Welcome to the Sun Country Airlines Second Quarter 2022 Earnings Call. My name is Kathy Darnell, and I'll be the operator for today's call. At this time, all participants are in a listen-only mode. Please be advised that today's conference is being recorded. I'll now turn the call over to Chris Allen, Director of Investor Relations. Mr. Allen, you may begin.

Thank you. I'm joined today by Jude Bricker, our Chief Executive Officer; Dave Davis, President and Chief Financial Officer; and a group of others to help answer questions. Before we begin, I would like to remind everyone that during this call, the company may make certain statements that constitute forward-looking statements. Our remarks today may include forward-looking statements, which are based upon management's current beliefs, expectations, and assumptions, and are subject to risk and uncertainties. Actual results may differ materially. We encourage you to review the risk factors and cautionary statements outlined in our earnings release and our most recent SEC filings. We assume no obligation to update any forward-looking statement. You can find our second quarter press release on the investor relations portion of the website at ir.suncountry.com. With that said, I'd like to turn the call over to Jude.

Thanks, Chris. Good morning, everyone. Demand for all segments of our business remains as strong as it's ever been. Our revenue in Q2 grew over 29% versus the same quarter in 2019 on block hour growth of 23%. During the pandemic, we launched and built out our cargo business and now, over the next several quarters, our main focus at Sun Country is to staff our airline to get back to 2019 utilization levels on our passenger fleet as quickly as possible. We want to deliver this growth while also maintaining the operational excellence and service levels that our customers expect of us. I'm especially proud that year to date, Sun Country has led the industry in completion factor with 98.2% in this challenging operational environment. That performance during such rapid growth is a testament to the hard work and talents of all our team members that deliver for our customers each day. Like all airlines, we're facing the challenges of record-high fuel, a tight labor market, and inflationary pressures. We built a model that we believe can deliver profits in any environment. We were profitable through the pandemic, through a war, and now through record fuel. Our flexible network, combined with having a large percentage of our flying committed to long-term pass-through contracts, gives us the ability to be successful regardless of what challenges we're facing. By design, our response to high fuel is to cut off-peak flying and concentrate our schedule on periods of the calendar when we're able to achieve acceptable returns. As fuel rose rapidly through February and into May, we aggressively cut weaker periods like mid-week flights in May and September and long-haul routes that are more fuel intensive. These capacity cuts, along with all our revenue initiatives, allowed us to deliver over 29% schedule service TRASM growth versus 2019 for Q2. As we've had more lead time going into the third quarter, we expect our scheduled service TRASM to approach a 40% improvement, and we continue to see strength across our selling schedule currently posted through April of next year. We expect not only to be profitable in all environments, but also to deliver industry-leading margins. I want to give some color as to why, for the first time in 10 quarters, that isn't the case. The capacity changes we've implemented in the second and third quarters were all cuts. However, the fare environment and our fleet size justify significantly more flying during peak periods. We weren't able to add this flying due to crew constraints. Since ratifying our pilot agreement at the end of last year, we haven't had any issues with retention or hiring. However, we're attempting to train about four times the amount of crews versus pre-COVID levels. At the end of June, about a third of our FOs were in a training status. This resulted in a reduction for June, a peak month, of 30% in passenger fleet utilization versus 2019. With 40% of the fleet committed to contract flying, we were under-allocated to the best margin opportunities during the quarter, namely scheduled service in large volume domestic markets. As hiring retention continues to not be an issue, we expect our crew constraints to be temporary. Again, I'm so proud of all our team members here at Sun Country for going above and beyond every day. And with that, I'll turn it over to Dave.

Thanks, Jude. Before I get into a discussion of our results, recall that Q2 is a seasonally weaker quarter for Sun Country compared to Q1. This is unlike many of our competitors whose business strengthens during Q2. Sun Country posted an adjusted operating profit of $4 million for the quarter and an adjusted EPS loss of negative $0.03 per share. Adjusted operating margin was 1.8%. Our results were driven by a combination of unprecedented growth in unit revenue, historically high fuel prices, and under-capacity driven by staffing issues. I'll delve into each one of these items in my remarks. First, revenue and capacity. Second quarter revenue totaled $219.1 million, a 29% increase versus Q2 of 2019. Demand continues to be robust. Scheduled service revenue was $152.6 million, a 22.5% increase over Q2 2019, and scheduled service TRASM grew 29% versus 2019. For the month of June, scheduled service TRASM was 44% higher than 2019 and July finished over 40% higher than July 2019. So, recent positive revenue trends are continuing and are evident in our forward bookings. Our average fare of $173 was 22% higher than Q2 of 2019. System block hour growth for the quarter was 23% higher than Q2 of 2019, driven by the growth of our cargo segment. System ASMs declined by 6%, compared to Q2 2019, which was considerably smaller than we would have optimally been, even at fuel prices above $4. As Jude mentioned, since finalizing our pilot agreement in December of last year, we've been able to attract all of the pilots we need to meet our staffing requirements. In addition, attrition has continued to moderate since Q4 of last year. As we implement the new agreement, we've been increasing the size of our hiring and training pipeline to accommodate our growth plans. This work is underway and we continue to make good progress. Pilot output in June was more than double the output in April and our September new-hire class is over 30% larger than earlier in the year. Charter revenue for the quarter was $42.7 million, a 25% increase over Q2 of 2019. Over 90% of the charter flying we did during the quarter was under long-term contracts. While increasing the proportion of business under contract is a favorable trend, there remains ample opportunity to increase the amount of profitable ad hoc flying that we do. In 2019, 49% of our charter flying was ad hoc. This gap to today's number represents growth potential for our charter segment as the number of available pilots continues to increase. Cargo revenue for the quarter was $21.2 million, flat compared to Q1 2022 and down by 4% versus Q2 2021. The decrease was driven by more aircraft undergoing heavy checks compared to last year. We did not fly main deck cargo aircraft in 2019. Turning now to costs. Our Q2 non-fuel costs per block hour only increased 3.6% versus Q2 of 2019, despite the implementation of our new pilot agreement. Adjusted CASM over the same period increased 15% versus 2019, alongside a 6.4% decrease in total ASMs. This increase in our non-fuel CASM is largely driven by the fact that we were significantly undersized relative to both our initial plans for Q2 and the profitable flying opportunities that were available to us. The average price that we paid for fuel in the second quarter was $4.39 per gallon, far higher than the $2.29 per gallon we paid in the second quarter of 2019. Relative to the Q2 guidance we gave last quarter of $3.50 per gallon, the higher price drove $15.5 million in added fuel expense. We experienced that the reduction in fuel expense would have led to an adjusted operating margin for the quarter of 9%. So, despite the capacity challenges I've discussed. Let me talk now briefly about guidance. As we move through Q3, the demand environment remains very strong and we expect scheduled service TRASM to be in excess of 40% higher than Q3 of 2019. We expect third-quarter total revenue to be up 25% to 28% versus 2019 and operating margin to be between 3% and 5%. Our projected Q3 fuel price is $3.84 per gallon, and we expect to fly 31,000 to 32,000 block hours, or approximately 1.5 billion ASMs. We believe the fundamentals of our business plan remain strong and our model is highly resilient to changes in macroeconomic conditions. Our focus remains on profitable growth. The fact that we have grown less than anticipated has resulted in a decline in aircraft utilization relative to pre-COVID periods. As our pilot output continues to improve, we anticipate growth will come at higher margins as fixed aircraft costs are already being incurred. Finally, let me focus on our balance sheet where we closed the second quarter with $308 million of liquidity, consisting of $283 million in cash and $25 million of an undrawn revolver. Despite extremely high fuel prices, we generated over $15 million of free cash flow during the quarter, excluding aircraft CapEx, and we continue to expect to be strongly free cash flow positive for the year. Our strong balance sheet continues to provide capital deployment flexibility in the quarters ahead. With that, I'll open it up for questions.

Thank you. Our first call comes from the line of Duane Pfennigwerth with Evercore. Go ahead, your line is open.

Hey, thanks. Good morning. You gave some of the stats on training, but maybe you can just kind of re-summarize that. Can you speak to how your throughput is changing? How did the number of flight instructors change? I think you were looking for a step-up there in the month of July. And just to maybe bottom line it, when do you think you're going to be fully back or where you want to be on staffing, maybe with an eye toward the fourth quarter?

Yeah, so just a couple more stats. I talked about the pretty dramatic increase in our pilot output. There have been a couple of bottlenecks in the training pipeline. One of the biggest ones, which we've now largely overcome, is on basically check airmen, IOE pilots who can certify our pilots to fly before they get online. We had only five IOE instructors in the months leading up to July 1, when we increased that number to 19. We'll continue to increase that number in the months ahead, so that bottleneck we think is largely cleared. There are a couple of other things we're sort of working through here as we go forward, which I think we're going to have solved in the next quarter to two quarters. We'll know a lot more in the next several months, but all of our trends are very favorable. If you look at our growth, as we look out later into the year, we'll be accelerating again relative to the fourth quarter. So, we've just been going through implementing the new pilot agreement. The good news is, some of the uncontrollable factors, like attrition and new hires, we have a solid handle on, so we can attract all the pilots we need and our classes are as big as we want them to be.

Okay, great. And then just for a follow-up on network, obviously, right here and now you're constrained, but can you give some color on the types of markets that maybe outperformed in Q2 versus the markets that underperformed, with the benefit of hindsight?

Sure, Duane. So, the most disappointing under-capacity allocations were in markets that had significant demand and could handle much more capacity, showing notable revenue improvements. We believe that adding more capacity wouldn't have changed the revenue environment much. Most of these markets were Minneapolis to large cities like Denver, Dallas, Baltimore, Boston, New York, Portland, Seattle, Houston, and Indianapolis. We don't know for sure, but we believe they were positively impacted by a return of business demand, which lifted overall fares. We think there was a lot of opportunity to add significant capacity. Instead, we were allocated more into fixed fee, as we talked about, as well as leisure markets that didn't see the revenue improvement that we observed in these larger markets. Grant, anything to add?

No, I'll just add one thing. We've grown Minneapolis non-stop destinations by over 50% through COVID. As Jude mentioned, some markets performed better than others, but broadly, I would say Minneapolis performed very, very well. The new markets did meet expectations and we did see a lot of good growth opportunities that remain in the market. We will be opportunistic, and we will take advantage of it as the capacity becomes available.

Okay, thank you.

Thanks, Duane.

Thank you. Our next call comes from the line of Michael Linenberg of Deutsche Bank. Go ahead. Your line is open.

Great. Hey, good morning, guys. Just following up on...

Hey, Mike.

Hey, guys. Just following up on Duane's question. When I did see you pull down also some of the long, you know, high-volume summer markets, say West Coast, Hawaii, I just assumed that that was all because energy prices or fuel prices were above $4 a gallon, but it does sound like you just didn't have the staffing. Was it a combination of both or would those markets have worked – some of those longer-haul markets, would they have worked, given where overall fares are, where pricing is and the higher fuel? Was it mostly a staffing issue that drove that?

It would have worked, absolutely. Keep in mind, for Hawaii, we're talking about a market that would've started around Memorial Day, a little bit before. Everything in June works on the schedule service side. We were making decisions based on a combination of fuel intensity—it's about 50 gallons per passenger to fly someone to Hawaii versus about 20 gallons on our domestic network—as well as crew efficiency. Since we're crew constrained, if there's any positioning or penalty, we can get more flying done in a different way, then that goes into the calculus as well. Hawaii, we expect to be back next summer; it would have done just fine in this environment, but we're just trying to put the best stuff in.

Okay. That's helpful. Then just... I know this got picked up and maybe it was from an interview, and it was just maybe an off-the-cuff conversation about potentially flying wide-body airplanes. When I sort of think about what you're dealing with right now, it doesn't seem like that that's anytime soon, but maybe it is. And it may be that in conversations that you're having with Amazon, if you were to do wide-body, I'm sure that there'd be a cargo complement as well. Otherwise, I don't think it would make sense. Anything that you can sort of just add to that? Maybe again, that was kind of off-the-cuff? I want to put that to rest.

Yeah. Sure. So, the question from the reporter was noting that wide-body rates are in our pilot agreement. Do we think it would work? My response was, yes, it'll work, but we don't have any plans to do it in the near future. So, multiple years from now, we might consider that, and I agree with your sentiment that there would need to be a cargo complement as well to get the same synergies out of our multi-segment business in narrow bodies into the wide-body space. So, our focus right now is putting pilots out onto the line, and that'll be our focus for the next two quarters.

Okay, great. And just squeezing one quick one on the pilot contract. Obviously, you're rolling out various elements. When is the preferential bidding system? Is that now up and running or does that take some time? Because I do think that that will also help work things through. Is that are you there yet on that part of the contract?

Yeah. That's a good question, Mike. The answer is no. We have some of the stuff in place that maybe doesn't help from a productivity perspective. What we don't have in place is prep bid, which will help us. We don't have that in place yet. That's probably early in the year. We're working through this productively; we've got our vendor chosen and so forth. We just need to implement it, and it's going to be early next year, but that's going to help, no doubt.

Okay, great. Great. Thanks for the time, everyone.

Thank you, Michael. Our next question comes from Barclays, from the line of Brandon Oglenski. Go ahead.

Thanks for taking my questions. Jude or Dave, does this, you know, the training problems you're having right now or the constriction here, does this change your longer-term capacity plans, especially as we think about 2023 or 2024 relative to where you were maybe pre-pilot contract?

Yeah, I mean, I think in the near term, we're certainly constrained by pilots. We expect as we move into 2023 to be able – our goal, and we have line of sight on a plan, to achieve a 20% block hour growth rate, which I think is achievable over a more sustained period. We're not going to grow for growth purposes. I mean, we need to have high-margin opportunities for that incremental flying, which I think exists in today's environment, even with fuel prices. In a recession or higher fuel scenario, that growth rate would change. But we're building out training capacity, and we also have a contract and a value proposition to incoming pilots with diversity in our flying and growth rates that 20% is attainable.

Yeah. Let me just give you a couple – this is Dave. Let me just give you a couple other numbers though. We originally expected to end the year with 42 passenger aircraft. That's where we'll be. We are in advanced discussions, pretty close right now, on three more aircraft that'll deliver to us later in 2023, and we are remaining active in the market. The beauty of the fleet plan, as we talked about many times before, is we don't have fixed orders coming in, so we can pivot, go up and down based on how much we can fly and what the opportunities are. We're going to continue to do that, just like we've been doing. But we're in the market; we're still looking for aircraft. We've got a strong lead on three more, so we're moving forward and planning for sustained growth.

And Dave, I guess, as you look out into 2023, if you're able to achieve that 20% growth in block hours, where would you see the CASM benefit come out?

You mean, like on what P&L line item or what time period?

No. I mean, I think the target was below 6 CASM, but now maybe a little bit around 6. Where would you see longer-term CASM, I guess shaking out, to be more specific?

Well, CASM will be heading down as we grow. I don't have a revised plan right now to give you a number. I think our costs are well in hand. I just don't have enough done on the 2023 plan yet to give you a good 2023 number. The other thing to think about, this is always tough with us because we've got a big cargo business. So, we have costs that derive unassociated with ASMs. We really look at a lot of stuff on a cost per block hour basis, which we feel is pretty well in hand, but I don't have a precise CASM forecast for you right now.

Okay. Appreciate it, guys. Thank you.

Thanks, Brandon.

Thank you. So, our next call comes from the line of Scott Group with Wolfe Research. Go ahead.

Hey, thanks, good morning, guys.

Hey, Scott.

So, I think you talked about 44% unit revenue growth in June, 40% or so in July, any thoughts on where we go from here and what you're seeing with fares as fuel prices are starting to come down?

So, Scott, just want to make a clarifying point, which is that that's for scheduled service TRASM, which is about 60% to 70% of our block hours. The rest is in long-term fixed contracts, which adjusts slowly. We've seen really consistent year-over-three unit revenue improvements in sales for the entire selling schedule out through April. We don't see any slowdown associated with any pullback in demand from where we were on peak levels in July. Our own capacity can influence that if we're able to add more. We don't want fares to get too high where travel is unattainable for a large portion of our customers, but there's no indication in any of our forward bookings of any weakness or any change from this summer.

And so, at least for now you feel like you'll be able to sort of keep the drop in fuel and keep the benefit of that.

Yes.

And then you talked about, in the beginning, that you want to have industry-leading margins. Maybe just think about that's maybe the goal of double-digit margins. What has to happen – realistically when can we get back to a double-digit operating margin?

If you look back in the second quarter, the foregone opportunities of flying, it's hard to tell, but it's probably worth on a pre-tax and operating basis, around $15 million, which would have put us pretty close to double-digits. The answer to your question becomes how quickly we can put crews out onto the line to get the passenger fleet back to utilization levels that we had in 2019. The fuel price is higher, so the flying opportunities for high utilization are concentrated when fares are naturally higher. In May, there wasn't that much. In September, there won't be that many opportunities to add other than ad hoc charter opportunities. But for summer months, where this demand environment is so good, we're forgoing significant opportunities with utilization down 30%. That's the key to delivering back to operating margins that lead the industry, I think.

So, would that be your goal or expectation for 2023, to get back to leading the industry?

Yes.

Okay. All right. Thank you, guys.

Thanks.

Thank you for joining the call, everybody. We'll talk to you in three months. Have a great day. Thank you for your participation in today's conference. This does conclude the program, and you may now disconnect.