Sun Country Airlines Holdings, Inc.

welcome to the sun country airline second quarter 2023 earnings call my name is josh and i will be your operator for today's call at this time all participants are in a listen-only mode after the speaker's presentation there will be a question and answer session to ask a question during the session please press star 1 1 on your telephone and wait for your name to be announced to withdraw your question please press star 1 1 again please be advised that today's conference is being recorded I would now like to 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, assumptions, and are subject to risk and uncertainty. 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 filing. We assume no obligation to update any forelooking statement. You can find our second quarter earnings 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.

Thank you, Chris. Good morning, everyone. Our diversified 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 schedule service capacity in the industry. The combination of our schedule flexibility and low fixed cost model allow us to respond to both predictable leisure demand fluctuations and exogenous industry shocks. We believe due to our structural advantages, we will be able to reliably deliver the industry leading profitability throughout all cycles. We crossed a few milestones since our last call that I wanted to highlight. First, Sun Country surpassed a billion in revenue for the 12 months ending in June, a first for our 40-year-old company. In 2Q, we carried over a million scheduled service passengers for the first time in any quarter. We regained our position as the top margin carrier among the 11 carriers for the 12 months ending in second quarter. Recall that we were the first into this pilot contract cycle. In July, we executed a record number of flights in a day. Being able to deliver quality operations during peak days is a key priority for us as we execute our variable capacity model. This growth and performance is a testament to all our frontline employees that deliver for our customers every day. Consistent with the theme of the last several calls, we remain in an environment where demand across all our segments is strong. As it's been a common topic around the industry, I wanted to give some color on the revenue environment for our scheduled business. Our second quarter scheduled service TRASM was up 10% year-on-year on ASM growth of 6%, certainly very positive results. We expect to be able to accelerate schedule service ASM growth into the third quarter to mid-teens, and we expect TRASM to be down slightly year on year. However, I want to point out that schedule service TRASM versus 2019 was up in one Q and two Q by 34 and 43% respectively. We expect three Q to fall between those bounds. So we're seeing unit revenues stabilize at a substantially higher level versus pre-COVID levels. This reset seems to be persistent based on sales into our selling schedule currently out through April 2024. Minneapolis, by far our largest market, has been particularly robust through the COVID recovery. This summer we launched 15 new markets. All are performing well. Since I've been at Sun Country, we haven't had any MSP markets that didn't have a positive contribution. It's pretty amazing. One thing I'd like to call out is future cash flow. This year we'll produce about 50% more flights than were performed in 2019. In two years, I expect departures to grow versus this year by over 30%. We can produce those growth figures with the addition of only three net aircraft to the fleet at about a $60 million cost, along with the re-delivery of our 900s currently leased out. All three of the expected deliveries already have committed financing. So this free cash flow gives us the confidence in executing on the share buyback recently approved by our board.

And with that, I'll turn it over to Dave. Thanks, Jude. Q2 was a historically strong quarter for Sun Country, despite it being among the seasonally weaker quarters for our business. Total revenue increased 19.2% year over year to $261.1 million, while earnings before taxes were $26.8 million versus a loss of $4.8 million in Q2 of 2022. Adjusted out margin was 15.3% for the quarter. Revenue earnings and margin results were historically record highs for the second quarter. Revenue from our passenger business continued to stay strong in Q2, increasing 16.6% year over year to $227.9 million. Scheduled service plus ancillary sales generated $178.2 million in revenue, which was 16.8% higher than last year. This easily exceeded a 5.6% growth in scheduled service ASMs, was driven by a 2.7% growth in total fare to $177, and a two-point increase in load factor to 85.8%. Scheduled service TRASM grew 10.3% versus Q2 of last year. Since the second quarter of last year, we've seen a significant sustained increase in our scheduled service TRASM versus pre-COVID levels. We believe this is driven by the continued optimization of our network and changes in the public's demand for leisure travel. As Jude mentioned, during Q2, our scheduled service TRASM was up 43% versus 2019. And in Q3 of this year, we expect scheduled service TRASM to be up at least 35% versus Q3 of 19. We don't see any sign of scheduled service TRASM numbers returning to pre-COVID levels. Rather, they appear to be stabilizing at the higher levels we're now experiencing. Charter revenue in the second quarter grew by 16.1% to $49.6 million on block hour growth of 23.9%. A portion of our charter revenue consists of reimbursement from customers for changes in fuel prices as we do not take fuel risk on our charter flying. Q2 fuel prices dropped by over 38% versus last year. If you exclude the fuel reimbursement revenue from both Q2 of 23 and Q2 of 22, charter revenue grew 33.6% over the period and charter revenue per block hour grew by 8%. Program charter flying was 87% of total charter block hours versus 92% in Q2 of last year. We'll continue to pursue more ad hoc business as our available capacity increases. Second quarter cargo revenue grew 18.1% to $25 million on a 10.4% increase in block hours. Last year we had lower levels of flying due to scheduled maintenance events and the annual increases in our Amazon contract occurred in December of 2022. We expect year over year aggregate growth to peak in Q3 and moderate thereafter. We're expecting full-year 2023 block-hour growth to be in the high single-digit range. As always, our unique model allows us to move capacity between lines of business as conditions warrant. Let me turn now to costs. Total operating expenses increased 4.5% on an 11.3% increase in total block hours for the second quarter. Adjusted CASM was up 10.4% versus Q2 of 22. This compares to a 14% increase in the year-over-year comparison for Q1. We expect year-over-year chasm growth to continue to moderate in the quarters ahead. Daily aircraft utilization was still 9.5% lower year-over-year, which continues to put pressure on unit costs. Total non-fuel operating costs increased by approximately 25% versus Q2 of last year. Significant drivers of this increase include the aircraft ownership costs for the 5737-900s we currently lease to Oman Air, as well as non-repeating costs for the vesting of management stock options and a payment to one of our labor groups to settle past grievances. Excluding these expenses, non-fuel operating costs would have increased by 19.8% year-over-year. Fuel expense decreased 32% versus last year. Regarding our balance sheet, Our total liquidity at the end of Q2 was $263 million, which was slightly higher than the amount at the end of Q1. Year to date through July, we've spent $210 million on CapEx, which has funded a majority of our planned aircraft growth into 2025. We expect to be able to achieve our growth objectives over the next two years with higher aircraft utilization and the addition of only three net aircraft. As a result, we're expecting CapEx to decline considerably in 24 and 25. Our net debt to adjusted EBITDA ratio at the end of Q2 was 2.3. Since we do not have a significant debt burden, we have flexibility in how we deploy our cash. Since Q4 of last year, we've spent $47.3 million on share repurchases. Our boards authorized another $30 million in repurchase authority. which brings our current available share repurchase authority to $32.8 million. Turning now to guidance. We're anticipating Q3 total revenue to be between $240 and $250 million, an increase of 8% to 13% versus Q2 of 22 on a block hour increase of 13% to 16%. We're forecasting a $2.90 per gallon fuel price in the quarter, Operating margin for the quarter is forecast to be between 6% and 11%. The fundamentals of our unique diversified business remain strong, and our model is highly resilient to changes in macroeconomic conditions. Our focus remains on profitable growth. And with that, we will open it up for questions.

Thank you. As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again.

One moment for questions. Our first question comes from Duane Fenningworth with Evercore ISI.

You may proceed.

Hey, good morning. Just on Charter, can you talk a little bit and just remind us how fuel change year over year impacts revenue trends in Charter and also margins in Charter?

So I think it's important to break out what charter includes. There's several track programs. We have a fleet of 60 aircraft. Five of them are dedicated to track programs plus a VIP. So it's basically six aircraft. And those have absolute pass-through in fuel. We have a significant amount of ad hoc business. That is predominantly sports programs. Again, that's 100% pass through. Sometimes, however, we need to position aircraft at our costs. So there's a little bit of flying that we do in support of those that has fuel at risk. And then there's the military business, which is 100% pass through. So it's effectively, you know, over 90% perfect pass through.

Yeah, I mean, think of it this way, Duane. So we negotiate a charter contract, and that charter contract is a reference price, okay? If fuel is higher or lower than that reference price, we get reimbursed from the charter customer for either more or less, you know, based on the fuel price. When fuel is really high, the reimbursement is higher, so the revenue looks higher. When fuel is really low, the reimbursement is less, so the revenue looks less.

Got it. And then for some of the seasonal flying that you do, can you just remind us to what extent Mexico or Cancun is a part of that seasonal set? Obviously we heard some more cautious comments on Cancun specifically from Spirit yesterday, but could you just kind of comment on your trends to maybe Mexico and near Caribbean?

Yeah, I'll give you some backdrop. Our international network, is focused from Minneapolis in the wintertime. And in the summertime, the predominance of our international network is focused on origination and southern large markets. The distinction there is that the southern business is largely a scraping business where we don't support that flying with a lot of marketing. We're not focused on building a brand in some of these origination markets in contrast to what we do out of Minneapolis in the wintertime. And therefore, you know, we're a little more subject in the summertime to the prevailing airfare in some of these international markets. And I would be, you know, I agree with Ted's comments about some of the weakness that we're seeing in southern markets, but these are still highly profitable markets for us. And we have the ability to dial capacity to whatever optimal level is supported by the fair environment at that given time. Most of our international markets in the summertime are now winding down and will be out of by the end of August. And then we'll focus on building up our largely Minneapolis, but also some Milwaukee and a few others where we fly winter markets as we approach into the fourth quarter. Any color, Grant?

Yeah, Doug. Just echo Jude's comments that there was a little pressure this year, but the results were on an absolute basis were still acceptable for us, down from maybe what we've experienced. But we do some unique things down there. There's one market that has been particularly strong for us, which is Harlingen, which did not have sort of the competitive impacts, and that one performed very nicely. So, to Jude's point, our agility will make it work. We've been there for a while. and it's going to be something we continue to do in the summer.

My diagnosis of Cancun was that it was a really strong summer in 22, and a lot of carriers chased that demand into this summer. And if you look at capacity levels year on year, Cancun was the beneficiary of a lot of capacity growth in that drove down fares. I think there's still strong structural demand, and we can, as I mentioned, fly in any environment and be successful down there.

Okay, makes sense. I'm going to have to look up that originating market. that you talked about. I'll have to go look at my map, but I appreciate the thoughts.

Thank you. One moment for questions. Our next question comes from Catherine O'Brien with Goldman Sachs. You may proceed.

Hey, good morning, everyone. Thanks so much for the time. You know, hey, another topic that's been popular this turning season is you know, domestic carriers having to right-size day of week just based on their current view on, you know, where corporate now sits. Not that that's a market you chase, but, you know, I know your network has less overlap with some of these carriers, but have you started to see any pickup in competitive capacity into the fall or early winter as these changes start to take place in other airline schedules?

Generally, the capacity environment is constructive, meaning not a lot of growth. We are seeing some buildbacks into Minneapolis based on 2019 levels, you know, stuff that was cut that's coming back from non-Delta carriers. And so, but that's perfectly fine. On the day of week stuff, I mean, that's sort of what we do. And I don't think it should be a surprise to anybody that Vegas is a little weaker on Tuesdays than it is on weekend demand patterns. So I'm, you know, we built the business around that. It's not a substantial change. Here's a point that I can bring up, which is perhaps out of consensus. July doesn't have a lot of day-week sensitivity. There's a tremendous amount of demand, but it's elastic as compared to March, which has these fantastic days. So there's really deep demand that's inelastic on a few given days, particularly around spring break travel patterns. So July, we need to be a lot bigger than we were. And that means adding in to off-peak periods. So we have a capacity constraint that's a block hour constraint based on pilot availability. And so we choose to put our flying on the very best of days during that month. However, if we had more flying, we would expand and flatten the schedule with a relatively moderate or de minimis even reduction in unit revenues because the off-peak days are so powerful. In contrast, September is completely different. And as it always has been, you know, there's just not a lot of midweek opportunities in September. And I agree with the overall sentiment that there is a focus, a renewed focus, perhaps, from the big three onto leisure demand, which is crowding out somewhat leisure carriers when there is limited demand. But we already focus on flying around those limited demand periods. And so for us, it's really about adding into off-peak periods during peak months. So it's a more nuanced and complicated matter, I think, than the market is making sense of it at this point. Our opportunity is to grow into these 40% variable contribution, scheduled service networks that we have during peak months. And that's what gets our third quarter margins up into the mid-teens from where they are today at this field price.

Got it. That's really helpful. Thanks for the perspective, Jude. Maybe just two quick ones on costs for Dave. So, you know, you're... um just coming back to the casual commentary through your end that that eases could you just give us some more color on if that's ratable like with the step down in each quarter or anything you should be aware of on 4q capacity growth and then and then just on the share based comp um in the press release you noted there was like a one-off vesting and stock comp but but one key wasn't too far below this quarter um you know both were a little bit elevated last year Can you just give us some color on how we should expect that to trend, just since it's outside of your commentary on Canada Max? Thanks so much.

Yeah, sure. So, essentially, I think what this is consistent with Jude's commentary is we're a little bit oversized. You know, we mentioned on the aircraft front, we have enough aircraft. We had a few more to really sustain reasonable growth levels through 2025. So we're a little oversized. And as we continue, and that's negatively impacting CASM. As we sort of roll forward into the quarters ahead, and you see some of this growth, particularly like some of the third quarter growth, and then some growth we're going to have in the fourth quarter as well, those year-over-year numbers will begin to, will continue to, I should say, moderate. So, you know, we should be single-digit kind of stuff in the third quarter and fourth quarter. I'm not giving guidance on yet, but we should just see continually improving year-over-year trends here on the CASM front. Regarding the management options, you know, there were a number of folks here who had considerable options from Apollo when the original acquisition was made. Apollo's ownership, which I think is an important point for investors has continued to drop and is now sub 30% at the company. So the overhang is getting less and less, but that 30% was a sort of a trigger for the vesting of management options that happened last quarter. So when we fell below that number, a significant number of management options vested, um, So those original options are now fully vested, so vesting costs will not continue to recur in the quarters ahead, at least for those options. So that number will moderate.

Okay, great. Thanks so much, Steve.

Thank you.

One moment for questions. Our next question comes from Helene Becker with TD Cowan. You may proceed.

Oh, hi. Thanks very much. This is Tom Fitzgerald on for Helene. My question is just on what you're seeing in terms of pilot attrition and how you're feeling about getting first officers to upgrade into the captain's seat. I appreciate any call you could have. Thanks very much.

I'll make some very general comments and then, Greg, if you want to jump in. Well, we don't have any problem hiring pilots and our attrition is consistently below where we had expected it would be at this time. the issue boils down really to getting pilots to upgrade to captain. So we're constrained in the left seat, and we continue to make strides in improving that figure, and we will grow as we upgrade captains.

Yeah, I mean, to Jude's point, we don't have a problem hiring pilots right now. We've got really robust applications. We've got a great recruiting team on the attrition front. Um, you know, we, we watch that daily that stayed within our expectations. We see these other deals that are going on, you know, out there now that might affect that attrition, but we believe we can moderate that with additional class sizes that we can fill. So as you said, it really does come down to our ability to grow is at the rate of our captain upgrades.

And this is an industry wide issue as the, you know, and in the case of the big three, they did a bunch of early retirement. And so everybody's trying to, get pilots through the training pipeline and right-size their pilot groups. It's just taking a little time.

Yeah, I think one of the points is, you know, we've talked about this point for now a number of quarters. This continues to be a challenge for us, but I think, you know, you can look at the growth that we're looking at here in the third quarter as a testament to the fact that we are making progress, but it's not linear.

It's bumpy, and this is the focus. Thank you. And as a reminder, to ask a question, please press star 1-1 on your telephone. One moment for questions. Our next question comes from Mike Lindenberg with Deutsche Bank. You may proceed.

Oh, hey. Good morning, everyone. I did get on a few minutes late. I apologize if you may have addressed this, but just going from a 15% operating margin, you're guiding 6% to 11%. We're coming off of what was seasonally one of your weaker quarters. What are sort of the primary drivers there? Is it things like fuel? I know September is a tough month for you guys. Can you just run through some of the puts and takes, your thinking behind that, decel and profitability? Thanks.

I mean, the main thing is segmented capacity allocation. So we have very consistent profitability from our track and cargo programs, track, charter, and cargo programs. And, you know, it's a good thing that they, in many ways, it's a good thing that they are flat in capacity. And then we have schedule service, which is variable. And as I mentioned, you know, and Dave alluded to, you know, we're flying our airplanes in July, one of the strongest demand months of the year at about eight hours a day. And that number should be 1011. And that those are 40% incremental margin opportunities that we're that we're cutting out because of capacity constraints that don't have anything to do with with opportunity or airplanes. It's really about staffing. So that's the biggest thing. In contrast, the second quarter is a relatively flat demand period as compared to the third quarter. So third quarter, the way the third quarter goes July, in contrast, the second quarter has a really good April, a really good June. May is not great, but it's not that bad. It's not as bad as September. So it's a lot more flat. And that's the difference in the two quarters.

Makes sense. Jude, did you mention what your ASMs will be up, scheduled ASMs, in the September quarter?

We didn't mention that. I don't think we have an issue sharing it. I just don't have it in front of me. We can get it to you. I got it at about mid-teens.

Okay, mid-teens. Okay, and then just my last question, and this is more of a modeling question, as we think about the rental revenue, the $6 million. Is that sort of the right quarterly run rate, and when does that start to fade out? What is it, sometime late, 24, 25? Thanks for taking my questions.

Yeah, that's right. The fadeout will begin really in November 2024 and then continue through November 2025 as the five aircraft roll off and come to us to operate.

Okay. Thank you.

Thank you. One moment for questions. Our next question comes from Christopher Stathalopoulos with Susquehanna Investment Group. You may proceed.

Good morning, everyone. We want to get back to the comment you made on, I believe you said that the stock comp should be moderating giving the changes in the vesting schedule. So could you help frame the implied operating income for 3Q How should we think about stock comp there? I believe this quarter was a little north of 15%. That's a significant step up from recent quarters. I just want to better understand how we should think about that underlying as we think about the second half of the year. Thank you.

Yeah, I don't have that precise number in front of me. It'll just be a significant step down. I mean, in the second quarter, there was a significant chunk of options that had not yet vested. They all vested in one quarter. So there will be a step down number. I just don't have that, you know, in front of me.

As it pertains to the 2018 option grant that was associated with the Apollo transaction, all those options are either vested or done.

So that goes to zero. Yeah, so exactly. So that number goes to zero. And as with any other company, we have an RSU program, which is ongoing. So there will be some stock comp expense that continues, just at a significantly lower level.

Okay. The second question. So I think you're backing out the DNA associated with these five dry leases from your CASM-X. Could you just walk us through the rationale? Why? I'm guessing because they don't have associated ASMs. And, you know, but you're including the revenue side of it. And then also, as those come off, I think you said dry lease in 2025. If you could just kind of walk us through, you know, how we should think about the unit cost impact or unit margin. I just want to kind of better understand this relationship here. It's sitting in revenue here, but it looks like it's coming out of your chasm. Thanks.

Or at least the DNA is. Yeah, so, I mean, it's sitting in revenue and it's sitting in expense in our financials. But since, as you pointed out, it doesn't generate any ASMs, we take it out of the CASM comp and it's out of the TRASM comp. So it's out of unit costs on the revenue side and on the cost side, you know, in the same way that our cargo revenue isn't in our cost per ASM or revenue per ASM number that generate ASMs.

Just strategically, I want to just reiterate from last quarter, we're not being a lessor. We're just acquiring airplanes for future delivery. So, you know, when we report, we're doing our best to back out all those results so that you can kind of see the underlying success of the business, which is what we care about.

Okay. I keep getting one more. Yeah. I'm sorry.

Go ahead. No, I just wanted to follow up quickly. I just pulled a number. So, You know, stock comp in the second quarter, I think, is around 4.5. That number will probably drop to a million plus or minus.

For 3Q or a second half? No, for 3Q.

Okay. Okay. Great. Thanks. And just if I could get in one more here. So we've heard from U.S. peers talking about how this strong international travel is pulling from a pool of what would be domestic travelers and You know, are you seeing any of that? And if so, you know, what are your thoughts on one that might slow? Thank you.

I mean, my view is that we observe something and then try to make up a reason why it exists. And so, it's true that the transatlantic yields are much higher than they had been. I think it's a stretch to say that those folks that are flying transatlantic would have otherwise flown domestic. I think more confidently we can say summer of 22 was an outlier in demand recovery with a lot of recapture from the previous years. Instead, we're going down to a fairly consistent year over four unit revenue environment month by month where improvements are between 35 and 45%. And that seems consistent going into all the bookings we're seeing through the spring of next year. So I think it's a little much to draw that conclusion. But, you know, I think what gets me excited is just, you know, it looks like fares have sort of permanently reset into a post-COVID environment for our network anyway. Anything else, Grant? Yeah.

I would just add to that that those unit revenues versus 19, I think, were at the high end of that. So that's specific to us and a testament to the good job this team's done. And I also think Jude's comments are spot on. If you look at our network, we grew. Jude mentioned 15 new markets this summer. They've all met expectations. Our load factors are up. So we saw strong demand across our network and really happy with the results.

Okay, thank you. Thank you. I'd now like to turn the call back over to Jude Bricker for any closing remarks.

Thanks for joining us. Thanks for your interest in Sun Country and we'll talk to you again at the end of the next quarter. Good morning, everybody.

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