Skywest Inc Q2 FY2022 Earnings Call

Good day and welcome to the SkyWest Inc. Second Quarter 2022 Earnings Call. I would now like to turn the conference over to Mr. Robert Simmons, Chief Financial Officer. Sir, please go ahead.

Thanks, everyone, for joining us on the call today. As the operator indicated, this is Rob Simmons, SkyWest’s Chief Financial Officer. On the call with me today are Chip Childs, President and Chief Executive Officer; Wade Steel, Chief Commercial Officer; and Eric Woodward, Chief Accounting Officer. I’d like to start today by asking Eric to read the safe harbor, then I will turn the time over to Chip for some comments. Following Chip, I will take us through the financial results, then Wade will discuss the fleet and related flying arrangements. Following Wade, we will have the customary Q&A session with our sell-side analysts. Eric?

Today’s discussion contains forward-looking statements that represent our current beliefs, expectations, and assumptions regarding future events and are subject to risks and uncertainties. We assume no obligation to update any forward-looking statement. Actual results will likely vary and may vary materially from those anticipated, estimated, or projected for a number of reasons. Some of the factors that may cause such differences are included in our 2021 Form 10-K and other reports and filings with the Securities and Exchange Commission. And now I’ll turn the call over to Chip.

Thank you, Rob and Eric. Good afternoon, everyone. Thank you for joining us on the call today. SkyWest celebrates 50 years in 2022, commemorating our first departure in June of 1972. Over the past five decades, SkyWest has weathered many storms and continues to adapt and evolve to lead the regional industry. That’s a testament to our more than 14,000 people who are truly unparalleled. We wouldn’t be where we are today without the outstanding work of our people, and I’m humbled and grateful that I get to work alongside them. Demand for SkyWest's product during the second quarter remains exceptionally high, with our main constraint being crew imbalance, as we discussed last quarter. We made good headway during the quarter to realign our schedules and resources, producing results that were slightly better than we anticipated. We reported pre-tax income of $73 million and net income of $54 million. Improvement in our second quarter results from the first quarter was largely driven by outstanding operational performance, including a 99.9% adjusted flight completion rate during the quarter, a block hour production increase of 13% on our E175 fleet, and an increase in prorate revenue. I want to thank our people for their teamwork and efforts to deliver strong operating performance as we launched a very busy summer travel season. We received eight E175 during the second quarter and will receive 16 more this year, with a total of 240 E175 planned in service by early next year. Our re-fleeting process, which has been in progress for the last several years, continues to be a priority as we execute on our long-term strategy. During the second quarter, nearly 80% of our block hours were flown utilizing our dual-class fleet. While demand is solid, clearly our largest constraint is captain availability. SkyWest is fortunate to maintain a robust hiring pipeline and strategy for all workgroups, and we have new hire classes filled through year-end. We expect that the ongoing high demand for pilots will continue to result in SkyWest pilots being the most sought after in the industry, and we are planning our models accordingly. We have long been investing in tuition reimbursements, incentives, and various other partnerships and methods to reduce barriers to entry and clear the path to help increase equality among the pilot profession. Notably, of those who have joined our pilot pathway program this year, over 40% are women or people of color. As we discussed last quarter, we’ve taken a number of steps to address our new crew imbalance, including managing schedules with our partners, working with our pilot group to implement upgrade and captain retention centers, and offering sustainable career pathways, including guaranteed pilot interview programs for our captains. While these disciplined strategies are producing results, the timing required for training and upgrades will likely constrain production into late 2023 and early 2024. We will continue to work with our people to ensure we remain best positioned to aggressively manage this challenge. We are currently in pay conversations with our pilots and expect to increase our pilot investment going forward to ensure we continue to provide more stability, opportunity, and options than any other regional carrier can provide. During the second quarter, we formed SkyWest Charter as an additional entity of SkyWest Inc. Our intent is to enter the strong charter business within existing regulations, and we have applied for commuter authority with the Department of Transportation. We appreciate the strong support from many communities and airports, as well as the efforts of the DOT and FAA to enable this service that provides essential connections that many small airports rely on. We undoubtedly have the asset base, best fleet, high standards, and expertise to execute this operation well, and intend to hold SkyWest Charter to the exceptional high standards of safety and service associated with the SkyWest name. While demand for our products has never been stronger, the current staffing imbalance and ongoing re-fleeting doesn’t allow us to monetize that demand in the short term. We continue to expect 2022 production to be reduced by about 5% from 2021 production. We also continue to expect production in the second half of the year to be lower than the first half due to the crew imbalance. However, there are three components in the environment today that give us great confidence in SkyWest as an investment. First, there’s undoubtedly significant unmet demand for regional flying. Second, our strong pipeline and our ability to attract, train, and retain captains is far greater than our competitors, and third, SkyWest's asset value is unparalleled in the market. Our disciplined approach over the last decade in acquiring profitable assets at strong economics will enhance our ability to meet our objectives in this new economy. Although we continue to expect the recovery will remain choppy as we work through some headwinds over the next couple of years, we remain aggressive and deliberate in the steps we’re taking now to ensure we are well positioned for 2024 and beyond. Rob will now take us through the financial data.

Today we reported second quarter GAAP net income of $54 million or $1.07 diluted earnings per share. Q2 pre-tax income was $72.7 million. Our diluted share count for Q2 was 50.6 million shares, and our effective tax rate in Q2 was 26%. First, let’s talk about revenue. Total Q2 revenue of $799 million is up 9% sequentially from Q1 2022 and up 22% from Q2 2021. Q2 revenue breaks down with contract revenue up 8% from Q1 2022 and up 28% from Q2 a year ago. Pro-rate revenue was $95 million in Q2, up 20% from Q1 2022 and down 8% from Q2 2021. Leasing and other revenue is down 7% sequentially but up 5% year-over-year. These GAAP results include the effect of a release of $16 million of deferred revenue this quarter, compared to $11 million released in Q1 and $6 million that was deferred during Q2, 2021. As of the end of Q2, we have $69 million of cumulative deferred revenue that will be recognized in future periods. This quarter’s results also include two items I wanted to note. The first is a $15 million impairment charge we took this quarter on four of our older CRJ-700 aircraft that were part of our Express Jet fleet and are held for sale. This impairment is in the line item other operating expense. The second is a $10 million mark-to-market gain on our investment in Eve, as it started trading publicly during the second quarter. This gain is recorded below the line in other income. Let me move to the balance sheet. We ended the quarter with cash of $979 million, up from $856 million last quarter. Our CapEx during the second quarter was $197 million for eight new E175 aircraft and other fixed assets. Total 2022 CapEx is expected to be approximately $775 million, including the purchase of 28 new E175 aircraft compared to $556 million in 2021. We ended Q2 with debt of $3.3 billion, up slightly from $3.1 billion as of year-end 2021. Just a reminder that the only government debt we have on our balance sheet is a total of $201 million in PSP 10-year unsecured, no amortization, low coupon loans. Let me say a couple of things about liquidity. As of June 30, 2022, our cash position of $975 million included the effect this quarter of having repaid an incremental $103 million of debt before adding $191 million of debt financing for eight new E175 and $25 million in engine financing. We also have over $1 billion of unpledged collateral that could be deployed for additional liquidity if ever needed. Additional flexibility comes from the fact that including partner-owned aircraft, 50% of our fleet in service has no financing obligation. Consistent with our policy and practice, we are not in a position to give any specific EPS guidance at this time, but let me give you a little directional color. Q2 results were slightly better than expected for a variety of reasons referenced earlier by Chip, including optimizing our schedules by aircraft type, strong demand that we monetized opportunistically, and benefits from our evolving fleet mix. We expect Q3 results, however, to be slightly down from Q2 due to labor constraints and costs. The second half of 2022 will likely be worse than the first half of 2022 for similar reasons, with the second half of 2022 modestly profitable. We don’t expect to rebuild production from this pilot imbalance challenge until the end of 2023. Second, we won’t see the full year impact of the 47 accretive new E175 going into service in 2022 and early 2023 until 2024. Our actions today are setting us up for success in 2024. Third, we will continue to focus on liquidity and expect to end 2022 with a strong cash position in spite of the investment we’re making in 28 accretive new E175 this year. We believe that the actions we are taking now to invest in the growth of our ERJ fleet, work through the pilot imbalance affecting the industry, and preserve the optionality of monetizing strong demand opportunities over time will position us well for 2024.

Thank you, Rob. I’ll provide a fleet and production status update as well as an update on our prorate and leasing businesses. We continue a strong delivery schedule this year as we’ve discussed in recent quarters. We previously announced an agreement with Delta for 16 new E175 to replace 16 older SkyWest-owned CRJ-900 aircraft. During the quarter, we took delivery of two of the 16 aircraft. We anticipate taking delivery of the remaining 14 E175 during the second half of the year, and they will be placed into service beginning in the third quarter of this year through the first part of 2023. After we receive these aircraft, we will have 87 E175 under long-term contracts with Delta. Under our American contract, we have 20 new E175 scheduled for service throughout this year. We received 18 of those aircraft during the third and fourth quarters of 2021 and will receive two in the third quarter of this year. We have an agreement with Alaska to add 11 E175 short contracts. During the second quarter, we took delivery of six and had already taken four during the first quarter of 2022. We expect to take delivery of the last E175 during 2023 for a total of 43 aircraft under long-term contracts with Alaska. Demand for our E175 product remains very strong. Following delivery of those currently on order, our E175 fleet will be 240 aircraft. Let me review our current production in 2022. Based on the current schedules we have from our major partners for the third quarter, we anticipate that our block hours will be down by approximately 3% to 5% in the third quarter compared to the second quarter. As we look to Q4, we anticipate our Q4 block hours will be down 13% to 17% compared to the second quarter. Let me talk a little bit about our prorate business. As we’ve discussed, we are experiencing a crew imbalance that is impacting our ability to fully meet the strong demand for our product. As a result of this imbalance during the first quarter, we filed a 90-day notice with the DOT to discontinue service to 29 essential air service communities. This was a very difficult decision and one we would have preferred not to make. It appears nine of these 29 communities will transition to another airline by year-end. We continue working through this challenge and remain committed to help find a good solution for these and other underserved communities. Shifting gears to our leasing business. During the quarter, we entered into one long-term lease for CRJ-700. This brings our total CRJ-700 and 900 under long-term leases with third parties to 40. This line of business has very good cash flow and strong margin characteristics. Demand for our engine leasing business is returning, and we have placed a few more engines under third-party leases during the second quarter and anticipate placing more engines under leases by the end of the year. We have a strong delivery schedule this year and will continue working efficiently and effectively allocating our resources as we optimize our fleet mix. We have spent the last several years reducing risk and enhancing fleet and financing flexibility to ensure we’re well positioned. This flexibility will continue to be a differentiator for us, and we are committed to continuing our work with each of our major partners to provide creative solutions. Okay, Lisa, we’re ready for the Q&A now.

Thank you, sir. We'll take our first question from Savi Syth with Raymond James.

Good afternoon. I was just curious; American passed a pilot contract for their in-house subsidiaries which the base pay is quite a big increase, but when you include the bonus that supposedly is temporary, a pretty significant jump. I was curious if you have seen any impact in terms of retention or ability to attract since those contracts, or what do you think the read-through to the industry from that contract is?

Well, Savi, this is Chip. Thanks for the question. It’s a good question. Candidly, I think when we look at what America has done with some of their wholly owned, there are a couple of things that we can take some ideas from and some that we do not. From our perspective, we want to long term find a solution for pilots, not just for the next year or two. That package is very heavily weighted for the next 24 months. I said in my script that we’re investing in our pilots, and we’re getting close to having some good things to work out with them, but I think there’s a different angle to this. There’s no doubt in the economy we are living in today that labor costs are a big issue for everybody, not just our industry. So I think the most important thing for us is to come together as we work with our pilot group and evaluate what is the most meaningful process for our pilots and our group. We’re seeing very good traction and having meaningful conversations with them. Regarding the industry, obviously, there are factors from some of our partners that have been introduced through wholly owned carriers, and we’re having constructive discussions with them about long-term partnerships surrounding various labor shortages, especially with pilots. I think we’ve got good momentum and direction, and we believe that we have good solutions to help get us back on track, aiming for the 2024 timeframe.

That’s helpful. How should I think about clearly the department is well aware of these hiring constraints and the need to drive pay raises? How quickly do you think you’ll be able to pass that through across your contracts? Is that going to be a five-year process, a two-year process? Or could it be faster? How should we think about once you pass that pilot pay agreement, the hits, and how long it would take to get back to somewhat of a normalized margin?

I don’t want to go into too much detail about our strategies, but I’ll give you some assurances. We have a very good fleet renewal timeline from starting in 2023 through the next five or six years, and obviously, when you come up with that type of contract expiration and people wanting to renew, that’s the ultimate reset of some of these things. We also see some opportunity relative to the sooner we can fix the turnaround with respect to our captain issue, the faster we can get back to capacity. I mentioned in my remarks that the demand for our product is extremely high. We are not just pulling down significant capacity but believe there is a tremendous opportunity available in the next couple of years that we could pursue aggressively. I suggest this will not happen overnight; we do not have a partner that will simply write a check for these costs. But it is a gradual process. The more we can deliver, the more manageable those conversations will be because of the strong demand for flying, particularly in small and mid-sized communities today. That’s how we’re viewing it without getting into specifics.

Last one, just following up on that. It seems like your service timeline at American and Delta is moving a little bit faster than you were thinking earlier this year. I’m guessing it’s a function of operations being good. I’m kind of surprised to see that sequential drop from Q3 to Q4 on block hours, as it seems like more than seasonal. So is there something that I’m missing in that forecast, or is there a lot of conservatism in there?

Yes, Savi, this is Wade. The first part of your question regarding our timelines with American and Delta has been very consistent over the last couple of quarters. There have been no differences in the timeline for the E175s coming in. As far as forward guidance, as we have discussed in our remarks, there is a crew imbalance that we’re working through right now. We are modeling conservatively as we assess the situation and trying to ensure we can stabilize the fleet going forward. There is that crew imbalance that we are addressing over the next several quarters.

We’ll take our next question from Michael Linenberg with Deutsche Bank.

Good afternoon, guys. I want to go back just on Savi’s question on the pilot. Since I know you don’t have a union contract, but that said, you still have kind of agreements? Is there a structure in place where rates are set for several years, and then you negotiate and replace them with new rates? Like what’s the timing? I’m trying to get a sense of, if, over the next year or two, we see a meaningful increase in pilot pay, which we’re seeing across the industry, will it not show up until you guys renew some of your agreements, like Chip mentioned, in 2023, 2024, 2025? That’s usually a good time to kind of go back and discuss where things stand on the class side, etc.

Yes, Mike, this is Chip again. Just to clarify, we have a clear collective bargaining agreement with our pilots that is structured like any other contract with pilots. However, our current agreement expires at the end of this year. We have been in conversation with our pilots over the last several months; it’s a long process. There is a lot going on in the world, with various concerns across the industry. The focus of our package is primarily on the captain side and retention. But we intend to have an agreement probably coming out within the next month or so. Even if we weren’t bound by an expiration of our pilot contract this year, we’d likely open things up if we feel we need to, as we have done in the past. So the timing of the contract is what it is, but more importantly, we’ve utilized market opportunities to take care of our people in a way that benefits them long term. This is a key element; our strategy is to focus on creating a long-term solution in our pilot contract so that we can maintain our success here at SkyWest. The conversations are progressing well, and we will continue along this path.

Okay, that’s helpful. And then back to maybe Rob or Wade who mentioned the prorate revenue. $95 million is pretty good. I know it was down, I think, 8% versus a year ago, but up 20% versus the March quarter. I was operating under the assumption that that would start to decline as you reduce block hours. It seems you may be benefiting from a strong pricing environment and revenue environment. Can you give us the block hours, which may indicate that you did reduce your prorate flying more than the revenue suggests?

Yes, Mike, this is Wade. In terms of prorate, our block hours have indeed gone down quarter-over-quarter and year-over-year. The strong revenue we’re seeing in our prorate is similar to what our major partners are experiencing currently. The yields are solid, and demand remains high. We’re collaborating with partners to ensure we remain in the markets we serve. So the revenue environment for our prorate is very positive. We’ve observed strong yields across various small communities over the last couple of quarters, and it looks promising as we look into Q3 as well.

And lastly, I know you’ve been making various investments. You highlighted the Eve gain. I might be mistaken, but did you make a deal with Southern Airways Express? I can’t recall if you own a stake in another regional carrier.

Mike, this is Wade again. Yes, we've made an investment in Southern and that whole combination several years ago. They’re a good partner; they’re growing and doing a lot of positive things. We’re helping them with their strategic plans as they move forward. So yes, we do have an investment in them.

And Wade, are they a 135 carrier?

They are; they primarily operate Caravans under a 135 certificate. That’s correct.

Would it ever make sense to utilize them as the backbone of this charter operation, or do you prefer to establish a new operation?

Michael, this is Chip. I think it primarily relates to the fleet we intend to utilize, for which we have a significant amount of assets in the CRJ-200. There is no doubt that as we strategically look to ensure we continue serving the communities we support, we have deeply invested in them over the years. Sometimes it might make sense for Southern to backfill; other times we might use a commuter authority for a 30-seat CRJ-200. The best aspect is that we have a tremendous asset base, expertise, and flexibility with our other business relationships, including our partners, to navigate these situations as they arise given the current environment.

Thanks, Chip. Thanks, Wade. Thanks, everyone.

We’ll take our next question from Helane Becker with Cowen.

Thanks very much, operator. Hi, everybody. Thanks for your time. Can you provide an update on the application with the FAA for the part 135 carrier?

Helane, this is Wade. We filed for commuter authority in the middle of June, and we had many communities submit letters of support. We are currently working through the application with the DOT, which is currently reviewing it. We hope to have this sorted out in the next couple of months.

Yes. Should we think of it as a fourth quarter or first quarter event?

We are still working through the exact timing. I will tell you that we are going to operate this as both charter and on-demand charters. We believe we will start flying on-demand charters sometime during this year. As far as the commuter authority, we’re still working with the DOT on some things, so I don’t want to provide an exact timeframe, but I don’t think it will take too long. We will be flying on-demand charters here shortly.

That’s very helpful. Thank you. Can I just shift gears and ask Rob one question regarding your cash position? How are you thinking about the right number for cash and liquidity going forward? It seems cash exceeds revenue. I’m not sure if that’s the right level of cash to maintain, or maybe it is.

Yes, Helane. As we think of our liquidity position, obviously, the way we have perceived it has evolved over the last few years, especially through COVID. However, we believe that given the landscape for the next 18 months, we’re content with a higher-than-usual level of liquidity. We think this is one of our key competitive advantages—strengthening the balance sheet's capacity to finance additional airplanes. Notably, our debt net of cash has remained stable, which we believe provides a competitive advantage.

We have a follow-up question from Savi Syth with Raymond James. Please go ahead.

Thanks for the follow-up. I’m curious; United mentioned on their call that the current situation is probably accelerating where they thought they would get to from a regional mix—a lot smaller. They spoke of it being maybe half the size. I believe they are big supporters of the larger regional jets you operate, like the 70 CRJs-200 flying with United. Have you had any conversations regarding the future of those CRJs-200 and your expectation for their reduction over the next couple of years?

Yes, Savi. I believe fleet mix and strategies will be very dynamic over the next couple of years. I would also like to reiterate our perspective as a regional carrier. Much of the news focuses on reduced regional flying, but I believe it’s not due to a decline in demand, which we see as quite the opposite. The supply of regional flying is what will pose a constraint, and that’s why we aim to aggressively fill that demand. When it comes to CRJ-200, discussions around their future remain ongoing. The dual-class E175 and larger CRJs take priority due to their higher capacity, particularly with our major partners. The CRJ-200 fits well within our charter operations. Thus, this remains a dynamic conversation regarding fleet decisions.

That's a good segue to my next question. Following up on Helane's inquiry, what would you say about your part 135 operation, as it seems you have the systems in place to begin selling these fares? I assume you are aligning perhaps with major carriers. Could you explain how you perceive this opportunity and the infrastructure you already have in place?

Let me offer you some perspective on our approach. We are not pioneering this business model; there are carriers with the authority we seek who operate scheduled charter service today. We won’t need assistance from the DOT to begin charter operations. Our goal in this context is to operate at the same safety level as SkyWest Airlines while leveraging the expertise we’ve developed over the years. Concerning infrastructure, the primary challenge that arises when you start or transition an airline is the lack of intellectual property, pilot pipelines, or relationships that are usually required. We possess all of these elements in place and are equipped to execute this operation effectively. The demand for on-demand charter services is unexpectedly strong, and we're excited about the opportunities this may present for SkyWest.

If I think about the opportunity for pilots transitioning from that 250-hour requirement and needing to build hours, how do you foresee pilots moving through this operation into SkyWest? What hours will they be gaining, and how might this address the captain supply challenges?

I think about 95% of this relative to pilots is focused on captain supply. I want to emphasize that there are many available pilots we see in our pipeline with 1500 hours. The captain supply issue becomes the primary focus because of the applications and interest from experienced captains in the industry. We need captains to groom future captains, and we have much to figure out regarding the flow of how pilots will work in and out of this. However, we are committed to ensuring that the operational standards we maintain for our charter operation will mirror those of our commercial side, as a 121 operator. It’s important to note we routinely scale down several hundred pilots out of our initial training programs each year. They have 1500 hours and meet FAA standards, but do not fulfill our internal quality benchmarks, which we will uphold for this charter operation.

We will take a follow-up question from Michael Linenberg with Deutsche Bank.

Chip, just back on the charter operation. Many parties appear to be interested as you seek to provide service, especially regarding the 29 small cities you are potentially discontinuing service with. The DOT would likely also have an interest in a charter operation as these communities face reduced service from other carriers. How does this align with your charter plans? Are you aiming to backfill service in some of these locations?

Yes, Michael. I can’t speak on behalf of the DOT, but I can comment on the current marketplace. The nine communities we are exiting from are engaging with other carriers who are adopting similar models. I’m uncertain if the DOT will share the same perspective from a policy angle, but most data points support this direction. That said, we aren't overly focused on the potential upside from the charter operation as we have a significant workload ahead to get our initial 10 to 20 aircraft up and running and assess their operational effectiveness. However, there may be opportunities to explore, though we are prioritizing maximizing the capacity of SkyWest Airlines and operating the CRJ-200 to fulfill demand in economically viable communities.

Yeah, from a policy perspective, this really functions as a beneficial solution. Your filing reflected numerous supportive documents from chambers of commerce, mayors, and communities fearing the loss of service altogether. There's a significant number of Americans potentially losing regional connections, prompting urgency in solving this issue.

From our perspective, there’s a sense of irony around this, as there may be communities losing services or receiving restrictions requiring alternative service from another operator that might covet the same authority we’re seeking. Alternatively, service can end up being quite limited, perhaps comprising a nine-seat single-engine turboprop. Thus, this application process provides a meaningful opportunity for us.

Well, thanks for addressing all the inquiries.

That does conclude today’s question-and-answer session. I would like to turn the call over to Chip Childs for closing remarks.

Thank you all again for joining us on the call today. We appreciate your interest in SkyWest. In conclusion, we want to reiterate that there is a tremendous need for regional products in small, midsized, and underserved communities. Reliable quality service has a decidedly positive economic impact for any community. We’re focused on ensuring we are strategically positioned to respond to all of that demand. With significant available scope and incredibly strong demand, we’re bullish on the long-term future of SkyWest. As we celebrate our 50th anniversary, I want to thank our people for their dedication, support, and incredible flexibility. With that, we’ll end the call and reconnect with you next quarter. Thank you.

And that does conclude today’s presentation. Thank you for your participation. You may now disconnect.