Mesa Air Group, Inc. (NASDAQ:MESA) Q2 2023 Earnings Call Transcript May 9, 2023

Operator: Thank you for standing by, and welcome to the Mesa Airlines’ Second Quarter Fiscal Year 2023 Conference Call. All participants are in a listen-only mode until the question-and-answer session of today’s call. This call is being recorded. If you have any objections, please disconnect at this time. I would now like to turn the call over to Doug Cooper, Head of Investor Relations. Mr. Cooper, you may now begin.

Doug Cooper: Thank you, Brad, and welcome everyone to Mesa’s earnings conference call for its fiscal second quarter 2023 ended March 31. On the call with me today are Jonathan Ornstein, Mesa’s Chairman and Chief Executive Officer; Michael Lotz, President; and Torque Zubeck, Chief Financial Officer; and other members of the management team. Following our prepared remarks, there will be a question-and-answer session for the sell-side analysts. We also want to remind everyone on the call that today’s discussion contains forward-looking statements that are based on the Company’s current expectations and are not a guarantee of future performance. There could be significant risks and uncertainties that could cause actual results to differ materially from those reflected by the forward-looking statements, including the risk factors discussed in our reports on file with the SEC.

We undertake no duty to update any forward-looking statements. In comparing results today, we will be adjusting all periods to exclude special items. Please refer to our fiscal second quarter earnings release, which is available on our website for the reconciliation of our non-GAAP measures. With that, I will turn it over to Jonathan for his opening remarks. Jonathan?

Jonathan Ornstein: Thank you, Doug, and thanks everyone for joining us today. As we mentioned before, fiscal year 2023 is a transition year and our numbers reflect that. With that said, our results were largely in line with our internal expectations as we execute the transition of our CRJ-900 flying to United Airlines. In addition to the transition, we are still continuing to ramp up our more profitable E-Jet flying. While we are experiencing significant improvement of pilot retention and output, this quarter, our E-Jet utilization was still under six hours. Turning to the transition. We currently have 24 of the 28 plan CRJ-900s in service, albeit at lower block hours than initially anticipated due to a more conservative approach taken by United.

I’d like to thank all of the hardworking people at Mesa who have helped make this transition happen and United for their support. While we continue to see strong demand for regional flying and our pilot pipeline has recovered significantly, our focus over the past several months has been on ensuring the United transition and the numerous actions we have taken to strengthen our balance sheet are executed successfully. I want to take a moment to highlight the cornerstones of our plan moving forward. First and foremost, we have a strong relationship with United Airlines, which is as we work through the transition has been supported both operationally and financially. We are now flying 20 of the CRJ-900 with United. As we return to normalize operations and flying higher block hours, there maybe an opportunity to restore some regional jet service in neglected smaller and rural markets nationwide.

Three quarters of these markets have seen service reductions in recent years with the average reduction eliminating 30% of flights in a given market. This deficit is magnified by the fact that regional flight service accounts for 50% or more of the total air service in 29 U.S. states and accounts for over 75% of service in 11. That’s per the Regional Airline Association. Our new CPA with United contemplates addition of over a 100 daily regional jet flights across the country, representing a solid step for the regional airline industry. Unfortunately, without legislative action to counter the significant negative impact of the 1,500 hour rule, we are still concerned about the long-term future of regional aviation service to rural America. Further to our mission to improve mobility, reduce congestion and decarbonize travel, we remain excited about the potential of our previously announced co-investments with United on new technology and electric aircraft, including Archer and Heart Aerospace.

We believe eVTOL and short distance electric aviation will be integral to addressing transit needs in smaller and congested communities moving forward. While the current pilot shortage continues and needs to be addressed industry-wide through legislative action, the current industry bottleneck is now ensuring in adequate number of qualified First Officers to upgrade to Captain. As a result of United’s new AVA program requiring that candidates have flown as Captains for two years as well as our pilot labor agreement, we believe we have a sufficient number of First Officers to fill our Captain requirements going forward. Without Captain upgrades, most airlines find themselves with an imbalance of First Officer and captains, and as a result have paused hiring First Officers.

This is just another downside created by the 1,500 hour rule. With that said, we have positioned ourselves to rebuild our pilot pipeline and now have three significant pilot initiatives in place. Again, with the support of United, Mesa offers an industry-leading pilot pay scale. This has been a major benefit for retention as fewer pilots are leaving to go to other carriers, most notably national and low-cost carriers, which in the past may have offered higher wages. Our participation in United’s AVA program, which is one of the most rapid paths for pilots to join the regional industry and transition to a major airline has proven successful in attracting and retaining pilots. Mesa pilots are afforded an opportunity to transition to United within four years.

Lastly, the Mesa Pilot Development program, which was launched in September in Inverness, Florida, is one of the fastest and most cost creative paths for pilots short of the 1,500 hour threshold to accumulate hours. This program has already graduated a cadre of 11 pilots to Mesa training and has had so many enrollers that we are now preparing to launch a second location in Arizona. To support this expansion, we have taken delivery of four more Pipistrel Alpha Trainer 2 aircraft with 21 more on the way. Finally, as you may know, Mike Lotz, who has previously served as Chief Operating Officer at Mesa and Virgin Express is stepping in and taking on expanded responsibilities. Mike continues his role as President and will be overseeing all of Mesa’s operating groups following the retirement of Brad Rich.

With that, I’ll turn the call over to him. Mike?

Michael Lotz: Thank you, Jonathan, and good afternoon, everyone. Let me start by saying how excited I am with my expanded role overseeing the day-to-day operations of the company. In my 25 years as President at Mesa, I’ve also previously served in the COO and CFO roles and have been involved in all aspects of our business and particularly our relationship with United. Working through this transition, optimizing pilot output, providing exceptional operational performance for United and DHL, all while operating at the highest level of safety will be my primary focus. Transitioning to CRJ-900s from American to United has been a major project for the company. Although we are keeping both Phoenix and Dallas’s crew and maintenance bases, our entire network has been transformed.

Our Houston hub has increased from 55 to 95 flights per day. As you may or may not know, United has never operated the CRJ-900 in their regional fleet. So everything from seat maps to jetway staging, ground handling procedures and fueling are all new to the United operation. Given these aircraft, they are flying to 30 cities in the network. This transition entailed a lot of preparation and work. We painted 28 aircraft and repositioned our maintenance parts and ground equipment. This was not just a simple swap of aircraft from one operator to another. We appreciate the support we received from United during the transition. Ultimately, the real benefit of the transition is that Mesa is able to provide United with 100 additional large, 76 regional jet flights every day.

Upon our completion of the transition to United, our contracted regional fleet will consist of 80 large regional jets, comprising a mix of E-175s and CRJ-900s. Our plan is to add back the underutilized E-Jets as fast as possible. Additionally, we will continue to operate four 737, 400s and 800s at DHL. While our fleet utilization in the past two years has been impacted by the industry-wide pilot shortage, as Jonathan mentioned, we are now seeing attrition below pre-pandemic level, and thanks to the number of initiatives we have implemented. Mesa continues to be a top destination for pilots. It’s especially worth noting that recent pilot turnover is larger result of pilot retirement or transfers to United as part of the AVA program. Nonetheless, we are maintaining our focus on attraction and retention in our pilot pipeline.

We currently have almost 1,600 new hire applicants and combined with the Mesa Pilot Development program, we have confidence in our ongoing ability to keep our classes filled with a combination of new hires and Captain upgrades. We are continuing to focus on optimizing pilot training throughput, and also have access to an additional sim if needed. With that said, in the March quarter, we flew 48,186 block hours, a 5% decrease from the December quarter. I would like to point out that our billed block hours for the March quarter were actually 51,660. We expect our June quarter block hours will be approximately 46,000, a 4 percentage reduction from the hours in our March quarter. The reductions for both periods are primarily attributable to the CRJ-900s being transitioned out of America – out of America and as well as the First Officer Captain imbalance.

Looking forward to the September quarter block hour should be closer to 55,000 as a result of the transition being completed and the benefits of our Captain upgrade actions. We expect subsequent quarters to continue to improve, but will not be providing projections for the next fiscal year at this time. As a final point, I’d like to reiterate that during the quarter, Mesa incorporated a new 737-800 freighter to our DHL operation. This brings our total cargo fleet to three 737-400s and one next-gen 737-800. With that, I’d like to now turn the call over to Torque to walk through our financial performance.

Torque Zubeck: Thank you, Mike. Now I’ll take this opportunity to review our financial performance and our balance sheet. For the second quarter of fiscal year 2023 revenue was $121.8 million, 1.1% lower compared to $123.2 million in Q2 2022, while contract revenue fell by $8.2 million year-over-year. These decreases were driven by recognition of deferred revenue and lower block hours, partially offset by higher United block hour rates for new pay scales. The decrease in contract revenue is partially offset by an increase in pass-through revenue of $6.8 million, driven by pass-through maintenance revenue and pass-through property taxes. Mesa’s Q2 2023 results include per GAAP, the deferral of $5.7 million of revenue versus the recognition of $0.8 million of previously deferred revenue of Q2 2022.

The remaining deferred revenue balance of $24.5 million will be recognized as flights are completed over the remaining term of the United contract. On the expense side, Mesa’s overall GAAP operating expenses for Q2 2023 were $148.7 million, down $19.3 million versus Q2 2022. This decrease was primarily due to $22.7 million lower non-cash impairment of assets held for sale versus Q2 2022. Aircraft rent also fell by $8.6 million attributable to the reclassification from operating lease to finance lease for certain CRJ-900s, and depreciation and amortization expense fell by $4.2 million, primarily driven by the lower depreciable base from the CRJ-900 asset impairment charge in Q4 2022. Maintenance expense fell $1.4 million this quarter versus Q2 2022, driven by lower expenses for seat checks and parts partially offset by an increase in pass-through maintenance.

We expect maintenance expenses to be roughly consistent at this level for the next three to four quarters. The decrease in GAAP operating expenses was partially offset by higher flight operations expense of $54.8 million, $12.4 million higher year-over-year, reflecting higher pilot pay scales and increased training costs as we continue to drive pilot throughput. General and administrative expenses were also $5.7 million higher versus Q2 2022, driven primarily by higher pass-through property tax costs and we expect G&A will be consistent for this level for the next three to four quarters ahead. Total adjusted operating expenses excluding one-time items were $132 million, an increase of $2.7 million compared to the prior year. On the bottom line, we reported a net loss of $35.1 million or a loss of 88% per diluted share compared to a net loss of $42.8 million or a net loss of $1.19 per diluted share for Q2 2022.

Now, on an adjusted basis, Mesa reported a loss of $21.3 million or a loss of $0.53 per share compared to a net loss of $10.3 million or a loss of $0.29 per share a year-ago. The adjusted loss for Q2 2023 excludes a $2.1 million gain on investments and $0.5 million gain on a disposable of fixed assets. It also excludes $16.7 million of asset impairments and another $0.7 million from a deferred financing write-off for the sale of assets. Adjusted results from Q2 2022 excluded $39.8 million of asset impairment charges and a $2.3 million loss on investments. Next, let me turn to the balance sheet. During the quarter, we closed on the sale of four of the 11 CRJ-900s agreed to be sold to a third-party. Mesa also sold to United the remaining eight CRJ-550s and 10 out of 30 engines previously agreed upon.

Importantly, these transactions generated $35 million in cash and we paid down approximately $52 million in debt during the quarter. For the June quarter, we expect to close on the seven remaining CRJ-900s and 20 engines agreed to be sold, which together will generate approximately $33 million in cash and pay down $42 million in debt. Going forward, we still have excess CRJ-900s and are working to sell these aircraft. We recently entered into a letter of intent to sell an additional seven aircraft, which upon completion of the sale will pay off approximately $68 million of debt associated with these aircraft. Cash for the March quarter excluding restricted cash decreased by $4.6 million from the prior quarter ended December 31, 2022 to $51.4 million.

Total debt at the end of the quarter was $608.7 million, down $77.9 million from the prior quarter. This included scheduled debt payments made during the quarter of $28 million and finance lease payments of $4.6 million. We have $44.7 million of scheduled principle payments remaining in 2023 and after the repayment of debt associated with asset sales, we expect the fiscal 2023 year-end debt of approximately $470 million. We expect to maintain cash at its current level or better through the end of the fiscal year. Given the transition at Mesa, we will not be providing more specific financial guidance at this time with block hours impacted by the transition as Mike indicated, we expect earnings for the June quarter to be similar to the March quarter.

With that, I’d like to now turn it back over to Jonathan for closing remarks.

Jonathan Ornstein: Thank you, Torque. In summary, we’ve undertaken an important transition for Mesa. 2023 continues to be a year of transformation, and 2024 we will build on the foundation we are establishing in 2023, focusing on returning to normalized block hour utilization. We look forward to speaking with you over the coming quarters. At this point, operator, please open up the call as I’d be happy to field any questions that the analysts may have. Thank you very much.

Q&A Session

Operator: Before taking our first question, I would like to turn the call back over to Jonathan for brief remarks.

Jonathan Ornstein: Thanks, Brad. Before we take the first question, I just want to thank everyone for their patience as we experienced some technical difficulties with the publication of our earnings press release, forcing the delay of the call. We look forward to taking your questions now. Thank you.

Operator: Thank you, sir. Our first question for today will come from Savi Syth of Raymond James. Your line is open.

Savanthi Syth: Hey. Good afternoon, everyone. I appreciate the color on the kind of the block hour progression here. I was curious along those lines. On the deferred revenue, do you kind of expect to book more deferred revenue here in the next kind of couple of quarters of the year or do we start to see that starting to reverse now?

Torque Zubeck: Yes. Hey, Savi. This is Torque. The deferred revenue is associated with the recognition of revenue as we are flying more. So we’ll see a little bit of that. But I don’t have specific guidance for you right now.

Savanthi Syth: Okay. But it shouldn’t be deferred revenue. It should be, if anything, recognizing a little bit?

Torque Zubeck: Right. A little bit just as the contract moves forward.

Savanthi Syth: Makes sense. And then just a little bit on the – as we can address the pilot issue, looks like your block hours are stepping up. And I can appreciate not wanting to give a lot more color than the end of this fiscal year. But generally, what does that fourth quarter look like in terms of utilization? I’m just trying to appreciate how much more that kind of Torque, no pun intended there, but the model has in terms of being able to improve kind of pilot, captain levels and really start operating the fleet better?

Michael Lotz: Yes. Savi, it’s Mike. So in terms of utilization, I think, we gave guidance for 55,000 for the September quarter. I mean, with 80 aircraft, 72 lines. Even at 10.5 hours of utilization, we targeted to get that number up into the 65,000, 66,000 range. And that will probably take us a couple quarters to get there.

Savanthi Syth: Okay. That’s super helpful. All right. I’ll get back on the queue.

Operator: Our next question will come from Michael Linenberg of Deutsche Bank. Your line is open.

Shannon Doherty: Hi. This is actually Shannon Doherty on from Mike. Thanks for taking my question. I think in your opening remarks, you mentioned that the E-Jet utilization was still under the six hours, despite being below pre-pandemic levels of attrition. Can you just give us more color on what’s happening here on keeping the utilization so low?

Jonathan Ornstein: Sure. This is Jonathan. We had to spool up pilot training, which something that really – we moved as quickly as possible even just getting people through training takes three or four months. We got a second sim. We added instructors, ground instructors last month to give you an idea our attrition was around 15 pilots. That’s the lowest it’s been that, frankly, since any of us can remember. And we put out of IOE something over 50. Those are good numbers. I mean, when we go long close to 40 pilots a month, that’s the equivalent of five aircraft. Now, there is the challenge about First Officers, most of the other regionals and in fact a lot of the national carriers are having trouble because they just don’t have people who have enough time in a 121 aircraft to upgrade to Captain because of the acceleration and attrition that occurred earlier in the year.

At Mesa, we’re fortunate that as a result of the AVA program, as well as our labor agreement, which allows us to, we’re able to move First Officers up to Captain and we don’t think that will slow us down. And in fact, I think in this month, our Captain class is about 30 individuals. So it’s just a matter of how fast we can spool up. There’s really no mystery in terms of what it does to our numbers. I mean, clearly at six hours, we’re not going to make money. We’ve got a bunch of aircraft parked. We are also continuing to hire and train CRJ pilots. We think we have an adequate number for the most part with what we have, but again, we’re just going to continue to hire people and put as many people on and keep pushing up the utilization on the existing CRJ fleet.

But clearly, the focus is going to be on the E-Jet. And again, between all these various programs, I do think barring some big spike in attrition, which seems to be coming less likely as things have slowed down a little bit. I think we’re moving forward pretty well in terms of adding net pilots to our roster.

Shannon Doherty: Thanks, Jonathan. And just a quick follow-up on the profitability rate. So do you think that Mesa can once again return to mid-teen operating margins in the years to come? Or has the profitability bar been permanently lowered given the post-COVID issues that have disproportionately impacted both you guys and other regional airlines? What would it take for you guys to get back to pre-pandemic profitability levels after transformation? Like, do you need to engage with or re-engage with your airline partners or?

Jonathan Ornstein: No. I have to tell you, Mike and I, and Torque discussed this very subject to this morning because I really was – wonder what I would say in regard to that. It’s something I wanted to address. I think our belief is that flying our aircraft, the existing aircraft without additional aircraft, but flying our aircraft, we believe that once we are at basically full steam, in other words, flying the aircraft north of 10, 10.5 hours a day, that we could achieve margins between 5% and 8%, consistently. Because there’s so much leverage in that last hour, it’s really pretty astounding and probably something maybe even we didn’t understand going into this. But I think that we feel that it may take us – it could easily take us another year, but to get to that full run rate.

But I think that at that point, looking at margins, 5%, 6%, 7%, 8% is doable. And the question becomes, can we achieve that any sooner, just based on what happens in attrition and our ability to upgrade folks and bring people on Board. I will say that we now have, as we mentioned, I believe almost 1,700 applicants. We’ve got almost that equivalent amount lined up in the Mesa Pilot Development program. The real question is just the upgradeability of First Officers. United has helped tremendously in the AVA program by requiring Captains for the AVA program to graduate into the AVA program they had to have served as a Captain for two years and as well as our labor agreement and the support of our pilots that allows us to upgrade people. So I think that, we’re going to work very hard to get to those numbers.

I think also that there maybe some opportunities on the cost side once we get to sort of a steady state. I mean, to be frank, given everything that’s happened, I think it’s fair to say, and I think Mike would and Torque would agree that we have thrown a lot of money out there to sort of make this happen more rapidly. And I think once we get back to normal, I think we could take a closer look at how we might be able to fine tune the operation as well.

Shannon Doherty: Thank you so much.

Operator: And our next question will be from Savi Syth of Raymond James. Your line is open.

Savanthi Syth: Thank you. Maybe just quickly follow-up on – clarify on the first one, six to eight, you were talking about pre-tax margin, right, Jonathan?

Jonathan Ornstein: Yes.

Savanthi Syth: Yes. Makes sense. And just on the fleet side, you’ve done a lot of kind of monetizing the fleet, which is great and so I realize there’s about 80 aircraft on the United fleet and then you have 20, maybe 20, 24 kind of CRJ-900s that you’ll kind of keep open to fill in there until you can fully fly there. But with the sales, like how many CRJ-900s do you have then X whatever you’re dedicating to United that you can maybe continue to monetize or place in your JV in Europe. What’s the – once what you have kind of done is complete, like what’s left over?

Jonathan Ornstein: Well, I’ll start and I’ll let Mike and Torque. But I think our view now is that we’re going to sell as many 900s as we can. We have the seven that we think we have a contract for. I think we’re looking to packaging some of the additional 900s with parts which we have plentiful and engines, which are very valuable. There’s a certain number that we need to operate the existing United agreement until such time as we can operate E-Jets. And I think, we’re also obviously going to be looking at other opportunities for the aircraft. But I don’t think at this point that we would slow down in terms of selling aircraft and starting to continue to pay down the government debt, which most of the aircraft are offsetting the government debt. And then we have RASPRO all of which, we are looking to wind down as quickly as possible. Do you want to add anything to that, Mike or Torque?

Michael Lotz: No. I just think Savi that, look the capacity we have with the United is for 80 large regional jets. So right now the mix is maybe 30%, 970%, 175s. And look, our goal is to try to get as many E-Jets flying as quickly as possible that they’re certainly more profitable for us. They’re obviously newer aircraft compared to our very old 900 fleet. So it’s just going to be, as that movement comes where the E-Jet start coming in and the 900s come out, that’s where we’ll look at opportunities to dispose of those assets and monetize any equity we have in them.

Savanthi Syth: And just in terms of kind of trying to gauge kind of the revenue per block hour, I guess the kind of the best way for us to think about is kind of work backwards. Is that right? Like a mid to high single-digit margin and that’s what you kind of get too. What I’m trying to understand is that, there’s a fixed and a variable component, and I’m trying to understand how much of that current revenue for block hour is probably overstated because it’s over or kind of lower block hour production?

Jonathan Ornstein: Yes. And look, it’s difficult to forecast that because of the mix of the fleet between aircraft that we may own and aircraft that United owns, or in certain cases DHL. So that’s a difficult number to nail when you have that kind of a mix. Yes. I think what Mike is saying is just not linear because on some aircraft, we’re making either the lease payment or the ownership payment and others are partners are, so it’s just not linear.

Savanthi Syth: Makes sense. And maybe if I can just ask just one last, kind of taking a step back on this kind of the regional front, just any kind of thoughts now that you’re seeing a little bit of settling on the pilot side and maybe light at the end of the tunnel through this kind of period. Just your view on the regional airline market here in the next kind of three years or so?

Jonathan Ornstein: Sure. I mean, look a lot of folks were concerned about the differential that existed between the majors and the regionals in terms of cost benefits. When we’ve looked at it, even with the new wages that cost benefit, there’s still a significant delta between the costs. So I think from a macro perspective, the regional business, it still has good legs and I think still makes sense. And there are just cities out there that are just going to be too small or are just served better with multiple departures into hubs that I think will require regional jet service. Am I concerned that over time, if cost levels continue to escalate, is there a point where the aircraft doesn’t work? I’m sure that point does exist. But between fair levels increasing, demand being strong and the importance to the network for United in particular, the feed traffic has lots of value.

So I don’t see a situation where the regional industry just sort of goes away at this point. Because I think all three of those things are to our benefit. I think that it’s still going to take innovation. There’s going to – and there is innovation out there and I think that that will continue. But I think for the basic fleet of aircraft that we operate, they’re going to be in service for quite some time. And I think we’re pretty safe on that. As the costs may have gone up, but they’ve also gone up at the major level and their cities that are just going to stay on the map regardless.

Savanthi Syth: Makes sense. Thank you.

Operator: And at this time, we have no further questions, gentlemen.

Jonathan Ornstein: Okay. Well, thank you very much everyone. I know that this is obviously a tough quarter. We have ways to go. United has been extremely supportive in terms of helping us through this. As you know, we have begun a good process to liquidate assets that we have are surplus to our requirements. And we have been getting surprisingly in good prices doing that and allowing us to pay down a significant number of debt. Again, on the pilot side, we’ve made what I consider to be remarkable progress. Certainly surprised me that the attrition levels are down to this and this has been sort of the second or third month where we’ve seen attrition levels much, much lower and our output on training, while it took us a while to get there, there’s no doubt longer than we had hoped or anticipated.

But we’re now at levels where we’re beginning to put out real numbers. And when you combine that with the lower people leaving, I think, we could see some things really starting to turn. But I don’t want to underestimate that it’s going to take time. But clearly, we have modeled this enough to know that if we can fly the aircraft between that magic 10 and 11 hours, this operation will be profitable going forward. I think that United is also very much determined to see that happen. They would like us to be healthy, they rely on us, and I think that they put a lot of energy into helping us get to that point. So we’ll continue to plug along and hopefully next quarter, we’ll talk to you again, and we continue to appreciate your support. Thank you.

Operator: Thank you all for your participation on today’s conference call. At this time, all parties may disconnect.