Skywest Inc Q3 FY2023 Earnings Call

Ladies and gentlemen, thank you for standing by. My name is Brent and I will be your conference operator today. At this time, I would like to welcome everyone to the SkyWest Inc. Third Quarter 2023 Results Call. It is now my pleasure to turn today's call over to Rob Simmons, Chief Financial Officer. Sir, please go ahead.

Thanks, everyone, for joining us on the call today. As Brent 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 and then Wade will discuss the fleet and related flying arrangements.

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, whether as a result of new information, future events or otherwise. 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 2022 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 and thank you for joining us on the call today. I want to start by saying how devastated we are by the horrific attacks on Israel and the escalating conflict in the Middle East that has put millions of innocent lives at risk. While we do not operate in these areas, the SkyWest team is made up of thousands of people from different backgrounds, countries and cultures and together, we mourn the loss of innocent lives. We're working where we can to provide opportunities to aid in the humanitarian response and look forward to an end to the violence in the region. Today, SkyWest reported net income of $23 million or $0.55 per diluted share and announced new flying contracts with United for 19 new E175 aircraft over the next 3 years. Also during the third quarter, we purchased 1.2 million shares for $50 million under our previously communicated share repurchase plan and have acquired 19% of total shares outstanding year-to-date. The quarter's results demonstrate that the SkyWest playbook continues to work as intended. This playbook is focused on our team, our fleet, our partnerships and a strong balance sheet. We continue to one, execute our multiyear fleet transition with focus on dual class and maintain an efficient and flexible fleet. Two, enhance our partnerships and ensure we continue to deliver on our partners' needs. Three, maintain a healthy and strong balance sheet that continues to help create opportunities benefiting our people, our partners and our shareholders. SkyWest teams continue to deliver exceptional performance, helping the airline achieve top 3 DOT on-time carrier status now for several months out of the year. So far this year, SkyWest has delivered a record of more than 240 100% completion days when adjusted for weather, the most in a single year in our history. This is an outstanding achievement but even more so when you realize that we report performance at more than 240 airports nationwide. This feat doesn't happen without extensive planning and resource allocation to manage through challenges as well as exceptional teamwork. Our people do a tremendous job and I want to thank them for their commitment and reliability and great service. Pilot availability and specifically captain availability has been an ongoing challenge here and across the industry and we continue efforts to stabilize our crew balance. We recognize that pilots have more options than ever before and appreciate that they are recognizing the value proposition at SkyWest. Both for those who choose to make a career here and those who want to transition to one of our major partners. We're fortunate to have a positive working relationship with our labor representatives that enables us to move quickly on behalf of our teams. This unique relationship continues to benefit our people and helps us consistently deliver an outstanding product. Captain attrition has continued to stabilize through this quarter and attrition was again slightly lower than planned. We are still prioritizing upgrades while filling new higher pilot classes. And it will take some time to regain our crew balance and restore production and full utilization of our fleet. However, our existing fleet can accommodate large future growth without additional CapEx spend. And with the captain situation beginning to stabilize, we feel good about adding another 19 E175s over the next 3 years. I want to shift gears to SkyWest Charter or SWC which has continued to successfully complete on-demand charter flying since it began operation earlier this year. Demand for these charters is extremely strong and we are encouraged by SWC's business. While commuter authority at the Department of Transportation has languished for no regulatory reason, we still believe SWC is the best possible answer for small community air service. Regardless of the status of that application, we're pleased with strong demand for SWC's product and are very optimistic about its future. In fact, charter demand is stronger than we originally anticipated with the SWC fleet now at 13 aircraft. We did not anticipate this level of flying within our original plan operating under commuter authority. SWC is certainly exceeding expectations even without commuter authority. That said, it is and will remain a very small portion of our overall business with our primary focus remaining on our contract flying and major partner relationships. As always, we remain disciplined to ensure our assets are deployed efficiently and profitably. Overall demand for each of our products remains exceptionally strong. As we deliver on our business fundamentals, we remain laser-focused on executing reliably for the long game and ensuring we are best positioned to respond to opportunities.

Rob will now take us through the financial data. Today, we reported a third quarter GAAP net profit of $23 million or $0.55 earnings per share. Q3 pre-tax income was $24 million. Our weighted average share count for Q3 was $42.6 million and our effective tax rate was 4% which reflected an $8 million benefit from the lapse of an uncertain tax position. First, let's talk about revenue. Total Q3 revenue of $766 million is up 6% sequentially from Q2 2023 and down 3% from Q3 2022. Q3 revenue breaks down with contract revenue up 2% from Q2 and down 5% from Q3 2022. Prorate revenue was $110 million in Q3, up 33% from Q2 and up 16% from Q3 2022. Leasing and other revenue is down by less than $2 million sequentially and year-over-year. These GAAP results include the effect of $57 million of revenue deferred this quarter compared to $60 million deferred in Q2 and $13 million that was released in Q3 2022. As of the end of Q3, we have $305 million of cumulative deferred revenue that will be recognized in future periods. As indicated last quarter, we expect to defer revenue of roughly $60 million in Q4. We anticipate we will begin to recognize previously deferred revenue in Q1 2024 and beyond. Let me move to the balance sheet. We ended the quarter with cash of $820 million, down $42 million from $862 million last quarter. The $42 million reduction in cash during the quarter included the accretive actions of number one, repaying $110 million in debt. Number two, buying back 1.2 million shares of SkyWest stock in the open market for $50 million at an average price of $42 per share. During the 9 months ended September 2023, we have repurchased 9.6 million shares or approximately 19% of the outstanding shares of the company for $244 million at an average price of $25 per share. And number three, paying $36 million in aircraft deposits toward our order for 19 new E175 aircraft we announced today as we continue to invest in our fleet transition. Our CapEx during the third quarter was $32 million. We ended Q3 with debt of $3.1 billion, down from $3.4 billion as of year-end 2022. These cash-related numbers tell an important story about the quarter that we continue to generate positive free cash flow from operations despite production constraints. Our strong free cash flow also benefits from a lower investment in CapEx than in prior years. Our balance sheet and solid liquidity continue to be powerful tools to create shareholder value. Tools that have helped us repay over $330 million in debt and repurchase over $244 million in stock during the 9 months ended September 30, 2023. Consistent with our policy and practice, we are not giving specific EPS guidance at this time but let me give you a little color on Q4 and the preliminary outlook for 2024. We expect Q4 to be modestly profitable on pre-tax GAAP basis, including approximately $60 million of deferred revenue but seasonally down from Q3 as per normal. As Wade will discuss in a minute, we anticipate our Q4 block hours to be flat to down slightly from Q3, primarily due to seasonal factors. Although many variables can impact our 2024 production outlook, we are currently planning for our 2024 block hours to approximate our 2023 block hours with pilot availability being the gating factor. As the GAAP noise from deferred revenue goes away in 2024 and including the benefit from our share repurchase activity this year, our 2024 GAAP earnings per share could again return to the high $5 handle where we were pre-COVID. Our solid balance sheet, reliable cash flow from operations and strong demand for our product provide a catalyst for improving our return on invested capital, including the following. As a result of our year-to-date purchase activity, repurchase activity of 9.6 million shares, as of September 30, 2023, we had 41.2 million shares outstanding. As of September 30, we had $136 million remaining under our current share repurchase authorization and we anticipate continuing to be opportunistic in repurchasing shares going forward. Over the first 3 quarters of 2023, we executed on our balanced capital deployment by also repaying over $330 million of debt. Our debt net of cash continues to be lower than our pre-pandemic levels of 2019. The underutilization of our fleet in place today can accommodate 14% ERJ future block hour growth and 35% CRJ future growth in block hours before the incremental capital investment in the 175s announced today. We continue to expect our 2023 capital expenditures to be approximately $300 million lower than 2022. And as announced today, we continue to deliver fleet solutions for our partners with 19 new E175s being added for United. We now expect to take delivery of 23 new E175 aircraft starting next quarter through 2026. We believe that our strong cash position and the actions we are taking now to prepare the way over the next couple of years for incremental utilization of our fleet, to work through the pilot shortage affecting the industry and to preserve the optionality of monetizing strong demand opportunities over time will position us well to drive total shareholder returns.

Thank you, Rob. Today, we announced a new flying agreement to acquire 19 new E175s and place them under a long-term contract with United. These new E175s will replace 19 CRJ700s. We anticipate 4 of the E175s will be delivered in the fourth quarter of 2024, 7 in 2025 and 8 in 2026. These 19 are in addition to the remaining 4 E175s we have on order. We anticipate taking 2 in the fourth quarter of this year, 1 in 2024 and the last E175 in 2025. At the end of 2026, our E175 fleet total will be 258. This order will continue to solidify SkyWest as the largest Embraer operator in the world. The debt remaining on the 19 CRJ700s will be repaid by the time they come out of contract with United. We expect to work to place these 700s under flying agreements and believe they will be extremely valuable to our partners as they move to replace single-class 50-seat product with dual-class aircraft. These aircraft are some of the newest next-gen CRJ700s in the world. Let me review our production. The third quarter block hours increased by approximately 3% as compared to the second quarter of 2023. Based on the current schedules we have from our major partners for Q4, we anticipate that our fourth quarter block hours will be consistent with the third quarter. With regard to staffing, we have seen an improving trend in our captain attrition and anticipate that our 2024 block hours will be flat as compared to 2023. I would also remind you that we can add approximately 14% more block hours to our ERJ fleet before adding any aircraft. This number is over 35% for our CRJ fleet and makes each additional block hour accretive to the model. Our partners remain very engaged in supporting our efforts to restore production. Let me give a brief update about the status of SWC, our new charter business. SWC began operating on-demand revenue charters beginning in April and we have been investing in training and hiring of employees since that time. We are pleased with SWC's progress and the sport charter bookings for this fall and winter have been significantly higher than we originally anticipated. We anticipate SWC could create a positive contribution to our earnings beginning in November. As far as our prorate business, the demand remains extremely strong, just like the rest of the industry. We have seen very strong yields and great community support. We will continue to work with the communities on the best way to continue our service. We have spent the last several years reducing 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 to the continued exceptional demand for our products. Okay operator, we're ready for Q&A now.

Your first question comes from Michael Linenberg with Deutsche Bank.

You mentioned that CapEx for this year is $300 million lower than in 2022. With the addition of the 19 E175s, how should we view your previous CapEx figures and what the new estimates are for 2024 and 2025?

Yes, hi, Mike. Yes, for '24, we expect to bring in a total of about 5 new E175s. Including the CapEx from those 5 next year, I would expect CapEx in '24 to be flat to slightly up from '23.

That's helpful. And again, in '25, Mike, the number of deliveries is 8.

Mike, this is Wade. As I mentioned earlier, there are numerous opportunities for those airplanes, including the ones you just described. Additionally, American Airlines has a 65-seat CRJ700 that is in high demand. We see both of these opportunities available to us, and we expect to start flying them in the near future.

Okay, that's great. And then just last, Rob, on your GAAP EPS for next year, if I heard you right, I think you said $5. What is the release per quarter? Is it just the reverse? Is it roughly $60 million of revenue that gets released for each quarter? Or is it a different number? I want to make sure my pacing is right.

Yes, sure. Let me clarify. What I mentioned about GAAP EPS for next year is that it is projected to be in the high $5 range for 2024. This estimate takes into account around $40 million to $50 million in deferred revenue reversals over the course of the year, which translates to roughly $10 million to $15 million in reversals each quarter. It's not a significant figure for next year.

Will it actually pick up after 2024, or will it continue at the same rate until we exhaust the entire $300 million plus?

Yes. What I would say is it's going to be approximately that 24% rate for the next couple of years in all likelihood. It depends on a number of factors, including our overall production but '25 should look quite a bit like '24.

Your next question comes from the line of Savi Syth with Raymond James.

Just curious on the E175 order with United, does that replace any of the aircraft that you're flying for United today? Or how does that work?

Yes, Savi, this is Wade. We have 19 CRJ700s that are flying for United today. And as the new 175s come in, they will replace those airplanes. And as we said, we anticipate that we would still work with all of our major partners in placing the 700s elsewhere to replace potentially single-class 50-seat airplanes.

Got it. I missed that comment and it makes sense what Mike was asking before. Thank you. And just on the pilot side, I wonder if you can provide a little bit more color. It seems like what we're hearing everywhere is much slower growth next year. Some of those low-cost carriers might not even be doing extra hiring. Are you seeing that today? And just any kind of updated thoughts on how kind of the building up the captain supply will progress over the next year?

Yes, Savi, this is Chip. That's a great question. I think your perspective on the industry from the last 10 days aligns with what we've been sensing over the past month. When examining the environment, we continue to observe further stabilization of captains and pilots according to our models. Additionally, regarding capacity and the number of pilots that major carriers have, most of them employ more pilots now than they did prior to the pandemic. Various factors influence our predictions, and these factors are encouraging us to maintain a more positive outlook. We anticipate building substantial momentum in the latter half of 2024 into 2025. However, as you are aware from the last couple of years, it remains a very dynamic situation that we are closely monitoring to ensure we can stabilize and elevate our production to where it should be.

Makes sense. I'll get back in the queue. Thanks.

Your next question comes from the line of Helane Becker with TD Cowen.

Thank you, operator. Hi team, I appreciate your time. I'm curious about SWC as it appears to be a promising area for growth. Chip, I believe you mentioned confusion regarding the FAA's slow approval process. Are American and Southwest expressing concerns about this emerging segment of the business?

Helane, this is Chip. Yes, I'm looking for a question in there, but I will try to add some commentary on all of it if you will. I guess my question is, there’s a lot of opportunity with SkyWest Charter. We're very optimistic about some of the developments within the college sector and certain markets where SWC is operating. One thing to note that makes us optimistic is that we're entering markets that have seen a surge in demand since the pandemic, and they have not had reliable service providers in these areas. From our perspective, SkyWest has always been a strong performer in the aviation industry, and as we expand into these other markets, we’re receiving a very warm welcome from the communities interested in our services. Regarding the DOT, we believe we understand why they are not approving our request for commuter authority, and there seems to be some unusual behavior related to their decisions. As we monitor this process, we remain committed to advocating for the communities' needs. We were hopeful that SWC would deploy about 20 to 25 aircraft for small community service under commuter authority, which is actually a modest fleet. Currently, we have 13 or more aircraft providing on-demand service within Charter. There are many good opportunities we see here, but in the larger scheme, this remains relatively small compared to SkyWest Inc. and our overall fleet with SkyWest Airlines. We are still planning to deploy 19 E175s to SkyWest Airlines, which is part of a broader strategy where we can leverage our expertise, excellent safety record, and proven procedures to advance our product into various models in different locations. That’s our current position with SWC.

That's really helpful. Thank you very much.

Your next question comes from Catherine O'Brien with Goldman Sachs.

First, congratulations on the United deal, it's exciting. With those additional aircraft, you called out that your 175 fleet is going to increase to 23 aircraft between now and 2026. We've seen your CRJ900 200 seats get a bit smaller over the last year. How should we think about net growth of the total fleet between that E175 growth and any changes you would anticipate in the CRJ side? Understanding that you expect those 19 CRJs coming out of United to land somewhere else. I guess like any changes above and beyond that if there are any.

Yes, Kate, this is Wade. Great question. As we mentioned, we have 23 E175 aircraft coming, with 4 already on order. They will arrive in '24, '25, and '26. Additionally, our current ERJ fleet is still underutilized by 14%, so there’s room to improve that utilization. Our CRJ fleet is about 35% underutilized, meaning there are significant opportunities to enhance utilization there as well. We currently have enough shells available for our CRJ fleet. We are always in discussions with our major partners regarding their future fleet needs. With our existing orders, our current fleet, and ongoing discussions, we definitely see many opportunities ahead to expand and effectively utilize our dual-class fleet as we plan.

Got it. You'd expect like CRJ probably and understanding there's tremendous capacity to increase utilization on that side of the business but you'd expect like shell count to be fairly stable over the next couple of years. Is that right?

Yes, we anticipate our shell count to remain very stable. We have many CRJ900s and CRJ700s available for deployment in the future.

Got it. And then maybe another one on SWC, that being a positive contribution to earnings in November on better-than-expected demand. I know obviously things have changed with some of the delays in the commuter authority but it sounds like the on-demand charter, that's a happy new piece of news there for you guys. What was your initial expectation of when SWC would be a positive to the bottom line? And I guess how should we think about the size of that contribution going forward? Thanks so much.

Yes, Katy, this is Chip. Just real quick on it, I think that initially we anticipated that we would probably be well into 2024 before we would have a positive contribution from SWC. I mean clearly, our plans originally, as we were looking at commuter authority, we knew it would be a measured, I don't want to say a slow but a measured and predictable process as we were starting to pick up more small communities through the process that that takes. And now we have massive demand from colleges and other entities that want on-demand service absolutely right now. That's why the time line has certainly picked up. Now I think from our perspective, since we're still in the infancy of how we're trying to build up the demand, we'll probably hold off and evaluate it and give you some more information when we meet on the fourth quarter results, maybe give some more color of what our expectation contributions are going to be there. But so far we're optimistic but it's still a little bit early and we'll know a lot more in the next 3 months and get back to you on some more specifics then.

Totally fair. If I could just sneak in one last question about the leasing business, I’ve noticed that revenue has been relatively flat. We often hear about the limited availability of new tech narrow-body aircraft driving appealing lease rates in that segment. Are you observing any differences in the supply and demand dynamics regarding the aircraft and engines you are considering for that business? Or has the approach changed, and do you plan to retain those and utilize them in your own operations? I would appreciate an update on the future trend in that area. Thank you.

Yes, Kate, this is Wade. The demand has been really strong. We've seen significant demand in both leasing and selling assets across all types of our engines, although it's flat in that line item. Some of the decline relates more to our ground handling business. However, we observe a strong pipeline for leasing and anticipate growth moving forward. We recognize the supply chain challenges and many companies in the market are currently seeking engines for assistance. There remains potential for growth in this area. We are actively collaborating with clients on this now. Overall, we expect strong demand over the next couple of years.

Your next question comes from the line of Duane Pfennigwerth with Evercore ISI.

Just maybe just to revisit some of the themes, so first on staffing and your kind of increased confidence, what are you seeing? Is this a function of things that you have implemented on the retention side? Or do you suspect that there's maybe less competitive bidding at the moment from the mainline carriers? Is this a function of maybe adjustments to capacity plans out into early 2024?

Yes, thanks for your question. This is Chip. There are probably three main points to discuss. First, we have taken significant steps internally to ensure we are the leading regional carrier for pilots looking to build a long-term career with us. In the past 18 months, we have seen encouraging trends in captain attrition due to these efforts, marking a very positive change in the last year. Looking ahead, in terms of overcapacity, we are closely monitoring the hiring trends of major carriers, who currently employ more pilots than they did before the pandemic, as indicated by public documents. This has led us to discussions about capacity, and we have noticed a consistent trend over the last few months, which we expect to strengthen in the coming months. Lastly, while we still face challenges with pilot supply, our partnerships with flight schools and the strength of our cadet program are at an all-time high, yielding very positive feedback from first officers. We are at a crucial juncture where we need to continue producing more captains to enhance our productivity, which will be vital for us over the next year.

Okay, great. And then on the United agreement, maybe you could just talk a little bit about is it a function of the demand appeared or your ability to service that demand appeared? If we think about like the pipeline of incremental business where you'd be going out into the market and acquiring new aircraft, what's the rate limiter on that? Is it sort of coming to the right terms with the legacy? Or is it your confidence in your ability to go execute that business?

Yes, this is Wade. We've been working with United on this deal for a while, right? And United has been extremely supportive of us to continue to get a very good complete 175 fleet in their large dual-class scope with them. And so, we've been working with them for a while on this. The legacy was very supportive. They wanted this product in there. They could see that we were improving, that our demand is coming back, that we're able to fulfill these contracts. And so I think between the confidence that United had and what we had in our abilities, we worked with them and we came to an agreement on this with Embraer and United. And we do have these deliveries over the next 3 years, right, the end of '24, '25 and '26. It will give us time to get our overall fleet utilization back where it needs to be as well. It was just a great 3-way agreement that we did. I would even add GE into that as well. All of our major partners that we had in this one was very good and it was a good transaction for us.

I guess just should we expect more of these over time is kind of the question? Is this a one-off? I mean it's great to see it. Is this a one-off? Or do you think there could be more of these over the coming quarters?

Duane, this is Chip. I hope we see many more of these in the upcoming quarters. Given the current environment, we're realistic about our situation. Securing 19 175s is an excellent outcome considering the timing and global challenges we face. However, there are significant obstacles to obtaining more. Primarily, interest rates for aircraft financing are very high. As we discussed earlier, developing captains remains a challenge. We believe that ordering more aircraft will aid in recruitment and retention. Nevertheless, we need to ensure we achieve the right pricing and financing for these aircraft. The advantage we have at SkyWest is our strong competitive position, as we are more creative than others in making these deals happen. While I can't guarantee that there will be many more of these opportunities, I can say that this is a key part of our strategy, and we are better positioned than anyone else due to our balance sheet, our talented professionals in the industry, and our innovative approach. I hope to see more of these in the future, but we do face considerable challenges as well.

Your next question comes from the line of Savi Syth with Raymond James.

Thanks for the follow-up. Can I ask on the prorate side, how many kind of aircraft are you doing on the prorate side? And is that now mostly the larger RJs or kind of just a mix there?

Yes, Savi, this is Wade. We have somewhere in the range of 25 to 30 airplanes in the prorate side. I think you have probably seen publicly our Delta fleet has transitioned to a dual-class fleet primarily on that starting the first part of October. And so that has transitioned. The rest of it still is in a single-class 50-seat airplane.

Got it. Just a quick follow-up on the charter side. What is the seasonality like? Does it provide a nice offset, or is it something different?

Yes. I think honestly, Savi, this is Chip. We're kind of still learning ourselves. I mean what I do know is that from now through the spring is extremely busy. And we're hearing, I mean to a certain extent, we're like, okay, this is basketball and is that what this primarily is? And if it primarily is basketball and we start to look at what happens after spring and summer and there's also other sports of baseball and other ones where there's a lot of other things that happen with this. We're new to this. And to a certain extent, like I said before, the industry is new to an entrant that can do this reliably and predictably. Because that's the number one shocking thing for us getting into this space is how bad the competition is to be candid. It may be unfair but just to be honest, we can deliver a product that a lot of people haven't seen before in this space. That having been said, it is a bit seasonal that we see today. We're looking at what things can happen next summer to keep the seasonality strong throughout the summer. But obviously, we're going to, as we said before, continue to pursue commuter authority. And when you get to that level of seasonality on that side of the business, it could offset very nicely. That's kind of the process that we're going to take with it.

Is that still like 100 pilot type operation? Or does that need to grow?

No, that would need to grow. If we are sitting here, we typically assume we need about 10 pilots per aircraft. We have the needs of 13-plus today. And like we said, there's a fair amount of small community service we could do on top of that, so we'll continue to need to grow the pilot element of that business model. Which, to be candid, has some very, very attractive prospects. We have some amazing pilots joining and we have a long list of pilots that would love to be involved with it.

There are no further questions at this time. I will now turn the call over to Mr. Chip Childs for closing remarks.

Thank you again, everybody, for your interest. We appreciate the amazing work that our people have done this last quarter. I can't speak highly enough of what our performance does with the opportunity it in turn provides for our people and shareholders and all of our stakeholders. Quite candidly, we're grateful for the sensitiveness that everyone is moving forward in the world we're living in today and keeping safety the utmost paramount priority that we have and we continue to have what we hope is a very good, well executed and safe holiday season and we will return back and report on the fourth quarter in 3 months. Thanks again for your interest.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.