Southwest Airlines Company (LUV) — Q1 2020 Earnings Call Transcript

Thanks, Chad, and thank you all for joining us today. We're going to start out with prepared remarks from Gary Kelly, our Chairman and CEO; Mike Van de Ven, Chief Operating Officer; Tom Nealon, our President; and Tammy Romo, Executive Vice President and CFO. And then, of course, we'll open it up for Q&A. A few quick disclaimers before we get started. We will make forward-looking statements in our remarks, which are based on our current expectations of future performance. And of course, our actual results could differ from current expectations for a number of reasons. We called out special items in first quarter 2020, and we'll make reference to those results that compare to prior year GAAP results. Both of these topics are covered in our earnings release disclosures as well as on the IR website. Today, we issued a press release announcing underwritten public offerings of our common stock and convertible notes. We cannot discuss those offerings on this call, and we won't be taking questions about them. We will, however, discuss our current liquidity position, cash burn and related topics, and we'll take questions about those and other topics as always. So with that, we'll go ahead and get started, and I'll turn it over to Gary.

Thanks, Ryan, and good morning, everybody, and thanks for joining our first quarter 2020 earnings call. It's all about COVID-19 effects, of course. Our route system is over 95% domestic. We had a very strong January and February performance with solid unit revenue growth and better-than-expected cost performance. Earnings were higher in each month year-over-year. Our operation was performing magnificently in terms of on-time performance and baggage handling, and our customer service scores were industry-leading. We saw no COVID-19 effects on bookings until the end of February, and the effects on bookings, cancellations and traffic beginning in March were unprecedented and, quite frankly, breathtaking. So here we are. One of Southwest's greatest and most enduring strengths is its preparedness, and we were prepared. On the heels of last year's outstanding performance, and despite the MAX grounding and the excellent momentum that continued into January and February, we're in a very strong and healthy position when the coronavirus struck. We started the year and March with a surplus of liquidity and that was by well over $1 billion. We began this year with the smallest amount of debt to total capital in our history, only 24%. And on a $27 billion balance sheet, we had over $10 billion of unencumbered aircraft. While no one anticipated this economic catastrophe, we were prepared. In my time and Tammy will detail all the actions taken since March 1. But in summary, including spending cuts, schedule reductions, fuel price declines, and the elimination of shareholder returns, we reduced our planned spending for 2020 by over $6 billion. Excluding working capital changes and proceeds from the payroll support program of the CARES Act, our cash burn for April is roughly $900 million, and that includes CapEx and debt service. Our goal will be to drive that lower in May and June through more aggressive schedule cuts and hopefully increasing revenues. The pure cash outflows or spending has been cut in half from pre-COVID levels. Our financial management philosophy has always been and will continue to be very conservative. It has served us well, and no one can match the track record of profitability or the financial position of Southwest Airlines. No one has served shareholders or bondholders better over the last 49 years, and we intend to continue that record. Cash in this environment is an asymmetrical risk. Not enough is a huge problem. Too much means we'll pay down debt or we'll buy available assets opportunistically. We're in a recession. Historically, it has taken years—typically 5 or more—for business travel to recover. With some businesses issuing no travel orders, that has to be the expectation going forward that business travel will recover very slowly. Further, this recession has already put tens of millions of Americans out of work, and consumer sentiment has been severely damaged. That will also affect near-term travel demand expectations. And finally, for those who are willing and able to travel, the country needs to open back up, so there's something for people to do when they get there. So I mentioned all of this to underscore the imperative of low cost in this environment because every traveler will demand a low fare. That's our business model, and we're America's strongest and most successful low fare carrier. We're working on a variety of things: number one, strategic plans that are based on three basic recovery scenarios and is being led by our President, Tom Nealon. We're working on customer experience modifications at the airport and on the airplane to ensure that customers feel safe. We're working on our capital structure and liquidity needs to see us through this pandemic so that we emerge healthy and strong. We're obviously working on the fleet, and that's being led by our Chief Operating Officer, Mike Van de Ven. And then last, we're working on early retirement and other voluntary exit or reduced work programs for our employees. So before I pass to Mike, I want to thank all of our employees. This has been a crisis unprecedented in our history, but our people are battle-hardened. They are resilient, and they have done a masterful job running the airline, serving our customers and implementing myriad new procedures and protocols, and they are all vital to this company and essential to our country, and they are my heroes. I'm very grateful to our employees, and I'm very grateful to our leaders for keeping Southwest strong. And with that, Mike, I'll hand it over to you, sir.

Well, thanks, Gary. And I really appreciate your comments about our people. They really are tenacious and to lean into this kind of headwind and deal with their own personal uncertainty and angst is just, frankly, amazing. And they're steadfast, they're fearless, and I just couldn't be more proud to be a part of this team. Now as you mentioned, the year began really with our best overall January and February operations that we've had in probably over a decade. All the critical operating measures of on-time performance or bag handling and the lowest ratio of customer complaints to the DOT, we were in the top 2 for the industry in each measure. We realized the efficiencies of various technology and equipment investments that we had made previously to be able to execute our schedule and recover from regular operations. Those investments proved to be invaluable in March, and they allowed us to rapidly adjust our network and our crewing and our maintenance plans as we reacted to the COVID-19 demand changes. I think they're going to be great assets for our NOC to minimize our daily operating costs as we move forward. So when the year started, the MAX return to service plan was one of our primary focus points. Now our operations focus is threefold: first, ensuring that our environment is safe for our employees and customers; second, rapidly adapting our daily operations to whatever existing conditions are out there; and third, managing our fleet as we prepare and position the operation to support, hopefully, an eventual business recovery. We're managing through all that coordination through our emergency response program, and that is led by one of our emergency directors, our Senior VP of Operations and Hospitality, Steve Goldberg, and he is doing a tremendous job. He has 53 teams across the company working together on a daily basis to manage the crisis. It's coordinated and it's focused with intentional efforts and deliveries that span specifically across 30, 60, and 90-day time frames. The highest priority is ensuring that we create an environment for both our employees and our customers that introduces whatever additional mitigation techniques and strategies are needed to minimize the spread of this virus. We've implemented social distancing procedures throughout the operation where feasible, along with voluntary temperature checks. Our employees have access to adequate masks and wipes and hand sanitizers while at work. We're in the process of adding plexiglass face guard shields for our ticket counter gate and our cargo agent positions. In terms of aircraft cleaning, we have an enhanced overnight cleaning process that includes wiping down all high-use areas in the cabin, galleys, and cockpit with a hospital-grade disinfectant. Each month, every aircraft receives an additional application of a disinfectant through the use of an electrostatic mister and an anti-microbial mist that covers all the surfaces of the aircraft, providing protection for up to 30 days against virus contamination. We're also adding additional cleaning procedures during the turn and expect to have those in place within the next 30 days. We're using social distancing techniques for customers during the boarding process and while on board, and we've eliminated our in-cabin service to further mitigate risk. In short, we will be ready to support our employees and customers' needs as travel begins to rebound. As we move into May, the disruptions we've experienced associated with various state-by-state travel restrictions and some of the international restrictions have been abating. Our published flight schedule is about 1,400 flights a day, and our focus is on running the most cost-effective operation. We can be very flexible with the tools I mentioned earlier. We have the ability to look out 4-plus days with respect to bookings and demand, and we can easily reaccommodate customers while simultaneously further reducing our flight activity. Our goal there is to minimize our cash burn further, primarily through reducing fuel, landing fees, and engine flight costs. The significant reduction in flight activity has left us with excess aircraft, which we're managing through a combination of long-term storage and parking programs. We've moved 106 NG aircraft into long-term storage, combining those with our 34 MAX gives us 140 aircraft in long-term storage. The additional NG aircraft were selected based on their age and proximity to an upcoming significant heavy maintenance requirement. It will take a minimum of 3 or 4 days of time and possibly more to bring those into the active fleet. We have about 250 NGs in short-term parking that rotate in and out of active flying. The benefits of the short-term parking program is that the aircraft remain part of the active fleet and are more cost-effective in terms of storage costs. When it is time to bring aircraft back into published flying schedules, our most cost-effective to fly is the MAX due to its lower fuel burn and maintenance costs. Based on Boeing's latest updates, it will take at least a couple of months before those aircraft are ready for revenue service. Wrapping up, we've offered our employees voluntary extended leaves, allowing them to be home with their families through August. Many of our operations employees are taking advantage of these programs and helping the company in a significant way. We're exploring additional early-out and further extended time-off options. Our top priority is the safety of our employees and customers as they work and travel. We are actively managing our daily operations to tend to our customers at our lowest cost profile, currently with 390 aircraft in storage or parking programs to reduce costs. We have a wonderful partner in Boeing to assist with our fleet plans in this uncertain time. We are really at war with COVID-19, and we are blessed to have a ferocious group of warriors to face this challenge together. They inspire me daily, and with that, Tom, I'll turn it over to you.

All right. Thank you, Mike. Good morning, everybody. So I also want to start by acknowledging our team, our people. I want to thank all of our employees, especially our frontline employees who are out in the airports, our ground operations folks at our maintenance hangars and our call centers and our NOC, our network operations center. A special thanks to our flight attendants and pilots that are on the planes every day taking care of our customers. Honestly, you guys are truly amazing. The respect and admiration I have for each of you is really indescribable. What you're doing is heroic, and I mean that very sincerely. By all accounts, the first quarter started off as Gary and Mike indicated. Demand and pricing were both strong. We had solid loads in January and February, and March bookings were in line with expectations. We had a lot of confidence in our RASM guidance of being up 3.5% to 5.5% for the quarter. Our RAP Rewards program was also performing well. Consumer spending on our co-brand cards was strong in January and February, with record levels and double-digit growth year-over-year. Our customer satisfaction scores, which are at the very top of the industry, were also at record levels for both January and February, with significant increases versus our stringent internal targets. Everything was shaping up phenomenally. However, everything changed dramatically and quickly beginning in late February. Our bookings were holding up relatively well at that point, but we began to see a significant increase in cancellations that accelerated through March. By March 9, cancellations began to exceed new bookings, resulting in a massive spike in cancellations by the end of the month, with cancellations up over 500% year-over-year. This resulted in net negative bookings, which is never seen before. As demand collapsed and cancellations rose, we reduced our flights. For the back half of March, we ended up canceling 34% of our roughly 3,800 daily flights. Our capacity declined 17% year-over-year for March. Even with a 34% reduction of flights, our load factors fell steadily to single digits by the end of the month, where they stand today. Our March operating revenue dropped nearly 50% year-over-year and ancillary revenues fell dramatically. Our first quarter RASM performance was negative 11.8%, with revenue of $4.2 billion falling over $1 billion short of our expectations. With the country still in lockdown, we're seeing record low passenger demand and revenue trends in April and May, with operating revenue down approximately 90% to 95% year-over-year and single-digit load factors. At this point, it's challenging to predict when or how trends will turn around. We're focusing on what we can control and manage, including our flight schedule and operational quality. We continue to lead in customer and brand scores in the industry, thanks to the people of Southwest Airlines. As for capacity in the second quarter, our April capacity was down 50% for the first two weeks and down roughly 70% for the last half of the month. May is currently down about 60% to 70% versus pre-COVID schedules, with June down around 50%. We've also adjusted our operating day by removing several flights before 7 a.m. and after 8 p.m., restructuring service across our network while maintaining service to all our domestic cities, including 5 Hawaii markets. We have preserved over 80% of prior itineraries, and any capacity reductions will be reflected in republished schedules as we manage capacity based on demand. At a high level, I would like to update you on our GDS initiative, focused on growing our share of the corporate travel market. We announced last week that we'll be going live on May 4 with the travel ports Apollo and Worldspan GDS platforms, meaning that all our everyday low-fare content will be available with industry-standard ticketing and settlement capabilities. Adoption from travel management companies has been tremendous, positioning us strongly as business travel begins to bounce back. To close, Southwest entered this situation as the best-prepared U.S. airline, and we are confident that we will emerge from this strong and ready to compete aggressively in the new normal environment. With that, I'm going to turn it over to Tammy.

Thank you, Tom. I'm happy to round out today's comments with a discussion on our costs, liquidity, and fleet before we move to Q&A. With our revenue production dramatically off trend, as Tom just covered, we are clearly focused on controlling our costs and preserving cash. I commend our employees for their quick work to rally together to reshape our cost trajectory in the near term. I also want to recognize our finance teams, legal teams, governmental affairs teams, commercial and operations teams—really, all Southwest teams—for their tireless efforts over the past weeks. Today's rapidly changing environment requires rapid financial scenarios, forecasts, and actions. Our people have risen to the task day after day, often night after night. They are truly warriors in the face of this significant challenge, and I sincerely thank them for their continued efforts. Our first-quarter unit cost trends illustrate how diligent we’ve been at reducing costs quickly. Despite first-quarter capacity declining nearly 7% year-over-year, which was 5 to 6 points lower than previously expected, first-quarter CASM, excluding fuel and profit sharing, increased only 5.1% year-over-year. For March alone, we saved approximately $100 million in non-fuel costs based on self-help measures despite roughly 75% of our cost structure being fixed due to the sudden fall-off in demand and capacity reductions. We saved another roughly $150 million in the first quarter from less fuel consumption and falling fuel prices, with roughly half of these savings coming from fewer gallons used. In the second quarter, capacity is expected to be down at least 60%, and we estimate operating expenses to be down around 35%, both versus original expectations prior to the pandemic. The benefit from the fuel price decline means costs could be down nearly 40% in the second quarter versus plan. These combined efforts have resulted in a reduction of more than $2 billion in full-year 2020 operating expenses. In terms of capital spending, we have virtually eliminated all expenditures this year, totaling over $1 billion, and canceled our deferred projects and reduced aircraft delivery payments. We’ve canceled or deferred hundreds of projects but are continuing to work on several critical workstreams, such as our recent GDS launch Tom just covered. We have a new agreement with Boeing and are currently working on our revised aircraft delivery and payment schedules for 2020 and 2021. The agreement allows us to take no more than 48 aircraft through the end of 2021. While we have not finalized specifics and have some time to do so, we currently expect to receive fewer than the 27 MAX aircraft we had planned for this year. Between our work with Boeing and our retirement plans for the 700 fleet, I feel comfortable with our fleet flexibility over the next several years, both to flex up or down as needed. We are mindful that the environment is fluid and dynamic and want to position ourselves to adjust quickly based on travel demand recovery or prolonged recovery with no growth. We included our March 31 order book in our 10-Q that was filed this morning; however, it isn't updated for this agreement. For 2020 and 2021 deliveries, excluding 16 leased aircraft with third parties, we have reduced our contractual Boeing deliveries by at least 59 aircraft or roughly half. I am proud of what we’ve accomplished quickly, and it is showing up in significantly lower cash burn in the second quarter. Our original outlook for second quarter burn pre-pandemic was an average core cash burn in the range of $60 million to $65 million per day, and with actions to date, we now estimate our second-quarter average core cash burn to be in the range of $30 million to $35 million per day. It’s important to note that this average core cash burn includes cash outflows, capital expenditures, and debt service but excludes cash sales, refunds, and proceeds from financing transactions and the payroll support program. Regarding refunds, roughly 80% of our tickets sold are nonrefundable. Consequently, most trip cancellations have led to the issuance of travel credits. In March, when trip cancellations peaked, total cash refunds were around $250 million. Thus far in April, cash refunds are running roughly half that of March, with total trip cancellations remaining somewhat elevated. As of March 31, air traffic liability was $6.2 billion, of which $3.6 billion or 60% was our loyalty program balance outstanding for Rapid Rewards. About 1/3 of our total air traffic liability balance represents travel credits already issued at around $2.1 billion. This leaves a net balance of $500 million to $600 million that is not related to Rapid Rewards or issued travel credits, which we expect to fly in the coming months. This represents less than 10% of our total air traffic liability, which is manageable. On the cost front, I want to highlight that our employees are pitching in to save the company money by participating in voluntary time-off and temporary leave programs. We logged nearly 490,000 hours reduced from these programs in March alone, saving an estimated $15 million in salaries and wages. Over 3,000 employees are utilizing voluntary leave and partial pay programs in April, and for May, more than 7,000 employees have elected voluntary leave. As we adapt to a dramatically reduced flight schedule, we need to manage our workforce effectively to limit the impact on our people. We have extended leave programs through the end of August and are considering options for voluntary early retirement and long-term leave programs. Our first-quarter fuel price was $1.90 per gallon, down $0.15 or 7.3% year-over-year. Brent crude oil averaged $51 per barrel in the first quarter, but the real story is the dramatic fall-off in prices, with Brent crude at $69 per barrel in early January, ending the month at a low of $23 per barrel. We continue to see relief from lower energy prices, saving $80 million in the first quarter compared to market prices at the beginning of the year. For the second quarter, we estimate a fuel price in the $1 to $1.10 per gallon range, resulting in a $200 million reduction since the beginning of the year and significantly lower than last year's second quarter price of $2.13 per gallon. Considering the reduction in fuel gallons due to capacity cuts, we currently estimate 2020 fuel expenses to be down over $2 billion from beginning-of-year levels, which is welcome relief in this low-revenue environment. Our fuel hedging program allows us to fully participate in falling market prices, which have continued to slide recently, without facing risk in our portfolio. We have not adjusted our hedges for 2020, but the percentage hedged in our premium cost per gallon has increased due to fewer fuel gallons consumed. This pattern will persist as long as capacity remains drastically reduced. The $97 million fuel hedging premium cost this year remains unchanged. For context, we are over 100% hedged in the second quarter, leading to a GAAP loss of $2 million in the first-quarter adjustments recognized in other comprehensive income. While our second-quarter premium expense is $4 million lower year-over-year at $24 million, it spiked to $0.12 per gallon compared to $0.05 per gallon last year. Overall, there is no movement related to our hedging positions or premium costs in 2020—just noise in the metrics due to reduced fuel gallons from capacity cuts. Despite the ongoing grounding of the fuel-efficient MAX fleet, our first-quarter fuel efficiency improved 0.8% year-over-year due to reduced capacity in March. We operated fewer of our less fuel-efficient aircraft, leading to slight improvement year-over-year. We should see further improvement in the second quarter for the same reason. Finally, regarding liquidity, we ended the first quarter with cash and short-term investments of $5.5 billion and currently have over $9 billion. We included in our press release the detail of the sources of incremental cash this year, totaling $6.8 billion through yesterday, so I won’t list those again. However, we're not done. We remain focused on reducing our cash burn and evaluating other liquidity sources to bolster reserves, positioning us to prepare for any scenarios well into 2021. We are the only domestic airline rated investment grade by all three rating agencies. Even after our financing transactions, we still have over $6 billion in unencumbered aircraft and roughly $2 billion in unencumbered assets like real estate, spare engines, and ground equipment. In closing, we remain focused on keeping our employees and customers safe, conserving cash, adjusting flight schedules and fleet as necessary, and leveraging our strong balance sheet and financial position to boost liquidity further. Despite our first quarter net loss, we generated a pretax return on invested capital of 18.1% or 14.3% after tax on a trailing 12-month basis. We have a proven track record with a seasoned leadership team that has successfully managed through uncertain times. We don’t know how this crisis will continue to unfold or what the recovery will look like from air travel to the broader economy, but we entered this crisis as the best-prepared U.S. airline, and we plan to emerge as the best-prepared U.S. airline, both financially and operationally. With that, Chad, we are ready to take analyst questions.

I hope you're well. When you contemplate the debt maturities you're facing in the coming years and the issues you've had with the MAX, how do you think about the attractiveness of hundreds of lightly used NGs coming available on a global basis over the next few years?

Hunter, how are you doing? I'm doing great. Yes, we have significant flexibility with our fleet plan, and I'll say that our preference is to get new airplanes from Boeing. Boeing has been a great partner with us, and they have certainly been working with us to restructure our order book as we manage through the situation here. I think we'll have plenty of opportunities to get the new airplanes we need from Boeing. We will have plenty of aircraft should we need to tap into more airplanes. We also have flexibility on the other side to retire older or less fuel-efficient airplanes. Even though fuel prices are low, fuel costs are still our second-largest cost component. A 14% savings on fuel burn compared to the next-gen aircraft remains very meaningful.

Okay, Tammy, thanks. You and Tom together mentioned some high-level inputs on three recovery scenarios. I was wondering if you could frame those out for me at a high level, whether through capacity or revenue. I know you're not going to make predictions, but what are the numbers around those three recovery scenarios that you would be comfortable sharing as you think about contingency planning?

Yes, sure, Hunter. The scenarios were design themes. One would be current trends continuing, which would suggest a U-shaped recovery. The second would be a gradual increase off of an L-shaped recovery. The third will characterize as a true U-shaped recovery beginning perhaps in the fourth quarter. This work is ongoing. Through the CARES Act payroll support program, we have a commitment to avoid any involuntary downsizing until September 30. If things don’t improve, we’ll need to act after that. We aim to have options defined by mid-summer. We can see May developing, and it feels like we're starting to see some improvement beyond April's low point. We have modest expectations for June at this point but are hopeful. The significant cash burn for April was without working capital changes, approximately $900 million. We can't sustain that rate, and will consider additional cost reductions and schedule cuts as immediate measures.

Gary, I was hoping you could speak to what you have seen coming out of prior downturns. The situation has unique attributes, but if we think back to post-9/11, the industry took years to recover, while Southwest did so in a couple of quarters. Why would post-9/11 serve as a good comparison for what we're facing now? Where does it fall short?

At least in previous recessions I've experienced, Southwest was in a similar position as a low-cost carrier with a strong brand. Historically, we were never as large as we are today, and while we had a different footprint, there are many similarities. We had a strong balance sheet and cash reserves to anticipate the unexpected. My earlier point underscored that we fully expect that traffic will recover, but it will take a long time. This recession is deeply affecting business travel, which is reduced rapidly. We expect to see business travel return gradually over time, and I believe we better position ourselves to increase market share amidst those changes. Post-9/11, Southwest's low-cost model allowed us to gain share during the recovery, and while a lengthy recovery appears likely today as well, the duration is a heightened concern. There are many unknowns regarding the future of travel. Some experts predict things may not return to normal within the next 6-12 months. We must ensure we have the staying power to endure this crisis and be prepared with low costs and a plan. Although we may need to restructure, I believe we have a solid business model.

Yes, sir. And I know Tammy will want to speak to this too. But basically, we felt it was important for the federal government to flood our country with liquidity to get through this crisis. Our approach has been through the CARES Act payroll support program thus far. We received $3.2 billion through that, with half received at this point. The other part of the CARES Act is the secured loan program. Our share of that is $2.8 billion, and the application is due this week. We will apply but have no immediate plans to draw down on it, with until September 30 to decide. In terms of the structure of the loan, it would be a 5-year senior secured term loan. The terms are reasonable at LIBOR plus 250 basis points. The loan is prepayable at any time, providing us good options. It acts as a valuable backstop and we're thankful for it.

Gary, I was just thinking, I've known you almost 30 years, and I think this is the first time I've heard you refer to the roaring '20s. I like that reference a lot, just not really part of the vernacular in the past.

So the $2 billion of non-encumbered assets consists of various miscellaneous assets such as gates, slots, and simulators, as well as general assets, including engines.

But LaGuardia and D.C. slots are included in that pool?

Yes, that would include those types of assets.

Okay. And Gary, you mentioned at the top of the call that you saw a decline in booking from corporate travel. What sort of limits are you considering when it comes to capacity?

What we’re considering is not a physical reduction in capacity, but we may not take bookings that fill the airplane. We would rather manage that from a bookings perspective than reduce capacity physically. That said, it’s about understanding that if we fill the airplanes, we might not find customers willing to take that risk, so we will respect people’s comfort zones during this pandemic. The fact is, while we're working very hard to regain customer confidence, we also recognize that everyone is eager for travel and interaction. So, if we manage to open the middle seat or two, we still hope to offer travelers acceptable spacing without requiring it face value.

I want to add that while social distancing is just one mitigation effort, our aircraft environment is set to be disinfected thoroughly, supported by behaviors that minimize any risk of virus spread. With the combination of protocols we’ve implemented, we are committed to operating in the most cautious manner possible as the world evolves. As we emerge, we continue to bring back an environment that inspires trust in customers and employees alike.

Gary, you mentioned that you think things bottomed out the first week of April and saw gradual improvements afterward. Are you seeing these slight increases related to states lifting restrictions or perhaps with some markets precipitating demand? Do you see any chance for a summer travel season?

Dawn, that's a great question. Yes, we're tracking booking trends closely, but it's proprietary information. However, we see some bookings for July, and we anticipate that demand could build if restrictions ease. Our family plans are proof of that, with many eager to travel when possible.

It's important to recognize that our national average of booking levels may not reflect that concerns remain high for travelers. As states ease their restrictions, people who believe they can travel safely will begin to book.