircrafts that you guys are specialist at operating, maintaining you guys know how to generate decent returns. Why is Alaska looking at doing something in-house? Is this just one they want diversification or did this have something to do with your own resources given the fact that you are bringing on a lot of airplanes over the next 1.5 years for United, Delta and Alaska? Were you in a situation or in a position where you didn’t have room to flex up to do additional flying? Is this a lost opportunity, any color that you could give us on this would be great?

Yes, Mike, this is Wade. So as far as the Alaska, 30 aircraft, I believe they were looking for fleet from some diversity with some of their supplier base. They wanted a little bit more diversity in that group. We have not had discussions with them on those 30 aircraft, though.

Wade, is there any sort of implicit read-in? Maybe I am reading between the lines here, but that they decided to pursue diversity maybe because they weren’t as pleased as maybe they thought they would be with your operation? I mean, your – I would suggest your completion factor suggest otherwise, but maybe it’s the wrong interpretation.

No, I think – Mike, I think that what we tried to do is – I am sorry, this is Chip, what we tried to do is make sure that we have the absolute top level performance across the board. I don’t necessarily believe from what we have heard with this diversity, direction are going on they are unpleased with our product at all. I think they are very pleased with it. Our perspective, I think we go back and we exercise discipline. I mean, the most important thing we can do is deliver on what our capacity is and be transparent with the partners. And I think from their perspective with their direction I think that they wanted it to go at different strategic direction and we are going to continue to be disciplined with all of our partners on what our capacities are so.

Okay, great. Thank you. I appreciate it.

Thanks Michael.

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

Hi, good afternoon. My first question is two parts. One is on the 50-seat RJ reduction, I am a little surprised it’s not more. I was wondering especially on the United side if that was just kind of a natural win in kind of the revised agreement you had with them and it starts stamping up more in 2017, ’18, or if you were able to extend some contracts. And secondly, on the same fleet topic, just looking at your 76-seat numbers, I think you have a 37 increase in E175s in the one table, but it looks like a 32 increase in kind of the total tally for the year. And I was just wondering what the difference was?

Yes. So – Savi, this is Wade. So there – your first question related to the 50 seaters, as in my prepared remarks, we talked about we got rid of 54 ERJ145s that is just naturally part of our revised agreement with United, the natural expirations associated with those. In 2016, we talked about that there are 20 E145s that are coming out. We do have the opportunity based on crew availability to extend those with United. And so we are definitely working with them based on our resources and what we have available. And so that’s the 50-seat question. And then as far as the E175s – okay, so some of them – I think your question is more just around delivery dates versus in-service dates. And so right now, the numbers that I talked about we have 37 E175s in 2016, those are delivery dates that we anticipate having.

Got it, okay. And then just kind of a larger kind of picture question and maybe this is for Chip. Just kind of the regional airline industry has kind of gone through significant structural changes over the past 5 years. You had consolidation of contracts that are no longer compatible or profitable with how it’s being flown. You have partners that are in a very different financial shape and you have got now regulation changes. I was just kind of thinking and I know you have done a lot in-house to restructure and get the operation to a good level, just kind of wondering as you look out over the next kind of 3 years to 5 years, how do you see the industry evolving, given so much fluctuation that’s going on today?

Well, Savi let me start our vision of this where as we started this fleet optimization plan almost 2 years ago, it’s – from the results looks like it’s working pretty well for us. I think as we have gone through this, we see some of the information out in the market and their views about all of this, what I can’t say is in the next 3 years to 5 years we do anticipate particularly, if these fuel levels, a very strong demand on our product. And as long as we continue to execute and provide industry leading service, it’s – for us it’s about being in the right position over what happens over the next 2 years, 3 years to 5 years, but we are very optimistic on the demand. We understand what we started almost 2 years ago is probably going to need to be a little bit fluid and we have to keep our eye on the ball and be disciplined about it. But at the end of the day, I think that we are very optimistic about the demand in the industry. And I think others within the industry would continue to say that. I think it goes back to the crew question, can we crew to the demand and I think that’s going to be everybody’s execution strategy over the next 3 years to 5 years in order to meet that demand.

So as you look out you are going to start to get a kind of increasing retirements at the main lines as well, so if crew decisions are kind of the big points, does that maybe limit your growth opportunities?

I think everybody in the industry would say today, that demand is strong enough that as long as we are disciplined and we approach this with our partners in the right way, that pilots are going to be what could possibly limit our ability to grow. That’s something that we work with everyday, we have got systems and processes in place to be very disciplined on that. So to the extent that the supply and demand metrics works with the demand out there and the supplies available in the industry, I think that we are well into that issue today.

Great. Thanks.

And our final question comes from Helane Becker of Cowen and Company. Please go ahead.

Hey guys. It’s actually Conor in for Helane. In the fourth quarter, it actually looked like your 50 seaters were up quarter-over-quarter, is – am I looking at that correctly or is that just in-service versus what you have on the books?

Yes. So the 50 seaters quarter-over-quarter, we did take out a lot of planes in transition that are going between agreements, then we also have planes that are transitioning out to lease returns, the retirements. So it’s just a function of planes that are more in transition than anything else.

Okay. So it’s not that you signed, like an additional agreement or anything like that to extend any of those, correct?

No. Not during that period of time.

Okay. And then you talked a little bit about – well, you mentioned the fact that you are doing some work with the ExpressJet pilots, can you just talk about a timeframe that you may get some deal in place and if your current guidance for the 2016 about the double-digit earnings growth includes an additional agreement?

Yes. Conor, very clearly I would say that I would – we have considered that variable in the guidance that Rob had provided, first and foremost. Second of all, we have made some very good progress on the ExpressJet side from the labor perspective in our view, hats off to the efforts on both sides of the teams there. We are optimistic and we should likely find out if there is some – when we can get some finalization of that agreement. I think hopefully, sometime by the end of the month, mid to latter part of the month.

Okay, great. And then my last one is what was the total debt balance at the end of the year, I know you paid down some debt, but did you add any during the quarter?

Yes. We brought on a couple of new airplanes in the quarter and added roughly $40 million of debt during the quarter. But if you look at the balance sheet, the bulk of the debt is in the long-term liabilities number of about $2.5 billion.

Okay, great. Thanks guys.

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

Okay. Thank you. Once again, so I want thank you for your interest in SkyWest. It’s a very interesting time in our industry and we have great confidence in our business strategy. Especially, we have confidence as well in the 20,000 professionals that execute our strategy. And with that, we will end the call at this time. Thank you.

And thank you, sir. Today’s conference has now concluded. And we thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.