SOUTHWEST-AIRLINES Earningcall Transcript Of Q2 of 2024

Bob Jordan -- President and Chief Executive Officer

Thank you, Julie, and thanks, everyone, for joining us this morning. We have a lot to cover today, so

let's jump right in. In my comments today, I will touch briefly on our results for the quarter and then

provide detail on the plans we announced earlier this morning to implement meaningful changes to

our business and better position Southwest Airlines to produce higher returns in a more competitive

higher  cost  environment.  As  Julie  mentioned,  Andrew  will  provide  details  on  our  revenue

performance,  including  the  work  underway  to  calibrate  our  revenue  management  system  and

processes, and Tammy will discuss our cost, capex and balance sheet.

Starting with our overall results, they are not where we need them to be, and they are not reflective

of what we are capable of delivering. We will cover where we fell short, as well as our action plan in

detail later on the call, but I'll hit on a few highlights first. Our frontline employees executed very well

as  we  continue  to  improve  in  nearly  every  operating  and  customer  metric.  Once  again,  we  ran  a

high-quality operation with a completion factor of 99.5% despite challenging weather.

This  was  further  evidenced  by  our  performance  following  Hurricane  Beryl  earlier  this  month.  We

experienced an 8% cancel rate on July 8th as the store moved through the Houston area but had

only  a  0.3%  cancel  rate  the  following  day  as  we  recovered  quickly  with  almost  no  operational

hangover  from  the  prior  day.  I  am  very  proud  of  our  team.  And  following  the  global  technology

outages, we were able to recover very quickly and experienced a near zero cancel rate.

Investments  made  to  advance  core  operations  and  modernize  technology  meant  that  we  had

redundancy  in  place  for  key  systems  that  we're  experiencing  issues.  Time  and  time  again,  the

purposeful investments we've made to improve our resilience and ability to recover from disruptions

are  demonstrating  their  value  and  that  investment  will  continue.  Our  exceptional  customer  service

continues to improve as well and was recently recognized by J.D. Power, where we were awarded

the leading Economy Class Customer Satisfaction distinction for the third consecutive year.

Reliable operational performance and customer service are and always will be cornerstones of our

business  model.  Moving  on  to  revenue  performance.  Unit  revenue  for  the  quarter  declined  3.8%

year over year primarily as a result of domestic capacity outpacing demand. The decline was also a

result of Southwest specific challenges as we fully mature our usage of a new O&D based revenue

management system.

Andrew will go into more detail later, but bottom line, we sold too many seats for the peak summer

travel period too early in the booking curve. It's not unusual to have growing pains with these types

of systems. We are working quickly to action opportunities to drive performance improvement. We're

also adding additional leadership expertise and support, including our plan to hire a chief revenue

officer to focus on revenue management and pricing.

We  continue  to  have  confidence  that  the  new  revenue  management  system  will  be  a  driver  of

long-term  revenue  improvement.  The  management  team  and  I,  with  the  support  of  our  Board,  are

completely aligned on the imperative to produce results and ultimately deliver returns ahead of our

cost of capital. Doing so requires an evaluation of all opportunities and a willingness to evolve some

long-standing selfless policies while staying true to our values. With that in mind, I'll discuss some of

the changes we are making to further evolve Southwest Airlines.

These  are  part  of  an  ongoing  strategic  transformation  of  the  business,  and  we  will  share  more

details  during  our  investor  day,  where  we  will  outline  a  comprehensive  plan  to  deliver

transformational  commercial  initiatives,  improved  operational  efficiency,  and  capital  allocation

discipline.  As  I  shared  back  in  April,  our  teams  have  been  hard  at  work  evaluating  fundamental

changes to our seating, cabin and boarding procedures. It's clear that the open seating model that

served us well for so many years is no longer optimal for today's customer. I want to stress that this

decision was not made lightly.

We have been very thorough and deliberate in how we approach the question, conducting multiple

sophisticated research studies over many months that evaluated customer preference and looked at

different  types  of  cabin  layouts  and  seating  methods.  Our  research  shows  that  80%  of  our

customers  prefer  an  assigned  seat,  and  86%  of  our  potential  customers  prefer  an  assigned  seat.

Further, when a customer defects from Southwest to one of our competitors, our open seating policy

is cited as the No. 1 reason why.

The answer is clear, there is more demand for Southwest Airlines with an assigned seating model,

and  there  is  a  significant  ability  to  monetize  the  cabin  more  effectively  with  a  premium  seating

option. By extension, these changes are expected to drive significant value for our shareholders. We

feel  confident  that  the  solution  we  are  implementing  will  retain  the  positive  elements  of  the

Southwest  Airlines  experience  and  enable  us  to  evolve  in  a  manner  that's  consistent  with  what

today's air traveler is seeking. While specific cabin layouts are still being finalized, we expect roughly

one-third of seats across the fleet to offer extended legroom.

We're also designing a boarding process that retains the organized com our customers enjoy today,

but also complements an assigned seating model. We've been studying this in depth to preserve our

operational efficiency and how quickly we turn an aircraft. We've conducted both live boarding tests

to understand passenger movement in a real-world environment and also more than 8 million digital

simulations  to  test  different  boarding  options.  These  digital  boarding  simulations  include  data  from

real flights with real passenger manifest to understand differences in boarding times stemming from

passenger mix, things like families traveling together, customers who may need more time to board

experienced versus inexperienced travelers and more.

The  data  clearly  indicates  that  any  operational  impacts  are  neutral  or  an  enhancement  to  current

performance. We're also approaching this change in a capital-efficient manner. New aircraft will be

delivered  with  our  improved  RECARO  seats  beginning  early  next  year.  For  existing  aircraft  where

we must retrofit to a new configuration, we plan to use existing seats within our fleet to avoid a large

capital expenditure.

We're  working  quickly  to  realize  the  value  of  this  new  model  as  soon  as  possible.  New  seat

configurations require FAA certification, which typically takes several months and only then can we

begin  the  process  of  retrofitting  the  fleet.  We,  therefore,  expect  to  make  bookings  available

beginning next year. The aircraft downtime should be minimal to complete the cabin changes, but

keep in mind that we have a fleet of roughly 800 aircraft to retrofit and that will take time.

Changing  from  an  open  seating  model  an  assigned  seating  model  will  be  a  complex  and

transformational  change  that  cuts  across  almost  all  aspects  of  the  company  and  is  one  of  several

commercial initiatives currently underway to be detailed at our investor day. Given the significance

of  the  changes  I've  asked  our  chief  commercial  officer,  Ryan  Green,  to  take  on  leadership  of  this

initiative on a full-time basis. As EVP of commercial transformation, Ryan will lead this effort along

with  other  commercial  initiatives  already  underway.  Ryan  has  led  the  work  to  this  point  and  is

steeped  in  knowledge  regarding  customer  trends  and  previously  and  successfully  led  efforts  to

transform  our  Rapid  Rewards  loyalty  program  and  the  digital  customer  experience,  and  Ryan  will

report directly to me.

Additionally,  today,  we  are  publishing  schedule  that  incorporate  red-eye  flying,  which  will  phase  in

rapidly  by  summer  2025  and  combined  with  ongoing  reductions  in  turn  time  through  new

technologies  and  procedures  will  enable  us  to  fund  nearly  all  new  capacity  the  next  three  years

through initiatives rather than additional aircraft capex. These initiatives are part of a comprehensive

strategic  transformation  and  reflect  a  commitment  and  my  personal  commitment  to  deliver  an

implementing plan aimed at driving shareholder value and achieving ROIC well in excess of our cost

of  capital.  We  will  provide  more  details  around  the  timing  and  value  of  these  initiatives  and  other

tactical and strategic initiatives when we gather for investor day in late September, but we wanted to

keep you up to speed on some of the decisions that we've made already and the deliberate plans

we  have  in  place  to  implement  them.  And  before  I  close,  I  want  to  again  recognize  all  the  efforts

from our incredible employees.

Thank you for excellence and the dedication that you bring to work every single day. And with that, I

will turn it over to Andrew to provide a full update on our revenue performance and outlook.

Andrew Watterson -- Chief Operating Officer

Thank  you,  Bob.  I'm  very  excited  about  the  strategic  initiatives  we  have  coming.  I  am  also  very

proud of our people for their continued focus on safety, running a quality operation with the lowest

year-to-date cancellation rate in the industry, and our strong customer service performance trends.

Moving to revenue performance.

We  have  experienced  challenges  in  managing  demand  across  booking  curves  as  we  deployed

efforts to address load factor underperformance. As a result, we experienced yields and ultimately,

revenue dilution from selling too many seats too early in the booking curve. As you will likely recall,

back in the spring of 2023, we transitioned to a new and modernized revenue management system.

The system is fundamentally different from and superior to our prior system.

The  new  system  manages  revenue  on  an  origin  of  destination  basis  compared  with  our  prior

leg-based system. The decision to implement this new system followed an extensive review of our

options,  including  a  comprehensive  18-month  long  pilot  to  evaluate  and  test  two  new  revenue

management systems against our prior system. What we directly observed during the testing period

was  the  system  we  selected,  consistently  produced  superior  results.  The  goal  is  to  maximize  the

revenue performance of our flights, especially best flights.

And  the  new  system  accomplishes  just  that  by  considering  what  customers  are  willing  to  pay  at

different phases of the booking curve, including taking note of the differentiation between business

and  leisure  customers.  However,  adapting  to  a  new  system  is  not  straightforward.  Add  to  that,

changing  schedules  from  Boeing  delivery  shifts  and  what  we  got  was  a  complicated  rollout.

Regardless, while we estimate about two points of year-over-year headwind to the third quarter from

bookings already in place, we were taking decisive actions to recalibrate the system.

The  estimated  impact  is  already  built  in  to  our  3Q  RASM  outlook  of  flat  to  down  2%  on  a

year-over-year basis. The outside experts, that Bob mentioned, are supporting our employees and

getting the most as the capabilities of this new system. The good news is that we have confidence in

the superiority of new system as evidenced by the month-long AB testing that we conducted. As we

gain  expertise  in  optimizing  system,  we  expect  to  see  a  noticeable  tailwind  to  performance,  likely

starting in September of this year.

Adopting a new revenue management system is a once-in-a-generation implementation, and we are

committed  to  executing  a  successful  turnaround  in  our  revenue  performance.  In  addition  to  the

improvement,  we  expect  to  see  in  our  revenue  management  performance,  our  plan  includes

continued  network  optimization  and  capacity  moderation  moving  to  the  back  half  of  the  year.  Our

summer,  fall  and  recently  published  winter-based  schedules  all  include  actions  to  target  supply

demand across geographies and calendar periods, as well as scheduled quality actions to facilitate

demand capture. By the fourth quarter, we expect less capacity oversupply as well improvements in

our revenue management.

We are planning for our capacity to decline 4% year over year in fourth quarter, with seats and trips

down  roughly  8%  and  therefore,  we  expect  RASM  growth  to  be  positive  year  over  year  by  fourth

quarter.  We  will  deliberately  and  urgently  pursue  tactical  opportunities  to  improve  financial

performance,  including  calibrating  our  revenue  management  process,  continuing  our  work  to

optimize our network. Further, we also have a plan to capitalize on transformational opportunities to

generate incremental revenue, some of which Bob shared with you. Before I close, I want to thank

our  people  again  for  doing  such  an  amazing  job  driving  operational  excellence  and  providing  our

legendary hospitality, I am so appreciative of their contributions.

With that, I'll turn it over to Tammy.

Tammy Romo -- Executive Vice President, Chief Financial Officer

Thank  you,  Andrew,  and  hello,  everyone.  As  Bob  mentioned,  I  will  provide  an  update  on  our  cost

performance  before  turning  to  fleet  and  balance  sheet.  Overall,  our  second  quarter  CASM-X

increased 6% year over year and we continue to expect CASM-X for full year 2024 to increase in the

range  of  7%  to  8%  on  a  year-over-year  basis.  The  higher  year  over  year  CASM-X  growth  in  the

second  half  of  this  year  is  driven  primarily  by  a  continuation  of  market-driven  labor  cost  pressure

from our new contracts, as well as from the moderation of year-over-year capacity growth.

We  are  urgently  and  deliberately  pursuing  opportunities  to  mitigate  cost  pressures,  including  the

drag  from  overstaffing  related  to  previously  reported  Boeing  delivery  delays.  As  discussed  on  our

first  quarter  earnings  call,  we  have  expanded  our  voluntary  leave  and  time  off  programs  to  further

reduce labor expenses and bring staffing levels in line with our current fleet. We have halted all the

critical hiring, and we continue to expect to end this year with head count down roughly 2,000 from

year-end 2023. And we continue to plan for headcount to be down again in 2025 as attrition levels

exceed our controlled hiring levels.

Our  second  quarter  average  fuel  price  of  $2.76  per  gallon  was  in  line  with  our  expectations.  Our

hedge  portfolio  continues  to  provide  protection  against  spikes  in  prices  and  we  are  continuing  to

opportunistically  add  protection  with  no  change  to  our  target  of  a  roughly  50%  hedge  position.

Turning to our fleet. We prudently adjusted our 2024 delivery expectations prior to our April earnings

report to mitigate Boeing delivery risk our internal planning functions.

We, therefore, continue to plan for 20 -8 aircraft deliveries, 31 -700 retirements, and four -800 lease

returns  for  the  year.  We  remain  committed  to  our  fleet  modernization  benefit  and  our  planned

reduction  in  aircraft  exceeds  our  planned  delivery.  We  also  remain  committed  to  longer-term

capacity discipline and ROIC production. We expect third quarter capacity to increase approximately

2% and fourth quarter capacity to decrease approximately 4%.

Accordingly, our expectation for full year 2024 capacity continues to be up approximately 4% year

over year. Looking beyond 2024, we remain committed to earning our right to grow and plan to keep

any future growth at or below macroeconomic growth trends until we reach long-term financial goal

of  returns  on  invested  capital  consistently  in  excess  of  our  cost  of  capital.  Our  expected  capital

spending  for  2024  is  approximately  $2.5  billion,  which  is  in  line  with  our  prior  guidance  and  well

below our expectations of $3.5 billion to $4 billion at the beginning of the year. We are in ongoing

discussions  with  Boeing  regarding  the  financial  impact  of  delivery  delays  and  as  with  past

compensation, we expect any financial damages to be realized as a reduction in the cost basis of

certain aircraft.

Our balance sheet is obviously a critical competitive strength with an investment-grade rating by all

three  rating  agencies.  We  continue  to  be  in  a  net  cash  position  as  we  ended  second  quarter  with

cash  and  short-term  investments  of  $10  billion  versus  $8  billion  outstanding  debt.  We  expect  a

modest  $29  million  in  scheduled  debt  repayments  for  the  full  year,  and  currently,  2024  interest

income is still expected to more than offset 2024 interest expense. Following the pandemic, we have

maintained  elevated  liquidity  levels  primarily  to  fund  fleet  modernization  efforts,  labor  contract

ratification  bonuses,  debt  service  considerations  and  to  provide  insurance  against  unforeseen

business risk.

With  much  of  the  uncertainty  largely  behind  us,  we  intend  to  start  normalizing  our  liquidity  levels

back toward pre-COVID levels targeting minimum total liquidity, including our undrawn revolver. Our

long-term  financial  goals  remain  unchanged;  maintain  a  strong  balance  sheet,  investment  grade

credit ratings and ample liquidity, grow earnings, margins and capital returns. As Andrew said, we

intend  to  pay  off  2025  debt  maturities  at  least  partially  in  cash  and  specifically  plan  to  repay  or

refinance the first tranche of the payroll support program loans as the associated interest rates start

to  ratchet  higher  for  the  industry  beginning  next  year.  We  also  remain  committed  to  our  legacy  of

healthy shareholder returns.

We are proud of our history of returning capital to our shareholders. We returned more than $13.5

billion  through  share  repurchases  and  dividends  since  2010  and  we  returned  $215  million  to

shareholders through dividends in the first half of this year. We paid another dividend just a couple

of  weeks  ago  during  third  quarter.  We  are  actively  reviewing  our  return  of  capital  policies,  and

ultimately, our goal is to restore shareholder returns to historic levels.

As I close, I want to reiterate that our financial performance is not reflective of what we can and must

deliver. As shareholders, you expect us to lead the industry in financial performance and we will be

satisfied  with  nothing  less.  There  are  areas  we  need  to  improve,  which  we  are  owning  and

addressing as a management team. Despite these distractions, our employees remain steadfast in

their  dedication  to  the  mission  of  the  company  and  to  providing  our  storied  and  world-class

hospitality to our valued customers.

I am both proud and grateful for our employees. I am excited about the plans we have in place to

secure a bright future for Southwest and to share more about our tactical and strategic initiatives, as

well  as  our  capital  allocation  plan  at  investor  day  in  September.  We  remain  fully  committed  to

executing  on  a  plan  to  restore  returns  on  invested  capital  in  excess  of  our  cost  of  capital,  as  this

remains our guiding financial principles. And with that, I will turn it back over to you, Julia.

Julia Landrum -- Vice President, Investor Relations

Thank you, Tammy. This completes our prepared remarks. We will now open the line for analysts'

questions. We would like to get as many of you as possible, so we ask that you please limit yourself

to one question and a brief follow-up, if necessary.

We will now take the first question.

Operator

Questions & Answers: