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Republic Airways Holdings (NASDAQ:RJET)

Q3 2010 Earnings Call

November 8, 2010 9:30 a.m. ET

Executives

Hal Cooper - EVP & CFO

Bryan Bedford - President & CEO

Greg Aretakis - VP, Revenue Production

Daniel Shurz - VP, Planning and Strategy

Joe Allman - VP, Controller

Tim Dooley - Vice President of FP&A

Analysts

Duane Pfennigwerth - Raymond James

Helane Becker - Dahlman Rose

Michael Linenberg - Deutsche Bank

Stephen O'Hara - Sidoti & Co.

Glenn Engle - Bank of America Merrill Lynch

Operator

Good day ladies and gentlemen and welcome to the Republic Airways Holdings third quarter 2010 Incorporated earnings conference call. [Operator Instructions.] I would now like to turn the presentation over to your host for today's call Mr. Hal Cooper, chief financial officer. Please proceed.

Hal Cooper

And thank you operator and good morning everyone, welcome to our third quarter 2010 conference call. On the call today we'll have of course Bryan Bedford, our Chairman and CEO; Joe Allman, our Vice President and Corporate Controller; Tim Dooley, our Vice President of FP&A, Greg Aretakis, our Vice President of Revenue Production; and Daniel Shurz, our Vice President of Planning and Strategy. Before we get going, let me start by covering our Safe Harbor disclosure.

Please note that the information contained in our earnings release and this call contains forward-looking information as defined by United States securities laws. Forward-looking information is subject to risk and uncertainties, and we refer you to a summary of risk factors contained in our most recent filings with the SEC.

Okay, with that, first off, as I'm sure you're all aware by now, in conjunction with our earnings release this morning we also issued a press release regarding our filing a prospectus for an equity offering that we are launching today, the proceeds from which will be used for general corporate purposes including to finance a portion of our Embraer 190 aircraft order that was just firmed up last week, and to bolster our liquidity position.

Due to the fact that we are now in registration, we are unable to answer any questions related to the offering on this call, and we'll thank you in advance for respecting this SEC-imposed restriction. With that, I'm going to turn the call over to Bryan, who's got some prepared remarks, and then we will be able to take your questions. Bryan?

Bryan Bedford

Hey thanks Hal and good morning to all of our listeners today. First, of course I'd like to start out by congratulating my 11,000 coworkers on bringing home the best quarterly financial results, frankly, we've ever had at Republic.

This summer, I had a truly unique experience seeing the wonderful work that all of our employees are doing on the front lines by going undercover inside our airline and I'm just so proud to have all of our front line folks working as hard as they are for us, working toward our shared goals of treating our guests with respect and doing everything they can to make this a successful airline. And I think our third quarter results demonstrate that their hard work is paying off. So a big thank you to all 11,000 of my coworkers.

I'd like to highlight a couple of results from our earnings release this morning, so let me start by breaking out some of our fixed-fee business segment results. A very good quarter for us, with pre-tax income of $22.7 million. That's a pre-tax margin of 8.7% on our fixed-fee revenues. And that's slightly better than the 7- 8% guidance that we've historically provided and we improved this result by utilizing the planes a little better and actually had slightly better unit cost performance than we were expecting.

Unit costs ex fuel for the quarter actually dropped to $0.0752 from $0.0761 in the prior third quarter. This is a particularly good result given that our average stage length actually decreased about 5% in our fixed-fee business. Of course, we realize we must remain both a high-reliable airline and a unit cost-competitive airline in order to remain a preferred provider in this segment, and we do remain committed to both operational quality and cost leadership in this market.

Excluding fuel, our fixed-fee service revenues were down about $21 million, or 8% ,on a 7% decrease in block hours, and that's the effect of a reduction of approximately 15 lines of 50-seat [lines] that have exited our fixed-fee business over the last year.

Turning to the Frontier operation, I'm pleased to say that we continue to improve our operational and financial performance. Total revenues were $445.8 million for the quarter. That's an increase of 9.7% from the combined Frontier/Midwest 2009 results, and that revenue increase was achieved on a capacity increase of 7.8% for the third quarter.

Unit revenues in the third quarter came in at $0.1151, which is a 2% increase over '09 results and in line with the guidance of 1-3% we gave on our last call, and I'll ask our VP of revenue management, Greg Aretakis, to give you a little more color on that in just a minute.

Our load factors at Frontier for the quarter remained very strong. We produced an 87.4% load factor for the third quarter, which was another record and compared favorably to the 86.1% load factor in Q3 '09.

Fuel costs for the quarter came in at $2.32 per gallon, and that excludes a $200,000 charge we took for our fuel hedge mark-to-market adjustment.

Operating unit costs for the quarter, excluding fuel, was $0.0717. If we exclude a $7.6 million cost of integration and aircraft return expenses that we incurred in the quarter, our actual unit costs were $0.0698, and we produced that with an average seat density of just about 100 seats per departure in our branded operation, so we're very pleased with the progress we're making on Frontier's unit cost structure.

We reported a GAAP pre-tax income for the quarter at Frontier of $11.6 million, but on an ex-items basis we're reporting $19.4 million in pre-tax income. Overall, the company has remained stable, and has performed nicely. We have a consolidated pre-tax ex-item profit of $42.9 million, which tax-affected would result in a net income of $26 million.

Earnings per share for the quarter - and again we recognize this can get a little confusing, so I'll try to break it down for you - GAAP EPS was $0.58, and that's using a diluted share count that now includes the $2.5 million in convertible shares associated with our $25 million TPG note facility. Excluding those shares, you'd add back $0.04 and the result, excluding the items for the quarter, would add back another $0.14. So excluding those two items, we're at $0.76 for the quarter, which compares nicely to the guidance that we gave on our last call, which was a range of $0.65 to $0.70 ex-items. So again, we're very pleased with how the quarter shaped up.

As we look into Q4, we're obviously seeing oil prices that are moving higher, and that will impact results. We're now projecting consolidated earnings per share on an ex-item basis of $0.05 to $0.10 for Q4, and that's assuming current fuel prices.

Greg will walk you through our capacity and revenue results, and some guidance for Frontier operations.

Greg Aretakis

Thanks Bryan, and good morning everyone. I'd like to start this morning by reviewing the third-quarter actual results versus the guidance we gave on the last call, and as Bryan mentioned earlier, give you some color as to what's going on within the 2% TRASM increase.

Third quarter results, as Bryan mentioned, on our last call we had guided for 1-3% increase in TRASM versus 2009 for the combined operation for Q3 and we came in right in the middle of that at 2%. While that number may seem a bit low to what the rest of the industry is announcing, when you break down our TRASM you'll see we achieved a passenger ticket unit revenue increase of 9%. That was aided by our focus on our Classic and Classic Plus bundled products, which passengers pay a higher fare that includes payments for what would otherwise be categorized as ancillary revenues, which is part of the reason why our TRASM number is lower than the change in our ticket revenues.

On a year-over-year basis, our stage length at Frontier was up 7%, which we believe reduced our TRASM comp by 2-3%. And of course, we still have the accounting adjustment to revenue associated with the acquisition and other differences in accounting year-over-year, which for the quarter had a negative effect of a couple of percent.

In the third quarter, we had forecast a capacity increase of 7-9%, and we came in at 7.8%. As I mentioned, in the third quarter we began a marketing effort to promote our bundled fares, and that effort is ongoing. These products, available primarily on the Frontier Airlines website, offer our customers choice and value that sets Frontier apart from other domestic airlines.

During the summer, we used our Classic and Classic Plus bundled products and promoted them, and they increased by more than 70%. Now, granted, that's off a fairly low base of usage. However, we remain very encouraged by the response that we got to the bundled products. As we increase sales of these products, we are also shifting sales to our lower cost internal distribution channels. Effective October 1, these products are now fully available on the former Midwest Airlines network, and we expect them to be just as popular as they have been for the Denver customers.

The competitive landscape's been a bit more calm that what we were seeing a quarter ago. While we continue to see a steady diet of weekly sales, most of these are capacity controlled or limited to offbeat travel days. And industry-wide we've seen a number of efforts recently to get fares to go up. Many of these have been successful. Given the demand in the industry, it wouldn't be surprising to see this trend continue.

For the December quarter, we're now looking at capacity to be flat to down 1% from the fourth quarter of 2009 and we expect the TRASM to be flat to up 2% versus 2009's fourth quarter results of $0.1016, so in the $0.106 to $0.108 range. Again, the capacity is driven by our ongoing re-fleeting efforts.

Full-year 2010 capacity increase for Frontier should come in right around 6%, and full-year TRASM should still land us in a range we've previously been talking about, which is a $0.105 to $0.107 range result of flat to up 2% for the year.

We're also introducing capacity guidance for 2011 of 4-5%, heavily weighted to the last two quarters of 2011. This morning we updated our website. We have forecasts and statistics for all of 2011 for Frontier and the fixed-fee business.

A quick look at advanced bookings on the branded business for the fourth quarter. October is in the can now. We ran 83% load factor, which was a record for the combined system and up 2 points versus October 2009. November and December are both looking strong, and we believe that we could end up as much as four load factor points ahead of the 77% load factors we reported for each of those months last year.

And with that, I'll pass it off to Daniel Shurz to talk a little bit about our fleet development and changes in the network. Daniel?

Daniel Shurz

Thanks Greg, and thanks Bryan. In the third quarter we ended up with a relatively stable network. We had a lot of development in the second quarter. We only added one new market during the third quarter, and after Labor Day we discontinued two other markets.

And combined with the removal of the four 318s and the one A170 from the Frontier schedule, we've been making some more detailed schedule optimization changes in the past to remove weak flights from the system on a day-of-week basis in the weakest travel periods in Q4 and Q1.We've made some announcements about new services in the first quarter of 2011, the most significant of all the new deployment of an A190 in Omaha for new flights to California and Florida.

As Greg mentioned, we expect our fourth quarter capacity to be flat to down 1%, and the first quarter of 2011 will follow that trend as we expect capacity now to be flat to up 1%, again, primarily driven by the reduction in our fleet in September.

As a reminder, we are making some significant changes to our Milwaukee hub schedule in November that includes basing additional A319s in Milwaukee and reducing the level of utilization on our high-unit-cost E135 and E145 aircraft that are based there. Our seats per departure in Milwaukee will grow from 64 to 72 after implementation, and in February we'll be offering nonstop service to 36 destinations from Milwaukee, which is five more than a year earlier.

Finally, let me turn to our expectations on competitive capacity. We expect total domestic capacity in Denver to be up 6-7% in the fourth quarter, which will be the highest rate of increase during 2010, and we actually expect that growth to moderate in Q1 to a range of 3-5%.

Milwaukee capacity growth levels have definitely been moderating due to changes that we're making at Frontier as well as diminished competitive growth, and we now expect growth of 9-10% in domestic capacity in Q4 and 5-7% in Q1 2011. And the landscape in Kansas City remains very calm. We expect domestic capacity in Q4 to drop by between zero and minus one percent, and we expect capacity growth in the first quarter to be between 2% and 4%.

With that, I'll turn the call back to Bryan.

Bryan Bedford

Thank you Daniel. Finally, I just want to touch on our announcement last Friday that we've firmed up six Embraer 190 aircraft for delivery in the second half of 2011. We have the ability to take an additional 18 E190s or E195s, basically at one aircraft per month starting in January of 2012. And these aircraft would be used to replace on a one-for-one basis our smaller 37- to 76-seat aircraft in our Frontier portfolio.

Now that change, combined with our desire to replace our remaining A318 aircraft with A319 or A320 aircraft, means that we will be doing a lot of work over the next year or two to up-gage the equipment on our Frontier business. That should further lower our already low unit costs.

These fleet changes are expected to increase our average seat density by about 10% over the next two years and our fleet transformation will see us remove our five remaining 120-seat A318s and replace them with three 186-seat A319s and seven 162-seat A320s.

We intend to remove six smaller jets as our new E190s are delivered next year. We already have competitive unit costs. Again, we believe that these fleet enhancements will both expand that unit cost advantage and give us much better, more mission-capable equipment. So we believe this is a solid strategic transaction for our Frontier business.

And with that summary, operator I think we're ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions.] Your first question comes from the line of Duane Pfennigwerth from Raymond James.

Duane Pfennigwerth - Raymond James

Just wondering on the branded business if you could talk about near term. Ex fuel costs, it looks like capacity is going to be down sequentially, so how should we think about the cost profile in the near term? And then also, what explicitly is your fuel guidance for the fourth quarter? And if you could tell us, what spot jet number that assumes?

Tim Dooley

The fuel prices, assuming a $2.50 per gallon, which puts you right around [$]83, [$]84, that range on a per-barrel basis. As for unit costs, into 2011 we think the re-fleeting will have some benefit on those unit costs. However, we do know that we have higher scheduled Airbus maintenance costs in 2011. So those two should sort of cancel each other out, but we're still in the process of forecasting 2011, and seeing how it all falls out. But we're likely to stay in that 7.0 ex-fuel range going forward.

Duane Pfennigwerth

And specifically the fourth quarter relative to the third quarter, just trying to get to the magnitude of the branded losses that are implied in that 5- to10- cent guidance.

Tim Dooley

The fixed-fee business is projected to make 7-8% in the fourth quarter, so you can do the math and figure out what the branded losses would be in the Q4.

Duane Pfennigwerth

Just on cash flow, wondering if there was anything that sort of helped you either financing-related or maybe timing of payments in the quarter. Can you give us some color there and maybe update us on where unrestricted cash is as of today?

Joe Allman

We're sitting on about $199 million of unrestricted cash today. We did have some timing issues at the end of the quarter where we had received some cash in related to an asset sale that went out subsequent to the quarter filing, and that's about $5 million. So it's a little bit higher than what I think we guided you to. I think we were thinking we'd be in the $193 million to $196 million range and we ended at about $199 million.

Duane Pfennigwerth

And then just lastly, on Denver, wondering if you could comment, what percent of your network is Denver, and then on those competing capacity stats, I assume that's total supply. What is your supply growth versus competing supply growth that compromises that up 6-7[%] and up 3-5[%].

Daniel Shurz

Denver, on an ASM basis, varies by month, but as ASMs in the Frontier network, call it 75-76% of the Frontier network is Denver-based approximately. There are three main components of Denver capacity: in order of size, United, ourselves, and Southwest. Essentially you're looking at United flat to down 1% for forward months. You're looking at ourselves in the down 2-3% Q4, down a little bit less than Q1. And you're looking at Southwest growth rates between 30-40% year-over-year in each of the months. It's starting to trail off somewhat in March to upper 20s.

Operator

Your next question comes from the line of Helane Becker from Dahlman Rose.

Helane Becker - Dahlman Rose

Just in terms of the outlook for the restricted cash, I know you don't want any questions with respect to the equity offerings, but does that help with either financing costs or does that help with the credit card holdbacks? Or can you adjust that at all?

Joe Allman

Right now I don't expect any significant change in that. Obviously we will strike up additional discussions with our partner on that front, but we had that before us as we look into 2011 as well, and we think we can do better. But that's about as much guidance as I can get you there.

Helane Becker

And then just in terms of the aircraft on order, can you get ex in financing for that?

Bryan Bedford

Yes, we have been in discussions with the [BNDS] and feel very good about the financing prospects for attaining competitive financing on the Embraer deal. I think an additional component of the capital raise that we're doing will certainly, at least in our view, result in a better credit assessment, which enhances the ability to pay in the financing as well as improves the credit terms of the financing, so that is a halo effect of the offering. Having said that, what we have worked out is backstop financing with Embraer on these six firm planes, which is why we in fact would go firm. We wouldn't firm up aircraft that we have financing already arranged and on terms that we understood and had modeled. So that's why 18 remain conditionally firm. So we'll just have to see how that works out over the course of the next several quarters.

Helane Becker

Okay, great. Great performance there, Bryan, on Undercover Boss.

Bryan Bedford

[Laughter.] Thanks Helane. That wig was uncomfortable.

Helane Becker

I bet it was. Thanks for the help.

Operator

Your next question comes from the line of Michael Linenberg from Deutsche Bank.

Michael Linenberg - Deutsche Bank

Couple questions. First, where is your hedge position for the fourth quarter and 2011? If you indicated it I apologize.

Tim Dooley

We're hedged 10% in the fourth quarter, and that's without the money calls which are actually pretty close to being in the money at this point. We just have a 5% slice for Q2 through Q4 of 2011 and those are using [inaudible].

Michael Linenberg

And then my second question, and this is to Bryan. Any update on where we are with the pilots and the flight attendants at Republic in their contracts and even some of the potential seniority integration issues?

Bryan Bedford

There's not a lot I can tell you on that, other than I can represent that all the work groups have been working just about as well as you could possibly expect, in a collegial way, trying to come up with an integrated seniority list that all folks can live with. And yes, I do sense that there is a good dialog going there, and that's happening under the auspices of a federal mediator, which again is not a requirement. It's something that we recommended they engage and they accepted that. So again, not a lot I can tell you on the process, other than dialog is ongoing. It seems to be collegial and I believe it will get worked out in due course.

Operator

Your next question comes from the line of Steve O'Hara of Sidoti.

Stephen O'Hara - Sidoti & Co.

Could you just talk about the branded offering? How standardized is that across the network at this point? And when do you expect to be a standard offering?

Bryan Bedford

That's a great question Steve. Again, we've got a lot of different products in that mix, from small regional jets, 37-50 seaters, then moving into E-Jet products ranging from 76-99 seats, and then of course into the Airbus with products from 120-162 seats. So even though we have three different airplane types we've got a lot of variance in the gauge. And that's something that we recognize as a real opportunity for us to address over 2011, and that some of the aircraft fleeting announcements we've made recently, both on Airbus and E-Jet move us a lot closer in the direction we want to go.

As we sit here going into the Thanksgiving holiday, we will actually have our stretch seating products, which gives you at least five extra inches of leg room in coach. That product will actually be rolled out on all of our E-Jet and Airbus product offerings in time for the holidays. We have Wi-Fi products on all of the E-Jet's that are - I believe we start offering that product on December 1. The fleet will be completed by the end of the year. And that's using the GoGo Wi-Fi product, and of course we have live TV on all Airbus products. So the product offering is getting a lot more consistent with the availability of stretch and some form of in-flight entertainment. And we'll make further progress on that in 2011 as we start changing out some of the smaller aircraft for the right size capacity.

Stephen O'Hara

Okay, and you think that will aid in - it's got to help on the selling aspect, where you're using it in different aircraft or something like that. It's got to help the planning, right?

Bryan Bedford

Well clearly people prefer the larger capacity planes. The E-Jets are great, but we can operate an E190 for about the same block hour cost as we can operate an E170, yet we pick up an extra 23 seats, so that's a great product for us. Not only does it have terrific range from our hubs, but it has extraordinarily attractive operating economics. So those are good upgrade opportunities for us. I think the same is true for operating an A320 versus a A318. Our block hour costs are just about the same, but you pick up an extra 42 seats. When you're running plus 90% load factors in the peak summer months - June, July, August. We're projecting a lot of demand, so we just think this is incrementally moving us in the right direction for making us a competitive low-cost provider.

Operator

Your next question comes from the line of Glenn Engle from Bank of America Merrill Lynch.

Glenn Engle - Bank of America Merrill Lynch

A few questions please. The first is can you talk about the Southwest AirTran acquisition, whether it means anything to you in Milwaukee?

Bryan Bedford

It's hard for us to get in the minds of Southwest Airlines on a market-specific basis. I think what we would tell you is probably what you've heard elsewhere, that we really don't see competition increasing any differently with a merged Southwest/AirTran than we would otherwise if they didn't merge. Now, having said that, you can appreciate any time you can actually take a brand off the store shelf it's one less competitor in the marketplace, and we think that's a positive. Of course, Southwest is a higher-unit-cost producer than AirTran, and it's our experience in this business that costs tend to migrate from the lower- to the higher-unit-cost producer, which could lead to a more rational pricing environment. And certainly it extends our competitive cost lead in overlapping markets. So again, Southwest is obviously the big guy in the market anyway. The fact that they're going to be a little bit bigger doesn't necessarily change the dynamics from our perspective. Again, I think it's fair to say that one less brand means one less competitor in the marketplace.

Glenn Engle

And how are you doing fighting for the business travel in Milwaukee right now?

Daniel Shurz

I think we've seen gradual strengthening in the year-over-year performance on unit revenue in Milwaukee. As we've added back destinations, particularly on the East Coast - Raleigh earlier in the year, Hartford at the end of September - I think it's become clear again in the market that we are the natural business category in the most important markets. We are seeing good response in terms of booking to our [inaudible] it's in good loads all summer and obviously with bigger aircraft coming into Milwaukee and northeast markets later this month I think we're going to continue to see this.

Glenn Engle

Finally, can you go through the aircraft that are scheduled to be - leases that are scheduled to be expiring over the next couple of years, and whether the integration costs are likely to remain fairly steady over the next several quarters?

Bryan Bedford

We'll probably have to take that one offline with you Glenn.

Operator

And at this moment I'm showing no further questions on the line. I'd like to turn the call over to management for closing remarks.

Bryan Bedford

Appreciate the time with you this morning. Again, want to thank our 11,000 employees on a terrific quarter, and frankly a great head start going into October. So please keep up the great work and we look forward to giving you another positive update on the business when we give you our year-end results in March. So thanks so much.

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