Mesa Air Group, Inc. (M2A0.F) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining us today for our Bank of America Transportation, Airlines and Industrials conference. Today with us in our next session is Mesa Air Group. With us from Mesa is its President and Chief Financial Officer, Mike Lotz; as well as Torque Zubeck, their Senior Vice President of Finance. Mesa is an interesting story. It's a little bit different than your traditional airline. It specializes in kind of the regional carrier business with relationships with American and United. But the pandemic has been a bit different to Mesa, right? They've taken the opportunity during the pandemic to change for the better. And for those of you that may be new to the Mesa story, maybe just going to hand it over to Mike for a few minutes to maybe walk through some of the big initiatives that they've undertaken through the pandemic and sort of begin to sort of emerge from this in much better shape than they were going in. So with that, I'll hand it over to Mike.

Thanks, Andrew. We're a unique carrier. We're not your traditional airline. We have contracts that we fly under for primarily United, American, but we also have a contract with DHL. And in these contracts, we're basically providing the aircraft, the maintenance and the crews to our partners. And our partners really take on the bigger risks for an airline, which are the passenger load, the air fares, the fuel on an aircraft. So we're very well insulated from changes in activity, and it was really crystal clear during COVID, where other airlines had significant reductions in revenue because the passenger traffic for a company like Mesa that contracts our business out. We saw some drop in revenue, but our contracts with our partners are split between fixed and variable revenue and the fixed variable stayed fairly constant because it's based on basically the number of aircraft that we operate. Our variable revenue obviously went down with the reduction in block hours from our partners, but our variable costs went down as well. So we were very uniquely positioned for COVID. And obviously, the reduction in block hours had an impact on it, but not like you've seen at some of the carriers that are 100% dependent on passenger volumes. So we fared out fairly well. And then we also got the assistance with the CARES Act, we got payroll support. There were 3 payroll support programs. We were able to get granted funds under each one of those, which also helped to offset some of our variable costs. And then we took a significant loan with a $195 million U.S. treasury loan that was recently closed on back in November. And most of that loan was not going directly into cash. We did pay off a significant amount of our other loans prior to accepting the treasury loan, but it was certainly helped bolster our balance sheet significantly. And then during COVID, things obviously slowed down for us. We kind of -- we looked at the company and other things that we could do. We got into the cargo business, we're flying out 737s for DHL with 2 aircraft. And then we started digging into the electric aircraft business. We looked at -- I think the electric aircraft kind of the entire aspect of that industry. And we were pretty impressed with how far it's come along. So we teamed up with United and did a pretty significant venture and purchased 200 electric aircraft from a company named Archer Aviation. We also agreed to invest in their pipe for $25 million. $20 million of it was United and $5 million of it was between Mesa. It's just been -- it's been a very interesting time for us. Like you said, it's been more about looking at opportunities. Our business model proved to be stable through the COVID environment. And we look forward to the next couple of years and expanding on those areas even more so.

That's great, Mike. Look, a lot of good things, I think, going on at Mesa these days. But maybe let's kick off with kind of where you ended with Archer, right? ESG, it's a big focus, both here at Bank of America and in the investment world. As a regional carrier, you're really emerging towards the forefront of this. You, along with your partner, United, invested in Archer, as you mentioned earlier this year. Can you maybe walk through a little bit more of the specifics of the deal? What's Mesa's capital -- total capital commitment here to Archer, both in terms of investment as well as commitment to buying aircraft in the future? And I guess, maybe more importantly, like how can you lend your expertise within the airline industry to Archer in order to make this eVTOL a reality?

I think the -- so the baseline of the deal was the aircraft purchase, right? So you have this Archer aviation with the electric aircraft. And they're pretty far along in the development. But they really desired, obviously, an order for aircraft. So the kind of baseline of the deal was that we, with United, decided to order 200 aircraft. 160 of them would be going to United and 40 of them to Mesa. The price of those aircraft, the exact deliveries, obviously, are still to be ironed out. But that was the base of -- baseline of the deal. And in exchange for that, we received a significant amount of warrants, almost 3 million warrants in Archer. And they vest over different periods of time, 40% vested immediately. 30% will vest once the Archer stock merger has completed, the other 10% when the aircraft gets approved. And then the last 30% kind of as the aircraft is delivered. So that was kind of the baseline of the deal. And then we needed Archer, we were confident Archer's going to do a stock transaction and as well as raise money for a pipe. And so we agreed to invest in that pipe, the $25 million. $20 million of it is United and $5 million is Mesa. Well, our cash out and this will be the $5 million in the pipe transaction, for which we'll get 500,000 shares in that the merged company allows [ the shares to vest ]. That's kind of our investment in it. We certainly -- we have put multiple aircraft on -- [ just like we did ] in the past. [ We were ] the first operator to certify the CRJ-900 in the United States with the FAA. But I think between our expertise in putting aircraft on and our expertise in small aircraft and working with small communities. And obviously, United has a very significant infrastructure that [indiscernible] and technical expertise. We think that [ they ] use that to start to maybe getting these aircraft certified and compliant. That was done on the basis of [ we're ] first regional. We're probably the first airline to get into the -- just the fact they had a significant electric aircraft order, and it's something that we plan to [ looking through to ] pursue and they're the leader in the industry, certainly on the regional side for electric aircraft.

Great. And I know it's very, very early innings in terms of what's going on here at Archer. But any sort of current timetable that you can speak to in terms of different FAA approvals, when you could -- when are you expected to take your first delivery? Like when can -- based on what you know right now, when can all of this really begin to become a reality for Mesa and really the traveling public?

Yes. I mean, I think the initial presentations that we looked at were like 2025, 2026 time frame. But Archer's, I think, presenting later today. I'd urge everyone to listen in on them and hear it directly from them. They are certainly the closest to the process.

Yes. Yes I know Archer is presenting at the conference. So I'll plug for another panel there. Maybe switching gears a little bit and maybe bringing in Torque here. Look, not many airlines over the course of the pandemic can speak to lower net debt-to-EBITDAR today versus sort of where you guys were pre pandemic. Why was Mesa or the Mesa's regional model able to do this? Why is it different than what most other airline investors are familiar with? Just kind of walk through folks how you were able to do what you did to the balance sheet.

Yes. Sure, Andrew. So Mike kind of got into this is our regional model is really a contractor model for us other than a traditional airline. And so as he mentioned earlier, we get paid to fly the aircraft, right? We're not subject to the passenger demand in there because their -- that's all the mainline carrier's responsibility. But we -- so that gave us a fixed base to work from. And we're primarily responsible for crews and maintenance, and not fuel, as Mike mentioned earlier. So during COVID, while United and American saw dramatic decreases in revenue. We still had our fixed costs covered. And then obviously, we did have some flying that worked in that program. So anyway -- and as you think about that with the mainline carriers, also from a relative basis, mainline carriers had to maintain a certain amount of service. And when you think about regional carriers, when there's low demand, it's more economical for us to fly some of those markets where maybe in the past, they needed to fly mainline. And so that actually gave us a relative basis more flying than maybe in the past. And so that really helped us. And as for debt, most of our debt is built into aircraft. And so over time, we continue to pay down that debt at -- on a scheduled amortization table. So earnings haven't really been hit hard and our debt in aircraft related scheduled paydowns have continued forward. So really relatively stable. Obviously, our revenue did come down, but the baseline and the debt payout continued forward as normal.

Great. And I think it's important to remind folks, right, just from a PSP perspective, right? You didn't -- a lot of it -- vast majority of it was grant money. You did take the treasury loan portion of it. I know there were some NOLs you were able to draw cash on. So it was really an opportunity, I guess, to kind of almost refinance the balance sheet at better rates. Can you maybe talk a little bit about how that progressed and kind of where maybe your weighted average cost of debt is these days versus where it was pre pandemic?

Sure. Well, maybe I'll let Mike take that one. Mike, do you want to cover that?

Sure. So look, the -- first of all, on the NOLs, I don't recall us even putting cash in any of our NOLs. So we -- we're still carrying $500 million NOL on our books. We weren't able to cash any of them, but we certainly are not paying any cash taxes as part of our NOL. And look, the restructuring of the debt, it was really -- it was quite significant. So we borrowed $195 million from the treasury. It's interest-only, which is really important. It's 5 years interest only. I think it was LIBOR 3.50 and it was replacing -- we did pay down $165 million of debt leading up to that. And that $165 million of debt, although it was not much of a higher interest rate. It might have been LIBOR 4.00, LIBOR 4.25. The real benefit is that, that previous debt was amortizing. And it was amortizing probably only over the next 4 or 5 years. So this $165 million that we plan to repay over the next 5 years now has just been pushed out. So we did get the short-term benefit of $30 million or $40 million. But over the next few years, the fact that we have interest-only debt really helped to allow us to generate some cash over the next few years because our CPA structure is still the same.

That's great. Maybe just lastly, on the balance sheet. I remember a few years ago, a lot of the discussion was around [ tail ] risk and how you wanted to match up lease duration with contract duration. You've just recently all extended all your CPAs over the last year or 2. It seems like the focus is going a little bit more away from lease towards ownership. Can you maybe talk about -- a little bit about that strategy? And just how you think about what are the right debt levels from here? And why has that changed over time?

Yes. Sure. Yes, Andrew. I mean, we think about debt differently than maybe other airlines do because when we think about it, all of our debt is primarily aircraft debt. So if we were going to get a contract for another 20 aircraft, we would like on a 12-year contract, we'd go out and we borrow, say, $450 million of debt and that would be good because that $450 million would be scheduled to be paid off over that 12-year contract, and it will be built into our CPA contracts. So when we think about debt, we see that as a good thing. It's kind of a guaranteed payoff for us. And so it's a really good business. So we'll take as many new aircraft as possible and definitely buying them is more advantageous for us than leasing.

And why is that buy over lease? Is it just better rates there? Or you just get access to the residual value?

Yes. Well, we get access to the residual value, and we get better rates and it's -- and better cash.

Okay. So owning aircraft, it's just a better financing decision to own rather than lease these days?

Yes.

Okay. Fair enough. When I think about the regional airline industry, I've always thought about it as sort of the minor leagues for pilots, right? They go to Mesa, they learn how to fly. You train them. And I think the longer-term aspiration for a lot of these pilots, not all of them, is to kind of move up to more of a mainline carrier. Can you speak a little bit to your recruiting efforts? And how do you -- what -- how does -- where does pilot availability stand today now that demand is beginning to come back really across the entire industry?

Yes. Yes, Andrew, it's -- there's really nothing certain in this industry right now. Prior to COVID, we were in a situation where we were keen to keeping up with attrition, but we were having to pay bonuses in order to retain -- to attract and retain first officers. But today, we actually have more applications on file than we had pre COVID, which is great, and we are starting to hire again. And we don't think we're going to need to offer those signing bonuses. So that's a good position to be in. But we'll see, things change pretty quickly here. How long that supply will last for us, is hard to predict. But one of the things that's happened with COVID is the attrition has slowed down significantly. So we think that will give some of the aviation schools a chance to try to take -- a process to bring pilots in and move them on through United through Mesa. So we think that's an advantage for us as well. And then we do offer upgrade opportunities for 737s. We're the only regional that has that. We think it gives us a recruiting edge as we move forward. So we think there's some opportunities there. And obviously, we stay linked in with all the flight schools. So right now, we're thinking we're in a pretty good position. But again, things could change.

Right. I think I put out a report early 2020 right before the pandemic hit, just talking about the potential for a pilot shortage across the industry. Do you think -- and depending on kind of your assumptions that was coming maybe middle part of the decade or so. Do you think anything has changed from that standpoint, given what has transpired?

It's hard to predict. I think -- [ thinking ] this thing has probably shifted things to the right a little bit. So eventually, there may be a shortage, but I think this COVID thing is sort of -- will push us off for a couple of years from that potentially. And I don't know, Mike, you might have a different perspective on that, but that's sort of I think it's probably slid. I think there may be a pilot shortage, but we'll see where things roll.

Sorry, Mike, we...

You're on mute, Mike.

Got it. One of the things that we had seen some attrition to were as opposed to the bigger 4 carriers, we could see some attrition into the Spirits and the Frontiers. So we keep our eye on that, too. Sun Country is expanding a little bit now, Frontier as well. And then you got a couple of start-ups that are recruiting and of course they're going to tap into the regional field as well. So we keep our eye on that tier also because we do get some attrition into that area.

Got it. So I guess, kind of summing up the regional model, right? You have these contracts in place with your mainline partners. It helps in terms of visibility on the balance sheet. When we think about the cost structure of Mesa, right? And the buzzword in the investment community these days is all about inflation. In an inflationary environment, do you feel like that's -- in terms of your cost structure relative to other airlines, would you say inflation is good, bad or indifferent for Mesa?

I think our biggest exposure on the inflation side is look, we have contracts with our partners. We've kind of guaranteed those rates for not today, but going out into the future. The contracts all have escalation provisions built into them. The labor contracts have pay scales that go out over time that we don't pay -- we're not to pay more because there's any inflation to our crews. But I think we're fairly well insulated from it. So some of our escalations probably have caps in them. So to the extent that our -- some of our maintenance, parts' costs and stuff like that, that might produce the higher inflation than our contract provides. There might be some exposure, but I don't think there's that much for us.

Okay. Okay. And kind of before switching gears a little bit. You got your United CPA redone kind of post -- right before the -- a little bit before the pandemic hit, you got the American CPA done during the pandemic. Maybe just talk a little bit about your relationships here today and how you think you can really grow these over time? And if there's any opportunity to maybe expand beyond just these 2 mainline carriers?

Yes. So with the -- I can start with United, right? We did do a deal pre-COVID, we now are going to have -- we almost -- we have a couple of deliveries left, but we'll have 80 E175s at United, all fairly new aircraft, fairly long terms on them remaining, premier aircraft in the industry and certainly for United. And we'll continue to work with United on other opportunities as they become available. As part of that deal, we did take 20 CRJ-700s out. But fortunately, United provided for us to be able to lease them for a long time for 9 years to one of their other regional carriers, which worked out well from a fleet perspective from us. And we've done -- we did the Archer deal with United. So clearly, we're working very closely with them on other things. On the American side, we're very fortunate to do an extension during COVID. Our contract was starting to expire in the beginning of this calendar year. It was a fairly long transition, but it was starting to wind down. And we were down -- we had 54 aircraft under contract, and we were able to get an extension with American during COVID for 5 years and -- not for all 54, but for 40 of the aircraft. And it was just a month or 6 weeks later that we finished inking that deal that they asked if we could pick up 5 more aircraft. So we're up back to 45. And again, I think on the costing side, I think it's something that makes us always focused on keeping our costs under control, being the leader in the industry and providing low-cost reliable service. And I think that's one of the reasons we were able to get our extension at American. We believe we're the -- we're their low-cost regional provider, and they have certainly motivated to keep us in the portfolio for that reason. And so and the end is, we did other opportunities at American going forward as well. They had this unique scope provision where it's not 50 seats, it's 65 seats, which is an interesting dynamic that Delta, and United do not have. On the DHL side, we have 2 aircraft, we're picking up a third into the operational, continue to work with DHL on expanding that piece of the business. And then as far as other operators, we're always open to do business with Delta, Southwest or any of the ULCC carriers and as those opportunities present themselves to us, we'll certainly take a really good look at them.

Great. So just heads up to everyone on the presentation. We have a little under 5 minutes left. And just wondering if there are any -- if anyone in the audience wants to ask a question, feel free to type it out here in the Vericast system, and I can get it into the -- get any of your questions into the team. But maybe kind of last topic I wanted to hit on Mike and Torque is your DHL cargo operation. This was something that the team and Jonathan and the team had been speaking about for a while. It's finally coming to fruition now. Like you said, Mike, you're going from 2 to 3 freighters soon. When I think about this, the DHL relationship, is there a certain period where DHL is testing out your cargo abilities? And then as you prove yourself kind of like as you have in the regional passenger industry, can -- is there a time period where then they can come back to you and sign you up for more flying? Just curious how that relationship works.

Yes. Andrew, maybe I'll take that one. Traditionally, cargo operators generally move in smaller aircraft tranches, than, say, the mainline passenger carriers do where they're adding 20, 30 or 40 aircraft at a time. So there's really kind of no defined period with DHL, where they're testing us out. We're doing a really good job with them with the aircraft that we have. We're excited at the third aircraft. And we're hopeful that as we continue to expand, as DHL continues to expand, we'll play a role in that. And obviously, we're not just limited to DHL. Amazon [ ordered ] 20 aircraft to Sun Country, and that's certainly an opportunity we would consider as well. But as we think about growth opportunities, we didn't want to be in this business for just having 2 or 3 aircraft. Our goal is to have at least 10 aircraft working the cargo business within the next couple of years. And so that's really where we see this going. And we expect -- especially with the pandemic and the growth of e-commerce, we think this is a growth opportunity for us.

Fair enough. Mike or Torque, any -- are there any surprises? Anything in the cargo business that has sort of surprised you? Or any parts of the operation that you feel like you need -- really need to improve upon or maybe rethink or something that -- anything unexpected come up from the new operations there?

I'll take this one. No, I don't think anything unexpected came up other than it is incredibly similar to our regular business, the exact same model, the invoice is the same, it's fixed range block hour rated, performance, tracking. So nothing really surprised us. I think the one good thing we have for us that we don't want to under estimate is we're not trying to get into the cargo business when we talk to other operators now. We do have a cargo operation. I think that's just very helpful in terms of things. You're trying to get more business but we already have it. We have the aircraft owner's certificate. We carry a cargo and that just goes a long way. The only last thing I did want to touch is that we are also continuing to pursue our venture in Europe. It's still on, it's very early stages, but we do have some surplus 900s, and we continue to work on that project and expect to have more news on that next quarter.

Great. Well, we have about a minute left in the presentation. I do not see any questions coming in over the Vericast system. So maybe, Mike, maybe one last thing. We're entering conference season. I'm sure you're out there in front of a bunch of investors now that you've reported your March results. What is kind of the -- what are the kind of the one or 2 things you would like investors to understand about Mesa as the industry recovery begins to unfold here?

I think the biggest thing is that look at our last few quarters through COVID. We performed extremely well from a profitability standpoint and from a cash flow perspective. So we have a very strong model that can get us through the most difficult of times. And that we're innovative. We're looking at new things. We're looking at electric aircraft. We're looking at other creative things in the industry, and that's really a focus of ours, that we want to be the leader at that end of the business certainly on the electric aircraft side, we're really focused on that and are looking at other opportunities.

Excellent. Well, that took us right to the 30-minute mark. So Mike, Torque, really appreciate the time today, and good luck with the rest of the conference.

Great. Thanks, Andrew. Appreciate it.

Take care.

Bye.