Hawaiian Holdings Inc (HA) 2006 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, thank you for standing by. Welcome to the Hawaiian Holdings, Inc., second quarter fiscal year 2006 earnings results conference call. [OPERATOR INSTRUCTIONS].

And now I would like to turn the conference over to Allyson Pooley of Integrated Corporate Relations. Please go ahead.

Thank you. Good afternoon, ladies and gentlemen, and thank you for joining us today to discuss Hawaiian Holdings second quarter 2006 earnings results. On the call today from the Company are Mark Dunkerley, President and Chief Executive Officer, and Peter Ingram, Chief Financial Officer.

By now everyone should have access to the press release which went out at 1:00 Pacific, 4:00 Eastern Time. If you have not received a release, it is available on the Investor Relations portion of Hawaiian's website at www.hawaiianairlines.com.

Before we begin today, we would like to remind everyone of the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. The following prepared remarks contain forward-looking statements and management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance, therefore, undue reliance should not be placed upon them.

For a more detailed discussion of the factors that could cause actual results to differ materially from those projected in any forward-looking statements, we refer you to Hawaiian Holdings recent filings with the Securities and Exchange Commission including its most recent annual report filed on form 10-K, recent quarterly report filed on form 10-Q, as well as reports filed on form 8-K. As a point of clarification, at various points during the call reference will be made to results for both Hawaiian Holdings, also known as Holdings, and Hawaiian Airlines, known as Hawaiian, its sole operating subsidiary.

From April 1, 2003, following Hawaiian's bankruptcy filings through June 1, 2005, the day prior to Hawaiian's emergence from bankruptcy, Holdings deconsolidated Hawaiian and accounted for its interest using a cost method of accounting. As a result, the financial results of Holdings during that period do not include Hawaiian's financial results. For comparative purposes, reference will therefore be made to the combined results of Holdings and Hawaiian for the period prior to Hawaiian Airlines emerging from bankruptcy last year, when the Airlines results were then consolidated into Holdings numbers.

With that I would like to turn the call over to Mark.

Okay. Thank you very much, Allyson. Good afternoon and thank you for joining us today. I'm going to start today with the highlights of the quarter and then address the key issues that we face in the market today. I'm also going to update you on the progress we're making with the aircraft that we purchased earlier in the year. Peter is then going to discuss our second quarter financial results in more detail. And finally, of course, we're going to open up the call for your questions.

Allyson had sort of mentioned it, but just as a reminder, Hawaiian Airlines successfully emerged from bankruptcy on June 2 last year and as a result of its reorganization and our reacquisition of Airlines our financials remain quite complex. As we discuss our results, we're going to compare our 2006 consolidated financial performance with the combined prior year results of Hawaiian Airlines and Hawaiian Holdings. This we believe is the most relevant for evaluating our business.

In the quarter, we faced the twin challenges of relentlessly increasing fuel costs and a substantial increase in the competitor capacity in our markets. We're pleased that in this environment we managed to improve our operating profit but at the same time we recognized that our progress this quarter lagged that of several of our competitors who have benefited from a reduction of competitor capacity in their own home markets.

Later I'm going to discuss a number of internal initiatives to improve our future results but first to the numbers for the quarter. We reported a 10% increase in operating revenue, and that coupled with our cost containment efforts resulted in an operating profit of 9 million. Our net result was impacted by a significant special charge related to the redemption of our outstanding subordinated convertible notes in April. This redemption, which we discussed in detail during our first quarter's conference call, completed the restructuring of our balance sheet that included an expansion of the term loan financings at Hawaiian Airlines. Taking out the convertible bridge financing allowed us to avoid significant potential dilution to shareholders. Excluding the special charge, we would have reported pre-tax earnings of $6 million.

Thanks to the hard work of our employees and despite some significant challenges such as the protracted closure of a key taxi way at Honolulu, we also continued to maintain our industry-leading ranking in terms of on-time performance, baggage handling and the avoidance of cancellations. As a result of the outstanding service provided by our dedicated employees we were recently named the Nation's Top Airline serving Hawaii, in Travel and Leisure Magazine's 2006 World's Best Service Awards.

In part, because of our consistently strong service, we continue to do better than any of our competitors at filling our airplanes, which is reflected in our solid load factor of 86.9%, which is up 1.8% over last year. Our yield also improved to $0.1217, resulting in a RASM increase of 9.4%. And although this RASM improvement doesn't match some of the second quarter numbers reported by the network carriers, it's important to remember that we have faced quite a different capacity environment in the quarter than our competitors have faced in their own home markets.

Whereas domestic 48 capacity is down year-over-year the number of seats operated between the U.S. mainland and Hawaii has increased by 2.5% and in our interisland markets we saw a substantial capacity increase of 21% in July with Mesa's entry into the market in June. On the cost side, CASM, excluding fuel, declined marginally to $0.0792, and if we had excluded the impact of purchase accounting the decline for the quarter would have been 2.8%.

Now let me address the fuel prices in a bit more detail. Our average cost per gallon in the second quarter was $2.15, which is a 24% increase from already high levels a year ago. The cost of jet fuel was the single largest component of our operating expenses, representing almost 28% of the total. As I mentioned in last quarter's conference call, we have a number of conservation initiatives in progress, and we continue to seek efficient ways of sourcing our fuel requirements. This most notably includes our practice of purchasing our Honolulu consumed fuel from Singapore where we benefit from generally better pricing than would otherwise be the case.

We're also focusing on our non-fuel-related costs. During the second quarter we initiated a top to bottom review of our expenses, and we have identified a series of discrete areas where we expect savings. Obviously, the management of labor expenses and employee relations is essential in our industry. For the 83% of our work force is represented by unions with the International Association of Machinists, the Association of Flight Attendant and the Airline Pilots Association representing the largest employee groups. The contracts with each of these groups become amendable during 2007 and 2008.

In the meantime, we are focused on achieving productivity improvement within the current contractual terms, and ASMs per employee increased 5.2% versus the same quarter last year. Although we're not currently engaged in full-fledged contract negotiations, during the second quarter we signed a letter of agreement with the IAM covering our unionized reservation agents and certain back-office staff, including accounting.

Essentially the agreement allows management to outsource these activities in exchange for providing job security for the incumbent employees in the affected areas. Importantly, this development will allow us to use outsourcing as a mechanism to control costs. The ink is barely dry on the agreement and we're just starting to investigate the scope of the opportunity to outsource activities. So it will be premature for us to give you a sense of just how significant we expect those savings to be. But we think these efforts demonstrate that we are turning over every rock in our business to see where savings can be made.

Turning to the fleet, we continue to prepare for the entry into service of the 4 used 767s that we purchased in the first quarter of this year. The additional aircraft bring our long-haul fleet to 18. The additional aircraft is scheduled to enter service beginning in September at a pace of roughly 1 per month. As we mentioned last quarter, 1 of these 4 aircraft will serve as a spare for our total wide-body fleet. The planes are going through an extensive modification process including equipping them for overwater operations.

Additionally, we are going to be outfitting each with new interiors to meet our standard interior configuration of 18 seats in first class and 242 seats in coach. As a result of certification issues related to the interior modifications of the first of these aircraft, the first one will enter the fleet without completely modified interiors, but we are on track to meet our scheduled requirements and we do expect to have 2 fully modified aircrafts in service by early October. As a reminder, our rollout schedule for the additional aircraft begins September 9th, with the extension of our daily San Diego/Maui service from its current summer early schedule to daily flights year-round.

Then during the fourth quarter, we're going to transition our Seattle to Maui and our Portland to Maui services to daily from the current schedules of 4 and 3 times a week respectively. Additionally, we're going to add 3 additional weekly frequencies respectively to our Seattle to Honolulu and Sacramento to Honolulu schedules. We're very excited about this fleet expansion and the growth potential that comes with it. As evidenced by our load factors, demand for travel to-and-from Hawaii remains robust bolstering our confidence in the marketing success of this expansion. Now, before I turn this call over to Peter, I'd like to take a minute to discuss the recent entry of Mesa into the interisland market.

As a reminder, the interisland business accounts for approximately 30% of our revenue. Until June, the interisland market was served primarily by us, Aloha, Island Air and a couple of other smaller carriers. Since the year 2000, the market has experienced a decline in passenger levels attributable to both the increased direct service from the mainland to outer islands and the expansion of infrastructure on the neighbor islands which reduces the need for some travel to Honolulu by Hawaii residents. Despite this trend, the interisland market remains a co-element of our business and the strength of our brand and the quality of our service puts us in the best position in this traditionally competitive market.

As you all know, Mesa entered the market in early June. So we're still in the early days of the new competitive environment. During July of this year, the market had over 20% more seats than in 2005. Not surprisingly, this growth has been coupled with pricing promotions by all of the participants. Thus far, our traffic levels have increased despite the capacity increase, but we cannot conclude that this short-term stimulation is a harbinger of the longer-term. It would also be incorrect to assume that these markets were underserved previously and as an example, I would point out that the Honolulu to Maui market has 39 daily round trip flights before the recent increase and now has 55.

With the schedule increases, the combined seat capacity in this market today exceeds that of the combined LaGuardia JFK to Boston market. From a competitive standpoint we continue to believe that our 717s give us a product advantage in terms of passenger comfort, including the only first class product in the market, as well as the lower cost associated with the larger gauge of aircraft. Our presence in the community, our customer relationships and our strong frequent flier program also position us solidly. Well established relationships with several mainland carriers, coupled with our own connecting fleet, generates important levels of traffic for us.

As we said in the past, we didn't pick this fight, but we do believe we are well positioned to fight it. In summary, I'd like to say again that we are pleased to have returned to the black in terms of operating profit, but at the same time we do recognize that our progress this quarter has lagged that of several of our competitors. Financially, we're well positioned thanks to the debt restructuring we did in the first quarter. Recognizing the twin challenges of rising fuel prices and expanding industry capacity in our key markets, we are today focused on efforts to improve revenues and further control costs to buttress our competitive position in the period ahead.

Now, I'm going to turn the call over to Peter, for further financial discussion.

Thanks, Mark. Let me start by taking a couple of minutes to tick through the most significant income statement items and then spend a couple of minutes on the balance sheet. For comparative purposes today I'll be discussing the consolidated GAAP results for the Company in 2006, relative to the combined results for Hawaiian Airlines and Hawaiian Holdings for those periods in 2005 when the airline was in bankruptcy. We believe this is the most relevant basis of comparison for which to consider the ongoing enterprise.

For reconciliation of these numbers to our GAAP results I refer you to the Investor Relations portion of our website where this information is posted. Starting with revenue, our operating revenue for the quarter increased 10.2% year-over-year to 222.3 million. Revenue per seat mile improved 9.4% on a 1.8. load factor increase and a 7.1% improvement in yield. Despite the capacity increases in the TransPacific market that Mark alluded to earlier, our TransPacific yield improved 8.2% year-over-year.

Interisland yield were off by 1.9% for the quarter, but this was more than offset by higher load factors. As Mark also said it's too early to draw conclusions as to the long-term impact of Mesa on the interisland competitive mix since the Q2 results reflect only about 3 weeks of the new competitive environment, but we continue to be confident in our competitive position. Turning to expenses, our operating expenses increased by 5.8% in the quarter on a capacity increase of 0.7%, so our cost per seat mile was up about 5.1%. Excluding fuel, we were a little better than flat on operating CASM with a decline of 0.3% year-over-year. And if you adjust for the differences in our expenses related to purchase accounting following our emergence from bankruptcy, our CASM improved by 2.8%.

Obviously fuel is the big driver on the cost side but there are a number of ins-and-outs so I'll tick through several of the line items for you. First, let me touch on the purchase accounting impact. As we detailed in the press release, our net income is reduced by about $6.3 million in the second quarter due to the accounting differences following our emergence from bankruptcy and the reconsolidation of Airlines into Holdings, compared to a 2.7 million impact last year. $4.7 million of this quarter's impact is in the operating expenses, with the remainder being on the revenue side or in the non-operating lines.

Of the operating expense piece the biggest slice relates to depreciation and amortization expenses as we amortized certain of the intangible assets established when we went through the purchase accounting exercise. Notably, although these amortization expenses will continue to hit us for a number of years, the year-over-year variances will dissipate now that we have past the anniversary of Hawaii Airlines emergence from bankruptcy in early June. Our fuel expenses rose to 59.2 million in the quarter, an increase of 11 million or about 23%. The average cost of gallon we observed in the quarter was 2.15, inclusive of delivery cost, taxes and hedge impact.

This cost per gallon was 24% higher than last year's second quarter so essentially our entire fuel variance is accounted for by changes in price. As Mark said, we continue to pursue conservation initiatives and our consumption per block hour has improved as a result. Lower consumption per block hour saved us about 1.1 million in the second quarter compared to last year which helps offset some of the increased flying that we did this year. Our hedges saved us $1.7 million in the operating line although this number underestimates the true economics of hedges we had in place for the quarter.

As we discussed on the previous call, we hadn't designated our forward contract for hedge accounting last year when they were initially put in place, and as a result we took some mark-to-market gains in 2005 relative to hedges that settle in 2006. The net result of this is that the hedges that settled in the second quarter generated proceeds to us of 5.2 million, although as I said the impact on our operating line was only 1.7 million. Going forward, we have about 48% of our third quarter fuel consumption hedged at an average designation price of 2.05 which does not include taxes and delivery cost. Beyond the third quarter our hedge position is negligible. You will notice that wages and benefits expenses are down about 5% for the quarter.

Last year's 2Q reflected an accrual for bonuses and stock related compensation related to Hawaiian's successful emergence from bankruptcy and the absence of similar items in 2006 accounts for most of the year-over-year variance. With the adoption of FAS-123R this year we had about $1.2 million of stock-based compensation expenses in the second quarter which is about $700,000 higher than it would have been under the previous accounting rules.

On the maintenance line we had a $4.3 million year-over-year increase related to a couple of items. First of these is higher power by the hour engine maintenance expenses. That's a result of 3 factors, the inclusion of more engines in the power by the hour program relative to last year, contractual rate increases in the contract and some increases in the overall hours flown. The combination of these 3 factors accounts for about $2 million of the increase. In addition to the engine expenses we had more activity on the airframe overhaul front of this years quarter accounting for about a $1.9 million year-over-year increase. This includes seat check work on the 767 fleet, as well as some landing gear overhaul work that came due on our 717 fleet.

Offsetting some of these increases is a decline in our other expenses by about 12%. Most notably in this regard I'm happy to report that we spent about $2.6 million less in professional fees in the second quarter than we did last year. Those of you who have followed the Company over the past year know that Hawaiian's emergence from bankruptcy and the readiness effort related to complying with Sarbanes-Oxley drove an inordinate level of professional fees throughout 2005.

We committed to driving that number down considerably in 2006 and those efforts are reflected in the improvements shown in this quarter. Our non-operating expenses for the quarter were 31.1 million, the biggest piece of this relates to a special charge related to the redemption of the subordinated convertible notes that we issued as a bridge financing when we emerged from bankruptcy. We completed the redemption in April, prior to our last conference call, but after the end of the first quarter. To recap this transaction, we had $52.3 million of outstanding notes from an original $60 million financing. The difference between these numbers reflects some limited redemptions that were completed in late 2005.

Under the terms of the notes, we had 12 months from our emergence from bankruptcy to redeem the notes before they would become convertible into about 12 million shares of common stock. The repayment terms called for a 5% prepayment premium, so about $2.6 million of the $28 million charge relates to this payment. The remainder of the charge reflects the unamortized debt issuance cost and the fact that we accounted for these notes on our books at a substantial discount relative to the face value. The discount relates to the warrants that were issued in connection with the issuance of the note and to the fact that the $4.35 conversion rate reflected a beneficial conversion relative to the price of our stock at the time the notes were issued.

As we said last quarter we're pleased with the restructuring of our balance sheet that was accomplished in the first half of this year. Our term loans now extend to 2010 and 2011. We ended the quarter with over $170 million in unrestricted cash, and avoided the potential dilution related to the convertible note. I would like to mention one other residual element of the financing changes made earlier in the year. When we extended the term loans we had $10 million of financing, which was held in escrow.

The terms of our deal allowed us to draw that money from escrow conditioned on a specific asset acquisition that we had not yet consummated. Since that acquisition did not occur, the $10 million was returned to the lenders in early July and our term B loan balance was reduced commensurately. In our 2Q statements we do not include the escrow funds in our unrestricted cash, so this transaction does not affect that balance.

And with that I would like to turn the call back over to the operator and we'll spend a few minutes fielding any questions you might have.

Thank you. [OPERATOR INSTRUCTIONS] The first question comes from Nick [Capiano] with Imperial Capital.

Hi, Mark, hi, Peter.

Hey, how's it going Nick.

Good, thanks. On the interisland competition, you saw, as you noted in the call, you have seen about 3 weeks of it. Given the scale at which they've launched and the current schedule that Mesa is running, might we imply that-- kind of extrapolate what we think the impact-- you did mention the specific impact to the load factor. Can we extrapolate that out, or take a cut at it? Is that a fair way to look at it or has it been dynamic and there will be-- trends may significantly change from the impact you are already seen in the first three weeks.

I think much more the latter than the former, Nick. I think the first few weeks we have seen a lot of pricing initiatives. We have seen a lot of advertising. We have seen a lot of local press that's been generated. There's been a sort of palpable sense that there are a lot of people jumping on airplanes to take advantage of some the low fares. All of these things, I think, over time are going to-- are likely to diminish.

As we have mentioned a couple of times, we don't think that the underlying trend in the marketplace is going to change. We think that the reasons why people have traveled less in the last 5 years are going to be with us as we go forward. So 3 weeks-- we just-- I mean, even internally let alone in terms of public statements we're making, even internally, we're not overly focused on the results in the first 3 weeks. Mesa has made a lot of statements about how they are doing. I think the proof of the pudding is going to be a little ways down the road.

Sure. Understood. And in terms of the-- if you can give us some more color on what you are seeing relative to the fare levels and fare increases in the TransPacific market and just trends you see going forward there as much as you can.

Well, the-- it-- again, it's quite a dynamic sort of marketplace. I think we have seen that fare levels are rising is pretty clear from our financial results. But they are not rising on a 1 for 1 basis with fuel, I think unfortunately is equally clear. I would describe the situation as-- I think our situation appears to be reasonably different from our competitors in that we have so far been successful at filling airplanes and anecdotally the sense we get is that our competitors aren't quite as full as we are on the routes that we fly side by side. That is anecdotal. We don't know that absolutely for a fact. We certainly are doing everything we can to promote an improved revenue environment in the markets that we serve but at the same time we have to be responsive to competitive pressures and different markets are behaving differently in that regard.

All right. Thanks very much.

Next question comes from Jason Kremer with Caris & Company.

Good afternoon.

Hi, Jason.

On your fuel hedging it's negligible going into fourth quarter. I was wondering, are you guys planning on increasing that in the third quarter or even increasing the third quarter hedging?

Well, frankly we're looking for opportunities out there. We-- we're looking to see which way the market-- which way the market moves. One of the reasons why we hadn't been building further hedges over the course of the last several months, is that we have seen a sort of funny shape to the fuel curve being driven on, surprisingly, by a lot of global uncertainty at the moment. At the time we didn't feel that it was the right thing to further add to hedges.

We make that determination on a sort of rolling forward basis. And that will be what we continue to do just wait and see if we believe in the advisors we have who advise us believe that the kind of risk reward profile for hedging is out there. So what I would say is in the sense that our policy I don't think is going to change going forward, but our policy is to look at the facts that are in front of us, and to take advantage of opportunities.

Okay. And do you guys see going forward as fuel prices keep going up, are you going to be able to raise prices to absorb some of this just in-- I know probably not in the interisland market but in the TransPacific market/

In the short-term in our business, cost of fuel and prices for air tickets is just completely disassociated with one another. The price of tickets is determined by the number of seats in the marketplace and the number of people who want to travel. Our-- today we are selling tickets for-- pick a date-- November 1, and no matter what the price of fuel is we're going to have to make good on that transportation promise. So the people who price our tickets and who manage our revenue, and they do generally a very good job of doing that, the people who do that are simply trying to maximize the revenue. Obviously over the medium longer term, airlines make capacity decisions based on what they think the price of fuel is going to be, but in the short-term, unfortunately, there isn't a whole lot of connection between the two of those. Of course if the price of fuel goes down hopefully the reverse would be true as well.

Okay. And you guys are seeing some benefits from the load factors obviously? Being so high.

Yes, absolutely. And, just to be clear, I think we have done extremely well, not only in this last quarter but, frankly, over the last couple of years, on load factor. One of the things that we ask our revenue management people to do is to maximize revenue, not maximize load factor. So we are-- we have certainly pointed out load factor has been good. One-- when our revenue management people are at work, we give them the authority, and we want them to use it, to be able to trade load factor for yield when they see the right relationship.

Okay. Thank you; that's all I had for now.

[OPERATOR INSTRUCTIONS] We have a question from Helane Becker with Benchmark Company.

Thank you very much, operator. Hi, guys.

Hi, Helane.

Do you have just for us what FTEs were at the end of the quarter and what the aircraft in the fleet are now?

Aircraft in the fleet today are 25.

Okay. And do you have the percent of distribution of capacity 717 versus the longer--

Yes. We have 25 aircraft in our fleet, 11 717s operating interislands and 14 767s operating TransPac. By the end of this year on the schedule which I can repeat if you like.

No. No, you don't have to; I got that part.

We will get another 4, so it will go to 29 of which 18 are going to be 767s.

Got you.

Okay that was 1 question and the FTEs on the payroll are 3,350.

Okay. And then are you-- with the 4 additional aircraft coming in, are you having to train in advance of that, and is there going to be some-- if we look at your wages, some-- maybe in the third quarter, some additional costs associated with the aircraft coming in that aren't necessarily productive revenue?

Yes. Yes. I think you are exactly right on that. The answer is yes. We have already started training some pilots; some of those numbers were in the second quarter, certainly they-- those numbers will be in the third quarter. In addition, we have hired some flight attendants who are currently going through training and their expenses are also partly in the second quarter and will be in the third quarter as well.

Okay. So the productivity numbers that you cited earlier in your remarks are probably understated by these few unproductive people, right?

Yes. Logically, yes. Frankly I haven't done the math myself, but I can't argue with the logic that you just shared.

Okay. Great. Well thanks for your help.

You bet.

Moving on to Jamie [Mendola] with Watershed Asset Management.

Hi, Mark and Peter. Can you guys hear me?

We can hear you now.

Great. You talked a lot in the past about pricing and how it's primarily driven by capacity. It's good to see the unit revenues were up much stronger in Q2 than Q1. Can you talk a little bit about what is going on in the competitive marketplace and what you are seeing out of your competitors in terms of capacity and their ability to raise prices themselves?

Yes, and no. We actually compete with, I think, a broader array of competitors than any other airline, certainly of like size, flying today. And what we find is the competitive activities of these varied competitors is very different. Some competitors are-- compete aggressively on the basis of price, some do not. We are-- our approach is sort of market-by-market and frankly I think one of our advantages of being the size that we are, is that we are small enough where we can concentrate market-by-market and pursue the right strategy for each market rather than having to deal with the sort of un-- gargantuan number of network connections that our network carrier competitors have to take into consideration. What is out there at the moment, as I say, is some carriers are competing in price. Some are not. It's very hard to say that there's a trend one way or the other.

Great. Next question I have is relating to the capital structure, I was wondering, Peter, if you could just walk through what the balance sheet looks like in terms of your new term-loan structures at the end of the quarter?

Yes, basically, if the-- with the term loan we put in place earlier this year, the term A loan, the senior term loan, had an original $62.5 million principal amount. That one amortizes at 2.5 million per quarter. So that one at the end of the quarter was at a $60 million balance. The term B was 72.5 at the end of the quarter but as I said the term B had the $10 million that was held in escrow so that one is now a $62.5 million balance at the end of the quarter or following that repayment, which was in early July. So 60 on the term A, 62.5 on the term B. The convertible notes, of course, are gone. So that is the vast majority of our long-term debt. We have got a little piece that is a note payable to the IRS following a settlement that was done a couple of years ago, but the main debt on the balance sheet is those 2 term loans.

Okay. Great. Thanks, guys.

That concludes the question and answer session. I will now turn the conference back over to you.

Okay. Well thank you all very much for joining the call. Appreciate the questions. If you have any more, and the ones that we can answer, we would be happy to answer them for you. With that, we look forward to seeing you in one quarter's time when we will again have a quarterly conference call. Thanks for taking the time. Bye-bye.

That concludes today's conference. Thank you for your participation.