Southwest Airlines Company (LUV) — Q2 2019 Earnings Call Transcript

Thanks, Greg, and thank you all for joining us today. We need to cover a few disclaimers before today's comments. First, we will be making forward-looking statements based on our current expectations. We'll also reference non-GAAP results, which exclude special items both in our earnings release. Given the ongoing MAX groundings, our current outlook is based on the most recent guidance from Boeing. That includes an assumption of regulatory approval for the MAX return to service during the fourth quarter of 2019. Any changes to these assumptions could result in additional adjustments to our flight schedule beyond January 5, as well as further aircraft delivery delays and that could result in additional financial impacts. Please check our IR website for more detailed information and disclosures. We have a great lineup of speakers today including Mike Van de Ven, our Chief Operating Officer; Tom Nealon, our President; and Tammy Romo, our Executive Vice President and CFO. To kick us off, I will turn over the call to our Chairman and CEO, Gary Kelly.

Thank you, Ryan, and thank you all for joining our second quarter earnings call. This year has been quite an adventure. While we faced some challenges earlier in the year, the major issue has been the MAX grounding. The good news is that we were exceptionally well prepared for the unexpected. We are in a strong position, despite the setbacks from the MAX, and we're confident we'll overcome this and regain our momentum. Unfortunately, since our last call, the MAX grounding has lasted much longer than we expected, which is not surprising given the recent news about the software fix from Boeing being delayed until September. In the meantime, we are operating effectively and achieving strong financial results without any funds from a Boeing settlement. I want to commend our team for their outstanding efforts; they are not only resilient and tough but also brilliant and compassionate. I appreciate their hard work during this challenging time, especially with 20,000 flight cancellations. While our frontline employees have faced many difficulties, we also have many hardworking individuals in the back office who deserve recognition. Our planners have done an incredible job adapting to the circumstances, particularly those in network, operations, and financial planning. I’m very proud of everyone’s dedication. Our financial results are robust, showcasing strong margins, cash flow, revenues, and cost performance, and there's more information in the press release. You will receive valuable insights from Mike, Tom, and Tammy, but I want to highlight a few key points. First, the MAX remains our primary focus and issue, but that's manageable. Everything else in the company is performing exceptionally well. Second, our business is solid, with the second quarter meeting expectations and a 3% to 5% increase forecasted for the third quarter. Third, our cost management is on track; we anticipate flat CASM-Ex in the second half of the year, considering the MAX issue. Fourth, regarding Newark, we've made a strategic decision to consolidate our New York operations due to the MAX grounding and an 8% reduction in our capacity. We acquired slot pairs in Newark and have grown our presence at LaGuardia significantly since then. We will be focusing our New York operations from LaGuardia, which better serves our customers. Historically, we've consolidated operations in other markets, and Newark has been financially underperforming. This transition will allow us to enhance our service at LaGuardia. Lastly, we are ready to resume our expansion in Hawaii without waiting for the MAX, which is a strategic decision for our growth in California and Hawaii. So, those are the main updates. Now, I'll turn the call over to our Chief Operating Officer, Mike Van de Ven, for more details and insights.

Thanks, Gary. I want to start just by reiterating what Gary said about our people. They are indeed resilient, and they make this company great by taking care of our customers, our operations, and each other. I am immensely thankful for their efforts. In an environment where we have 34 MAX aircraft out of service, our performance for the quarter I believe was very good. Most importantly, we took very good care of our customers. First, we used all of our spare aircraft to cover any scheduled MAX flying through June 7. We then reaccommodated the remaining impacted customers to other flights where possible. So we ran an all-time quarterly record load factor of 86.4%. We did that without any spare aircraft from April 1 to June 7. And just to state the obvious, spares are important. They protect against unexpected events like the unforecasted hail event we had in Denver on May 28. That took 24 aircraft out of service for a period of up to two weeks in a time when we were already without spares. In that kind of environment, with no margin for recovery for any unexpected events like that, our people found a way to get 85% of our customers to their destinations within 30 minutes per scheduled arrival time. Through aircraft swaps, crew changes, extending the operating day, just whatever it took. As a reminder, we schedule our operations with less block and turn time than any other carrier in the industry to begin with. We carried 99.5% of the checked bags on the flights they were checked on. We led all marketing carriers with the lowest DOT customer complaint ratio, and our Net Promoter Score was still industry-leading at about 59% for the quarter. All those numbers were down a bit from last year, but given the impacts of the MAX grounding, having our overall operations results still in the upper tier of the industry is a testament to the people of Southwest Airlines. Going into the third quarter, in the peak summer travel month, we are focused on continuing to improve all aspects of our operational reliability. We've operated with the appropriate spare levels beginning in June 8 and we're going to carry that throughout the year. We're already seeing improvements in the reliability of our service. Our on-time performance, which was significantly impacted, has rebounded nicely since adding back the spares. We finished the month of June fourth place in the industry with respect to marketing carriers, and we expect to finish July either third or fourth. One of the carriers ahead of us is Hawaiian, and they benefit by a larger percentage of their network being interisland service in Hawaii. In terms of delivering our product reliably and hospitably, I'm very pleased with our performance thus far. Turning to the MAX, while the operational challenges are manageable, they do grow in complexity as the groundings extend. Boeing, as Gary mentioned, still has work they must complete. The FAA must review and approve that work before granting regulatory approval for the return to the MAX to service, and we are in continued conversations with Boeing and the FAA. As we mentioned in the press release, we're in the process of removing all MAX aircraft from service through January 5. I'll walk you through a high-level outline of our approach to reintroducing the MAX to our regularly scheduled service on January 6. For context, when the MAX grounding is lifted, we're going to have three groups of aircraft to address, and each of them has a unique process. First, we have 34 MAX aircraft that Southwest has in long-term storage in Victorville, California. Secondly, we're going to have a group of aircraft that Boeing is storing that have not yet been through the delivery process to Southwest Airlines, so we don't own those airplanes, and they're not on our operating certificates. Lastly, there will be aircraft coming from the Boeing production line after the grounding is lifted, which we will want to accept as delivered in the normal course of business. The first step in the process, regardless of the grouping, is instruction from the FAA as to the specific requirements that will be mandated to make the fleet operational. That will likely include software uploads and/or other technical requirements for the aircraft, along with some required pilot training. We're going to assume that the pilot training requirements will not include additional simulator training. We have an agreed-upon 30-day time frame with our pilot union to complete the expected computer-based training, and we plan to time the work to bring the aircraft back into the operational fleet to correspond with the end of our pilot training period, so every pilot is prepared to fly every aircraft in the fleet. In addition to those mandated activities, there will be additional maintenance procedures to transition the aircraft from long-term storage into an operational readiness state. At this point, we believe that those activities and approvals could take one to two months to complete for the Victorville aircraft, and that we could intake up to three Boeing storage aircraft per week once they're ready for storage deliveries. We plan to take production aircraft as they're available for delivery. Our delivery schedule with Boeing continues to evolve as their production and schedules change. We expect the majority of our 41 contracted deliveries for the remainder of this year, which, by the way, would have been in the Boeing storage grouping, will likely be moving into 2020. Assuming regulatory approval to return the MAX to service by early November, our baseline plan will be to control the process so we can provide the network with at least 30 MAX aircraft to the operational fleet by January 6 and then we would ramp from there in a controlled fashion depending on delivery schedules. This approach is intended to balance aircraft availability with customer demand in early 2020, then match crew staffing to the aircraft availability. In terms of pilot staffing, given the removal of the MAX line through January 5, we're going to defer our October pilot new hire class and the associated captain upgrade class until March or April next year. While there is some cost savings in 2019 from deferring those classes, the primary driver was to better match flight crews with their flying needs to give them more productive schedules. In closing, I'm very proud of our people and our performance this quarter. As it relates to the MAX, we have a plan to remove MAX flying for the remainder of the year. We have detailed plans for the ungrounding of the fleet once that occurs. We have an idea of how we can resume taking deliveries from Boeing, and we're ready to make adjustments to those plans if we need to. Just as our people are doing this summer, we want to be prepared to provide exceptional customer service to our customers for the holidays later this year. We're focused on running a safe, reliable, on-time, and enjoyable operation, and I really think we've got the best team in the industry to do just that. With that, I will turn it over to Tom.

Thank you, Mike. Good morning, or good afternoon, everyone. As both Gary and Mike mentioned, this quarter has posed challenges. Nevertheless, our performance was impressive. We achieved record passenger and operating revenues, along with a remarkable load factor of 86.4%, which is notably commendable given the circumstances. Additionally, it's worth highlighting, as Mike pointed out, the quality of our operations despite the MAX cancellations. Our on-time performance and customer satisfaction scores, along with our brand reputation, remain at the industry's forefront. I understand this may sound repetitive, but these accomplishments are truly thanks to our team. Mike, Gary, and I have spent considerable time at our stations this quarter, and I can assure you that team morale is high, with a clear commitment to operational excellence and customer care. This commitment reflects in our metrics and in customer feedback, which is outstanding. In terms of scheduling, we have focused on sustaining our network's strength, despite operating with significantly fewer aircraft than expected. Our network team, as Gary has noted, has excelled in modifying and re-publishing our schedules. Similarly, our revenue management team has effectively navigated the revenue landscape. Our new reservation system has significantly enhanced our revenue management capabilities. I am pleased with our second-quarter RASM growth of 6.8% year-over-year, aligning with the improved guidance we provided during our June 19th Investor Update. For context, during our April 25th earnings call, we anticipated Q2 RASM would increase between 5.5% and 7.5%. Several factors influenced that original forecast. Firstly, we expected leisure demand trends to improve compared to the first quarter, and both leisure and business travel demand indeed remained solid throughout Q2, even improving month by month. Secondly, we anticipated a strong yield environment, particularly for close-in fares, which we experienced. Our base business showed slight improvement as we moved through Q2, supported by a system-wide fare increase in mid-May. Thirdly, we expected a one-point year-over-year RASM boost from our reservation system, and that was realized. Additionally, we anticipated a one-point year-over-year RASM benefit from reduced capacity due to the MAX flight removals, which turned out to be around two points. Lastly, we had three points of year-over-year tailwinds from second quarter 2018 items, including Flight 1380 and last year’s less-than-optimal flight schedule, along with a half-point benefit from the Easter shift out of Q1. These factors culminated in a 6.8% RASM growth for Q2, a commendable performance despite the challenges. Both our domestic and international operations performed well, especially our international RASM in the Mexican beach markets. It is worth noting that Q2 posed execution risks. Our network planning team worked diligently to remove MAX flights while manually adjusting and republishing our schedules to maintain network integrity. Our revenue management team had to navigate complexities due to the MAX grounding, which limited higher-yielding inventory caused by past passenger re-accommodations, particularly in April and into early May. The commercial team executed incredibly well amidst these complications, producing flight schedules that minimized risk and worked effectively for our customers and for Southwest both operationally and commercially. Our ancillary revenues showed strong growth too, up 11% year-over-year. The implementation of our EarlyBird variable pricing product last fall has been quite successful, aided by our new reservation system. We've also introduced a new credit card tailored for small to medium-sized businesses, with early results looking promising. Our Rapid Rewards program had an outstanding quarter, with total loyalty program revenue up 15% in Q2, and we continue to see strong credit card acquisition and retention rates. We are pleased with our Rapid Rewards performance, which has been recently recognized with multiple accolades from the Freddie Awards. The program remains strong economically, and there's substantial potential for future growth. Moving on to Q3, trends remain positive. We're experiencing healthy demand for both leisure and business travel and a favorable year-over-year yield trend. We anticipate Q3 RASM performance to rise by 3% to 5%. The MAX aircraft will be included in the schedule for all of Q3, which alleviates the same close-in re-accommodation issues we faced entering Q2. Our Q3 RASM outlook includes a one-point headwind due to challenges from Q3 2018 stemming from Flight 1380 and last year's suboptimal schedule. Similarly to Q2, we expect about a two-point year-over-year RASM benefit due to reduced capacity resulting from the MAX grounding and a 0.5-point benefit from our new reservation system. We are noticing a slight negative impact on Rapid Reward redemptions and ancillary revenue due to MAX-related flight cancellations, but we still expect strong year-over-year performance in both areas. Regarding our Hawaii expansion, it's off to a tremendous start, with results exceeding expectations across all categories. We now operate 14 daily flights, with demand strong and load factors exceeding our system averages. Our Hawaii in-flight product and customer experience are performing exceptionally well, with Net Promoter Scores above our average. The interisland service also shows robust demand, with a healthy mix of local customers. Our fares are aligned with expectations, and we are witnessing the Southwest Effect in the markets served, supported by our low-cost structure. We plan to announce further Hawaii services soon for sale. As we look ahead, our commercial team will proactively manage any additional MAX flight cancellations and network adjustments through year-end, with a continued focus on execution. Our 2019 RASM outlook suggests year-over-year growth above 3%. By Q4, we anticipate a deficit of 75 MAX aircraft, leading to a sequential revenue penalty. This, paired with the typical seasonal variations between peak and off-peak Q4 periods and the complexity of holiday scheduling, indicates we still have work ahead. We are not ready to provide guidance for Q4 RASM impacts at this point. Protecting holiday travel and minimizing customer impact is a priority. As the fleet shortfall increases, the decisions ahead may become more challenging. Despite these issues, the Southwest brand remains strong, with excellent Net Promoter Scores and positioning at the industry's top tier. We expect to continue revenue growth despite the anticipated decline in year-over-year capacity. As with our Q2 results, we foresee our Q3 RASM expectations placing us among the industry's best. Now, I will pass it over to Tammy.

Thank you, Tom, and hello everyone. Thank you for joining us today, and I'd like to add my thanks to all of our terrific employees for their focus and hard work. Our people are simply the best, and they have proven that time and time again. Gary, Mike, and Tom have outlined the challenges that we've been managing through with the MAX groundings, and I will round out our remarks with some commentary on the MAX impact on our cost, fleet and capacity plans, our balance sheet, and cash flow. Starting with cost, I'd like to commend our people for a great job at managing cost in a challenging quarter. Our second-quarter nominal cost, excluding fuel and profit sharing, came in a little better than we expected at the beginning of the quarter. On a unit basis, ex-fuel special items and profit sharing, our cost increased 10.9% year-over-year. The impact of the MAX groundings drove six points of this year-over-year increase, with the remainder of the increase primarily related to planned increases in salary, wages and benefits, maintenance spend, and airport costs. Our second-quarter CASM-Ex increase was favorable to the guidance we provided in our June investor update, when we were expecting a year-over-year increase in the 11.5% to 12.5% range. Following our investor update, the combination of the grounded MAX aircraft and weather resulted in a lower completion factor than expected, which drove ASMs down further. However, the incremental unit cost pressure was more than offset by lower-than-expected airport cost, shifting of advertising and maintenance expenses to future quarters, and solid cost controls. Turning to the third quarter, the year-over-year unit cost pressure due to the MAX groundings continued. We started the year expecting about two points of inflation in CASM-Ex in the third quarter of 2019. We now expect seven points of the year-over-year CASM-Ex impact from the groundings in this quarter, compared with the previously communicated three-point impact I mentioned on our April earnings call, when we had the MAX aircraft removed from our flight schedules through August 5. When combined with about a one-point increase in year-over-year CASM-Ex from cost shifting from first half 2019, we now expect our third quarter CASM-Ex to increase in the 9% to 11% range year-over-year. Sans shifting and the MAX impact, our third quarter CASM-Ex is relatively in line with our cost plan at the beginning of the year. The good news is that we have gained some non-fuel cost offsets for the third quarter, as our flight schedule changes were well in advance of our flight crew bidding process and we also had temporarily lowered landing fees. As Mike mentioned, we've also temporarily delayed some flight crew hiring. These offsets pale in comparison to the year-over-year unit cost penalty, but we are doing what we can to mitigate near-term pressure, and we will continue to do so. Looking at the full year, our current guidance is based on MAX cancellations through January 5. The MAX groundings are driving an incremental six points to full year CASM-Ex year-over-year, as we are six to seven points off our original capacity growth plan to grow 2019 ASMs nearly 5%. Therefore, we currently estimate annual 2019 CASM-Ex to increase in the 8% to 10% range year-over-year. As a reminder, our annual CASM-Ex increase also includes the previously communicated 0.5-point increase year-over-year from cost related to the ratified agreement with our mechanics and approximately $10 million of incremental maintenance expense for seven of our 737-700 aircraft that we have decided to keep instead of retire this year, which I'll cover in a moment. I won't spend too much time on fuel, as the market held fairly steady through the second quarter. Our second-quarter economic fuel price was right around the mid-point of our most recent guidance at $2.13 per gallon, which included hedging gains per gallon of $0.06 and premium expense per gallon of $0.05. We have great fuel hedging protection in place this year, with about a 65% hedge in both the third and fourth quarters. Our hedging premiums for this year remain at approximately $95 million, or about $0.05 per gallon, and we have a 58% hedge position for 2020. We're well prepared. For third quarter of 2019, based on market prices as of July 19, and given our current hedge, we expect our fuel price per gallon to fall in the $2.05 to $2.15 range. As I mentioned last quarter, our fuel efficiency has been significantly impacted by the MAX grounding. The second quarter ASMs per gallon declined 1.7% year-over-year, and third quarter ASMs per gallon are also expected to decline year-over-year in the 1% to 2% range. This decline highlights the fuel efficiency of the MAX, which is about 14% better than the 737 NG fleet. Once the MAX returns to service, we expect to get back on track with our desired fuel efficiency gains. Turning to fleet and capacity, we have not taken delivery of any aircraft since the MAX groundings in mid-March, and we didn't retire any aircraft this quarter, so we started and ended the quarter with 753 airplanes. We don't have an update to our contractual delivery schedule with Boeing at this point, which shows 41 remaining deliveries this year. But we expect the majority of these will shift to 2020. We have been working through the delivery delays with Boeing. Based on their guidance, we are currently assuming we will get 16 aircraft deliveries during the fourth quarter of 2019, which includes seven leased aircraft. To help mitigate the impact of the delivery delays, we are postponing the retirement of seven of our own -700s. With this in mind, we now expect to retire 11 -700s this year versus the original retirement plan of 18. Turning back to the second quarter, our ASMs declined 3.6% year-over-year. For third quarter, given the absence of the MAX aircraft for the entire quarter, we expect capacity to be down in the 2% to 3% range year-over-year. With the extension of the MAX cancellations through year-end, fourth quarter 2019 capacity is expected to be flat to down 1% year-over-year. Looking at our second half 2019 plans versus where we are now, the impact of the groundings is far greater in the back half of the year and, of course, that's a function of the growing number of MAX aircraft we had planned to have in our fleet. For full year 2019, we now estimate capacity to be down in the 1% to 2% range year-over-year. Finally, turning to the balance sheet and cash flows. We ended the quarter with very healthy cash and short-term investments of approximately $4 billion. We originally estimated our total 2019 CapEx spend would be in the $1.9 billion to $2 billion range, with approximately $1 billion in aircraft-related spend. Based on Boeing's most recent guidance for our remaining deliveries this year, we now expect total 2019 CapEx to be in the $1.2 billion to $1.3 billion range, with aircraft-related CapEx to be in the $400 million to $500 million range. The $500 million to $600 million reduction in this year's aircraft CapEx will shift to 2020, assuming the delivery delays are caught up next year. Despite the year-to-date operating income penalty of $225 million from the MAX groundings, $175 million of which was in the second quarter, we generated strong operating cash flows in the first half of the year of $2.1 billion, with free cash flow of $1.7 billion, allowing us to return $1.2 billion to our shareholders through share repurchases and dividends. In closing, I'd like to extend another huge thank you to all our employees who are managing through all the challenges the MAX groundings have presented. I am tremendously pleased with our financial results this quarter. Despite the negative financial impacts and operational challenges from the MAX groundings and the 20,000 canceled flights, we still managed to produce strong margins and all-time high quarterly revenues, load factors, and earnings per diluted share. Our pre-tax return on invested capital was a strong 23.4%, even with a 1 to 2 point year-to-date penalty from the MAX grounding. Our balance sheet and cash flows remain strong, allowing us to continue to provide meaningful shareholder return. Our revenue production is strong, and we continue to benefit significantly from our new revenue management system, our Rapid Rewards program, and ancillary revenues. We have great fuel hedging protection in place in 2019 and beyond to mitigate fuel price pressure. While lower capacity is putting year-over-year pressure on our non-fuel unit costs, we remain diligent on controlling the costs we can. Based on what we know today, we continue to expect solid margins in 2019 at or near industry-leading levels even with the MAX penalty, with the opportunity to continue delivering stellar returns on capital. We will get past our near-term challenges from the MAX groundings, and our second quarter 2019 financial results demonstrate the strength of our low-cost business model, our network, and our amazing people. With that, Greg, I'll turn it back to you now to take questions. Thank you.

Hi. Good afternoon, everyone. Thank you for taking my questions. Gary, I know you've got versions of this question on the last call, but just given everything that's going on with the MAX, I thought it was important to ask again. When does the risk tied to having a single fleet type offset the economics of that single fleet type?

Andrew, thank you for your question. It's an issue we'll want to investigate further. There's no way to eliminate risk with a fleet. If we had one manufacturer at 50% and the other at 50%, having 50% of our fleet grounded would be a major issue. There's nothing new to report today. We believe Boeing is a strong company and a great partner, and we still consider the MAX 8 to be the best aircraft in its category. We haven't changed our perspective in 90 days. The nuance in your question is worth exploring because some of our competitors, who have a more diversified fleet, aren't seeing their growth plans affected as severely as we are. The likelihood of facing such a unique situation again and trying to implement a strategy narrowly focused on avoiding this seems unwise at this moment. In short, we don’t see a need to alter our strategy right now. In the longer term, this is an issue that requires thorough exploration and debate, which won't happen in just 90 days. Practically speaking, diversifying the fleet would take us years. Unless we consider acquiring another carrier and running a separate airline, there's no straightforward solution.

Fair enough. Thank you for that color there, Gary. My second question maybe for Tammy. Just want to get your thoughts around IMO 2020 and your hedging policies. The 58% hedge in 2020, how much of that is just WTI as compared to jet tracks, and I'm just curious to get your expectations for the potential impact of this regulation on jet fuel? Thanks.

We've been contemplating IMO 2020 for quite some time and that has certainly informed our hedging strategy. We have about a 10% position in heating oil for 2020, and we have a combination of Brent and WTI. We have a diversified portfolio, and we feel like we're positioned well should we see prices increase or the crack spreads rather increase from current levels. In case you missed it in our earnings release, we have a 58% hedge for 2020, very well hedged.

Yeah. Thanks. Good afternoon. Gary, I'm wondering if you can just talk about, given the plan that Mike laid out for reintroducing the MAX, how we should think about capacity growth, and if you'd like to discuss that CASM-Ex kind of into next year, just given all the moving pieces? Thank you.

Mike has a significant amount of work ahead, especially considering the variability in the Boeing delivery schedule moving forward. At this stage, we can only establish a baseline and make some assumptions. We have clearly outlined our near-term expectations. If we adhere to those timelines, assuming Boeing completes its deliveries in September and the FAA gives approval in October, we could begin receiving deliveries in December. Currently, we are estimating how many airplanes we can physically bring back into service, how many Boeing can return to service, and how many they can actually deliver. There are three different sources for the MAX 8s, and our daily capacity has its limits. This situation is unprecedented for us. It could impact the retirement plan for some of the MAX or 737-700s scheduled for next year. We are considering either speeding up or slowing down those retirements. Ultimately, our main objective is to deploy as many MAXes as possible as soon as we can. If we're not satisfied with the resulting capacity, we might consider accelerating the retirement of some of the -700s.

To help with what all this means for our 2020 cost, while the MAX groundings are obviously creating a material impact on our year-over-year ASM growth in CASM-Ex trends for 2019, our long-term unit cost target is unchanged. Our unit cost goal excluding fuel and profit sharing is annual year-over-year growth below 2% as I discussed on last quarter's call. I just want to point out that this cost target includes our estimates for salary, wages, and benefits, and increases for our people. We are experiencing pressure on our 2019 unit cost due to the lower capacity from the MAX groundings. That's about again six points to the full year. While this does create some near-term challenges for us, these pressures are one-time and will pass. The year-over-year comparisons for next year will be more favorable given this year's impact from the grounding. My target for next year is to absolutely drive towards declining year-over-year CASM-Ex in 2020.

That's very helpful. And then Gary, just another one for you, given your tenure at the airline, can you just talk about over the last 25 years how the economics of your partnership with Chase have changed? What that means for helping the durability of your business over a cycle? Where your economics are now relative to the industry given that you most recently did the deal in 2015? And it's clear that the economics have become more favorable for airlines over the past few years? Thank you.

I'll give you a quick comment, and then, Tom, love for you to opine on that topic. But just starting with 25 years ago, we didn't have an affinity card and saw that as a great opportunity. In the industry, I don't know that I have as much of a perspective there. Certainly for us, we've come a long way in 25 years. When I started as CEO in 2004, we quickly concluded that the number one enhancement needed for the Southwest brand was to overhaul our frequent flyer program, and Tom covered a lot of material in his remarks. That's an award-winning, industry-leading frequent flyer program that is the foundation for obviously driving the revenues. We have a great plan, our customers love it, and they take our credit card in droves. We're far more stable today in terms of our revenue generation than we were before. The new program was launched in 2011, and that may be even the single biggest accomplishment that Southwest had over the last 10 to 15 years. Tom, anything you want to add on the economics? Obviously, we hold a lot of that very close to the vest, but we are really thrilled with the partnership. We're thrilled for a long time.

Thank you.

Thanks very much, operator. Hi, everybody. I'm not sure who can answer this question. But when you talk about the pilot training and taking one to two months, do you have to put them through the simulator? Can you just sort of maybe address that?

Hi, Helane. This is Mike. We're not expecting to require simulator training for the pilots on the MAX. We believe it's essential for them to be aware of the MCAS system and its functions within the airplane. My understanding is that adequate computer-based training can effectively inform the pilots about this. We've been training our pilots in hand-flying since we started the airline. Over the past two years, we've implemented a program called envelope training, where pilots undergo scenarios at the edges of the aircraft's performance limits. They have also participated in simulator training related to incidents like Ethiopian and Hawaiian Air over the last two years. This marks the second year they've completed all of that, so we feel computer-based training will suffice, supplemented by ongoing recurrent training in the simulator.

The other thing that I would add is that Southwest is the gold standard for the industry. We hire first officers that, on average, have 6,000 hours of flight experience. In addition to that, we hire first officers that have captain experience. So you start with a very experienced cockpit crew. We only fly the 737, and we are the industry leader when it comes to training and operations. Our pilots are very comfortable with the MAX and are looking forward to restoring it to service. They will play a key role when we communicate and when we’re reintroducing the MAX to our customers. But we factored all of that into our plans. We're allowing more than ample time for training and reintroduction of the fleet. Our pilots will communicate our safety measures with customers. We will work hard to do that.

Got you. Can I ask you one question about Newark? So I understand this. This is not just a suspension of service. When the MAX does come in, you're not going back? This is just leaving the market, returning the slots?

Currently, the slots are not assigned anymore, although they were when we acquired the company in 2010. The FAA unscheduled them a few years ago. We have made a decision to consolidate our operations, and I believe that's important. Our presence in New York City will be significant, focusing on LaGuardia, where our customers prefer to go. We see a great opportunity to expand our seat capacity at that airport, leading to improved productivity, a more cost-effective operation, and increased revenue by consolidating our services into one location rather than spreading them across two airports.

That's very helpful. Thank you, everybody. Thanks, Gary.

Hey, good afternoon, everybody. Gary, I'm already kicking myself for asking this question last quarter because I'm going to ask it again today and probably will continue to do so for as long as the MAX remains grounded. Have you given any further thought to how long you can tolerate or would choose to tolerate year-on-year capacity declines before you consider non-organic growth? You're clearly agitated by funneling profits and market share into your competitors' coffers. You've said as much today, and I respect that. So I have to imagine there’s a breaking point out there somewhere.

Does that mean I get to kick you too? Just kidding. I'm trying to be practical without being overly legalistic here. Obviously, we can't comment on anything like that in substance. I'm just trying to navigate the situation a bit. From a practical standpoint, we approached this in March believing it was a short-term issue. We have a strategy in place, and this is really not impacting that. We expect it will be resolved by the summer. It was disappointing to encounter another delay pushing it out to early next year, but that’s something we can handle and manage. The tolerance for this situation actually extends well beyond that, as your question touches on a significant strategic concern.

Okay. Fair enough. I appreciate that. As a follow-up for Tammy, you talked about some soul-searching on this whole fleet-type structure. Should we assume that Boeing competitors are circling you more aggressively in the current environment than they ordinarily do? Or is that not the case?

That's always the case. Yes, that's always the case. Mike has been looking at other airplanes, and there's nothing available. We want to understand what options are in the marketplace. We need to feel confident that we've made the best decision for our company, our shareholders, and our customers. I hope I have answered that question.

And then a quick follow-up for Tammy. How should we think about the engine overhaul expense on the 700s that you're keeping? Just wondering if that will hit the P&L or if the plan is to run them down before you park them? I suppose MAX might impact that calculus.

There is about $10 million associated with pushing those seven aircraft, and that's all contemplated in the guidance that we provided to you this morning. And that's going to hit fourth quarter as we pull….

Thank you. Regarding the replanning challenge you've been managing, it seems you're expecting to grow in mid-single digits in Q4. According to our calculations, the MAX contributed significantly to that growth. Without the MAX, your plan likely involved reducing the fleet, possibly cutting back on stages or utilization. Could you explain how you intend to address that effectively? I assume some aircraft will be taken out of service in Q4 due to maintenance requirements. How do you plan to manage this situation while minimizing any damage to the schedule?

Tammy, can I take a shot at that? You can refine it later. Is that alright? We are currently working through the details. If we were to remove the MAX from the fourth quarter schedule, it would amount to almost 11%. For context, we experienced a reduction of 7% in the second quarter due to the MAX and an 8% reduction in the third quarter, which improved in the fourth quarter as we added more airplanes. The holiday schedules are tricky because there is a considerable difference between peak and off-peak days. This situation complicates everything, requiring us to go back and manually adjust the schedules. We do not want to cut our capacity by 10% to 11%. We may adjust our operation by extending certain days and making other modifications to manage this reduction. Until we understand the specifics, I prefer not to provide an exact figure. However, we have the flexibility to make those adjustments. The schedule may not be optimal and could result in a RASM penalty due to some flights not being ideal for our customers. Nevertheless, we will approach it considering what is more profitable instead of just focusing on CASM or RASM independently. We expect to achieve a solid quarter with good profits, and we will release a schedule that we can stand behind, ensuring it is well-staffed and operational, even though it may not be perfectly optimized.

I want to add to that. Part of your question was about how we plan to unwind this both financially and in terms of the quality of the schedule. We weren't considering it earlier, and the network planning needs to take MAX flying out of Q2. We have to carefully navigate through March and update our April and June schedules to maintain the integrity of our network. We're being very opportunistic; we've examined routes that have been underperforming compared to the average.

Tammy, anything you want to clean up there? I think we’ve got a lot of flexibility to manage the circumstances of fluctuating capacity. We can make adjustments along the way. It's complicated, but I feel we’re set up well to handle the challenges.

We will work through that, and you'll be proud of the results when it's all said and done. Thank you very much.

Thanks for squeezing me in. Gary and Mike, a question for you on the obvious with the MAX. Can you talk about the plan to make sure you get confidence from passengers in terms of flying the plane and how you're going to tackle that?

Why don't I discuss them in reverse. Tom, regarding reintroduction, we maintain daily communication with the FAA. They are dedicated to a thorough review, ensuring that all concerns raised have been properly addressed. We do not anticipate any further resistance when it’s time to reintroduce the aircraft. Our priority is to safely return the MAX to service.

There's so much media on the topic; it’s going to increase as the aircraft begins to be reintroduced to service. There will be some people who book away from the MAX initially. However, our customers' perception of Southwest has not changed at all. We’re spending time listening to customers, and their trust in us remains strong. How we communicate as we reintroduce will be critical. We will be flexible with customers who are uncomfortable flying on a MAX initially.

We will roll out a communication campaign. Our pilots are a key part of that communication. Nobody in this company, especially our pilots, is going to do anything that they deem to be unsafe. So it’s about convincing our constituents of the safety measures in place. We are going to work hard to ensure their comfort.

All right. Well, that does it for the analyst portion of the call. Thank you for joining us. If you have follow-ups, please give me a ring.

Thank you, Greg. I'd like to welcome members of the media to our call today. Greg, would you please give instructions on how everyone should queue up for a question?

Hi. Thanks for calling on me. I had two quick questions. The first is Gary, in your earlier remarks, you mentioned 20,000 cancellations. Are those all MAX cancellations? Over what time frame did those occur?

That was total. Normally you'd have 3,000 cancellations, so to put it into perspective. I would attribute the vast majority of that excess to the MAX.

We included cancellations prior to operating the MAX schedule, and April and May without spare aircraft made re-accommodating customers difficult, leading to a spike in cancellations.

Okay. My other question real quick was on the Newark gates. What happens to those? Are you able to sublease those gates to someone else?

It's a month-to-month lease, so no.

Okay, and are you re-leasing them from United?

I don't know. I don't think so.

Hi everyone. My question is do you feel like Boeing misled or provided any incomplete information at Southwest about the MAX?

I don't think there was any malintent at all. In hindsight, we wish this never happened, and we wish we had the knowledge we have now.

So you don’t see that there was anything criminal that happened?

No. No. Boeing is a great company and is important to not just Southwest but our country. They recognize the problem, and I’m confident they’re addressing it.

Hi, good afternoon. You've said that you expect some of your MAX deliveries to slip into 2020. How confident are you that you will receive those planes when you need them, given that planes are stacking up at Boeing facilities?

We're sort of not confident to 100% confident. There's no way we could be 100% confident that we're going to hit our assumed timeline. This is new territory for Boeing to unground airplanes.

We have 41 airplanes on a delivery schedule to take in 2019. My preference would be if they made all those airplanes to have them rescheduled into 2020 so we can take them right off the production line.

Hi. This is a quick question for Gary. Just to clarify, I think it was the last question on the analyst portion. That FAA you said they are reviewing MCAS and signed off on it?

That’s not exactly what I said.

Okay.

Hello, all of you? I just wanted to see if you could be more specific about when you anticipate selling flights for Southwest Hawaii service for previously announced routes?

While we’re not ready, we still intend to serve Hawaii from Sacramento and San Diego, as well as Kona and Lihue. Our interisland demand is exceeding expectations and we will make announcements soon.