SkyWest Inc (SKYW) 2008 Q2 法說會逐字稿

Good morning, and welcome to the SkyWest Airlines second-quarter 2008 earnings call. For your information, all participants will be in a listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. (OPERATOR INSTRUCTIONS) This conference is being recorded and transcribed. I would like to turn the conference over to Bradford Rich, SkyWest, Inc. Executive Vice President and Chief Financial Officer. Sir, you may begin.

Thank you very much. And thanks to all of you for joining us this morning. First of all, let me just begin with some introductions of those participating with us this morning on the call. I have with me here at SkyWest Chip Childs, President and Chief Operating Officer of SkyWest Airlines; Also participating via phone line will be Brad Holt, President and Chief Operating Officer at Atlantic Southeast Airlines; I also have Michael Kraupp, our Vice President of Finance and Treasurer. Eric Woodward, our Vice President and Controller with me here at SkyWest. As well as other members of our staff. Before we begin, I will turn some time to Michael Kraupp to read our forward-looking statement.

Okay. In addition to historical information this conference call may contain forward-looking statements. SkyWest may from time to time make written or oral forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements encompass SkyWest's belief, expectations, hopes or intentions regarding future events. Words such as expects, intends, believes, anticipates, should, likely and similar expressions identify forward-looking statements. All forward-looking statements included in this release and conference call are made as of the date hereof and are based on information available to SkyWest as of such date. SkyWest assumes no obligation to update any forward-looking statement. Actual results will vary, and may vary materially from those anticipated, estimated, projected or expected for a number reasons. Brad.

Thank you. Let's see. This morning I really am going to try to keep my prepared remarks very brief. As usual I will try to use the script and stick pretty close to the press release that went out this morning. I am assuming that most, if not all of you, who are participating on the call has seen our announcement this morning. And as I said, I will try to keep my remarks brief and leave as much time as we can for question and answers. This has been a quarter that has been I think one of the most unusual quarters that I've seen in quite a while in my experience at SkyWest just from a standpoint of so much activity in a lot of different areas going on within the industry. Everybody, I think, is certainly well aware of the challenges that are prevalent in our industry, as well as just market activity in general, and so it's been busy. It's been a challenging quarter. It's one in which our results as you see them reported this morning are not exactly what we expected, but in light of market conditions and the challenges that we faced, we actually are quite pleased with the results.

As you can see from the release, reported operating revenues of $950.8 million for the quarter. We reported $36.4 million in net income which is $0.63 in diluted earnings per share, that compares to $40.6 million of net income and $0.62 per diluted share for the same period last year. In looking at things on a year-to-date basis for the six months ended June 30, we reported $1.82 billion in revenue. $65.6 million and $1.10 per diluted share compared to $75.4 million of net income and $1.15 per diluted share for the same six months a year earlier.

Some of the significant items affecting our performance, certainly our production as measured by block hours is a key indicator and a metric that we look at very closely, as indicated in the release for the first time in a lot of quarters we had reduction in our block hours of 1.3%. A few comments relative to production from just a high level. First of all, the block hour reductions have been more significantly felt in our Delta system, probably not surprising given the number of 50-seat regional jets that are flying within the total Delta portfolio, given that the ASA system is flying 100% for Delta, probably not surprising that the effects of the reduced production have been more significantly seen and felt at Atlantic Southeast Airlines and have not been as material at SkyWest Airlines.

Having said that, I think it is also important to keep in mind that the -- that the production reductions that we have seen really have been very much contained to the 50-seat flying. We have not seen reductions in our 700 and 900 line, at least so far. And as far as we have seen schedules for our major partners and things, we think that flying is still very valuable flying. It is productive. We haven't seen really any schedule reductions.

Relative to the 50-seaters, keeping in mind in some cases we have seen -- I think most of you know who have been following the Company very closely include within certain contracts our block hour minimums. We have taken a lot of questions, a lot of phone calls regarding the contracts and what they say about block-hour utilization. When we talked about reductions, in some cases we are seeing utilization, black hour utilization come down to minimums. And in some cases we have seen it go below. We do have particularly with Delta, block hour minimums in the contract. In -- in cases where the block hours go below those minimums, we do have provisions that call for changes to our block hour rates, and those contractual provisions we would expect to -- you know to be enforced as we move forward. I don't suspect there is any disagreement with our partners relative to to those provisions.

Moving on to our cost per ASM. This is the first quarter in I think quite a few quarters where we have seen an increase in the cost in our nonfuel cost per ASM. Now we have indicated in the release that some of this increase is due to the timing of our heavy engine maintenance, and a lot of that maintenance -- the heavy engine maintenance is direct pass-throughs so that -- those numbers, the increases there are both in our revenue and expense. But admittedly these increases are in two categories. One is what we just talked about which is the heavy engine maintenance which is pass through so this is really just a timing event, but there is another component which is just nonengine maintenance. As you look at the increase, approximately half is related to -- or excuse me, about two-thirds is related to the increase in the pass-through maintenance, but the other is nonengine related. I will just make a comment here that we are focused very specifically on improving our maintenance reliability. We are very focused on the reliability of the product, and in some cases, that has required some additional maintenance expenses.

The good news about this is that we are seeing in SkyWest's case just maintaining very strong reliability numbers. At ASA we are seeing significant improvement in our operation reliability. When we look at the DOT reports for the quarter, in April, May and June as we look at this from a standpoint of the Mainland domestic carriers, SkyWest was number one, number three and number two respectively in the three months in the quarter. As we look at ASA's performance and look at the improvement that is being made there, if we go back to the first of the year, we see their numbers coming in at number 12. And then just steadily improving from 8, then 13, but in the quarter from 9 to number 5 to number 4. The good news is the reliability of the product is very solid, in ASA's case significant improvement is being made and that is a key issue to us.

Now it doesn't mean that we are completely neglecting our responsibility to control costs but I will say that the top priority right now is the operation reliability of the product at both airlines and -- and now that we have this good improvement, our focus will revert to making sure that we are doing everything that we can to refine the processes, reduce costs wherever we can. A little bit more relative to just production and ASMs, also as indicated in the release of our ASMs for the quarter decreased 1.5%. I've already spoken about some the scheduled utilization decreases. As we look at our ASM estimates for the third and fourth quarter and, again, I need to emphasize two things in the numbers I am about to give you as estimates.

Number one is that they are just that. They are estimates. And -- and second of all, I think that we are trying to be conservative here in our estimates and our projections. So keep those two things in mind, but I think our -- the best number we have now for the third quarter ASMs is $5.6 billion for the fourth quarter would be $5.3 billion.

We have described in the release the composition of the Fleet, the aircraft numbers and where they are flying so I won't take the time to go through that. I would like to discuss just briefly the situation with Continental and our pursuit of ExpressJet during the quarter. I think most of you are very familiar with that. I won't spend a lot of time on it other than the financial impact of that during the quarter. That is that we have negotiated with continental a break-up fee in the event and under certain circumstances and conditions related to this transaction. We did collect net of transaction expenses the -- we had some banking and legal and those kind of normal kind of expenses related to these type of transactions and the net break-up fee that we collected was $6.3 million. We have certainly taken a lot of calls and questions regarding the transaction.

I would just say that, the -- the way that this -- the transaction ended really was not a huge surprise to us. We knew that was a potential outcome all along, I mean, from the day we started talking to Continental, we knew that at some point a deal could be done with Express. That is what happened. It wasn't surprising to us. And as far as we are concerned, our -- one of our primary objectives was to further development of our relationship with Continental. And that part we feel was a significant success. And we would hope that we would have an opportunity to do some business with Continental at some point in the future and at this point, we wish ExpressJet well with their new agreement.

We have also indicated in our release some information relative to our Midwest agreement. Midwest notified us that they were going through -- that there was some restructuring that was required there. Our -- we do have some exposure there. We -- we have described it as 3.3 million at the end of June, given some of the uncertainty around that situation. We are fully reserved for that $3.3 million in the quarter. And for those of you probably wondering, that was the number at the end of June. We have agreed to a preliminary kind of a transitional type agreement with Midwest for just a couple of months here while they are trying to work out some of the details of their restructuring. I will just say we are -- there is -- certainly an ongoing amount of exposure that is building. Keep in mind it is relatively a small portion of our business. The exposure under the interim agreement that we have struck is about $2.5 million a month. So I just say that we are -- we are analyzing and monitoring that situation very closely and considering our alternatives there.

In fact some of you that follow this very closely may have seen in schedules and things that we have -- there are nine of our 21 aircraft that are scheduled out of service. So that -- we are planning on a reduced Fleet going forward at Midwest. We are working with them on the details of some modifications of the agreement. On the remaining 12, but as I said, we are still just analyzing and monitoring the situation and at the same time still working to kind of negotiate through some modest changes to our agreement.

During the quarter, we continued to be in the repurchasing of our shares. Again we've indicated in the release that during the three months, we repurchased 1.4 million shares with -- at cost of approximately $21.8 million. When you look at the year to date numbers, we have repurchased 4.5 million shares at a cost of $90.8 million. I would just make a comment there that we feel this was a prudent thing to do to this point. Obviously we always are faced with the decision of analyzing the value created by repurchasing shares relative to the value created through other alternatives, and then always factored into the equation is just market conditions, industry factors that would -- would weigh in to what our position and our philosophy would be relative to the accumulation of cash. And I just would make a general statement that although we will always being cognizant of market conditions and opportunities that exist for repurchasing of shares, given the market conditions, the uncertainty with some of our contracts, we do feel approximates very important at this point to put more emphasis on the accumulation of cash.

We have articulated our position in the release this morning relative to our IROP dispute with Delta. There is a lot of information in the release. I think, the information is there for you to read if you were interested and I am not going to take the time on this call to walk through that detail by detail. As always, we have given you information relative to our equity-based compensation programs and the expense -- our expense for that was $2.6 million in the quarter pretax.

We are still in the process of executing on our previously announced -- I will call it a Fleet transition restructuring program. That might be putting more emphasis on it than what it is, but it is a - program that -- an announced transition out of some Brazilias bringing an additional 22 700s and 900. The four 900s -- there are four 900s in that plan, they will deliver this fall. All of the 700s will deliver throughout 2009.

Relative to our cash position at the end of the quarter, we ended the quarter with $669.3 million in cash and marketable securities. Maybe of some interest, the auction rate security issue has gotten a lot of attention. I am pleased to announce that our exposure in auction rate securities at the end of the quarter of the $669.3 million was only $10.9 million. Subsequent to quarter end, that actually has reduced to $2.5 million, and so we've -- we've successfully gotten out of those auction rate securities and pleased to announce we have it without any realized losses.

We are pleased with our cash position. We think that in general an overall view of our balance sheet, our liquidity, our capital structure really does position us really at the -- at the very top of the regional industry just relative to our financial position. When you combine that with our operational strength, the quality of the operation, the improvements being made at both entities, you take our financial strengths and position relative to the operational quality, and it -- we just continue to believe it positions us right at to the of the regional industry. We are certainly cognizant and fully aware of the challenges in the industry. We are trying to specifically and creatively address issues that we might have and challenges as it exist in our partnerships where we are trying to creatively find ways to create value to our partners. We are aggressively working on improvements to our cost structure. We are very well aware of the importance of controlling our capital expenditures in an environment like this. We are doing all of the things that I think you would expect us to do to be careful and prudent with the challenges that exist. At the same time, we are not panicking. We are positioning. We are aware that in these times, there are certain carriers that are -- that have some significant challenges, and with our preparations, both financially and operationally, we stand prepared to -- to take advantage of opportunities as they become available in these challenging times. I think with that, I will go ahead and conclude the formal remarks and we will now open up for questions.

Thank you. (OPERATOR INSTRUCTIONS) At this time, our first question comes from Lily Ng from Merrill Lynch. Please go ahead.

Hi, good morning, everyone. My first question is related to your prorate business. Brad, do you think you can give us an update on what's going on there? Because there was quite a bit of talk last quarter about that part of the business, and I was just surprised you didn't give us sort of much an update.

Yes, I certainly can. I mean certainly our prorate flying is a factor in our financial performance. I'll just give you some general numbers here. I mean, we were over our plan, by $4.4 million in prorate fuel, which we have full risk. And we are also a little under plan by approximately $1 million in our prorate revenue generated. So in total relative to our plan, we were under plan pretax, $5.5 million to $6 million in our prorate flying. I think that we have -- and then total -- I mean that's relative to plan. We had planned a small loss for our prorate flying. So it's -- although it's a relatively small portion of the business, you are asking a very good question. It did have a fairly meaningful impact on our financial performance for the quarter. A lot of people will say well, what are you doing to kind of mitigate the impact of that. Without getting into a whole lot of the specifics, I mean, we do have very specifically some plans in process that I think will mitigate those losses going forward. We are very optimistic that we can get our prorate flying back very near to a break-even which I think would be a good success in this environment.

Great. And my second question is back to your dispute with Delta. I was just wondering, they have obviously resolved some of the issues they have with several other regional partners. Have you seen -- have you seen any changes in sort of the attitude, and this is mainly regarding out-of-court conversations that you have with them, even all the stuff that you have going on in court. Have you seen a change in attitude? Are they -- are they more willing to work with you guys? Or is this still -- is this still -- would you still characterize the relationship as being sort of maybe more difficult than it was by historical standards?

Let me -- I think I can answer that very concisely. We -- what we have very clear agreement on with Delta is that we are going to compartmentalize this dispute, set it off to the side, let our respective legal teams kind of deal with this. I mean I can tell you our position, our attitude about this has not changed. We have agreed with Delta to set it aside. Let our legal teams kind of deal with this. There aren't any out-of-court kind of discussions relative to that dispute going on. And on the other side, we have very productive and cordial and -- discussions going on with Delta just relative to our systems. As I mentioned earlier in my remarks, we have got to be more proactive in creating value-driven solutions to our partners including Delta and were having those kind of discussions. On one hand the discussions are very productive. We just compartmentalized this dispute off to the side and this is just kind of running its course.

Great. Thanks so much.

You are welcome.

Our next question comes from Duane Pfennigwerth from Raymond James.

Hi, guys, good morning.

Good morning.

Just in terms of your production in the second quarter. Can you speak to where you were relative to minimums, and then just the second part of that relative to the guidance that you've put forth, what does that assume relative to your block hour minimums and what does that also assume also about Midwest?

Okay. Very good question. As some of you -- well, some of you may know this already just by your -- your own reviews of our contract that is publicly filed. There is some latitude for Delta to move at certain -- at certain times below the minimums as long as they bring them back. And so we have seen particularly at ASA, we have seen the black hour utilization slip below the minimums at certain times and then it will pop back up to the minimum. So that has been happening. The projections going forward are assuming -- first of all, through September, the estimates just include the schedules that we -- that we have seen through September. And then beyond September, we are just taking what information we have, from our partners what information we have gathered from Delta, where I think we are assuming -- I mean there is a high likelihood that beyond September, they could -- they could take us below our minimums. And so that's what we have assumed there. And then on the Midwest side, we have just assumed schedules moving forward with nine aircraft scheduled out of the system.

So regarding those minimums. At what point do you bill for the minimum even if you fly below the minimum?

We -- okay, so once there is kind of a -- for lack of a better way to describe it, a more permanent schedule that takes us below the minimums, then, at that point, by contract and our block hour rates need to be modified and I don't think that we have any disagreement with Delta relative to that.

That's great. I think Jim has a question.

Okay.

Brad, this is Jim Parker. It appears that you are not enforcing your contract with Midwest. And I want to know why not given that Midwest is owned by parties that have very substantial resources, meaning Northwest and TPG.

Okay, Jim. So I may -- so what you are--?

My question is you are not enforcing your contract it appears. Are you enforcing it or not? Are they breaking the contract? Are they violating the terms of the contract?

They have -- okay -- well, okay, so to be very specific, they are in default of the contract. We have sent them notice of default, which are just the normal things that, you would expect us to do to protect our rights under the contract. Now having said that the fact that they have defaulted and we have sent them notice and they haven't cured obviously gives us the termination right if we choose. So we can either terminate or we can try to -- to work out an acceptable solution that takes into account what -- Jim, what we don't want to have is we don't want to -- I mean, we don't want to enforce the contract to the point where we are -- we are doing flying that just isn't -- that just plain and simply isn't wanted and then becomes counterproductive to their overall strategy to survive. Okay. So we are -- we are trying to work out an acceptable solution here that works for them and works for us that is more appropriately configured to their particular needs at this point given the situation they are in. So whether right or wrong or whether that is enforcing or not enforcing, I mean, that is what we are doing.

Okay. And now you spent $90 million, I think, buying back stock in the first half, is that correct?

Yes.

Why won't you spend another $90 million in the second half of the year, or will you?

Well, as I said we are going to continue to look at market conditions. We are going to continue to evaluate other alternatives that we might have relative to -- I mean, Jim, you know how this works. We are plain and simply looking at the value created from repurchasing versus the value created from other alternatives. The uncertainty in this market is that always a factor in our alternatives becomes general market and industry conditions. And with the uncertainty of, as you just mentioned our Midwest contract, the uncertainty around what our block hour utilization is going to be. The uncertainty about 50-seaters. Certain of our partners have indicated they want fewer 50-seaters. To give us -- to give us the financial flexibility to work through many of those uncertainties we feel at this point it is very important to put more emphasis on the accumulation of cash than it is a very aggressive program in repurchasing. But, I mean, I am telling you our thinking today, as some of these uncertainties become clearer, based on market conditions, that may change.

Okay. Thank you.

You are welcome.

(OPERATOR INSTRUCTIONS) Our next question comes from Bob McAdoo from Avondale Partners. Please go ahead.

Just a little bit on the 22 airplanes. Have you laid out or described anywhere or are you willing to talk about how you plan on financing those? What's your -- what's your plan? What is the cash that you would require for that?

Well, I can tell you that I -- well, I got to be a little careful here. Let me put it this way. We feel very confident in our ability to secure very attractive debt financing.

This will be with the Canadian export people?

That is certainly one source our -- as I have already said our financial position, our credit worthiness still puts us right at the top of the regional industry relative to our financing rates. And that has not been compromised. So we still feel very good about our credit rating and our ability to finance an attractive rate. So kind of as a worst-case scenario, we have the ability to debt finance all of the airplanes with -- I am probably not going to tell you exactly what the advance rate will be on that -- in those financings, but it will not take a -- it will certainly be well within industry standards of that what advance rate would be. And then we also have some productive discussions going on with certain equity participants which we are very pleased with as those of you following the financial market and the financial community relative to aircraft financing know that equity investors into these aircraft have been kind of hard to find lately, and we have some productive discussions going on there. So I would expect that a portion of the airplanes would be leased. A portion will be debt financed. And the worst-case scenario, we have the ability to debt finance all of them.

Okay. Just the other half of that. The 23 turboprops that you are going to retire. What is the market for those like now? And are these currently owned and paid for kind of planes? What is the status there?

We have -- again, I will talk somewhat generally about this. Some of the aircraft are owned. Some of them are leased. Some of the leases are coming up for expiration. We have some really -- all of the leases will expire within relative very short periods of time. We have really no material tail risk exposure on any of the leases. The aircraft that are owned, we have kind of seen the market go full circle on the value of Brazilias. A year ago the values were pretty depressed, but we all know that as fuel prices go up turboprop values seem to go up with them because of their fuel efficiency and that's what we have seen in Embraer. The market actually is as good as we have seen in in a long for disposing of owned Brazilias.

What kind of range do you see out there, not necessarily that you think you are necessarily going to get that but what are some recent transactions you might have seen out there in terms of people buying these things.

Are you talking about what prices we have seen aircraft sale?

On the 120s, yes.

Okay -- okay, well, first of all, be cognizant of the fact the conditions of the engine -- when you are talking about a roughly $2 million airplane the condition of the engines is a very material issue. But with mid time engines that are in average condition we are seeing -- well, we are having some discussion about that amongst -- they are a little under $2 million.

Okay. All right. Just under $2 million with halftime engines. All right. That's all I got. Thanks a lot.

Our next question comes from [Keith Weisman] from Calyon Securities. Please go ahead.

Just a couple of questions on the Delta contracts. Have you thought about -- especially in light of Delta looking to cut back below minimum levels, cutting back on the pro rate flying since it obviously seems to be a money-losing operation for you at this point?

The question is are we planning reductions in the prorate flying?

Or just wiping it all out for the time being at least until the oil price environment is more favorable?

I will give a very quick response that just comes to mind. I will let Chip Childs, if he wants to fill in here with any more color on it, but, I mean, we have to keep and be cognizant of, number one, the needs of our major partners and their desire to have the code. Now, certainly we are not going to be completely philanthropic about this and just provide -- you know, the -- the -- provide code -- the majors code in environments or in operations that lose money for us on a sustained basis. But we are trying to be cognizant of our major partners' desires and needs for the prevalence of the code in certain markets. And also keep in mind that these are not markets where you go in and you develop and you establish loyalty and code -- and brand loyalty and you are in today and out tomorrow and then back in when conditions change. I mean, these are markets that you make pretty good commitments, and once you make those kinds of in and out decisions, you are making some long-term decisions generally and so we are trying to factor all of that in as I previously mentioned with some things that we have in the works to significantly mitigate the losses or get this back to break-even. You know -- then, we are really being -- trying to be sensitive to the needs and wishes of our major partners with the code in these markets. But, Chip, I don't know if you want to give more color on that?

Yes, I think the other thing is if you look at some of the smaller communities that we serve with this line. We have, as oil has been increasing during the spring months we have directly communicated several of these markets and said, look, this is a big economic problem here. Oil is doing this. The values -- our service is increasing into your community and we have met with local and state and government officials about that issue and we have been very impressed with the response with that. The RAA is also out working with small communities under circumstances and these small communities don't want to lose this service and they have been able to be creative with this type of flying to provide value to the communities and make sure that there is value also for our employees to continue to have the right domiciles in place, and with all that combined with working with the major partners, as Brad said early on in the call, this is something that we are committed to and something that we think is going to be able to provide some good value going forward to the communities and to shareholders as well.

Okay. And just one other question. You had made a comment that once the permanent scheduled changed that would you go back and renegotiate the block hour rates. What is the definition of "a permanent schedule change" versus doing it for two or three quarters. What is the tipping point where it becomes considered permanent?

That is a good question. What I am referring to is just the way that our contract works. It says -- our -- the terms of our agreement with Delta basically just say if there is a reduction that lasts longer than two months with block hour utilization below the required minimums, there will be a change -- a renegotiated block hour rate. So to ask a permanent change is beyond two months.

The rates have been changed already or they will be shortly?

No, we haven't had -- we have not had at either airline schedules that had block hour reductions below the two-month requirement yet. But I am just -- I am just saying, we certainly won't -- I mean with what we are hearing, that is more likely to happen in future schedules than it has so far.

But beyond September, do you think it is possible that--?

Yes.

Okay. That's it. Thanks.

At this time, there are no further questions.

Okay. Well, I hope that we have been thorough and responsive to your questions. I would feel a bit remiss as I walked through our operational performance and the improvements and that have been made. Our DOT rankings, both airlines now are in the top five in operational reliability. We owe owe a lot of thanks and gratitude to all the men and women of SkyWest Inc. Companies that are making that happen every day and appreciate all their efforts. I continue to believe that in spite of the difficult circumstances and the difficulty environment we are in, when you combine the operational strength of our entities and combine that with the financial strength that we have, we really are well-positioned here in this market to take advantage of opportunities that are presented. So we feel very bullish and optimistic about our future. Thanks to all of our employees, and thanks to all of you participating this morning and for your time with us on the call. Thank you very much.

Thank you. That concludes today's conference call. Thank you for participating. You may disconnect your lines.