SkyWest, Inc. (NASDAQ:SKYW) Q4 2022 Earnings Call Transcript

SkyWest, Inc. (NASDAQ:SKYW) Q4 2022 Earnings Call Transcript February 2, 2023

Operator: Good afternoon. My name is Devin, and I will be your conference operator today. At this time, I would like to welcome everyone to the SkyWest, Inc. Fourth Quarter and Annual 2022 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. Thank you for your patience. Mr. Rob Simmons, you may begin the conference.

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

Eric Woodward: 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.

Chip Childs: Thank you, Rob and Eric. Good afternoon everyone and thanks for joining us on the call here today. Today, SkyWest reported a pretax loss of $62 million or $0.93 per share in the fourth quarter of 2022. Reflecting in those results were $69 million of deferred revenue related to successfully amending the majority of our flying contracts, $36 million noncash impairment on 10 CRJ700 aircraft and an $11 million accelerated lease expense. We expect moving forward, we will be discussing deferred revenue regularly until the fleet utilization normalizes. Despite the noise in the fourth quarter, I want to point out that over the past year we have set ourselves up to be a fundamentally different and better company. We have done this by focusing on the core areas of our business that will help us set up for growth in 2024 and beyond and ensure we have a solid sustainable future.

These fundamentals include: enhancing our partnerships and arrangements to adapt to a new industry and ensure we continue to deliver on our partner’s needs; two, shoring up our operating processes and IT systems; three, effectively and efficiently utilize our industry leading fleet flexibility today and in the future. Four, maintaining a healthy and strong balance sheet, which is a key SkyWest differentiator; and last and most importantly continuing to ensure that we take care of our people and create value for our shareholders. We are confident our ongoing execute of these fundamentals will ensure we’re able to deliver value for all of SkyWest stakeholders. As we discussed last quarter, we invested heavily in our people throughout 2022, including increased pay for nearly every work group when finalizing a pilot agreement in the third quarter.

While this pilot agreement represents a significant cost increase, we are pleased to have worked with the majority of our partners to amend our contracts to help offset these higher crew costs. We continue to strengthen our partnerships and we appreciate their continued support and deep engagement in our efforts in the new environment. We remain committed to working with our partners to evolve, adapt and provide strong solutions to their needs. Our focus on dual class flying continues to deliver with 83% of our flying now dual class. We took four E175 aircraft in the fourth quarter and are expecting three more by the middle of 2024. Additionally, as we near the end of this fleet transition CapEx cycle, this leaves us capacity for growth and drives free cash flow within the existing fleet.

The pandemic fundamentally changed our industry and our ongoing environment. We have spent the past couple of years identifying vulnerabilities and refining and reinforcing our operation and systems. Post pandemic realities have had an impact on every aspect of our operation from fuel supply and airport staff to lodging and accommodations for our crews, We spent a large part of 2022 ensuring that we have the resources, processes and systems in place to run the most reliable operation and to mitigate negative impacts on our people and our customers. We also remain transparent with our partners about our constraints and are disciplined in ensuring we deliver on our commitments. As we’ve seen throughout the industry, over commitment without the ability to execute is a recipe for disaster.

As a result of our continued focus, I can proudly say our teams delivered some of the strongest operating performance in 2022 with over 99.9%% adjusted completion for the fourth quarter. This performance included the peak Christmas holiday travel period during which we experienced severe winter weather. In fact, SkyWest experienced severe weather disruptions in every key location across this geography. But we were able to proactively manage through this challenge with extensive planning and resources and as a result of our teams — as a result of our teams delivered exceptionally well to get 2 million passengers safely to their destinations between December 16 and January 2. I also want to commend SkyWest people for over 180 days of 100% adjusted completion for the full year in 2022.

Our teams have done a tremendous job as we develop the new normal and continue to provide the best product in the regional industry. Thanks again to all of our amazing people. We’re making good headway in our captain imbalance and we’re cautiously optimistic as we plan for the years ahead. We continue to fill our new hire pilot classes and are maximizing our training resources with priority on upgrades as we work to rebalance our crews. SkyWest is clearly recognized as one of the most desired career destinations. We continue to believe it will take some time over the next couple of years to rebalance our cruise and restore production and full utilization of our highly accretive fleet. As we rebalance, our ability to restore even a portion of production becomes accretive within our existing fleet mix.

We’ve made great progress with our SkyWest charter entity and once operationally ready, we expect to conduct charter flights in the second quarter. SkyWest looks forward to raising the bar in the Part 135 space with the implementation of several proven safety programs not required within Part — existing Part 135 operations. This entity represents another strong opportunity to utilize existing assets and deliver critical service in small and underserved communities. Overall demand for our products remains stronger than ever. As we execute 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 and the exceptionally strong demand for our products.

Rob will now take us through the financial data.

Robert Simmons: Today, we reported a fourth quarter GAAP net loss of $47 million or $0.93 loss per share. Q4 pretax loss was $62 million. Our weighted average share count for Q4 was $50.6 million and our effective tax rate was 24%. First revenue, total Q4 revenue of $681 million is down 14% sequentially from Q3 2022 and down 12% from Q4 2021. Q4 revenue breaks down with contract revenue down 14% from Q3 and down 11% from Q4 2021. Prorate revenue was $81 million in Q4, down 15% from Q3 and down 26% from Q4 2021. Leasing and other revenue is up 3% sequentially and up 6% year-over-year. These GAAP results include the effect of an increase of $69 million of deferred revenue this quarter compared to $13 million released in Q3 and $23 million that was released in Q4 2021.

As of the end of Q4, we have $125 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 a little over $1 billion, up slightly from last quarter. Our CapEx during the fourth quarter was $111 million for four new E175 aircraft and other fixed assets. Total 2022 CapEx was $645 million including the purchase of 25 new E175 aircraft compared to $556 million in CapEx for 2021. We ended Q4 with debt of $3.4 billion up from $3.1 billion as of year-end 2021, with this increase driven by the 25 new 175s delivered and financed in 2022. Just a reminder that the only government debt we have on our balance sheet is a total of $201 million in PSP 10 year unsecured no amortization low coupon loans.

Let me say a couple of things about liquidity. As of December 31, 2022 our cash position of $1 billion included the effect this quarter of repaying $110 million of aircraft debt. Additionally, we added $78 million of debt financing the four new E175s delivered during the quarter. 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 color. Last quarter, I stated that we expected Q4 earnings to be down from Q3 levels, but still be slightly profitable.

Q4 actual results of a pretax loss of $62 million included the following items not factored into last quarter’s comment. Number one, $69 million of revenue deferred in Q4 related to the successful amendment of the majority of our flying contracts. Number two, a $36 million impairment charge on 10 CRJ700s that were placed into a held for sale arrangement during the quarter. And number three, $11 million in accelerated lease expense on 21 CRJ aircraft being stored prior to lease expiration. Consistent with last quarter’s comments, we currently expect total 2023 results to be down from 2022, but remain modestly profitable before the effect of roughly $60 million per quarter in deferred revenue in 2023. This new deferred revenue expectation in 2023 comes from future variability in the fixed monthly reimbursement component of our newly revised flying contracts, the future shift to a partially variable model for fixed month reimbursements is causing this timing difference for GAAP where cash is received before the revenue is recognized.

The revenue deferred will be fully collected in cash in the quarter deferred with performance obligations fully met and the cash is not refundable. Excluding the effect of this estimated $240 million in deferred revenue in 2023, we expect a modest GAAP profit in 2023. We expect this deferred revenue balance will reverse by approximately $10 million to $15 million per quarter in 2024 with $240 million of this balance expected to reverse by the end of 2026. In spite of the GAAP loss expected in 2023, there are seven points would like to call out. The fleet in place today can accommodate large future growth without more capital investment. Wade will give more quantification around this in a minute. We expect CapEx to be down over $400 million year-over-year in 2023.

We expect cash at the end of 2023 to still be near $1 billion including expected debt repayment in 2023 of $450 million. We expect debt at the end of 2023 to be below 2019 levels with ongoing annual principal reductions expected to be over $400 million. Our leverage at the end of 2023 could be the lowest in the last five years. Debt net of cash at the end of 2023 could be $500 million lower than at the end of 2019. This CapEx reduction could drive the best free cash flow in the last five years. 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 imbalance affecting the industry and to preserve the optionality of monetizing strong demand opportunities over time will position us well to drive total shareholder returns.

Wade?

Wade Steel: 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. We previously announced an agreement with Delta for 16 new E175s. During the quarter, we took delivery of four aircraft for Delta, bringing us to 13 of those 16 aircraft. We anticipate taking delivery of the last three Delta aircraft at the end of 2023 and the middle of 2024. 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. We anticipate taking delivery of Alaska — the last Alaska delivery in the middle of 2025.

We currently have 42 aircraft under long term contracts with Alaska. Following delivery of the remaining four currently on order, our E175 fleet will be 240 aircraft. As we discussed last quarter, we came to an agreement with our pilots on a new pay package during the third quarter, which is a significant cost. During the fourth quarter, we came to an agreement with most of our mainline partners on addressing these new costs. We appreciate their support in this additional cost reimbursement. As Rob mentioned, we anticipate differing $60 million per quarter of revenue during 2023. This is primarily related to turning the fixed reimbursement to a variable rate towards the end of some of the contracts. The fixed rate does not turn variable for several more years.

The cash will be fully collected. There will be no additional performance obligations after the flight is completed and we will have reconciled the monthly invoices with our partner. We put the emphasis on optimizing economics, cash flow and risk mitigation. We chose cash flow and risk mitigation over a better account, Let me review our production. The fourth quarter block hours were down by approximately 12% as compared to the third quarter. Based on the current schedules we have from our major partners, we anticipate that our block hours will be down approximately 3% to 4% in the first quarter as compared to the fourth quarter. As we look to the full year of 2023, we anticipate that our 2023 block hours will be down 19% as compared to 2022.

As we look to 2024 and beyond, we can add approximately 30% more block hours to our ERJ fleet without any additional aircraft. This same number is over 40% for our CRJ fleet and makes each additional block hour very accretive to the model. Given our conversations with our partners, they are very engaged in supporting our efforts to restore production. Let me give a brief update about the status of SkyWest Charter, our new charter business. In June, we purchased a Part 135 aircraft carrier. Shortly thereafter, we applied to the DOT for commuter authority to operate scheduled public charters as permitted by both the 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 among other things.

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 application, we are moving forward with our plans for SkyWest Charter to operate on demand charters under its existing DOT authority once we are operational — operationally ready. We anticipate that our first revenue flights will be in March or April of 2023. 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. We placed a few more engines under third party leases last year and anticipate placing several more engines under leases during 2023. The demand for our engine leasing business will not fully be realized until the flying levels for the regional industry start to rebound. During the quarter, we also made the decision to part 21 CRJ aircraft prior to lease expiration, resulted — resulting in an accelerated lease expense of $11 million. We also are having success in selling some of our excess CRJ assets.

During 2022, we sold over $7 million of assets and we currently have signed letters of intent to sell approximately $20 million of assets. We anticipate these transactions will close during the first and second quarter. We have spent the last several years reducing risk and enhancing fleet and financing flexibility to ensure we’re well positioned. 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.

Robert Simmons: Okay, operator, we’re ready now for Q&A.

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Q&A Session

Operator: Our first question comes from Savi Syth with Raymond James.

Savanthi Syth: Hey, good afternoon, everyone. I’m just kind of curious on the pilot front that you said kind of cautiously optimistic. I wonder if you can help provide a little bit more color. It seems like — I know you said it’s going to probably take a couple of years to kind of get back to kind of full operations that you saw before, but just curious if you can provide a little bit more color on the cadence there and what level you think you might exit 2023 with?

Chip Childs: Yes. Thanks, Savi. This is Chip. That’s a great question. And when we — we spent most of our time evaluating like we’ve done in the past, particularly through 2022, we didn’t give any specific numbers, but we can kind of give you how we feel about what’s out on the horizon. We are, I would say, growing in optimism, yet not ready to do a wholesale change in our data or models going forward. But I think that there’s some things within the tone of our existing pilots. What’s happening in the environment out there that we’re gaining — being cautiously optimistic about how we can do it. I think that the big thing is that, 2022 is a big year, we lost a lot of pilots, specifically cabins and it just takes a lot of time to mathematically get back to the math that where we can increase our utilization 30% to 40% compared to where we are today.

So I would say, that’s about as much as we can say today. I think we’re — certainly when we’ve got with the new pay package that’s helped quite a bit, but until we get some more data closer to summertime. We’re not ready to really make a big modification in our models.

Savanthi Syth: That’s helpful color and especially around the timing of when you might have a better idea. Thanks, Chip. And then just on the asset sales, I was curious what type of assets you’re kind of taking off the books right now? And just any general kind of thoughts on where you want the fleet to be over the next couple of years? Obviously, the E175 fleet is what it is and will get to 250. But just curious on the CRJ fleet, what are the moves that you’d like to do and how you’d like to size that?

Wade Steel: Yes. Savi, this is Wade. So as we said there, we did have some excess and we do have some excess CRJ assets. They are primarily CRJ200 assets that we are selling right now. There’s good demand right now in the market for those assets. They — people like assets that have been well maintained and have good engine time on them. And so we are able to monetize some of the assets out there. There is some demand also for some of our CRJ700s as well, but primarily what we have sold and what is under letters of intent are CRJ200 assets.

Savanthi Syth: Got it. All right. I’ll get back on the queue. Thanks.

Operator: Our next question comes from Mike Linenberg with Deutsche Bank.

Michael Linenberg: Yes. Hey, Good afternoon. Just a couple here. Just the 21 airplanes that were parked, the lease CRJs, what’s the model?

Wade Steel: Yes. Mike, this is Wade. There’s a combination of assets in there. We have one big lease structure that’s remaining. And these are primarily CRJ200 and CRJ700 assets.

Michael Linenberg: Okay. And just given the fact that I always was under the impression that the CRJ200s would be the first to go and the fact that you have some 700s there and then you have another 10 that are available for sale. What’s going on? Is it just they’re getting pushed out by the better E1 70, E175? Is it CRJ900s? What — I figured that these would be valuable assets you’d want to hold on to them.

Wade Steel: Yes. The majority of what we are getting — what we are selling right now are CRJ200s for sure. There are some pockets of some CRJ700s. We — right before COVID, we purchased some CRJ700s for some extremely good prices and we are able to flip those at good values. And so we are going to be in the marketplace if there are good assets that we can trade where we have some excess CRJ700s, we will look at those and we’ll start trading some of those.

Chip Childs: Mike, this is Chip as well. I think it did not get too lost in what’s hitting the for sale block we still have a tremendously large base of both CRJ700s and CRJ200s and not only a large base of it, but a large buffer of aircraft we can still fly before we get to these. So I think from our perspective, as we manage the assets, these are assets that I think it’s good for us to put in a for sale scenario because we don’t see that we have so many still leftover that we can utilize over the next two to three years. I think it’s just smart asset management to kind of see what other people can do with this stuff and the response has been pretty good. So it’s good cash flow as well, particularly if we don’t likely think we’re going to get back to flying them many times soon.

Michael Linenberg: Okay. That’s helpful. And then just one more before I get back in the queue. Just to talk about the deferred, so it’s $240 million deferred, right? $60 million per quarter, and then it releases $10 million to $15 million, so let’s call it $10 million, that’s your two years 2024, 2025 or 2025, 2026. Just trying to think. I guess it maybe slower rate?

Robert Simmons: Yes. Mike, let me help you with that, Mike. So yes, for 2023 we’re expecting a deferred — revenue deferred of about $240 million that’s the $60 million per quarter. Over the years 2024 through 2026, we expect $240 million to be reversed.

Michael Linenberg: Okay. What about — so we had $69 million in the fourth quarter, which I think, Rob, you said that brought the previous deferred amount up to $125 million, does that also bleed out? So does that — that no longer builds. Right? Does that offset the $240 million. I’m just trying to figure that other component there?

Robert Simmons: Yes. So the $125 million is the ending deferred balance as of the end of year. 2023, we’re saying that there’s going to be another incremental approximately $240 million. And then starting in 2024, it starts to reverse and bleed off.

Michael Linenberg: It’s $10 million to $15 million over, you know, 36 months instead of 24 months, that makes sense. Okay. Now I have that — I have that figured out. That’s great. Thank you.

Operator: Our next question comes from Dwayne Pfennigwerth with Evercore ISI.

Dwayne Pfennigwerth: Hey, thanks. Rather than the accounting treatment, can you just expand a little bit on why this variable versus fixed component of your contracts makes sense. What drives a higher reimbursement versus a lower reimbursement in the future or I guess revenue rec in the future?

Wade Steel: Yes, this is Wade. So a great question. So what we tried to do in all these agreements with our partners. We tried to optimize cash flow and risk mitigation, right? And so what we focused on was the next several years, there’s not really much of a change, but as we get into some of the back end of some of these contracts, some of the fixed rates will turn more variable, right? And at that point in time there is some anticipation that the utilization will be back to normal. So really the way the economics are working on this, the cash flow is going to be good and reimburses for the costs that we’re incurring now. But there is some anticipation that the utilization will go up in the future. And just the shape of the recovery is really bringing in the revenue that’s how the block hours — it is based on the block hours that we fly is how the revenue gets brought back in.