Earnings Call Transcript - SNCY Q3 2021

Operator, Operator

Welcome to the Sun Country Airlines Third Quarter 2021 Earnings Call. My name is Amitras, and I will be your operator for today's call. I will now turn the call over to Chris Allen, Director of Investor Relations. Mr. Allen, you may begin.

Chris Allen, Director of Investor Relations

Thank you. I'm joined today by Jude Bricker, our Chief Executive Officer; Dave Davis, President and Chief Financial Officer; and a talented 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 subject to risks 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 statements. You can find our third quarter earnings press release on the Investor Relations portion of our website at ir.suncountry.com. With that said, I would like to turn the call over now to Jude.

Jude Bricker, CEO

Thanks, Chris. Good morning, everyone. To review, our multisegment business model is unique in the airline industry. Due to the predictability of our charter and cargo businesses, we are able to deliver the most flexible scheduled service capacity in the industry. The combination of our scheduled flexibility and low fixed cost model allows us to respond to both predictable leisure demand fluctuations and exogenous industry shocks. We believe that due to our structural advantages, we will be able to reliably deliver the industry's best profitability throughout all cycles. Traditionally, the third quarter is a relatively weak quarter for us. However, I'm happy to report industry-leading EBITDA and operating margins of 21.3% and 13.2%, respectively. While the Delta variant negatively impacted our scheduled service revenue, our cargo and charter segments outperformed to the upside. In addition, our variable capacity model helped to minimize our exposure to the demand weakness in late August and early September as we flew 41% of the quarter's scheduled service departures in July and just 22% in September. This focus on flying more during peak demand helped to produce a 4% increase in TRASM compared to the third quarter of 2019. In fact, TRASM improved in every month within the quarter in spite of the Delta variant. We attribute this trend to careful allocation of our capacity and continued improving performance of our ancillary products. Fourth quarter bookings are trending positively as well. Similar to the third quarter, we've loaded a schedule focused primarily on peak periods. For example, currently, in the fourth quarter, 85% of our ASMs are on peak days, up from 80% in the fourth quarter of 2019. I want to address two common themes across our industry. First, operational performance. It seems operations are straining everywhere across the economy as we recover from the COVID crisis. So I'm especially proud of our team's performance. We have maintained a schedule controllable completion factor of 99.9% throughout the quarter and in the trailing 12 months. Further, our trailing 12-month on-time performance is above 84%, with a mishandled bag rate of less than 2 per 1,000. This is while growing system block hours 15% compared to the third quarter of 2019, and we've added our fleet, substantially increasing it by about 50% since COVID began. In light of our growth rates, our operational performance is particularly impressive. Second, cost pressures. While we're certainly not immune to labor cost inflation, we still expect our fourth quarter '21 ex-fuel unit cost to be roughly in line with the 2019 comparison. This is despite significantly lower utilization as we bring back utilization on our passenger fleet to 2019 levels and work through some of our legacy contracts; we'll be able to continue to trend our ex-fuel CASM to below $0.06. Finally, I want to give a few thoughts on our charter business. I haven't devoted much commentary to this segment in the past. Our charter business is extremely valuable because it has pass-through economics. It is counter-seasonal to our leisure demand. It's a space where we have significant advantages, and namely, we can be more responsive than any other carrier. For example, all in the third quarter, we participated in the Afghan evacuation while also delivering our VIP product on our Kona Shuttle, and we flew our usual seasonal NCA football schedule facilitated by positioning aircraft throughout the country on scheduled service. In short, we're better charters than anybody. Recently, we announced a new 5-year agreement to support Major League Soccer and their charter needs. Generally, we're now seeing charter volumes back to 2019 levels. As we continue to find new charter opportunities, I'm confident that our charter segment will continue to grow proportional to our scheduled business. With that, I'll turn it over to Dave.

David Davis, CFO

Thanks, Jude. I'll now review our third quarter financial results in more detail and provide an update on our fleet acquisitions before moving into Q&A. We produced $173.7 million of revenue in the third quarter. This is the highest level since Q1 of 2020 and is higher than the third quarter of 2019. For the scheduled service passenger business, PRASM was $0.0619, which is only 1% below Q3 2019 levels. Viewed sequentially, PRASM increased 11% versus the second quarter of 2021 and an 8% increase in scheduled service ASMs. Ancillary revenue continues to stay strong at $42.91 per passenger, which is 33% higher than the third quarter of 2019. We're still trailing our 2019 load factor but are encouraged by the strengthening that we are seeing in pricing. Total revenue per ASM, or TRASM, which includes revenue from our charter business but excludes our cargo segment, was $0.0963, up from $0.0926 in Q3 of 2019. Charter revenue was $33.8 million for the quarter. Although still not fully back to Q3 2019 levels, charter revenue is rebounding nicely, and we are seeing strong growth in our sports business, particularly our flying for Major League Soccer. As Jude noted, we recently signed a 5-year deal to be the charter service provider for the MLS. Our track charter programs, which consist largely of casino flying, are still recovering from the pandemic, and there remains excess capacity from other airlines and the military charter market, which we think will subside once more lucrative international and business traffic begins to return. Cargo revenue in the third quarter was $24.4 million and benefited from a 4% increase in block hours versus the second quarter of 2021. Turning now to operating costs. We continue to maintain solid cost discipline with total operating expenses 6% lower than they were in the third quarter of 2019. Conversion from a leased to owned aircraft fleet continues to pay dividends as the combination of aircraft rent expense and aircraft depreciation was 13% lower than in the third quarter of 2019. Our efforts to lower distribution costs have resulted in a reduction in sales and marketing costs per passenger of 15% compared to the third quarter of 2019. Salaries were 26% higher versus the same period in 2019 due mainly to the insourcing of our MSP ground handling operations in April of 2020 as well as growth in our flying levels. On a per block hour basis, however, the combination of both rents and salary expense was essentially flat versus the third quarter of 2019, and operations at our MSP base have markedly improved. Turning now to our fleet. As we've mentioned in previous calls, our intent has been to acquire 5 incremental aircraft in 2021 and 8 in 2022, on our way to at least 50 passenger aircraft by the second half of 2023. With the acquisition of 2 aircraft since the end of the second quarter, we've now reached our fleet goal for 2021. We remain engaged in discussions on a number of additional planes, and we're confident that we'll be able to find what we need to grow at prices that will allow us to continue to average down our ownership costs. During Q3, we purchased an engine, an aircraft, and 3 engines for cash resulting in a reduction in our liquidity balance from $336 million at the end of the second quarter to $300 million at the end of Q3. We may finance unencumbered assets in the future, and our liquidity is sufficient to provide flexibility on the timing of future financing decisions. Total debt, including both finance and operating lease amounts on the balance sheet has only increased $5 million since the beginning of the year. And liquidity as of November 1 was $325 million, so we are in a very strong position to fund our growth. Finally, we summarize our expectations for Q4 in the earnings release. Q4 is a typically seasonally weaker quarter for Sun Country than Q3. In addition, fuel prices are expected to be $0.31 per gallon higher in Q4 than in Q3. For the quarter, we expect total revenue of between $164 million and $169 million, a fuel price of $2.55 per gallon, and operating margins of 1.5% to 5.5%. With that, I'd now like to open it up to questions.

Operator, Operator

The first question comes from the line of Hunter Keay with Wolfe Research.

Noah Chase, Analyst

It's actually Noah Chase on for Hunter Keay. I noticed you used the word sensibly when describing your capacity growth. What do you mean by that in the context of your expansion plans?

Jude Bricker, CEO

The main thing we would mean is making sure that we're able to deliver quality operational results. So we have the fleet to grow substantially faster than we're growing. But recall, we didn't have the kind of drawdown most of the airline industry had, so we kept everybody working through the COVID pandemic. Now we're running about 15% to 20% higher depending on the period. But as we look into the next year, then 2019 levels, which is substantial, considering that we stopped hiring like most airlines through the pandemic. So we're in a full ramp-up mode right now. We're hiring across all major labor categories, and that's about as fast as we can go.

Operator, Operator

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

Catherine O'Brien, Analyst

So I think you guys were the only U.S. airline to beat your initial guidance this quarter given the impact of the Delta variant mid-quarter. I guess what went better to offset that Delta-related weakness? I know you had mentioned in the press release you did see some across your system.

David Davis, CFO

Yes, this is Dave. I believe there were a few factors at play. When we set our initial guidance, the demand environment was still quite uncertain. We may have approached it with some caution due to the unpredictable nature of COVID. However, we saw more cargo activity during the quarter than we initially expected. Additionally, everyone at the company has been effectively managing costs and keeping our operating expenses in check. These elements all contributed to the operating margins we observed during the period. Overall, there wasn't anything particularly extraordinary, just consistent management of the business.

Catherine O'Brien, Analyst

Okay. Got it. And then maybe just one on the forward book. Your implied CASM ex-fuel, based on your guidance, would be down sequentially from third quarter despite ASMs actually being lower in the fourth quarter. Were there some timing events in the third quarter that drove a little bit of inflation? Or is the operation just really gaining efficiency going forward? What's driving that?

Jude Bricker, CEO

I don't think our CASM will decrease in the fourth quarter compared to the third quarter simply because we're operating on a smaller scale. There wasn't any significant one-time expense in the third quarter. In the fourth quarter, we are experiencing a slight increase in maintenance activities, but this will have a minor impact. Therefore, any changes in CASM from the third to the fourth quarter are primarily related to capacity.

David Davis, CFO

Yes. My comments, Catherine, were mainly around the fourth quarter as compared to 2019, which we would expect to be roughly flat. And there's some variability in there, so give or take a little bit.

Catherine O'Brien, Analyst

Got it. I'll sharpen the pencil on the midpoint for the model. If I could just maybe sneak in one last quick one. I've been hearing that the secondary aircraft market is starting to heat up a little bit and that used aircraft values are starting to improve. I guess, first, you've seen the same thing and probably it would be helpful if you could help us frame where used aircraft are versus pre-COVID when you're probably initially making the growth plans over the next couple of years?

David Davis, CFO

We recently reviewed our situation and have looked at 150 aircraft this year. We've acquired 5, indicating that we are selective. There are still many aircraft available for us to acquire. I haven’t noticed any significant tightening in pricing; if there has been any, it's minimal. We continue to find aircraft at similar pricing to what we encountered earlier in the year. There hasn’t been any major change, possibly just slight variations. The last two aircraft we acquired were done recently and follow the same economic trends as our earlier acquisitions this year. The used market is experiencing weakness globally. While we see some tightening in North America and Europe, Southeast Asia is currently very weak, leading to an influx of capacity from those markets. I am not particularly worried about securing the lift we need. Compared to pre-pandemic prices, Jude, would you say they are down 25% to 30%?

Jude Bricker, CEO

Yes, about right.

David Davis, CFO

Yes, we're buying mostly part-out values, even newer equipment.

Operator, Operator

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

Michael Linenberg, Analyst

Look, as a federal contractor and having to deal with this vaccine mandate, where are you guys on that? How does your personnel situation look?

Jude Bricker, CEO

Do you want to take that one?

Gregory Mays, SVP of Operations

Yes, this is Greg. So as you said, the vaccine mandate is something that applies to us. We've rolled that out. Our team has done a great job of getting the technology up so that people can upload their status. We're continuing to encourage all of our employees, and we're pretty optimistic with regard to where we are right now. I think the entire industry is sort of trying to figure out how to manage through this, and I think we've got a good plan. The deadline is the 8th of December by federal mandate. I think probably we'll use that month to try to chase down folks that haven't submitted their vaccination cards. I wouldn't expect any operational impact from the vaccine mandate this quarter. The reaction from the employees was mixed, as you would imagine. We're kind of dealing with some frustration, but we'll be compliant.

Michael Linenberg, Analyst

Very good. With respect to the pass-through economics of charter and cargo, Jude, as you mentioned, think about fuel prices being up a lot. I think Dave said they were up like $0.31 or maybe it was 31%. Maybe it is $0.31 per gallon, 4Q over 3Q. How quickly can you sort of repivot your capacity towards charter and cargo? And I guess you did say that 85% of your capacity in the fourth quarter is going to be peak days versus 80% in 2019. So it seems like in the scheduled business, you're really focused on the busiest days, maybe because of higher fuel prices. Just thoughts on that.

Jude Bricker, CEO

We can be pretty responsive when you think about ad hoc opportunities in the charter market. We can very close in and reallocate. But it doesn't have the kind of volume to really move substantial units of capacity out of scheduled service. So scheduled is planned at least 90 days in advance. And our Amazon flying is mostly flat. So the way we think about it is we want to have a cost structure, and these other segments provide the kind of economics where we can fly a little or a lot in scheduled business and deliver the same unit costs. And that's kind of where we're headed. I wouldn't think of it, though, as a reallocation in response to fuel prices. And one other bit of commentary, Mike, is what we're seeing on the yield side is really positive right now. I'm not sure even with this fuel price we want to move that much capacity out of the scheduled business, particularly for the holiday season. I mean, if you're out there buying tickets, it's going to be pretty expensive these days. Like the rest of the economy, we're dealing with reflation here, and the airlines just aren't able to bring back seats as fast as demand is recovering.

Michael Linenberg, Analyst

Yes. No, I've definitely seen it firsthand. Just one quick one on the Amazon. You did say it was fairly flat, but I suspect even though your fourth quarter seasonally is weaker than your third, is that the quarter where you're going to have the highest from Amazon? And I'm just thinking holiday shipping and the fact that I think everybody is running tight. Is that going to be your big quarter revenue-wise from a cargo perspective?

Jude Bricker, CEO

For this year, yes, I can't speak to the future. But this fourth quarter will be our highest volumes we've ever flown for them.

Operator, Operator

Your next question comes from the line of Brandon Oglenski with Barclays.

Brandon Oglenski, Analyst

So Jude, maybe can we follow up there on the comments about better yields? Because obviously, margins are coming down a little bit in the fourth quarter and probably a little bit due to fuel. So how does that change your behavior on the margin here on pricing and the outlook?

Jude Bricker, CEO

Yes. We experienced some lingering effects from the Delta variant on bookings starting in late August, which continued through the end of October, and early November is generally weak anyway. However, we are currently looking at a winter travel season, from Thanksgiving to Easter, that appears to be stronger than ever. Our ancillary products have reached over $40 per passenger segment, a significant increase compared to the winter of 2019 to 2020. Although load factors haven't fully returned to previous levels, yields have completely recovered. We would consider increasing our capacity for the winter season if it were feasible.

David Davis, CFO

Yes, this is Dave. Hey, Brandon. One important aspect to consider is the seasonality of this airline. The fourth quarter typically has weaker margins compared to the third quarter. As Jude highlighted, yields remain strong. The guidance we provided for the fourth quarter operating margin indicates that fuel is the biggest factor affecting that number compared to historical trends. If we account for the significant increase in fuel costs, we would normally observe similar patterns from the third to the fourth quarter that we see annually for this company.

Brandon Oglenski, Analyst

Got it. And I guess to those comments about you'd be flying more if you could. What's the constraint right now? Because I think you hit your fleet expansion plans? And Dave, you spoke about what you plan to add to the fleet next year. I guess, is it pilot limitations? Is it airport capacity?

Jude Bricker, CEO

Yes, it's hiring pilot constraints. As with everywhere across the economy, labor is just tight right now, and we're seeing some of the same things. I would want to make the point we're hitting our headcount objective, but there's some uncertainty in that. And so the way we deal with uncertainty is pull down some of what we wanted to fly with scheduled service. And then if we perform to the upside on our hiring or attrition is lower than what we had downside case forecasted, then we'll add more charters. And if we're sitting here talking in 90 days, and we have a higher charter production, that's why.

Brandon Oglenski, Analyst

Got it. And then last one for me. I guess, hypothetically, if you could get all the pilots that you needed and you took utilization up, where could you have system capacity today relative to where you were pre-pandemic?

Jude Bricker, CEO

Well, I think a good rule of thumb would be 9 hours a day per passenger aircraft, which would be an increase of ASMs from where we have loaded of about 20% to 25%.

David Davis, CFO

Yes. I think one thing to notice is that it's not just a staffing issue. I mean, there's still, as you pointed out, load factors remain a little low, and demand remains a little bit weaker than it was at pre-pandemic levels. So there's the impact on our capacity of just the overall environment relative to pre-pandemic levels and then some of the staffing constraints that you're talking about.

Jude Bricker, CEO

Yes, Brandon, that was a great point. When we think about October, we were at optimal levels. However, there are certain times of the year when we face capacity constraints. We are approaching that period, which typically runs from Thanksgiving to early January and then from mid-February to mid-April. There has always been enough demand for our capacity. So during those times, we could easily achieve utilization levels of 20% to 25%.

Operator, Operator

Your next question comes from the line of Chris Stathoulopoulos with Susquehanna.

Chris Stathoulopoulos, Analyst

So curious on the charter business, mostly commercial, and there's the military piece as well. But given what looks to be a fairly strong peak season, is there an opportunity? Or are you able to do any ad hoc flying for cargo within that segment?

David Davis, CFO

Well, ad hoc, as we would define it, would be scheduled after we bid the pilot deck. So we're taking reserve pilots or open time, in other words, putting out to the pilots for volunteer. The opportunity in cargo is pretty close to zero for that because the fleet is allocated to Amazon, who in particular in this quarter were flying about as hard as we can with that fleet. We don't have any slack.

Jude Bricker, CEO

Remember, Chris, we're basically scheduled takers in our cargo business. So we operate Amazon's schedule. The seasonality of that business is really driven by, as someone pointed out earlier, holidays, Prime Day, that kind of stuff where they have busier periods than other periods and not so much us allocating things to that segment.

Chris Stathoulopoulos, Analyst

Okay. And a follow-up. So your larger peers are focused on restarting business and long-haul international travel into 2022. Curious if you could give some color on the opportunities domestically. And as we look at your network, should we think about 2022 as filling out the schedule? Or adding more dots on the map? Or a little bit of both?

Grant Whitney, SVP of Network Planning

Chris, this is Grant. We've outlined our plans and have extended our summer schedule, with our winter schedule already established for some time. Our main focus is on maximizing Minneapolis's potential. We're pleased with our progress in expanding our network and providing our customer base in the Twin Cities with new travel destinations. We now offer over 70 nonstop destinations from Minneapolis, compared to about 40% of that in 2019, which is quite encouraging considering the challenges of COVID. We're also exploring opportunities outside of Minneapolis and are prepared to adapt our business plan accordingly. As Jude and Dave mentioned, as various factors align, we'll capitalize on those opportunities and communicate our progress. Our schedule is set, and we feel confident about our positioning. We're also achieving success in our charter business, and our cargo operations remain steady. Overall, our plans for 2022 are shaping up very well.

Jude Bricker, CEO

And that's consistent with our network strategy as communicated during the IPO. So for the Twin Cities, we want to be the leisure carrier for everybody paying with their own money. And then outside the Twin Cities, we want to be a flexible capacity that can bring down fares during peak periods in large city origination markets like Dallas.

Operator, Operator

At this time, there are no further questions. I would now like to turn the call over to Jude Bricker.

Jude Bricker, CEO

Well, thanks for your interest, everybody. Thanks for tuning in, and have a great day.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.