SkyWest, Inc. (SKYW) Q3 2022 Earnings Report, Transcript and Summary

Okay. Good afternoon. My name is Emma and I will be your conference operator today. At this time, I would like to welcome everyone to the SkyWest Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. Rob Simmons, Chief Financial Officer, you may begin your conference.

Thanks, everyone, for joining us on the call today. As the operator indicated, this is Rob Simmons, SkyWest 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. Demand for SkyWest product during the third quarter remained exceptionally high, with our main constraint being our crew imbalance. Despite the challenge to production inhibiting our ability to fully monetize this demand, we reported a pretax income of $57 million and a net income of $48 million. Operationally, our teams delivered outstanding performance to accomplish 99.9% adjusted completion and to be a top three on-time performer on the DoT's list for several months of the year. I want to thank our people for their teamwork and efforts to deliver strong operating performance. We received nine E175s during the third quarter and we received four more this year. We've modified some timelines on future deliveries to better manage resources and continue to expect a total of 240 E175s planned in service once our current orders are complete. Our refleeting continues to be a priority in our long-term strategy. During the quarter, 80% of our block hours were flown utilizing our dual class fleet. We were able to secure a new pilot agreement during the quarter, including large pay increases and enhancements for our pilots. This four year agreement is a significant investment in our pilots and became effective in mid-September. While it is still early, we expect the agreement to help manage attrition and encourage career progression into the left seat. We're proud of our ability to work directly with our people to provide more stable and rewarding long term pilot careers here at SkyWest, as well as career opportunities with a choice of our four major partners. We are uniquely positioned to provide more stability, opportunity and options for pilots than any other regional carrier. We remain fortunate to continue attracting a high level of talent and have built our new hire pilot classes well into 2023. We have a large number of upgrades scheduled over the next few months to help address our captain imbalance and continue to expect and plan for ongoing high demand for pilots. 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 in the pilot profession. While these strategies are producing results and demand for our product has never been stronger, we continue to expect that the timing required for training and upgrades will likely constraint production into late 2023 to early 2024. We continue to work with our people to aggressively manage this challenge. And we believe there's a solid upside potential as we mitigate attrition and rebalance our crew staffing. We continued making progress on operationalizing our SkyWest Charter entity during the third quarter. As we shared earlier this year, we plan to enter this strong business with standard on-demand charter service as well as scheduled charter service under additional commuter authority, all within existing regulations and requirements. We've been working with the Department of Transportation on our commuter authorization and we appreciate the strong support from many communities and airports who are very interested in the service. The DoT process is essentially a fitness review of the entity and we believe SkyWest Charter exceeded all measures of fitness regarding commuter authority. We undoubtedly have the asset base, high standards and expertise to execute this operation well and hold SkyWest Charter to exceptionally high standards of safety and service. We're making steady progress and plan to begin on-demand charter service as early as Q1 2023. We we're moving a number of strategic pieces into place to ensure we are well positioned for 2024. First, we anticipate that, as we initiate our new pilot agreement, we will stabilize attrition and our crew balance. Second, we're in productive conversations with our partners regarding agreements to align with these labor investments. Finally, within our operating entities, we continue to work through our fleet optimization at SkyWest Airlines and are on track to operationalize SkyWest Charter by year-end. Our execution of these initiatives will help ensure we're best positioned to capitalize on opportunities in the marketplace. Although we continue to expect the recovery to remain choppy as we've worked through some headwinds, particularly over the next year, we remain aggressive and deliberate in the steps we're taking to ensure we are well positioned for 2024 and beyond. Rob will now take us through the financial data.

Today, we reported third quarter GAAP net income of $48 million or $0.96 diluted earnings per share. Q3 pretax income was $57 million. Our diluted share count for Q3 was 50.6 million and our effective tax rate was 15%, which included a $7 million benefit from the release of an uncertain tax position liability. First revenue. Total Q3 revenue of $789 million is down 1% sequentially from Q2 2022 and up 6% from Q3 2021. Q3 revenue breaks down with contract revenue down 2% from Q2 and at 13% from Q3 2021. Prorate revenue was $95 million in Q3, flat with Q2 and down 26% from Q3 2021. Leasing and other revenue was up 2% sequentially and year-over-year. These GAAP results include the effect of a release of $13 million of deferred revenue this quarter compared to $16 million released in Q2 and $19 million that was released in Q3 2021. As of the end of Q3, we had $55 million of cumulative deferred revenue that will be recognized in future periods. Let me move to the balance sheet. We ended the quarter with cash of $1 billion, up from $979 million last quarter. Our CapEx during the third quarter was $224 million for nine new E175 aircraft and other fixed assets. Total 2022 CapEx is expected to be a little under $700 million, including the purchase of 25 new E175 aircraft compared to $556 million in CapEx for 2021. We ended Q3 with debt of $3.4 billion, up 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, ten-year, unsecured, no amortization, low coupon loans. Let me say a couple of things about liquidity. As of September 30, 2022, our cash position of $1 billion included the effect this quarter of repaying $100 million of aircraft debt and adding $40 million in engine financing. Additionally, we added $182 million of debt, financing the nine new E175s delivered during Q3. 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 giving any specific EPS guidance at this time. But let me give you a little directional color. We expect Q4 earnings to be down from Q3 levels, but still be slightly profitable. Q1 2023 may look seasonally similar to Q4 2022 as usual. We expect total 2023 earnings to be down significantly from 2022, but remain modestly profitable as we continue to put the pieces together for a successful 2024 and beyond. In spite of only modest profits expected in 2023, there are six notable expectations for 2023 that I would like to call out. Number one, we expect CapEx to be down over $400 million year-over-year in 2023. Number two, this CapEx reduction could drive the best free cash flow in the last five years. Number three, we expect cash at the end of 2023 to still be near $1 billion. Number four, we expect debt at the end of 2023 to be below 2019 levels. Number five, our end of 2023 leverage could be the lowest in the last five years. And number six, debt net of cash could be $400 million lower than at the end of 2019. We believe that the actions we're taking now to prepare the way over the next year or so for incremental utilization of our fleet, to work through the pilot imbalance affecting the industry and to preserve the optionality of monetizing strong demand opportunities over time will position us well for a successful 2024 and beyond. Wade?

Thank you, Rob. I'll provide a fleet and production status update as well as an update on our charter, prorate and leasing businesses. As we've discussed, we are nearing completion of our strong delivery schedule this year. We previously announced an agreement with delta for 16 new E175s to replace 16 older SkyWest CRJ900 aircraft. During the quarter, we took delivery of seven aircraft for Delta, bringing us to 9 of those 16 aircraft. We anticipate taking delivery of four E175s during the fourth quarter. We also came to an agreement with Embraer and Delta to extend the timeline of our last three Delta deliveries until the end of 2023 and the middle of 2024 as we work to resolve our captain imbalance. After we receive these aircraft, we will have 87 E175s under long-term contracts with Delta. We have an agreement with Alaska to add 11 E175s to our contract, of which we have received 10 this year. We came to an agreement with Alaska and Embraer to extend the delivery of the last E175 until the middle of 2025. We currently have 42 aircraft under long term contracts with Alaska. Following delivery of the remaining eight currently on order, our E175 fleet will be 240 aircraft. As Chip discussed, during the quarter, we came to an agreement with our pilots on a new pay package. The cost of the package is significant. As you can imagine, we have been working with our major partners on addressing these new costs. We anticipate that we will have come to an agreement with the majority of our partners on reimbursement of the new pilot rates prior to year-end. Let me review our current 2022 production. Based on the current schedules we have from our major partners for the fourth quarter, we anticipate that our block hours will be down by approximately 13% to 14% in the fourth quarter as compared to the third quarter. As we look to 2023, we anticipate that our 2023 block hours will be down by 20% as compared to 2022. Let me give a brief update about the status of SkyWest Charter. In June, we purchased a Part 135 air carrier. Shortly thereafter, we applied to the DoT for commuter authority to operate scheduled public charters as permitted by both DoT and FAA. The commuter authority application primarily is meant to demonstrate the fitness of the carrier in terms of financial, managerial and operational matters. We believe SkyWest Charter is a well-capitalized entity and has some of the best operational leaders in the industry. We have provided the DoT with all the information they requested and are waiting for them to approve and issue the commuter authority. Regardless of the status of our commuter authority, we are moving forward with our plans for SkyWest Charter to operate on-demand charters under its existing DoT authority once we are operationally ready. As far as our prorate business, the demand has been 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. Shifting gears to our leasing business. We have a total of 40 CRJ700s and 900s under long-term leases with third parties. 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 year and anticipate placing several more engines under leases during 2023. Demand for our engine leasing business will not fully be realized until flying levels for the regional industry start to rebound. We have spent the last several years reducing risk and enhancing fleet and financing flexibility to ensure we're well positioned. The flexibility will continue to be a differentiator for us and we are committed to continuing our work with each of the major partners to provide creative solutions for our products. Okay. Emma, we're ready for the Q&A now.

[Operator Instructions] Your first question today comes from the line of Mike Linenberg with Deutsche Bank.

Wade, I just want to go back on the numbers. So if I heard you right, it looks like there's eight E175s left to deliver. So, four in the fourth quarter. And then I guess four over the next, I guess, two, three years? What, 2023, 2024, 2025? Is that currently what's on the books?

This is Wade. So, you're right, we have eight E175s left to deliver. Four will be in the fourth quarter. Two will be in 2023. One in 2024 and one in 2025.

When I think about the block hour total that you gave us for 2023 down 20%, assuming no additional deliveries, it seems like that's probably a pretty good steady state for the next few years. Is that fair? There's probably a few tweaks here and there. For the main operation, not the charter piece.

Mike, this is Wade again. So, the 20%, there's definitely – in 2024 and 2025, as we look out, there are opportunities to increase the utilization of our current fleets and get back to higher levels of block hours.

And you also made the comment that this pilot – I guess, an agreement with your major partners about higher labor costs, you'll get something by the end of this year, and so that will start flowing through the P&L in 2023. And just based on Rob's sort of characterization of your earnings trajectory for next year, which is low, how much of the labor cost increase do you think you will be able to recapture through the negotiations with your four partners? Is it good chunk of it? Is it a small piece of it? Because the earnings depression next year may have a lot to do with training and transition and a slowing of growth, and it sounds like an underutilization of the current fleet. I'm trying to sort of parse out what are the pain points that take down profitability next year. And I'm trying to figure out how much of it is just labor and being able to pass on those higher costs. I realize it's a multi-pronged question. It will be my last question. So however you and Rob want to answer it, maybe even Chip too.

Mike, this is Chip. It's an exceptional question. A couple of layers there. But I think that your overall thinking is right. Given the circumstances for 2023, I will start by saying that our major partners are very engaged in regional pilots. They're very engaged in making sure that stability is paramount that we achieve in 2023. And yet, at the same time, making sure that they are the ones that are being able to provide exceptional careers for the pilots at SkyWest that want to move on. Relative to the profitability conversation, you're exactly right. There's some pain points relative to training and infrastructure that we're going to work hard on, given the fact that the block hours are coming down. We're very, very focused on the dual class fleet, particularly the 175s. But I will say that, after 2023, as you stabilize the labor force that there's tremendous non capital upside, just an increased utilization back to getting the 175 fleet and the other CRJ dual class fleet back up into the high utilization numbers that we're accustomed to seeing back pre-pandemic. That also being said, back with our partners, we fundamentally – our conversation with them are extremely positive. We have the most in-demand pilot group there is, mostly because of our ability to recruit, our ability to train, and they're just exceptional professionals. So, we want to make sure that we're taking care of them and their career needs that they want. But at the same time, we used to be a carrier that would say we can't afford to pay the rates that the majors or the discount carriers can pay. And right now, we don't have to have that argument. Our objective is to be a destination airline. Also have our folks flow to our partners. And we're going to continue in the upcoming months to make sure that part of the stabilizing what we want to do is we're collaborating with both our pilots and our major carriers and closing that gap. But we're confident that there's still a tremendous amount of infrastructure and training that we have to get behind us in 2023. But our partners are deeply engaged in making sure that they're participating in these challenges.

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

If I might pick up and ask a follow-up question to Mike's last one here. It's a bit of a two part. Clearly, the industry is changing a little bit here somewhat structurally by being, as you say, the victim of being the destination airline for pilots. I wonder if you could talk about like, one, what that means for your kind of value proposition to majors, if that changes at all, and the type of markets that you can serve? And then two, I was curious, because it seems like you go from losing pilots to low cost carriers and ultra-low cost carriers to not doing that, but then on the other side, you're going to start have to compete with low cost and ultra-low cost carriers in sourcing pilots directly because it seems like a lot of the ULCCs at least are going and kind of building relationships with flight schools and colleges and starting their own programs. So there might be some kind of competition on the front end. I wonder if you could talk about those two dynamics.

Savi, those are two great questions as well. On your first one relative to the value proposition of SkyWest, look, we just barely passed pilot package about a month ago. We're evaluating the impact on attrition. So far, the recent – we thought it would take six weeks to two months before you really saw the impact on it. And we're already seeing some good benefits, particularly on the captain side. And I think from our perspective, that's the first step. We're going to execute some additional steps here internally at SkyWest to do some things with pilots to make sure were that they understand what their value. All of our employees are valuable. But it's been an interesting dynamic over the past several years at SkyWest. And the evolution, where we are today is, we have a conversation with many of our senior pilots and senior employees that honestly have helped be the backbone of the operation. And they've given us good reasons of why we should be a destination airline. To your second point, destination airline with tremendous opportunities if they want to go to our major partners, and there'll be more programs, I believe, that will enhance those vertical pathways that will be a benefit to all of us, particularly our pilots. Second of all, relative to the sourcing of that, our sourcing is extraordinarily strong right now. We have seen that some of the low cost carriers may go directly to schools. And to be candid, given where we are with the imbalance of our pilots, I think that we would certainly applaud and understand wherever you want to be a destination pilot to. The pathway to get there is probably shorter than ever. And if you want to go fly for a discount carrier, you may have the opportunity to do it right out of school. We're not afraid, particularly with this pay package, in competing with that approach, combined with the fact that you still have optionality to go to one of the four best airlines in the world. So I still fundamentally believe that if it came down to a sourcing issue from schools and the pipeline, we're very comfortable with what's happening with schools and the pipeline. It's as robust as we've ever seen it. That having been said, we still fundamentally believe that – we applaud on a shorter pathway to the destination where pilots want to go. But we know we still will be the most promising option for pilots as we continue to work to our culture and become a destination airline as well as be able to have the option to go to the four best airlines in the world.

I suspect that SkyWest probably stands out amongst the regionals on that front, too. If I might, just on the block hour production kind of commentary, which is super helpful, when do you see kind of the Q-over-Q levels kind of stabilizing within that outlook? I know there's probably still – it maybe can come in better if attritions are better or maybe gets a little moved around. But when do things stabilize on the block hour production front because I'm guessing – go ahead.

Sorry, go ahead.

That was my question, Wade.

Savi, this is Wade. So when we start to stabilize, we think 2023 is still going to be a little choppy. We think we'll start to see the stabilization starting in 2024. And so, that's how our models are built right now. And that's how we're looking at it. And so, we look towards 2024 to see that.

So, you've seen kind of Q-over-Q declines into the fourth quarter.

When you look at a little bit, Q4, there's definitely – I gave 13% to 14% decrease between Q3 and Q4. Q1, we start to find a little bit of stability. And there may be some small decreases as you go along throughout the year. And some of it depends on operationalizing Charter and some other things that are out there. But that's what we see right now.

Savi, this is Chip. I would add that the numbers that we're referring to is basically – I don't want to get too detailed on the numbers. But we're evaluating our numbers based upon current trends with modest impact from the pay package on attrition. We do see some upside in this. At the same time, there's a lot of variables. This crew imbalance is a situation where we'd love to see some long term data that shows some things, but there are some things that could have a relatively strong impact on it. I'm not saying that we're pessimistic in our approach, but I would say we're pretty conservative in our approach, and there are various other factors that could have an impact. There could be an impending recession that is always good for regionals and staffing and those types of items that could happen. But at this point, we're not comfortable giving any more long term feedback and just providing some very, what we think is, solid, conservative estimates of what's going to happen relative to block hours in the future. But if it does change, we do have four partners that would gobble up block hours like crazy, that's for sure.

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

Just with respect to your down 20%, you guys have been pretty good at starting with a conservative view and then maybe ratcheting it higher. So I wonder how confident you are in that down 20%? Outside of industry factors, is it just a compensation consideration where maybe that down 20% could be something better, something closer to flat? And then, if you're down 20%, how would you mark the regional industry broadly? Would it be down 30%, down 40%, down 50%? How would you mark your share within that down 20%?

Those are good questions, Dwayne. I think down 20%, for us, is something that we're strategically very well prepared for. But we're also very well prepared for upside. Upside is easy. Down 20% means we still have a tremendous amount of pilots and flight attendant and mechanic training. It does require some infrastructure changes within the organization. And those types of things is what we're mostly focused on. And I think, to your point, I think we have been pretty good about being conservative and planning for with some good operational upside. So, look, I think that that's what we know today. Like I said, it's hard to predict what would happen. I would say, if I was betting over under, I'd probably bet a little bit over. But at the same time, when you take a look at the regional and where the rest of the regional world is going to be if we're down 20, I couldn't necessarily speak to it because I don't know exactly what their specific crew imbalance challenges are compared to ours. I know as much as we – and this is probably – not a bragging point, but an interesting point. I know that through the reductions over the past two years and coming out of the pandemic, just naturally, we have gained a tremendous amount of market share in the regional industry. And given the fact that we've gained a tremendous amount of market share in the regional industry, and when we can rebound if we have the capital, aircraft, and things to be able to respond, we could respond very, very quickly. But I really couldn't speak to the rest of the industry. I'm assuming that it's probably – I'm not hoping for anyone to have it tougher than we are. But I think that we typically do weather these things better than the others do.

If it's possible, can we put some numbers to the pilots that you'll need to hit that down 20%? Like, what would be the assumption on attrition from here? And what would be the assumption on hiring from here? And where would you expect to get those folks from? You probably have a pretty thoughtful view into the pipeline. And is this going to be dependent upon getting pilots from other airlines? Or do you feel like there's enough just sort of organic de novo pilots in the pipeline to kind of hit that down 20%?

Dwayne, I would say this. I would say that our assumptions are consistent, attrition assumptions of what we've seen so far this year, with organic timing and patience with upgrades. We don't have to go get predatorial with other pilots for the numbers that we've talked about. I think we've said even on the last call, when you don't hire pilots until 2021 and it roughly takes two years to get a lot of your FOs into an upgradable captain scenario, that's when it starts to – given various levels of attrition, that's when it starts to turn around in 2023 organically. So, by and large, our assumption is relatively consistent, maybe a little more optimistic attrition than what we've seen in the past, given our pay package, with time and patience to get the captains into an upgradable position organically, not dependent upon hiring from outside sources.

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

Can you talk a little bit about prorate? That's hung up well. Any thoughts on how that kind of progresses here in the fourth quarter and as you look into 2023 because the demand and the fares are there?

This is Wade. So, prorate, I said in my script, it's been extremely strong. Just like the rest of the industry, we've seen very good yields. A lot of these communities that we have prorates in, it's small communities. The communities are extremely, extremely supportive of SkyWest and what we're trying to do from both SkyWest Airlines and SkyWest Charter. There's just tremendous support there. I believe what we will be able to do is continue to serve the vast majority of the communities that we have today. And one of the entities that will be is SkyWest, right? That is our goal. And we're going to continue to do that. And we're going to work with the communities on what that service looks like and how we'll do it and under what agreements. But we're still very optimistic about prorate, the yields and the flying has been very good for us.

There are no further questions at this time. I turn the call back to Chip Childs.

Thank you, Emma. Appreciate it. We really appreciate everybody's interest in SkyWest. Thank you for listening to the data points that we have. And for joining us. Again, I wanted to thank all of our professionals here at SkyWest. They've just done outstanding work. Our operational performance is leading the industry and we continue to have just an outstanding product that is safe, reliable and among the top in the industry as far as levels of service. And I appreciate all of our people for the work that they've done. With that, we will circle back at the end of the next quarter to do the year-end summary and we appreciate your interest. Thank you.

That concludes today's conference call. Thank you for attending. You may now disconnect.