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Hawaiian Holdings (NASDAQ:HA)

Q3 2012 Earnings Call

October 23, 2012 04:30 PM ET

Executives

Susan Donofrio - Senior Director, IR

Mark Dunkerley - President & CEO

Scott Topping - EVP & CFO

Analysts

John Godyn - Morgan Stanley

Hunter Keay - Wolfe Trahan

Helane Becker - Dahlman Rose

Glenn Engel - Bank of America Merrill Lynch

Steve O’Hara - Sidoti & Company

John Reardon - Crowell, Weedon

Operator

Greetings and welcome to the Hawaiian Holdings Third Quarter 2012 Earnings Conference Call. (Operator Instructions). It is now my pleasure to introduce your host Susan Donofrio, Senior Director of Investor Relations for Hawaiian Holdings. Thank you. You may begin.

Susan Donofrio - Senior Director, IR

Thank you. Welcome everyone and thank you for joining us today to discuss Hawaiian Holdings third quarter 2012 financial results. On the call with me today are Mark Dunkerley, President and Chief Executive Officer and Scott Topping, Chief Financial Officer.

By now, everyone should have access to the press release which went out at about 4 O’clock Eastern Time today. If you have not received a release it is available on the Investor Relations page of Hawaiian’s website.

Before we begin, we’d like to remind everyone 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 and therefore undue reliance should not be placed upon them.

For 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 Holding’s recent filings with the SEC, including the most recent annual report filed on Form 10-K, recent quarterly reports filed on Form 10-Q, as well as reports filed on Form 8-K.

And With that, I’d like to turn the call over to Mark.

Mark Dunkerley

Thank you Susan and thank you all for joining us today. We were pleased to report another profitable quarter with expanding margins. We have done this at a time when we have grown capacity 28% is particularly noteworthy as it is unusual for an airline to grow substantially and to improve its margins at the same time. Our strategy of diversifying the sources of our revenue by growing into markets that have not been a traditional main state of our business continues to generate good results. As I hope I have never failed to mention the hard work and diligence of my colleagues at Hawaiian are cheaply responsible for the company’s achievements.

As unusual as it is for rapidly growing airline to remain profitable, it is equally challenging for growing airline to keep its hard one reputation for excellence in customer service. But our boys have as always risen to this challenge. Thanks to their hard work, Hawaiian remains the preferred carrier in all of the markets we serve. My colleagues have my deep thanks. Turning to the financial results that are high level both revenues and cost came in lower than we had forecasted at the beginning of the quarter. The revenue gap was largely a result of some substantial capacity growth in a number of select markets colliding with one of the seasonally biggest months of the year in September.

The improvements in cost against our prior guidance were the result of carrying fewer passengers and incurring lower maintenance expenses than anticipated. We had lot going on in the quarter, in July we increased our solo flights to daily from four times a week. This was partly to accommodate some of the growing demand for Korea to Hawaii seats and partly to provide good connections between China and Hawaii. To those of you who have not yet been Tengchong Airport is the best airport for connections in that part of the world.

We made progress towards acquiring a small number of turboprop aircraft, the new turboprop operation will provide service to communities which we don’t serve and which are too slow to watch services with larger aircraft. Our target date for an entry into service is in the back half of 2013. These communities are both the source of traffic for our other services as well as been a destination for visitors to the islands.

The new turboprop operation will complete our Hawaii product offering and cement our position as the flight carrier of our island home. We also implemented the first comprehensive redesign of our domestic onboard service in more than a decade. While continuing to offer the most comfortable cabins on our Hawaii 48 aircraft serving Hawaiian. Our onboard service has been completely redesigned to provide more on what our guest say they value most.

Delicious complimentary meals and cocktails, local products and our friendly attentive service. The feedback has been extremely good. Along with our leadership and punctuality and in the avoidance of cancellations, the redesign of our domestic onboard service no doubt helped in our being named recently the best U.S. airline amongst those who serve Hawaii while the readers of Condé Nast Traveler.

In just over a week we will be inaugurating service to our fourth Japanese City with three weekly flights to Sapporo. Next month Brisbane will become our second gateway in Australia and in March we will begin flying to Auckland, New Zealand. Looking backwards from the start of the Auckland service we will have started flights to eight new cities, seven of them overseas in less than three years.

Notably we will be the one only U.S. carrier serving Sapporo, Brisbane and Auckland. With that the heavy list of recent developments mentioned let me turn the call over Scott to review the results of the quarter in more detail. Scott?

Scott Topping

Thank you Mark. For the third quarter the company reported adjusted net income for selecting economic fuel expense of 40.6 million or $0.77 per share which exceeds the consensus estimate of $0.71. This compared to adjusted net income of 30 million or $0.59 per share in the same period last year.

The company reported GAAP net income of 45.5 million or $0.86 per share compared to 25.6 million or $0.50 per share in the third quarter of 2011. Both operating and net margins expanded year-over-year and trailing 12 month ROIC was 17.2% before tax and 10.7% on after tax basis.

Operating revenue was 549 million up 93 million or 20.5% year-over-year on a 28% increase in the capacity. Passenger revenue increased 20.5% compared to the third quarter of last year. Load factor for the quarter decreased 1.9 percentage points to 83.3% while yield decreased 3.6%. Combined this produced a decrease in revenue (inaudible) and a decrease in PRASM of 5.7%.

There are substantial impacts on our unit revenues from mix, in a moment Mark will dwell into the revenue picture in greater deal. Despite the headline fall in unit revenues we will decrease the demand environment for the Hawaii vacation as remaining strong. As expected other revenues grew at slower pace than capacity. However cargo revenue continues to strengthen improving 34% boasted by the expansion of our fleet and network. More A330s flying in the system in a higher proportion of international flights, we’re seeing positive trends for cargo revenue despite of weak global environment for cargo.

On the expense lines aircraft fuel costs increased 29.8 million or 21.9% driven primarily by an increase in volume. We consume 54.5 million gallons of jet fuel up 27.1% from the same period last year. The increase in consumption was partially offset by lower fuel prices year-over-year. Our economic fuel cost per gallon including hedging gains, losses and expenses related to contract settling during the third quarter was 307 compared to 322 in last year’s quarter. Our GAAP fuel cost was 304 per gallon compared to 317 last year.

We continue to maintain a disciplined approach to fuel hedging; we have hedged 67% of our consumption in the current quarter. In 2013, we have hedged 55% in the first quarter, 43% on the second quarter, 34% in the third quarter and 21% in the fourth quarter. In 2014, we have hedged 10% in the first quarter. More details can be found in the press release.

Aircraft rent expense was relatively flat compared to the prior year quarter, as we lapped the refinancing of our 717 fleet in June of last year when we terminated leases on 15, 717s and refinanced them with debt.

Additionally while we have two new leased aircraft this year as 717 and a A330 the cost associated with these aircraft are offset by cost savings from the return of a 767 in the fourth quarter of 2011. Depreciation and amortization expense increased 31.4% year-over-year to 23 million reflecting the addition of 3 debt financed A330s.

Our affected tax rate in the third quarter was 38.4% and we expect a similar rate going forward. Throughout the operating line we reported non-operating expense of 1.1 million in the quarter compared to 13.6 million in the prior quarter. The most significant difference year-over-year relates to unrealized gains on future hedge positions compared to unrealized losses in the prior period.

Hedge positions are market fair value under our accounting policies and changes or recognized through non-operating expense. The unrealized gains on fuel hedges were partially offset by higher interest and debt amortization expense in the quarter. Our balance sheet remain strong in this period of rapid growth. We ended the quarter with 433 million and unrestricted cash and another five million in restricted cash. Our revolving credit facility remained undrawn at the end of the third quarter providing additional liquidity of 67 million which is net of letters of credit.

At the end of the quarter our cash and equivalence was capacity under the revolver was 26% of trailing 12 month revenues. Financial leverage is measured by adjusted debt to total capital was 83% at the end of the quarter. This is down from a peak of 85.4% at last year’s end and we expect this metric to trend lower.

CapEx in the quarter was 41 million which includes pre-delivery payments of 31 million related to future aircraft and engine deliveries and 10 million related to other non-aircraft items. Also on the quarter we made an accelerated contribution to our pension plans of 12 million satisfying our required 2012 plan year contribution.

This brings the year-to-date total contributions to our pension and other benefit plans to 19 million. With that I’ll turn the call back over to Mark for further commentary on the business.

Mark Dunkerley

Thank you Scott. Our third quarter revenue results were mixed in every sense of the word. For the first time since I have been at Hawaiian we had both good and bad route results in each segment of our business with no correlation between new routes and established routes. Instead the individual route results correlated inversely with industry capacity growth. This mixed bag of individual route results vindicates our strategy of diversifying our business since in doing so we have less at risk whenever market specific issues dominate individual route results.

I will start with North America which now accounts for 47% of our passenger revenue that’s down from 63% three years ago. Overall industry capacity was up 13% for the quarter of which our contribution was 5 percentage points. Leaving out on new JFK service which by the way is doing just fine and United’s new DC service to get closer to the picture of what was happening on the West Coast, the number has become 10% for the industry and 2 percentage points for us. Even here the overall picture obscures a tremendous concentration of that capacity increase in the Bay area and Southern California.

Bay area industry capacity was up 25% and Southern California capacity was up 15%. Demand during the summer peak was sufficient to pillow of these seats but we knew that with the seasonal decline of demand from a peak in August into a trough in September yields and loads were going to suffer. We didn’t know by how much and as you saw in our revised guidance the falling away of revenues in September was deeper than we initially estimated.

With all that said and done the overall result for our North America routes was a present decrease of less than 1% in the face of some substantial capacity increases. Despite the pricing weakness in the few markets we continue to decrease the demand conditions throughout our North American business as good, because wherever capacity increases have been more moderate we have been able to fill planes and raise yields.

And even where capacity has grown rapidly there has been growth in the number of people visiting Hawaii or be it not enough to fill all of the additional seats. Looking ahead to the fourth quarter while the supply increases from the West Coast are decelerating when compared to the third quarter, overall capacity remains high as was the case in the third quarter, the capacity increases are concentrated in the Bay area in Southern California as a result on these select routes we anticipate the continuation of a competitive pricing environment.

It's a little bit of the same story in our international segment which contributed 31% of our passenger revenues in the quarter. That’s a growth of 36% in one year. Capacity increased 46% with the largest contribution coming from the inauguration of Fukuoka route.

Our capacity on existing routes increased by 23%. This came mainly from increased frequencies to Sydney and Incheon and in an up gage in equipment from a 767 to an A330 on our Osaka route. Load factor declined 3.8 percentage points while PRASM decreased 6.8%. Just like our North America segment the overall result is a combination of some vastly different individual route performance numbers.

First of all mix accounted for almost the entire declined in PRASM with the same store comparisons generating about flat PRASM year-over-year. The new international flying has been on slightly longer stage lengths which all things been equal will tend to depress unit revenues while lowering unit cost similarly. Within our route portfolio we continue to see good results for Tokyo, Osaka and Sydney. In the last year we inaugurated Fukuoka service in this new route is ramping up more slowly than prior Japan startups. It's still a good route for us, it's just ramping up at a more normal pace than had our other Japan services.

Our decision to increase capacity to Seoul was immediately followed by the decision of a competitor to do likewise. So there currently exists access capacity on this route which has had the predictable effects on yield. However demand on this route is growing rapidly not at least from the flow of Chinese visitors using Seoul as a connection point to Hawaii.

So we don’t expect the excess capacity to last long. Looking ahead to the fourth quarter the nature of distribution in these markets reduces our forward visibility when compared to that in our domestic markets. Without appropriate caveat said we would anticipated the same kind of mixed bag of route performance in this segment of our business with little impact coming from the early days of our two new routes.

Turning to our Neighbor Island business we saw higher traffic throughout the quarter but demand fell short of our capacity increases later in the period. The result was a third quarter PRASM decline of 7% with load factor declining 3.2 percentage points on capacity growth of 11.3%.

There was no effect from mix and so these results are pretty much directly comparable on a year-over-year basis. As with the long haul geographies, our results were mixed by route. Performance on certain route suggest that we have struck a good balance of supple to demand. On one route in particular however we didn’t see the traffic we anticipated materialize in September. There are couple of reasons for this, part of our Neighbor Island business is from other airlines. In September with some airlines clearly having difficulty in filling their own seats, we saw a reduction in the number of passengers transferring to our inter-island business from other airlines.

If you got empty seats to fill on your nonstop flights to some of the smaller destinations it's likely that you’re going to incentive your customer to go on that flight rather than to make a connection. So to a degree the full often Neighbor Island demand is partially result of the North America competitive dynamic at play.

In addition, during the summer we changed our pay structure to give us more control over managing our revenues. One of the objectives was to encourage this traditionally very late booking market to book a little earlier. They succeeded to a greater degree than we anticipated giving us what turned out to be a slightly misleading indication of the level of traffic we could expect when the aircraft doors finally closed. We are happy with the new pay structure and we are happy to see that it is having the desired of shifting the booking curve. So we are not second guessing our approach.

So what are we going to do going forward? Well on our North America routes we are fine tuning how we route capacity into an out of certain markets according to the time of year and the natural seasonality of demand. What we are not doing is drawing back from any of the routes in our portfolio. Our routes are profitable; we believe we have the best products. We attract the highest fares on the cost which are equal to or lower than those of any of our main competitors and we also believe that our distribution of capacity between the various routes to North America aligns with demand.

Taken together we like our position in the overall market and we are comfortable that this will continue to be a segment of the business that will contribute to our results. In our international segment we are pleased with the business and our as you know in all rating new services to new destinations in the coming few months. The early bookings for these new services looks strong.

Closer to home, we have already cut capacity for 4% to 5% over what have been in the Interisland schedule to better align the number of seats to demand on each route. We expect this improve our Neighbor Island results although it may take a quarter or so to judge the effect of these changes.

But looking at the quarter as a whole we were pleased to have our margins improve over the last year while been able to grow capacity by 28%. We had some unusual competitor and capacity dynamics in a couple of markets on the U.S. Mainland, in Asia and also in Hawaii. But all and all demand for the Hawaii vacation remained strong and we feel we are well positioned to take advantage of visitor growth with our existing services and those which we look forward to inaugurating in the next few months.

Let me turn it back over to Scott to give us a window into next quarter.

Scott Topping

Thank you Mark. Looking at the quarter in front of us, our growth will continue and we expect capacity to increase between 28.5% and 30.5% compared to the same period in 2011. For the full year of 2012 we expect year-over-year capacity to increase 20.5% to 23.5%, with no additional A330 entering our fleet until March there is little sequential capacity growth over the next two quarters though the year-over-year growth remains high. In addition our new deliveries in 2013 or for the most part offset by planned retirements.

Load factor for the quarter is expected to be in the range of down one to up one percentage points; yield is expected to be in the range of down 7.5% to 4.5%, combining these numbers we expect PRASM to be in the range of down 8% to down 5%. On a mix adjusted basis PRASM would be 4 to 4 percentage points better.

Other revenue will again grow at slower rates in passenger revenue diluting the growth in operating revenue per ASM compared to passenger revenue per ASM. The net result is that RASM is expected to be down 8.5% to down 5.5% compared to the fourth quarter of 2011.

Turning to cost, all year, we have noted that the first half of this year would contain a disproportionate amount of startup costs as well as unusually high pension expense relative to prior periods. We have also noted that in the second half of the year capacity added in the first half would drive unit cost slower.

This was reflected in the third quarter results and should continue through the fourth quarter where we expect CASM ex-fuel to be down 8.5 to down 5.5 percentage points. For the full year we expect CASM ex-fuel and ex-lease termination costs to improve from the guidance we had previously issued to be down to 6% to down 3%. Since last quarter we have made good progress with our financing plans, we recently agreed to terms with a bank to finance a A330 delivering in June 2013. With this finalized, financing will be in place to cover four of the five A330s scheduled to deliver next year.

We are also in a process of evaluating funding alternatives for our fifth 2013 delivery and early 2014 deliveries. We are confident in our ability to fund our growth as the A330 remains the favorites of vendors and (inaudible).

In the fourth quarter, we expect CapEx to be in the 55 to 60 million range. For the year, we estimate total spending between 380 and 390 million versus our prior expectation of 365 to 375 million. The difference is due to the purchase of two turboprop aircraft. With respect to interest expense we expect a similar level as we move sequentially from third quarter to fourth quarter.

Regarding fuel and staying with our normal practice, we are not going to give price guidance at this time. We expect our fuel consumption to be up 26% to 28% year-over-year in the fourth quarter as a result of our growth. With that said we have reached the conclusion of our prepared remarks. I like to thank all of you for being with us today and for your continued interest in Hawaiian airlines. I will turn the call back over to the operator now to open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Thank you. Our first question comes from the line of John Godyn with Morgan Stanley. Please proceed with your questions.

John Godyn - Morgan Stanley

First I was just hoping kind of clarify some of the commentary around PRASM, it sounds like Mark, a lot of the issues that you’re talking about are capacity related. What we had heard from some other companies was that there was this period of demand softness in September that had since stabilized, it sounds like you didn’t experience either the softness or the subsequent firming and everything that’s driving PRASM primarily is capacity, is that a fare characterization?

Mark Dunkerley

I think the capacity issues sort of dominated the picture. It maybe that there was some kind of finer granularity that other people saw I think, you know when we have seen such enormous capacity increases in the couple of route segments it gets a little hard to pass out, the bits and pieces but again demand for the Hawaii remain strong. We have filled most of the additional seats even in these markets that we have seen capacity increases of 25% odd. So I think the bigger picture is capacity demand still looks pretty healthy.

John Godyn - Morgan Stanley

And then when we think about the RASM guidance in the fourth quarter, it's not in any way strange to sort of get a 3.0 range out of you guys but I was just hoping kind of understand what’s driving the range just because we have seen some volatility in PRASM lately. Of course the economy at macros is always a big factor but is there anything in that range that kind of drives your thought process on what gets us to the high end versus the low end that’s non-economic that’s kind of really on your mind?

Mark Dunkerley

Well I think a couple of things that I would mention on that, first of all you know our international segment is grown to be a much more significant part of our total picture. Just a couple of years ago it's less than 10% of our total business and now it's pushing on the third. So, and with that we get less visibility just because we have got many intermediaries in terms of the way in which we distribute tickets, we distribute tickets in the way that our traditional to those market places. So we tend to see things reveled relatively late in the day and that is in large part that is one of the big elements that’s driving quite a broad spread.

It's also the case of course that with a bunch of new markets our level of recognition about seasonality and the puts and takes that happen almost on a weekly basis, market by market is just a less astute than it will be in the case a couple years in once we have experienced it a little bit. So on the international side that’s driving that. On the Neighbor Island side we found ourselves a little bit surprised in September, two reasons, one was the fall off in terms of business we are getting from other airlines but the second is we have incentivized people to book earlier to shift the booking curve and it has had an effect now. Because it's been traditionally so late booking when we see early bookings come in it's not entirely clear to us whether what we are doing is moving people earlier along the booking curve or whether we are actually shifting the booking curve.

So for those reasons principally we are being a little less precise in terms of the range. So it's got more to do with our ability to measure stuff and it has to do with any underlying kind of macro concerns.

John Godyn - Morgan Stanley

And then just one last question on costs, as we think about the possibility of a pension expense head win in 2013, is there anything that you can just sort of help us with in terms of bounding what it could like, just understanding the head win a bit more would be helpful.

Mark Dunkerley

Probably can’t give you right now a range but you know last year was largely driven by the change in rates and the change in the underlying value of the plane assets which drove high expenses. Rates don’t seem to have moved as much so far this year; there is less room to go. Portfolio is performing as you would expect it, it’s okay so just kind of sitting here and thinking about it, I would say it should not be nearly as dramatic as this year.

Operator

Thank you. Our next question comes from the line of Hunter Keay with Wolfe Trahan. Please proceed with your question.

Hunter Keay - Wolfe Trahan

Hey Mark let’s talk (inaudible) for a second here, looks like you’re going to grow your earnings like 75% this year, you’re growing your top-line by 20%. You’re executing the strategy exactly like you laid out for us in at the last analyst day, two analyst days ago. Your stock is down 7% and your forward multiple has compressed by more than anyone in the group by about 30%. So I’m sure you’re frustrated, I don’t blame you because you’re executing. So I mean what isn’t working here, I mean you’re obviously trying to reach out to the investors and we appreciate that but what isn’t working? I mean you got to ask yourself at a certain point at what point does it even make sense to even be public anymore and deal with this anymore.

Mark Dunkerley

Hunter first of all I can’t comment on your last comment obviously, but yeah you’re absolutely right we’re extremely frustrated. I think we have as you rightly pointed out, we laid out a strategy. If the time that we laid out that strategy, you know what I had projected that we would be able to do was actually more modestly good than we have actually been able to execute. So I think it was a last couple of years, I’m very pleased with the direction this company has taken and it is a source of tremendous frustration. Frankly, I had almost turned the question back to you and to many of the people who follow our stock. I think we are very open for ideas as to how we can get investors, existing investors, potential investors to understand the value of what we are doing because clearly we are quite frustrated.

Hunter Keay - Wolfe Trahan

I would just say the benefit of being public at this point really begs questions, I mean you guys in your ROC (inaudible) have told me that you’re basically carrying something in the neighborhood of $270 million in access cash in your balance sheet which is basically your market cap. Even if it has that as excess cash money is free, I mean in LBO some LBO cash hybrid of it take out of your stock, I mean it just seems to be begging for it at this point, I mean is there a marketing competent that been that you guys think about I mean that answer myself.

Mark Dunkerley

I can ask again directly to the issue of whether it makes sense to go private and I won't go there. I think we are, I think our first concern is for our shareholders and we are absolutely internally trying to figure out ways in which we can get our message to resonate better because we do believe that there is more an enough value in this some business as it is reflected in our market capital.

Operator

Thank you. Our next question comes from the line of Helane Becker with Dahlman Rose. Please proceed with your question.

Helane Becker - Dahlman Rose

So my first question was just something that I missed and what did you say fourth quarter capacity growth would be? Did you say 20.5 to 30.5 is that right?

Mark Dunkerley

These are some of the numbers obviously we know on the top of our head. Yes 28.5 to 30.5.

Helane Becker - Dahlman Rose

And then the other question I have for you Mark and this is really more a tourism issue I guess, I saw that the Hawaii tourism authority signed a joint marketing agreement with the Japan Tourism Authority, did you kind of bring more passengers from Japan to Hawaii. Which would have to obviously benefit you, you know so the question is really do you benefit in those instances, have they talked to you about what they are trying to do. What kind of and obviously when you see in the market during the earthquake and the Tsunami that they probably did very good for you but can you just talk about what they are trying to do here and later they consultant with you that or not?

Mark Dunkerley

Well first of all let me just say we have got an excellent relationship with Hawaiian Tourism authority and with them all of their marketing partners. We’re absolutely participants with them. We have made no secret of the fact that we see the future of our business is doing very closely tied to you know to Hawaii as a destination. I would also point out that I think Hawaii does a very, very good job of marketing itself notwithstanding the fact that the resources available to Hawaiian doing so pale in comparison to those of other major tourism destinations. Again speaking well of the organizations that promote the Hawaii as a destination and to the existing brand that we enjoy.

Absolutely clearly as we have expanded into Asia we have really encouraged TA to get focused on Asia. I think we are seeing largely from the same industry and it's our working relationship with them is very good. We do think it makes a difference.

Operator

Thank you. Our next question comes from the line of Glenn Engel with Bank of America Merrill Lynch. Please proceed with your question.

Glenn Engel - Bank of America Merrill Lynch

Is it fair to characterize the PRASM during the quarter is been down low single digits in July, down mid-single digits in August and down double digits in September and do you expect to have fourth quarter reverse of that because of the seasonality?

Mark Dunkerley

I haven’t looked at it Glenn on a risk, on a mix adjusted basis month by month. I think it is fair to say that we had most of those fall off was in September. I think looking forward and hence why as you recall we revised our guidance which brought down both cost and our unit revenues. I don’t think it's quite as extreme difference between the months of July and August and September as you have laid out. Turning to the fourth quarter, October is a better month than September, both still a fairly weak month. November is always a better month than October and then December is a good month gone up as a strong as August.

Glenn Engel - Bank of America Merrill Lynch

Second one, your cost was about $50 million lower ex-fuel from you’re initial forecast and I know you have had some maintenance and I know you had some fewer passengers but 15 million is a lot. Is part of it just that the extra flights you’re doing just a longer haul and are having a bigger PRASM, CASM impact than you had expected and is that something that’s likely to continue with new routes you’re adding which are longer haul as well.

Mark Dunkerley

I think some of that is in there, we have got some other issues in there. So for example as Shell would like to hear you know performance incentive payments are tied very directly to performance and so when we see ourselves revising our estimates for the year, downwards there is some money that is essentially to the pot from a P&L perspective in anticipation of lower annual incentive compensation. So there is a bunch of little bits and pieces. I’ll grant you that I think we were not quite as good at calculating what our CASM ex-fuel was going to be as we should have been because of the mix element.

Operator

Thank you. Our next question comes from the line of Michael Linenberg with Deutsche Bank. Please proceed with your questions.

Michael Linenberg - Deutsche Bank

Two questions here, you know you talked about some of the competition in some of the markets good and bad and it was interesting because you didn’t mention anything really on Fukuoka, you talked about it maybe ramping up not as quickly as Haneda and the Osaka market but then we did see a lot of, we saw new service and decent amount of capacity coming to that market from another competitor. So you is it just, your presence in Japan is strong and you didn’t see that type of impact that you saw in Seoul and in some of these other markets?

Mark Dunkerley

I think a lot of these routes, we’re talking about fly today or in some cases you know less than daily flights and so relatively small adjustments and schedule generate outsize changes to the amount of capacity coming into. In Fukuoka we had a competitor go from five week to daily for example which by itself doesn’t sound like a tremendous change but you know once you do the math on what is essentially to now two daily flights going from 12 flights a week to 14 flights a week, it's quite a bit of incremental additional capacity.

So I think it's more of that than it is us kind of waking up to find a world that we haven’t fully anticipated. You mentioned Seoul for example, Seoul was about a competitor that had been in the market, Aviana deciding to get into the market. Korean Airlines was operating twice a day, we were at daily Aviana came in with a daily offering again a big stock of capacity because of a single carrier decision to come in and compete.

I would point out that when we look at the three markets that we are about to go into in Tosa (ph) which is the airport for Sapporo. We’re the only carrier of either country providing service in that market. Brisbane which we stop in a months’ time that is likewise the case and in Auckland we will be the only U.S. carrier to providing service and our entry into the market comes about a year after Qantas which provided the competition to our New Zealand vacated the market.

So these are markets which at least on current viewpoints are quite a bit different than so do the Fukuoka and the (inaudible).

Michael Linenberg - Deutsche Bank

Okay good and then just my second question and this has to go to the small carrier, the regional operation. You know I appreciate the fact that you know we are starting to see some details here, you talked about the CapEx going up by 20 or 25 million and it sounds like I believe that’s for two airplanes. How big does that operation get and what’s compelling about it? What has compelled you to divert some resources and some CapEx and maybe to go back you and hunter had the conversation about the 275 million of market cap. I feel like that the small operation maybe it ties up 50 or 100 million of capital is there a point where maybe it makes more sense to buy back stock and maybe do a code share with the regional carrier or a de novo (ph) operation in Hawaii operated by you know one of the high quality regional carrier like a SkyWest or Republic or whatever. I mean what I realized it's a multi-pronged question here but it does seem like it's a decent amount of capital that’s ultimately going to be diverted to the small operation and I just, there’s got to be a compelling piece, maybe the returns will be high, et cetera.

Mark Dunkerley

Well first of all let me answer the first part of your question, I think ultimately this feels like a four to six aircraft fleet so it's pretty small. I think in some respects that also answers at least in part some of your second question which is, it is a very small operation. The aircraft that are appropriate for this operation are the 42C size of aircraft today in production as anyone manufacturer with those aircraft which is ATR hence we are going with the ATR42s.

It's an aircraft type, it's not broadly represented amongst some of the very carriers that you were talking about and given the small nature of the operation and the fact that ATR 42s aren’t actually pick on the ground in the U.S. that kind of leads us into acquiring the use of those aircraft. We have chosen to purchase the first two, we have obviously got other options for the remaining aircraft as we bring them on.

As to why we think it's important, you know we really believe that there are a number of small communities in the state that generate a fair amount of traffic, again enough to fill this scale of aircraft that we currently don’t touch. This is an important part of our franchise, I think that we feel that without that a presence in that part of the franchise we leave ourselves missing an opportunity.

Overtime I think we think this will be a profitable part of our business, we think we can do a good double servicing at this market place without importantly sucking up either great deal of capital but you pointed out also one of the things I’m always concerned about an enormous amount of management attention, distraction.

So all in all I think we can provide that service and it will be good for the company and coming back again to our market cap and our share price, one of the things that we’re very, very comfortable is that from a management perspective at least arguably our principal job is to run a really good business for the long term and you know like the short term stock performance has been incredibly frustrating to us.

We do still hold on to the notion that by running a good business, getting the blocking and attacking right, hosting good numbers that we will see improvements in the way our stock was traded.

Operator

Thank you. Our next question comes from the line of Steve O’Hara with Sidoti & Company. Please proceed with your question.

Steve O’Hara - Sidoti & Company

I was hoping if you can talk a little bit about the of our business, I mean it seems like a lot of the capacity it's been added into that market recently is more on the hitting direct islands as opposed to stopping in Honolulu. Can you tell me how that’s changed the efficacy of the Neighbor Island business long term in your opinion?

Mark Dunkerley

It's good question. And you really hit on the good point, we are just, more particularly I’m not satisfied that we have done a really good job in our Neighbor Island this year and I think we need to do better, I think we can do better. I do at the same time believe that this is a good business for us, I think it is within our ability to improve our financial results on this business and so I don’t think what’s at play here is somehow I changed in the micro-dynamics of the business. I just don’t think we have done as a good job as we should have done and it's going to be very much resourceful and improvement this next coming year.

Steve O’Hara - Sidoti & Company

Okay and then just hitting on kind of ancillary revenue and that source of revenue, in terms of the cargo, I mean are you moving, do you see the new iPad or the iPhone. Is that a beneficiary for you coming to into Honolulu from Japan or no?

Mark Dunkerley

Well first of all in terms of cargo what one of the really important things I think we would highlight is the fact that our trend is dramatically different from that of our competitors in this business. You know they are all suffering tremendously, of course they have got a big cargo infrastructure that they are having difficulty feeding. We by contrast are growing into this space thanks to a couple of things, the 330 which is been, which is a better cargo aircraft than the 767 and the fact that we are serving Asia.

As to iPad and that kind of stuff, we have actually traditionally not carried much of that stuff because you got to get through some regulatory requirements around handling, lithium ion batteries and stuff like that. That work is ongoing at the moment. I still think that most of our business is going to come from you know, perishables is coming out to Hawaii, West Bound and industrial component is going East Bound, out of Asia to North America.

Steve O’Hara - Sidoti & Company

Okay and then just moving on to Ancillary revenue, you know kind of on a past year basis, where is that per passenger now, do you think you have done enough to kind of unbundle that relative to the industry and you know there is more kind of fruit there to harvest.

Mark Dunkerley

We certainly think there is more fruit there to harvest, it's proving little harder to get at than we had initially hoped for but we are doing some good things as we for example standardize our fleet, it allows us to have a better premium seat product and ability to sell exit routes and things like that. In terms of things like car rentals and packages and insurance, we are doing a better job of that but I think there is more to be had. I don’t think it we are looking at doubling or troubling this business overnight. I think we’re going to grow it organically over the next couple of years.

Steve O’Hara - Sidoti & Company

Do you have a number for what it is on the passenger basis now?

Mark Dunkerley

I’m looking at Scott, we have the number at hand I don’t at the moment.

Scott Topping

Steve we don’t right now, but we can certainly follow up on that.

Mark Dunkerley

We can certainly get it to you.

Steve O’Hara - Sidoti & Company

Okay great and then in terms of cash taxes, are you guys federal cash tax payer and when do you see that you becoming one if you are not.

Scott Topping

We are not now, our best estimate of that is in early 2015.

Operator

Thank you. Our next question comes from the line of John Reardon with Crowell, Weedon. Please proceed with your question.

John Reardon - Crowell, Weedon

Mark you touched briefly on the new New York, non-stop run and don’t want to beat an old horse but has that run generated any through traffic from say Manila or Sydney to New York if Honolulu. I’m just curious and could you touch on how the New York, some of the things that have developed in the last couple of quarters on the New York run.

Mark Dunkerley

I can confirm we are seeing some connecting passengers going via Honolulu on to across pacific including some kind of multi-stop itineraries that have been relatively attractive for us. In terms of developments, well it's really very early days yet. I mean we obviously kicked off our new route in the summer period, we sort of collaborated ourselves little bit to what we can expect there.

We have had September and now into October which is traditionally very lean period for this kind of travel beyond kind of looking at what’s coming in. I don’t think we are yet in a position to sort of characterize on how, what’s happened is sort of unusual or different. I think we’re just pretty much assuming that everything at the moment is usual because we are seeing it for the first time.

Operator

Thank you. Our next question is a follow-up question from Hunter Keay with Wolfe Trahan. Please proceed with your question.

Hunter Keay - Wolfe Trahan

I do think that further reason the stock hasn’t worked because of the fears of competitive capacity. I think people have seen a lenient growing into this market for a while, Alaska has been this for couple of years and on the earnings call last week, South West mentioned, Hawaii is the possibility. I think some people are thinking about that has been something that’s going to be a perpetual overhang on your stock until they actually announce it. So I mean right or wrong so I guess my question is, is there anything that you learn from Alaska moving into your markets and less the region more so Alaska that you would do differently in terms of say defending your turf aggressively against the South-West incursion that might sort of mitigate at least in a longer term basis that’s probability of having them a negative impact on you guys.

Mark Dunkerley

Funny enough when we were sitting down in 2007, 2008 and looking at our long term strategy, they were among the alternatives, were two relatively binary choices, either we could expand West Woods to Asia, West Woods is from where we are to Asia or to do the kind of, a lot of the flying to Alaska is now doing. We recognize we can do both. We choose to go West Woods to Asia, we thought that the returns would be higher we thought we were in a better situation to do that and in that sense we would do absolutely nothing different. We are very, very pleased with the decision that we make and the ways that it has worked out.

Second thing I would say is that when we look at our side by side competitiveness versus all of other carriers supplying their trade between the U.S. Mainland and Hawaii. We do not see a deficit in our camp to anybody else. We think we have unit costs that are on the par or if not actually in the main lower, most of our competitors, we think we have the best product. If you look at average fares, you will see that we actually command a premium in the marketplace.

So I think you know clearly there is a market in which you cannot afford to be uncompetitive given the important role that fares play and how people make decisions. We don’t feel we are in a vulnerable position from that perspective now. As we think about the future, obviously we have to be continue to be mindful of that.

One of the things we don’t do and haven’t done is we are not traditionally a carrier that starts fare wars and alike. We try and be responsible, competitor responsible from the perspective of our shareholders. We of course, live and work in an environment where we are subject to how other people view the marketplace. At the end of the day as I mentioned in my prepared remarks this is a profitable route segment for us, we like our competitor position, we like our costs, we like the revenues that we get and we are not intending on going anywhere.

Hunter Keay - Wolfe Trahan

And one more. I just want to ask my first question differently, what benefit do you think you’re receiving right now be being a publically traded company?

Mark Dunkerley

I think we have had in the past you know access to capital, I think it is when we have needed it. I think we are in a position where as this world, as credit markets in general are uncertain, they have to be very good at the moment but who knows how long that remains the case. I think having an equity component that’s publically traded can be extremely useful to have.

Again beyond that I don’t feel like and comment particularly.

Operator

Thank you. Our final question is a follow-up from the line of John Godyn with Morgan Stanley. Please proceed with your question.

John Godyn - Morgan Stanley

I just wanted to follow-up on some of these questions that we have been hearing about the amount of excess cash that you have and how much could be used for buybacks and so and so forth. Can you just help us think about how do you think about excess cash and in particular is it important to have more cash on the balance sheet than you’re air traffic liability, I just want to understand how you think about excess cash.

Mark Dunkerley

I will just say to kind of introduce the answer, first of all we are clearly mindful that in an environment where people are talking, I mean headlines about macroeconomic news or very sort of uncertain, although we have seen none of that in our marketplaces. We wanted to make sure that in an event that there is a dip that we have really everybody has been expecting for the last four years come about that we have a cash cushion that means that we are in a stronger position in relative terms than our competitors.

At the same time we have got some additional fleet coming onboard and we have got we have had great response from sources of finance for those aircraft but we are mindful that in the next probably 1.5 – 2 years we have got quite a load of additional aircraft. We have some aircraft leaving the fleet too, so I think those are some of the things that influence our thinking but let me turn it over to Scott.

Scott Topping

I think we feel in our position, our growth profile, our size, we want to be a bit heavier than our competitors and we are running at 26% of trailing 12 month revenues which is in the higher side, we are not the highest in the industry but it's on the higher side which you kind of have look at that with respect to our growth, you know look at trailing 12 months it's 26 but if you look at the rate we are growing, you might argue that we are lower than 26 just because we are getting bigger quickly.

So I don’t think we are really, I think we’re where we want to be, I wouldn’t characterize our cash percentage to be heavy. We are not looking around to buy back stock or to do anything dramatic because as Mark said we are growing, we can put cash to work as equity and debt finance airplanes. We can but the turboprops at least the first couple of them with cash. So we are looking for ways to employ that and invest in the business but generally we are not feeling that we are heavy, we think we are about right.

John Godyn - Morgan Stanley

Is it fair to sort of just within the context of everything you just said and different uses for cash and macro volatility so on and so forth. Is it fair to say that you would need a significant, a very significant premium of cash to your air-traffic liability to truly feel like you have excess cash to deploy.

Scott Topping

That’s not a bad way of looking at it, we don’t have any financial policy around that and haven’t really thought too much through that but I can’t argue with your logic there. We are just more focused on the cash and liquidity we have been the revolver all that together been in a reasonable range.

Operator

Thank you. At this time I would like to turn the floor back to Mr. Dunkerley for closing comments.

Mark Dunkerley

Okay. Well thanks everybody for joining us today. Our third quarter was a period of high growth of course and we were pleased to produce this strong financial results that we announced today. We as you can tell from our commentary think that this is further evidence that our growth and diversification strategic is bearing fruit. Going forward, of course we are going to focus on costs and getting those revenue improved both in terms of our existing markets and in our new ones. So thank you very much for joining us today.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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Source: Hawaiian Holdings CEO Discusses Q3 2012 Results - Earnings Call Transcript
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