Southwest Airlines Company (LUV) — Q2 2021 Earnings Call Transcript

Thank you, Chad, and thank you all for joining us today. In just a moment, we will share some brief remarks and then open it up for Q&A. You will hear from our Chairman of the Board and CEO, Gary Kelly; Executive Vice President and Incoming CEO, Bob Jordan; Executive Vice President and CFO, Tammy Romo; President, Tom Nealon; and Chief Operating Officer, Mike Van de Ven. We also have a few other senior executives with us for Q&A, including Andrew Watterson, Executive Vice President and Chief Commercial Officer. We will make forward-looking statements today, which are based on our current expectations of future performance and our actual results could differ substantially from these expectations. We also had several special items in our first quarter results, which we excluded from our trends for non-GAAP purposes and we will reference those non-GAAP results in our remarks. Please see our press release from this morning and our website for more information on both topics, our cautionary statement and a lot of helpful information about our results and trends. Before we get started, I want to let you all know that we are planning an investor event in December and I will send out more information soon, so stay tuned for that. So, Gary, over to you.

Thank you, Ryan and good morning, everybody and thank you all for joining us for our second quarter earnings call. We are very delighted at the turnaround in our business from the previous four quarters of billion dollar losses. Our revenues nearly doubled in the second quarter from first quarter levels, and that was on a capacity bump of 44%. Our revenues were much stronger than we had been forecasting just 90 days ago, and all of that flowed through to better margins and better cash. Yesterday’s cash was over $17 billion, and that’s plus $1 billion line of credit, well in excess of our $11.4 billion of debt. While our bookings and revenue trends are even better than the month of June and certainly better than the second quarter as a whole, we are very well prepared to manage through if the Delta variant affects our business. And so far, we are not detecting any impact at all, again very strong bookings and revenue trends in the third quarter. I am very pleased with all of that, very pleased with our revenue, our July business, and the outlook for the rest of the quarter. This has been a long struggle to get to this point, profitability in the month of June. The pandemic, of course, turned everybody’s world upside down, and it’s still not completely right side up, but I must thank our employees once again for their heroic and very hard work. Normal summer demand is always a challenge to manage, and it’s of course even more so here in 2021, especially in June when we had technology issues and bad weather combined, making it very difficult. Things are much better in July, still not where I want us to be, but we will continue to improve, and I am very confident that we will adjust as necessary and if necessary. Our immediate focus is on running a very high-quality on-time airline and then gradually restoring our traditional efficiencies that are attendant with our low fare point-to-point high utilization business model. Given the revenue recovery, our next focus is to sustain our profitability that we have achieved here in June and maintain stability going forward. Next year, we plan to resume new aircraft deliveries, with the desire to restore our route network as needed to pre-pandemic levels. Clearly, the network restoration will depend upon travel demand, which may in turn depend upon the state of the pandemic. Worst case, we will reduce our growth and early retire our oldest aircraft, which will be accretive to earnings with the trade-out with the MAX. We are very well positioned and very well prepared to manage pretty much any scenario in the next couple of years. Things aren’t back to normal yet, but clearly, they have stabilized and are much improved and we are at a point now where we can actually plan and work on managing and spend less time on surviving in the intensive care unit. I did want to congratulate and welcome Bob Jordan. He will be our next CEO come February 1 of next year, and the reception so far has been terrific. The transition work is well underway. Bob is very busy and he may comment on that, but it’s going very, very well. I am very proud of Bob. He is going to do a terrific job, and I will hang around to support our team in any way that I can. So with that, Bob, let me just turn it over to you.

Alright, Gary. Hey, thank you, and good morning, everybody. It’s really good to be with you today and I am looking forward to reconnecting with many of you over the next few months as I begin to attend more Investor Relations activities. I am going to make just a few brief remarks. As Gary said, I am super excited for the opportunities to serve Southwest as the next CEO beginning in February. I am very glad that Gary will continue to serve as Executive Chair. Many of you know Gary has been my mentor and friend for over three decades. The two of us, along with Tom and Mike, are already working very hard to ensure that the transition will be a smooth and orderly one. Since the announcement on June 23, I have had the chance to visit and talk with hundreds of our employees around the company. I spent the day in Atlanta yesterday with our wonderful team there, and I am just amazed by their spirit, their enthusiasm, and their heart for each other and for our customers; I am energized by being with them. I am also focused on continuing to work with our leadership as we lead through the pandemic recovery and start to work on our 2022 planning efforts as we evaluate the post-pandemic environment and the many opportunities that are ahead of us here at Southwest. I have been part of the strategy here as we develop our strategy each year, and I am confident about our purpose and vision and where we are headed. I will be very purposeful in how we plan for the next several years. Our strategy is sound. We are a low-fare low-cost growth airline that prides ourselves on terrific customer service and being a great place to work for our employees. That business model and our people have been the enduring strength for 50 years now, and we have enjoyed unparalleled success in the airline industry. We have the nation’s most robust point-to-point network, and we have at least a decade’s worth of attractive growth opportunities in front of us with the Boeing 737. Our customer and brand rankings remain really high year after year, and our commitment to transparency continues with no bag fees and no change fees. We are committed to that. We have opportunities in the pipeline to continue enhancing the customer experience as just one example and that will be a focus along with our commitments to both diversity in leadership in the workplace and to environmental sustainability. We will remain focused on maintaining our strong financial position and our investment-grade balance sheet. As always, we will balance our commercial opportunities, our operational flexibility and reliability, and our financial performance. We want new itineraries for our customers, growth opportunities and job security for our employees, and we want to create significant value and returns for our shareholders. That formula has worked so well for Southwest for decades, and I expect that it will continue being what works for us for decades to come. We have a very deep bench of terrific leaders here at Southwest who are ready to lead for the future, and as a team, we are very aligned on the future of Southwest Airlines. Above all, it’s our people that bring our vision and our purpose to life, and I am just honored to serve them and support them daily. With that, I will turn it over to you, Tammy.

Thank you, Bob, and hello everyone. I will provide a quick overview of our overall financial results and some color on our outlook. On a GAAP basis, we generated a $348 million profit in the second quarter, or $0.57 per diluted share. In addition to improving revenue trends, the primary driver of our GAAP profit for the quarter was the $724 million of PSP proceeds that offset a sizable portion of salaries, wages, and benefits expenses. Excluding this temporary PSP benefit and our usual hedge-related special items, our non-GAAP net loss was $206 million, or a $0.35 loss per diluted share. Second quarter operating revenues, non-fuel operating costs, fuel costs, and available seat miles were all within our most recent guidance ranges. I am pleased with our overall financial performance in the second quarter. With the strong pent-up summer demand and solid cost performance, June marked a key milestone as we generated both average daily core cash flow and profits as we had hoped. This is our first monthly profit since February 2020, when soon after the negative financial impact of the pandemic began to impact our results, excluding the benefits of PSP proceeds, which is more reflective of our base business. These second quarter results, though not where we need to be, represent a significant recovery for our business and are a testament to our amazing employees who are simply the best in the industry and make us proud each and every day. By all indications, it appears that we outperformed the industry again in the second quarter. We provided a lot of color in our press release regarding revenue and cost trends. I will just add that our trips flown are estimated to be down 11% in the third quarter compared to third quarter 2019. As such, we have several cost categories that are expected to continue to trend lower than 2019 levels, such as maintenance expense, advertising expense, technology expenses, and passenger and personnel-related expenses. These cost categories are expected to ramp up as trips and passengers increase and as we resume a more normal investment agenda moving forward. We are mindful of the tight job market as well as general inflationary pressures. We expect to have wage rate inflation beyond our normal annual wage rate increases as we want to be competitive to retain and attract talent. Including the decision to increase the minimum hourly wage to $15 per hour across all workgroups, we now estimate $5 million to $10 million of additional salary, wages, and benefits cost pressure in the third quarter and approximately $15 million in the fourth quarter. We are also mindful of bottlenecks, shortages, and ramp-up inconsistencies across the travel industry as we restart after more than a year of little activity, and we are not immune. That said, we will continue our focus on ramping up costs, along with flight activity as efficiently as possible while being nimble to adjust and add where needed. We are hopeful to generate net income again in the third and fourth quarters on a GAAP and non-GAAP basis. Our ability to do so will largely be dependent on the revenue environment, which Tom will cover in a minute. Based on our current revenue outlook and even with the additional cost pressures we noted, our third quarter bottom-line outlook is over $200 million better than it was back in April. We have flight schedules currently out through early January, and we will continue evaluating growth opportunities and fleet and capacity decisions to construct the most efficient route network for 2022, being mindful that our network has evolved from what it was pre-pandemic. With leisure travel levels where they are today, it is easy to forget that less than 6 months ago, the environment was drastically different. Over the past year, we were most focused on raising capital and building liquidity, minimizing significant cash burn and drastically cutting capacity and cost. The changes that we made to our network are producing the revenue we had hoped, or even better than hoped, and we are now evolving our focus areas. First, we are focused on managing through the current environment with adequate resources to deliver a reliable operation. Then we need to optimize our cost profile with our route network in 2022. Beyond that, we will be focused on producing sustainable levels of profitability, margins, and returns. We plan to continue managing the business closely for the remainder of this year, but we have begun the 2022 planning process at a very high level. Although I don’t have any specifics to share with you today, I can reaffirm that we have tremendous flexibility, perhaps the most flexibility we have ever had going into any year in my nearly 30 years at Southwest. We have flexibility with our cost-efficient Boeing order book with a significant number of MAX options remaining in 2022. We have flexibility in terms of where to deploy our aircraft in the network and how much capacity to fly in 2022. We have a strong cash balance, modest debt requirements, and discretion over how quickly we want to resume non-aircraft investments in 2022. So, we have flexibility with our capital. Aside from our people, our biggest core strength is our balance sheet and financial preparedness even coming out of this pandemic. With that, I will turn it over to Tom.

Okay, well, thank you, Tammy. Good morning, everybody. While our second quarter operating revenue performance was very much in line with our expectations, we saw improving monthly trends throughout the quarter in both leisure demand and yields, and we also saw a steady improvement in business demand, which I will talk about in just a minute. We are also pleased to see broad-based improvement across the entire network, so this was not concentrated improvement in certain regions or cities, but really across the entire system, which was terrific to see. June’s leisure passenger traffic was actually higher than June 2019 levels, and June’s passenger fares were in line with June 2019 levels, very much as we expected. We also saw significant improvement in business travel revenues as well, improving from down 77% in May to down 69% in June versus 2019. Just keep in mind that on our Q1 call, we reported that our business revenues were down 88%. So throughout the second quarter, we saw a very steady sequential improvement in business travel from the first quarter. When I talk about business revenue, I am really referring to managed business travel. In terms of third quarter trends, we are continuing to see strong leisure travel throughout the summer. As I said, June’s leisure traffic performance exceeded 2019 numbers, and we are seeing that strength continue into July. In fact, we estimate that both leisure traffic and fares will trend higher in July relative to 2019 based on the trends we have seen so far. We are also seeing continued improvements in close-in demand and yields for business travel as well. So in total, that results in an improving July revenue outlook of down 10% to 15% versus 2019. In our earnings release, we introduced our August revenue outlook of down 12% to 17% versus 2019, estimating that August has a 1 to 2 point headwind compared to August of last year, due to the calendar shift that pushes all of Labor Day into September. Adjusting for the calendar shift, we are pleased with the way the booking curve is shaping up for the month, and demand and fares are also shaping up nicely for August. This is consistent with our expectations as we move from our highest leisure demand month, which is July, by the way, into August. With respect to business travel, the recovery path is less clear, but also clearly improving. Looking back to Q1 and every month in Q2, we have seen consistent sequential improvements over the past 6 months. We expect a continuation of steady weekly improvements in business bookings. More companies are returning to the office; we are seeing that. Corporate travel restrictions are beginning to be relaxed or removed altogether, which is great to see. We are undertaking our own surveys with our travel management company partners and business customers, speaking with them frequently and directly. We are encouraged by what we hear from them, and more importantly, we are seeing real travel activity. Business volumes and fares were down in the second quarter, but both showed improvement in April, May, and June and we expect sequential improvements in Q3 as well, though we expect overall yields will continue to be pressured in the third quarter versus 2019. Our booking curve for business has a natural tightening. I will say again that the guidance we are giving today doesn’t include any impact from the Delta variant. We have not seen any impact from the Delta variant at this point, so our outlook is based on trends that we are currently seeing, all of which are very encouraging. A quick comment on our Rapid Rewards and ancillary business: we saw another strong performance in Q2 in both our Rapid Rewards loyalty program and in our Chase co-brand credit card program. We have more Rapid Reward members today than we did in Q2 of 2019. June was actually the highest new member acquisition month in the history of the program, which was terrific to see. Our co-brand credit card program is larger now than it was pre-pandemic, with retail sales for the second quarter up nearly double digits compared to 2019, and the spend per card also beating Q2 of 2019 levels. We are pleased with the strength and performance of our loyalty and card programs. Ancillary revenue trends, such as upgraded boarding and EarlyBird, also performed extraordinarily well in the second quarter. A quick comment on our GDS initiatives, which are continuing to roll out. We have already gone live with Travelport and Amadeus, and will go live on Sabre on July 26, which is this coming Monday. This is a big accomplishment; it has been a tremendous amount of work, and it creates a big opportunity for us. This concludes the implementation phase of our industry-standard GDS works. We now have a full array of distribution channels, giving our business customers a channel of choice, be it on a GDS platform, Direct Connect/API channel, or our Swabiz self-service platform. Our Southwest business team is pretty energized and jazzed up; they have a great product to sell. We're in the right channels, and they are really focused on driving new business. The barrier is removed, making a big opportunity for us to win more business, both from existing customers and new customers. I think we are in a great position with a great business product and a great value. As of Monday, we will be in all the managed travel distribution channels, and I look forward to all the products we will create here. Just a quick comment on the network: we have made meaningful changes in our network since the pandemic began about 14 to 15 months ago. Over the past year, we have announced service to 18 new airports, with 15 of the 18 now up and running. All the new markets are performing within our expectations or ahead of our expectations. Each one is a very strong, very natural addition to our network that we have wanted to do for quite some time. New stations have a development curve; we understand that. We are pleased with where these stations are currently at. They will have time to develop. All of them are meeting or exceeding our expectations. We have the objective of restoring many of our pre-pandemic routes and O&D frequencies while also maturing in new markets. Our 18 new airports represent nearly 100 nonstop markets and over 280 new trips per day. By the end of the year, they will utilize roughly 55 aircraft. With our recent additions to Hawaii, we now have 37 trips per day from the Mainland U.S. to Hawaii with nearly 40 inter-island trips per day, utilizing roughly 37 aircraft. Our Boeing order book gives us tremendous optionality to fund our current network investments while also allowing us to pursue the planned restoration of our network, all of which we will be working through in our 2022 planning process that Tammy just alluded to. I think we are very well positioned for the future, and with that, I will turn it over to my friend, Mike, to talk about the operation.

Well, hi, thanks, Tom, and welcome everyone. From an operational perspective, I would say this is a pivotal quarter for us. We moved from managing and moderating our operation in the first quarter to really accelerating in the second quarter. If you compare March to June, we added about 650 additional daily trips, a 25% increase. Our customer and bag volumes far surpassed that, up nearly double with a 45% increase between those two months. That’s a monumental increase we have done in a short period of time in an airport environment that is still adapting, where everything in that environment seems to take a bit more time today. Our travel mix has been reported as primarily leisure, but our pre-check customers from a TSA perspective were down over 10% compared to June 2019. The airport restaurants have reduced hours or staffing levels, so there are longer lines. The third-party providers for wheelchair services have struggled to scale with customer demand. Hotel shuttle services have been less frequent, and the airport is one of the last experiences where masks are required. Considering all that, it’s a tough environment, and I am immensely proud of our employees. They continue to answer the call; they are truly Southwest warriors. They produced a very solid operation in the second quarter, so even as customer volumes increase, we launched service to seven new cities, rolled out our new maintenance IT system, and expanded our existing Hawaii service, all while delivering an on-time performance of 76.3%, in line with our pre-COVID results from 2017 through 2019. Our bag handling remains exceptional; it was our best quarterly performance outside of last year’s second quarter when travel demand was low. We continue to lead the industry with the lowest customer complaint ratio to the DOT for all marketing carriers. June was our most difficult month of the quarter. Our April and May outperformed previous years in all of our key operational metrics, and mid-month, we faced a combination of technology issues and weather challenges that caused significant delays into the network. We dropped our OTP to 62.4% for June. We need to and will do better moving forward. In July, weather is still a concern, as is the overall tempo of the airport environment, but the entire industry is feeling the impact, reflected in the overall industry OTP. We expect our operational reliability to continually improve. As we entered the second quarter, we had all the resources aligned until mid-June. Our focus areas for the operation moving forward include strong passenger demand and load factors going in and out of our large cities. We have 16 fewer flights than we did in June 2019, which means fewer ways to reaccommodate customers during delays or cancellations; longer operating days. We are adding staffing in several large cities to decrease peak hours. We have increased our minimum starting pay to $15 an hour and we are offering premium pay to employees willing to work open shifts. We are sourcing flight instructors to ensure we can support the training needs for pilots returning from an extended time off as well as our recurrent training needs. It feels good to be in a position where we can add flights and pick up our operating momentum. It’s messy; we have throttled down our activity and it’s messy coming back up, but our employees have navigated these challenges heroically. They have great hearts for our customers and each other, and I am so proud and thankful for their efforts every day. With that, Ryan, I think I will turn it back over to you.

Thank you, Mike. Chad, we will turn it over to you to give instructions on how to queue up for analyst questions.

Hey, everybody. Thanks for getting me on. I think there is probably a couple for Tammy but I am not sure. So the first one is where are you right now on average daily utilization and when do you plan on getting back to 2019 levels?

Yes, I can take that. So we are currently around 11 hours per day for our utilization. In terms of getting back, we are working through our schedule as we look into 2022. We are hoping to get back more in line with levels in 2019, but we are not too terribly far off either. A lot of that will depend on demand.

We still have what, 39 airplanes in storage as well.

Got you. And then sort of in the same vein on that, I know you said you’re going to continue to evaluate the 44 options. Given the ESG benefit you highlighted, is it fair to assume that the bar is very high for you not to exercise those, meaning whether it’s COVID-related or whatever, things would probably get a lot worse for you not to exercise those options? Is that a fair default way to think about it?

I think that it’s absolutely fair. We have a very cost-efficient Boeing order book. We have a strong ROI on those options. Obviously, we hope to continue growing the airline here, but if not, it’s a compelling business case for us to retire the older 700s. So, I think that is a fair assumption.

Thank you. Good afternoon, everyone. Maybe just the question on corporate. I think you said that your June corporate was down 69% and that’s a pretty nice step up from where it was a couple of months before that. I think some of the legacy peers are down a little less than that, so I am just wondering if that’s kind of normal given your mix of business and how do you see that trending over the next several months, given you are now complete with all your GDS integration?

What we’re seeing is something very similar to what I am hearing and reading from the other carriers as they report. To give you context, roughly 30% of our passengers are business travelers, producing about 35% of our revenues. We have the opportunity to drive more depth within existing accounts with GDS. You will see that begin to drive our Southwest business numbers up, if you will. We have seen about 5 points of improvement in Southwest business bookings each month over the past 4 or 5 months. We said in Q1 that we expected Southwest business travel to be down about 50% by year-end, and based on where we are now, we would beat that.

I can’t imagine that we are incongruous with anyone else in the industry.

That’s great color and that makes a lot of sense. Maybe a follow-up for Tammy, just given some of the labor issues that are hitting virtually every industry and every company out there. Maybe you can talk about what Southwest is seeing on the ground and some of the initiatives you are taking to make sure that you guys are fully staffed for the back half of the year? Thank you.

Yes, so we are increasing salaries across our system, the minimum wage there, which will certainly be helpful. We are actually staffed appropriately coming into the quarter, but there are some locations where we want to boost our hiring. We have recalled our employees that were on voluntary leave programs and we will recall all employees by the end of the third quarter, certainly by the end of the year. We are known as one of the best employers in America, so we don’t anticipate any issues there on the hiring front.

We have pockets where we need more people; we have pockets where we have too many people. We have been doing aggressive recruiting efforts in several of our large locations where we need workers. We have increased our minimum starting pay to $15 an hour to attract applicants for those positions. We will continue to ramp up hiring and will successfully meet that demand as we get into the next quarter.

The effort per hire is double what it used to be. So we acknowledge hiring is more challenging; I worry about it, but agree with Tammy and Mike. The minimum is up to $15 an hour, which will certainly help us.

Thank you for the time. Question for Gary and Bob, can you give us a sense for any differences in priorities, leadership styles, or relative strengths?

The biggest difference is that Bob is an Aggie, and I am a Longhorn. Other than that, we are sort of joined at the hip. Bob has been a part of coming up with and defining our purpose and vision, translating that into strategy, and he has been a huge part of the execution. I need to empower him and get out of his way; I had a good teacher in Herb Kelleher.

We are very passionate about developing our team and leaders for the next generation. I feel like we are similar in that way. I am probably a little more of a driver, which can be good but can also require slowing down and making wise decisions.

Thank you.

Hi, good afternoon everybody and thanks for taking my question. Just a very quick one from me. Any sense whether, not just you guys, but any sense whether you think the industry might need to step up its IT spend post-pandemic?

I think that’s the primary thing. The investment is significant and a hard area. This network is very technology-dependent; cybersecurity investment is very real.

We view ourselves as a technology company. We have an excellent team and ample dollars allocated for that effort. The pandemic has made us more efficient in our technology investment and management.

We did have a technology outage that hindered our operation significantly; it was not a cybersecurity issue, but rather a human error, and we are dealing with that.

I’m focused on improving the customer experience through investment to allow them to manage their lives via mobile devices.

Thank you very much operator for squeezing me and thank you guys. So I have two questions. One is, you talked about the level of credit card acquisitions in, I guess, the June quarter. I am wondering if you can say what you attribute that to?

We marketed it really hard with a strong offering and a lot more people traveling. It’s simply a great card worth the investment for the future.

Getting vaccinated increases consumer travel and spend, so it’s part of a large overall trend. We have commitments to diversity in our senior leadership group and are focused on developing our next generation of leaders. While we have a terrific pipeline, I would say we need to improve diversity in senior leadership.

We’re aware of our diversity benchmarks; it’s a process we believe we can improve upon over time.

I wanted to go back to the issue of the unruly passengers and ask, would Southwest advocate for more of those passengers to face criminal prosecutions versus civil penalties?

I have a hard time tolerating passengers that physically abuse our employees. That feels criminal to me.

We have policies in place to report abusive behaviors and support legal action where appropriate. We do not tolerate that type of behavior.

Thank you. If you have follow-up questions, you can reach out to our communications team. Thank you for joining us.