SkyWest Inc (SKYW) 2006 Q3 法說會逐字稿

Hello and welcome to the ExpressJet Holdings third quarter conference call. The callers will be placed on listen-only during the call until we open it up for questions. Now we will turn it over to Kristy Nicholas, Director of Communications. Please go ahead.

Thank you. Good morning, everyone, and thank you for joining the ExpressJet Holdings third quarter conference call. On the call we have Jim Ream, President and Chief Executive Officer, and Fred Cromer, Vice President and Chief Financial Officer.

Portions of this call may contain forward-looking statements not limited to historical fact but reflecting our current beliefs, expectations, or intentions regarding future events. A number of factors could cause actual results to differ materially from those in the forward-looking statements. Additional information concerning risk factors that could affect our actual results is described in our filings with the SEC including our 2005 10-K.

During this call, certain non-GAAP financial disclosures may be made relating to our performance measures. In accordance with SEC rules, we will provide a reconciliation to our most directly comparable GAAP financial measures on our website at www.expressjet.com.

Jim will cover the operating and financial results for the quarter, then Jim and Fred will take questions. Now I would like to introduce Jim Ream.

Thanks, Kristy. Good morning, everybody. Let me quickly go over the P&L and talk a little bit about working on the 69 aircraft and then we'll open up to whatever questions you guys might have.

For the quarter, we made $22.7 million, worked out to $0.38 a share on a fully diluted basis. Revenues up about 8.8% year-over-year driven by a block hours, up about 11.5%, [at] 13 more aircraft a fleet year-over-year and the utilization on all the fleet was up about 5.5%.

On the downside, the incentives were off $1.6 million, similar to what we saw on the second quarter, just principally a function of the benchmark we used to set that incentive, continuing to ratchet up as our performance maintained a pretty consistent level year-over-year, benchmark is actually approaching our run rate operation.

On the expenses, up 10.8% on a 12% increase in ASMs. Again, like the second quarter, we had a fair amount of expenses associated with projects relating to the 69 aircraft, which obviously is going to be outside of the Capacity Purchase Agreement with Continental. So we have those transitional expenses pretty similar to what we saw in the second quarter. Put some pressure on us on our margin year-over-year.

[Non-off] got better, more cash, less debt, and probably the thing that makes the least intuitive sense on the P&L, looking at the income tax expense, we had a catch-up entry last year that kind of artificially depressed sort of [less book] tax was for last year, so normalizing closer to our statutory tax rate for the second quarter of '06. Closed the quarter with $274 million in unrestricted cash and debt in capital leases totaled $153 million.

So a quick overview of the third quarter, related to the 69 aircraft, we're -- let me kind of talk about that kind of by the categories we've been talking about of the areas that we're looking to place the aircraft and giving the best update I can.

First, with regard to the idea that we thought we had an opportunity to maybe place some aircraft in an offshore operation that would be run within that foreign entity, that project is not going to come together. We had spent a ton of effort trying to make that happen and we just sort of hit a point where we don't think that's going to work with these aircraft in particular. May have some applications down the road with other aircraft deliveries, but for these aircraft, it's just not going to come together.

So, we'll probably not talk about that as much. We still have some transborder opportunities with this project no longer being viable, we have sort of engaged other parties, folks at some networks offshore and onshore to see whether or not we can do some things, still fly down into Mexico and up in Canada. Those projects are still ongoing, but the offshore entity is not going to work out.

So on the positive side, for the charter corporate arena, we just continued to make a lot of progress in that area. Just sort of numerous applications where this aircraft is a perfect fit for organizations that have big chunks of folks that they need to move kind of beyond sort of the way the scheduled networks work today.

As we continue to sort of meet more and more folks that have these needs, we continue to be surprised by the level of interest in the aircraft, its capability, and the economics of what we can provide to these entities. So that's done really well. In the second quarter I thought maybe we would end up with some applications where we would have to take the aircraft and reconfigure them into a corporate configuration, but we do not believe that we're going to do that right now. Just a 50-seat product seems to fit a real need in the marketplace and we're going to continue to pursue that. It fits well with kind of the scale of our support structure out there, sort of allows us to do a lot of these projects and support it pretty effectively.

So we're very happy about the progress that we've made there and we continue to believe that we will make more progress as we continue to work that. As it relates to the timing, we obviously are -- it's going to be complicated kind of getting a sense of the first, second, and third quarter as we have aircraft being released out of the capacity purchase agreement.

I would say that right now, for the first quarter, we feel that most of the available aircraft time that we have has been sold in this area. We're going to have a transition period, probably a couple of weeks as it stands right now to paint the aircraft and to reinduct it into our own Fleet out of the Continental capacity by agreement, but sort of absent that transition period, most of the time that we have available, we been able to find folks out there that have a need for this aircraft in this particular arena. So we're really kind of looking right now from an aircraft availability standpoint at more of a second and third quarter deployment as it stands as of this moment.

On the remaining aircraft and hopefully what is the second and third quarter look like, we're still in conversations with several networks. We put this call off as long as we could to see if, hopefully, it made some progress, but obviously we're dealing with organizations that are going to have their own timing. We're just not to a point of being done with those conversations, they have a sense of exactly what the second and third quarter are going to look like as of this moment.

We don't feel that we're that far away from being able to include those conversations, but as of this moment those are still ongoing. We continue to work on developing ideas for a point-to-point application of this aircraft. We've got a pretty good schedule that's starting to come together that we think leverages the capabilities of this aircraft and can provide some service that's not being done today. Doing it in such a way where we feel that we can minimize the cost of that, providing that operation.

All the back office you need to have in place to make that happen is still on track, and we will ultimately size that network based on how these other conversations end up with these other organizations that we're talking to. Right now, we're on track to be able to be in position to start selling tickets in February with a second quarter operation if, in fact, that looks like that's the best application for the aircraft.

So we're pretty excited about it. I think we found some opportunities here with this aircraft should work pretty well in sort of a branded flying basis. Once we have that schedule set we'll be able to sit down and sort of think about how to maybe still partner even in that kind of structure, but we've just got to kind of wait until we work through these conversations that we still have ongoing.

So unfortunately, that is the way this information in all of the areas that we are looking at. Feel pretty positive about it. We've made a lot of progress. Some things haven't worked out, but some other things have worked out better than we thought, so on balance, I think we feel pretty good. So with that, [Operator], I think we're ready for questions.

(OPERATOR INSTRUCTIONS). Jim Parker, Raymond James.

Jim, just questions here. One regarding the corporate aircraft opportunities that you have. I believe you have now allocated 15 aircraft to that? I would like to know, and apparently you're implying that you have sold time for 15 aircraft through the first quarter, meaning do you have the revenue sold and fully booked for 15 aircraft?

Yes, our best guess right now of the forecast for the first quarter is that those aircraft have revenue opportunities.

Well, wait a minute. Revenue opportunities -- I mean do you have them signed? Are these aircraft that are out there available for revenue or do you actually have revenue on the books for those aircraft?

We have parties that we are in conversations with. They're in various levels of documentation on it, some from signed all the way to sort of closing them out. But we absolutely have customers for those aircraft.

The first quarter revenues related to those airplanes would not show up on the books until we actually performed that service. We can't recognize revenue until we actually fly those charters, so in our revenue line that you're staring at today there is no charter revenue in the revenue.

What I'm asking -- I guess, Jim, maybe you've answered it -- you've got enough business signed up to fully utilize those aircraft in the first quarter?

Yes.

Can you tell us anything about the margins relative to the current business?

Well, I think the way we tried to model it is that the overall -- this sector is going to have kind of profit [per tails] that are comparable to what we earn today in the Capacity Purchase Agreement.

Another question would be you've just mentioned point to point utilization of these aircraft under your own brand. I believe you may have indicated some time ago that perhaps that wasn't something you wanted to pursue, but now you apparently intend to pursue it. What has changed and what is bringing that about?

Well, I think it's something we've always had as an alternative, and I think what's changed is that we've kind of done more and more work in setting the schedule and look at the markets and sort of seeing that the opportunities, is that we feel that those are an opportunity that's going to provide some real value in not only our company, but I think our sector as well, to be able to demonstrate that these aircraft have an ability to sort of be successful on a point-to-point basis.

So I think it's just sort of the passing of time as we've spent more time working on it and gotten more comfortable sort of with those sets of opportunities. You kind of go from the concept of it ultimately down to the specific markets and the flows of the aircraft and sort of an underlying cut at the economics [of what] it's going to take to provide that, all those things have sort of made us more comfortable as we've spent more time on it.

Perhaps there's a more diplomatic way to ask this, but how is this not another [Fly I], certainly didn't work running independent RJ's.

The only similarities would be the fact that they're the same airplane size. So every aircraft is going to have its pluses and minuses. Ultimately you have to have the right application for the aircraft. I don't care what size the aircraft is or you're not going to be successful. So we think that we found markets in which this aircraft is actually the best aircraft for those market pairs. It's just a function of can you build a network around that to do that effectively. We think that in the amount of time that we've spent doing that, that we can make that aircraft successful in those markets.

Ray Neidl, Calyon Securities.

Just to verify the margins, going forward for the next couple of quarters, I know you described what you're trying to do, but as we develop these businesses, we can expect to see probably margins for the whole Company in the same range as where they were in the third quarter. Is that a good assumption to make?

Well, I think we're going to have a transition period where we're going to have a couple of weeks where the aircraft are not doing anything. So that is going to put some pressure on us as we go through this transition of reinducting those aircraft into whatever application would ultimately find homes for them.

So the first three quarters of next year are going to be difficult to model. And we're still kind of at work in the middle of it. I think for the first quarter -- is the one that we're the most comfortable with -- is that on balance, once you back out the couple of weeks it's going to take to work with the aircraft that are being returned to us, on balance those aircraft have homes today that are under comparable economics to what we currently earn. Second and third quarter, we're still -- we don't have enough information to sort of give some rough sense of what we're thinking right now.

And as far as doing business, a contract business, what is out there in the industry that you see outside of Northwest to Delta? Without revealing specifically other things you might be working on, are there other opportunities?

Yes, there's a couple of other folks that we are talking to. We're kind of hesitant to say anything because we are bound by confidentiality agreements and in one case we got a call last week to think about a project that may make sense for both companies. So, even if I could tell you a list it would be wrong by the end of the week. So the fact is that there's -- as folks get -- every network, as they get a sense of what the next year looks like, can lead to some calls where, in fact, we may have something where we can be helpful.

And then regarding your overseas project, you said these aircraft, the 50-seaters, don't work on the project you were working on, which I assume was in Europe. From what I understand, there's lots of opportunities in China. Have you been examining that market for some kind of a partnership with some of these aircraft?

Yes, we have been. It's a project that obviously is going to take a back seat to working with the aircraft that we currently have. I think we just found that the opportunities that are there in most of these things that we've been looking at take some time to kind of ultimately be able to work them through and wouldn't fit with the timing of when we're going to get these aircraft back. So all of our resources are sort of directed to these aircraft right now and if those other projects we've been working on are going to sort of follow on once we have these aircraft identified where they're going to be.

And finally, generally, how would you describe your relationship with Continental? It appears that the contract you had with them supplied you with good cash flow for the life of the contract. I'm just wondering do you feel that that contract is safe? Do you have a good working relationship with the company?

Yes. No, Continental has been very helpful on the things that we need for them to help us with on this transition. I think the overall network is running very well, and I think they've been happy with the financial results of the aircraft looking at their segment reporting. So on balance, I think the relationship is very good.

Mike Linenberg, Merrill Lynch.

This is Lily, standing in for Michael. My first question is wondering if you could comment on the progress with your other affiliates, such as ExpressJet Services, Wing Aviation, your training services -- any update? That would be great.

Yes, I would say that most of the management efforts over the last eight, nine months have been working on the 69 aircraft. A lot of those projects are on pause as we sort of find the right outcome for the transition that we're going through. They're stable, there's some areas that are growing. There's some things that we need to do some work on, but on balance, if we had any sort of management capacity available to apply to this, it's been redirected to sort of working on the 69 aircraft. And that's going to be so probably for most of '07 as well. This is sort of where our focus is going to be until we have demonstrated we've gotten our way through it.

Regarding sort of some of these non-airline costs as [in the past have been] hitting up P&L, can you share with us what your forecast is for these non-airline costs, at least in the near future, just for modeling purposes or some of the -- what are you seeing in the next few quarters?

I think based on kind of the information that Jim has already articulated, that it's fairly dynamic. So it would be inappropriate for us to kind of forecast that going forward. There are expenses that we’re going to continue to expend as we explore these opportunities for these airplanes, and those obviously are outside of the capacity of purchase agreements, so it does take that 10% target margin and reduce it. So, I don't think we’re in a position to give you a forecast as to what that is going forward, but it's likely to be no worse than it has been as we sort of think about investments and finding homes for these airplanes, at least for the next quarter, anyway.

And my final question is this -- and maybe this is a little too early to say, but do you have a sort of philosophy of thought on what you think the optimal blend will be for your aircraft going forward? What’s the percentage you would like to see under contract flying, the percentage you’d like to see being on your own branded flying, and what percentage perhaps in the corporate charter business?

Well, it is difficult, as we are kind of going through this and getting a better sense of what those opportunities are. I think to be blunt about it is that the corporate provides a nice diversification play and we think we could bring some real value to the folks that we’re looking at providing the service to. And so those things you get excited about as you look at sort of what the potential is to ultimately move into that. So I think we’ll be very aggressive in that area.

On that the branded stuff, it's going to be however the results turn out. If we could ultimately get to a point that we could demonstrate that these aircraft can work outside of flying in and out of a hub and can demonstrate the point-to-point in the smaller communities can make some sense, that may have the right risk rate of return trade-off from what these companies are worth. That may mean that if we can demonstrate that, that you would put more aircraft into that. So I think we'll have to just kind of get through '07, see how we're doing and our results will sort of dictate where we [will] invest in aircraft.

So you were saying also that if one of these areas work out very well, you won't rule that out to dedicate most of or in fact all your assets into that area, so diversification is not something that you feel to be particularly necessary. You definitely have to have it as long as one of the areas work out well. Is that a fair comment?

Yes.

(OPERATOR INSTRUCTIONS). Rich Shea, Vardon Capital Management.

I guess three questions. One, do you have enough breadth in the corporate charter agreements to talk about how those (technical difficulty) [generics] scope out in terms of length of contract? Is there any detail you can give us on the number of customers now?

Well, the contracts right now are ranging between a year down to a few months. Now, the ones that are kind of closer in have sort of follow-on projects that we are working on. So they have kind of more of a reoccurring business behind what we're just currently signed up to do for them.

But there are a number of contracts that we're looking at that will be longer in nature and really just frankly, they are just long enough for us both to be comfortable that those are sort of the right economic structure to be able to provide the service. We've got a dozen people that we're chatting with and we're in conversations with a dozen more. They are all over the range of types of organization.

So, it's difficult to kind of get to the specifics beyond that, but we're bidding on more things right now and working on more projects than we have aircraft allocated to it as of this moment. So we'll just have to see how that plays out over the next 60 days.

We talked about this segment of the business a little bit differently than just kind of your generic charter operation in that we kind of like to call it travel solutions because it's not your typical charter business where you've got an airplane available and you're scrambling to find a customer for it. We're talking about longer-term contracts, partnerships with some of these companies that have longer-term needs for an airplane to meet whatever travel need they've got going forward. [That's opposed] to what typically people think of in the industry as airplane kind of available and then you're kind of just (indiscernible) got an airplane out there for charter business.

So that's kind of the mindset that we like to convey when we talk about this Corporate Aviation sector of what we're pursuing here and so it is a little bit different than your typical charter type operation.

Second question, just from the press release, it looks like you're negotiating with Continental on the 2007 block hour rates. Is the scope of those negotiations related only to 2007 block hours or are there other strategic components to that discussion?

No, this is an annual process that we go through for the aircraft and will continue to be covered under the Capacity Purchase Agreement. So the contractual obligation for us to kind of wrap up those negotiations by the beginning of November typically doesn't work based on kind of the fact that the schedules for the airplanes are in a state of flux. And so just like last year, we've agreed with Continental to extend that date a little bit further just so we have better information to plan our rates on and Continental's got more time to kind of look at those rates and digest them.

The third question is as you look at the aggregate opportunity set, recognizing that you're trying to optimize a solution around 69 aircraft, how does that make you think about or does that change your thinking in terms of the options you have with Embraer?

Well, I think right now we're just right at that doorway of having a pretty good sense of what next year is going to be, and until the next few weeks pass, I think it's really difficult to say whether or not we need planes right now or we've got plenty. Right now it could go in one direction or the other. I think we feel pretty excited about the opportunities we have with the aircraft on the branded side. If we ended up with a lot of airplanes that ended up in a couple of different contracts, I think we would seriously look at sort of getting with Embraer here and exercising some of the options to take advantage of that. But until we kind of work through these last series of conversations, it's difficult to forecast what our needs are.

Harrison Wreschner, Agamas Capital.

Two questions. First off, you guys said that debt had gone down as well as cash has gone up. Could you give us a little bit more color as to one, where the debt levels currently are and two, does that imply that you guys are out buying the converts back in the market?

No, the debt levels are consistent with what you saw at the end of the second quarter of this year. So we're still at $153 million. And right now, given all the uncertainties that are in front of us, that's probably -- we would not buy debt back right now until we've sort of worked through these last couple of traps.

And then another question I guess is in regards to the Capacity Agreement with Continental, could you give us a little bit more color on how confident you are to the fact that Continental will not terminate the agreement at the end of this year?

It's hard to forecast what another entity might do. I think we provide a valuable service to them and I think when you look at their financials, both on a segment and in total, I think what we do really makes that network a lot stronger. So I feel good that we're providing some real value to them and the fact is, they thought it was good for them to diversify, it's good for us to go through this transition, diversify, even if it's a little painful in the short-term. So really, with those decisions made, we're now back to just having a very constructive relationship and trying to do everything we can to make the Continental network as strong as it can be.

In terms of â€" you've heard the comparisons, unfortunately, to [Fly I] and some of the comfort that both your equity holders and your bondholders are receiving is the fact that there is this free cash flow generation coming out of the Capacity Agreement which is providing opportunity and liquidity for you to go out and source new opportunities with 69 Jets. So if you could give us some color, I'm assuming you guys are in talks now in terms of at the end of the year renegotiating the Capacity Agreement and setting the new terms; the steps you guys are taking and just a little color on how those talks are currently going, that would be useful.

Yes, it was a very difficult budget to put together, if you can appreciate having 274 and then the transition of those airplanes. It's a very fixed cost business. So being able to kind of allocate exactly the right amount of resources it's going to take to support Continental's network was something that was going to take a little time to do. I think we provided them with kind of the insight and the information that would make it pretty clear that kind of consistent with how the language of the Agreement works, we provided them a pretty solid plan for next year. Now their job is to go through that and that's what they're doing right now, is sort of going through it with a fine tooth comb and then sort of ask those series of questions where they want to understand every element of it and make sure that we're in agreement with what they're looking at.

And that's where we are right now. We're in sort of that mechanical phase of just a budgeting process and providing kind of what our expenses look like for next year, but it was complicated to be able to do and I think they've gotten their mind wrapped around how we've approached it and now they're just going through their own reviews.

Are you guys willing to potentially accept lower margins in order to guarantee that cash flow? That's something that I think overall the investors would actually appreciate is you continuing to build out your network just so we have a little bit of visibility and stability in cash flows.

Yes, I think it just has to be the right trade-off for our shareholders. There's obviously our sector, the regional sector, is under a lot of pressure to sort of renegotiate these rates and some of that makes sense. But I have seen some networks out there that have pushed it to a point where I'm not sure it makes sense for you to go down that path without sort of re-establishing some value that you can with the service you provide and the economy. So that's the trade-off you have, is sort of accessing something that's sort of right in front of you versus sort of taking some chances. But if you know you provide value in the economy, there's got to be a line there that you don't cross. I think as a sector, everybody's trying to figure out where that line is. We're certainly able to have those conversations, it's got to make sense for our shareholders.

And just last question. A lot of your peers have gone back to their employees in terms of renegotiating some of their contracts. Are you guys planning on doing the same in order to help lower your expenses in order to make yourself more competitive in the market, potentially on the cost line?

Yes, I think really the only one recently that's been doing it are some carriers that are in bankruptcy where they have some real strategic uncertainty about their future. So not the easiest thing to do to sort of advance those conversations on the one hand. On the other hand, as we benchmark ourselves, with [Labor] DOT informations available and then going through these RFD process, I think the [overall] scale of what we bring to the marketplace makes us exceptionally competitive in this arena.

And lastly, it's hard not to recruit and retain folks. So the idea of going in there and sort of moving those wages lower, I'm not sure it's impeding positive by the time you work through the cost of all the turnover you ultimately end up with.

So I think on balance, our folks do a tremendous job. They do a really good job. Our job is to leverage their capability and to find some things where we can make the investors happy and give them some things to work on.

At this time we have no further questions.

Okay. I appreciate everybody joining us this morning. As we have facts that we can share publicly, we will absolutely do so, but I appreciate everyone's patience and rest assured that we're working on this as hard as we possibly can. Thanks again. Talk to you soon.

Ladies and gentlemen, this concludes today's teleconference. Thank you for participating. You may all disconnect.