Southwest Airlines Company (LUV) — Q1 2022 Earnings Call Transcript

Thank you, Chad. And thank you all for joining us today. In just a moment, we will share our prepared remarks and then open it up for Q&A. Joining me on the call today, we have our CEO, Bob Jordan; Executive Vice President and CFO, Tammy Romo; Executive Vice President and Chief Commercial Officer, Andrew Watterson; and President and Chief Operating Officer, Mike Van de Ven. Just a few reminders that 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. Also, we had a few special items in our first quarter results, which we excluded from our trends for non-GAAP purposes, and we will reference these non-GAAP results in our remarks. Please see our press release from this morning and our IR website for more information, our cautionary statement, and our non-GAAP reconciliation for more detail. With that Bob, I'll turn it over to you.

Alright. Well, thank you, Ryan. Hello, everybody. Thank you for joining us today. Well, the first quarter was a tale of two really different environments. As expected, we incurred losses in January and February due to the negative impacts of the Omicron variant. We anticipated travel demand would rebound in March and we were pleasantly surprised at how quickly it bounced back and the extent to which demand and booking surged. While we reported a Q1 loss, we were solidly profitable in March, actually not too far off of March 2019's profit. And while modest, I'm very pleased that first quarter unit revenues increased as compared to 2019. That was the first quarterly increase since the onset of the pandemic. So, but for the Omicron impact, we estimate that we would have been profitable for the first quarter. In the first quarter, total operating revenues were 91% restored to 2019 levels, despite Q1 managed business revenues being only 45% restored. Looking forward, we're very encouraged with the bookings and revenue trends we're experiencing for Q2, which indicate operating revenues will be fully restored to quarterly record levels on stronger leisure and business demand. Our revenue initiatives continue to roll out and Andrew will cover our new fare product in more detail that we look forward to launching this quarter and getting another one of our revenue initiatives in place and producing value. We will have another meaningful fuel hedge gain in Q2, and we remain well protected with our fuel hedge portfolio in the second half of this year. Despite higher than normal unit cost inflation and productivity drags from underutilizing our assets, we expect to be solidly profitable for Q2 through Q4 and for the full year 2022. We are currently forecasting a healthy profit for Q2 with solid operating margins. Now, of course, this is based on our current outlook and barring any unforeseen material events, such as another wave that would impact or temporarily slow our progress, and we see no signs of that at this point. It just goes to show the power of our business model and how well our people are managing through a very difficult environment. Our March results and our current outlook for Q2 represent tremendous progress in our recovery. Even if we aren't fully expected to be optimized with our network fully restored until the end of next year, I'm just really, really proud of our people for their progress to date. We've come a long way, I'm just very thankful for their constant resilience. A key to our recovery is our continued hiring progress. And we now plan to hire and add over 10,000 new employees to the Southwest family this year, and that's net of expected attrition. By the end of this month, we will have welcomed roughly 6,500 new employees in 2022, and that's 5,000 net of attrition. And I'm just really pleased with our hiring progress. We continue to work through lower available staffing and training constraints to keep pace with rebounding travel demand. And we recently reduced our summer flight schedules to match our capacity guidance as we prioritize our operational reliability. I believe we have already accounted for the impact of staffing constraints in our full year 2022 guidance on capacity, down 4% versus 2019. But of course, we need to trim work capacity; we certainly can. But I'm cautiously optimistic that we can get to a good balance of headcount to operate our planned flights scheduled for the remainder of the year while setting ourselves up for resuming more material growth in 2023. You've heard me mention these things before, but we remain focused on a few key priorities for this year: first, getting properly staffed and focusing on our people; second, making progress toward our historic operational reliability and efficiency; third, providing our legendary hospitality; and fourth, returning to consistent profitability. It will take all 59,000 employees working together to execute on these focus areas and deliver a low-cost, high-quality product with low fares and great customer service. That's what our people are good at, and they've been good at that for 50 years, and they just do an incredible job. It's a tough environment, and they've been through a lot. I'm so grateful for them and what they do each and every day. Together, we're making tremendous progress to put this pandemic behind us. And while coming out of the pandemic has proven to be messy, as it was coming into the pandemic, I can assure you that we are very hard at work here at Southwest Airlines to make this company even stronger, and I remain very optimistic about our future. And with that, I will turn it over to Tammy.

Thank you, Bob, and hello, everyone. First, I'd also like to thank our employees for their resilience in yet another challenging quarter impacted by the pandemic and weather disruptions. The rapid rise of the Omicron variant significantly impacted our business in January and February, resulting in a first quarter net loss of $191 million, excluding special items. March, however, was a much different story as we experienced a rebound in demand and surge in bookings during the month, driving March operating revenues higher than March 2019. This was our first monthly revenue increase relative to respective 2019 levels since the pandemic began. Last month, cash sales also represented a monthly record as bookings surged for spring and summer travel. And we posted healthy double-digit margins for the month of March despite the significant rise in market jet fuel prices. Needless to say, I am excited about the strong revenue trends in the second quarter, as Andrew will cover in more detail in a minute. Taking a look at non-fuel cost, we are tracking in line with our 2022 cost plan with first quarter CASM-X coming in at the favorable end of our previous guidance range at up 17.9% compared with first quarter 2019. Thankfully, favorable airport settlements, better operational performance in March and lower-than-expected incentive pay created some end period cost relief in first quarter relative to our guidance. As we look ahead, we continue to experience unit cost pressure from operating at suboptimal productivity levels as well as higher inflationary cost pressures, primarily in salaries, wages, and benefits. We are leaving our full year CASM-X guidance unchanged at up 12% to 16% versus 2019 as we are still not able to fully utilize our assets or achieve optimal productivity levels due primarily to staffing challenges. That said, we do expect second-half 2022 CASM-X growth rate relative to 2019 to ease sequentially from first-half 2022. For our second quarter, we currently estimate CASM-X to increase in the range of 14% to 18% when compared with 2019 levels. Roughly half of that increase is a result of continued inflationary pressures in both labor and airport rates, which now includes labor rate increases across all workgroups as best as we can estimate at this point given the current labor market and our current outlook for profitability this year. We estimate the incremental labor accruals to be roughly 1 point to CASM-X. The remaining half of the CASM-X increase is attributable to headwinds from operating at suboptimal capacity and productivity levels. Our outlook for second quarter capacity remains down approximately 7% from 2019 levels. And while our moderated capacity plans are designed to provide operational relief given our current available staffing challenges, it continues to create unit cost headwinds, particularly with a shorter stage length as we add back higher-frequency business routes, which Andrew will speak to shortly. Turning to fuel. Market prices have been on the rise and highly volatile given the current geopolitical climate. Our fuel hedge is providing excellent protection against rising energy prices and significantly offsets the market price increase in jet fuel in the first quarter 2022. We are at 63% hedged for second quarter and estimate our second quarter fuel price to be in the $3.05 to $3.15 per gallon range, which is roughly $0.80 higher than our first quarter fuel price. That includes an estimated $0.61 of hedging gain, which represents cost savings of more than $290 million in second quarter alone. Of course, this is a snapshot of our fuel guidance at a point in time, and market oil prices and heating cracks have been moving pretty materially on a daily basis. By the way, the current energy environment is exactly why we hedge fuel. Even though the hedging gains in the second quarter won't fully offset the rise in market fuel costs, our hedging portfolio is providing meaningful cost mitigation. The fair market value of our fuel hedge in 2022 is estimated at roughly $1 billion. Turning to our fleet. We recently adjusted our order book with Boeing to replace the majority of our -7 MAX firm orders with -8 MAX firm orders in the short term, along with other adjustments, which we outlined in our earnings release this morning. I won't reiterate all the details but will note a few key highlights. Our current order book now reflects 21 -7 firm orders, 81 -8 firm orders, and 12 remaining MAX options in 2022. If you recall from our previous order book as of the end of last year, we had no -8 firm orders in 2022. While we are eager to bring the -7 aircraft into our fleet and remain confident in the aircraft, we simply wanted to go ahead and adjust our 2022 order book to provide more near-term certainty given the ongoing certification process for the -7. We are grateful for the flexibility we have in our order book to shift between -7s and -8s, and our plans this year to take 114 aircraft delivery and retire 28 -700 remain unchanged. While our CapEx guidance assumes we will exercise the remaining 12 options this year, we maintain flexibility to evaluate that intention as decision points arise each month. Given that the certification for the -7 has been going on for some time, we contemplated the possibility of taking some -8s this year into our 2022 CapEx estimate. Therefore, our CapEx guidance of approximately $5 billion remains unchanged. As I have mentioned before, we don't expect to incur a CASM-X penalty from holding onto extra aircraft versus accelerating -700 retirement while our capacity remains temporarily moderated. So from an economic standpoint, we may not decide to accelerate further aircraft retirements this year despite having more aircraft in our fleet than needed for current 2022 capacity plans. We are also mindful of aircraft and growth needs for 2023 as we plan to continue restoring the network. On our balance sheet, we ended the quarter with cash and short-term investments of $15.7 billion. Our leverage is at a very manageable 56%, and we continue to pay down and retire debt as opportunities arise as we have done with a portion of our convertible debt. We continue to be the only U.S. airline with an investment-grade rating by all 3 rating agencies, which remains one of our key competitive advantages. In closing, our second quarter financial trends are strong. Barring any unforeseen events or trend changes, we expect solid second quarter profit and operating margins. Our financial position and ample liquidity allow us to continue investing for the future so that we are ready to resume growth as soon as we are first able to restore our network and get staffing to desired levels. And we intend to grow. We are a growth airline. We have great momentum, and we are excited about the ample opportunities in front of us. With that, I will turn it over to Andrew.

Thank you, Tammy. I will provide some additional color on our revenue trends and outlook and point you to our earnings release for more detail. Looking first at Q1, January and February passenger revenues incurred 2 main negative impacts. First, $380 million due to softness in bookings and elevated passenger cancellations attributable to the Omicron variant. And second, an additional $50 million in January due to flight cancellations related to available staffing challenges, which were made worse by winter weather. However, we experienced a very different dynamic in March as we saw a surge in leisure travel and bookings along with a significant pickup in close-in demand. The improvement in March exceeded our original expectations for both leisure and business demand. March managed business revenues were down 36% versus March 2019 compared to our latest guidance of down 40% and put us back on a nice improvement trajectory from pre-Omicron performance in December of 2021. In fact, managed business revenues improved 34 points from January's down 70% to March's down 36%. We experienced higher managed business passengers. And most notably, March marked the first month since the pandemic began where managed business fares surpassed 2019 levels. Our revenue initiatives performed well during Q1 despite the Omicron impact. We saw benefits from our GDS initiative given the significant bounce-back of business demand in March. We also had a strong performance from our loyalty program with other revenue up 43% versus Q1 2019, which was assisted by incremental revenue from our new co-brand credit card agreement with Chase. A nice attribute from our new co-brand credit card agreement is that the revenue stream is rather insulated or diversified from the passenger revenue impact from COVID waves as long as consumer spending remains healthy. And Q1 retail sales spend per cardholder and overall portfolio size continue to grow versus 2019. Now our new market performance was impacted by the Omicron variant to a greater degree than the rest of our network. While Hawaii growth markets underperformed expectations slightly in March, largely driven by the COVID protocols that have since been lifted, we are encouraged by the strong demand we saw in March and heading into the summer months for Hawaii. We continue to adjust our Hawaii offering to best suit our customers' needs and allocate more of our capacity to business markets, and this can be seen in the changes beginning in June. In non-Hawaii new markets, we saw a modest outperformance versus expectations due to the sharp uptick in travel demand in March, which followed the general trend of the rest of the network of broad-based improvement across all geographies. All told, for Q1, we came in at the midpoint of our operating revenue guidance at down 9%. While the Omicron impact was higher than anticipated in January and February, the improvement in March outperformed our expectations, and we're very pleased with the recent revenue trends. Looking at Q2, the positive momentum continues, and we're expecting the operating revenues to turn positive versus Q2 2019, estimated to be up 8% to 12% despite capacity below 2019 levels and managed business revenues yet to fully recover. As we were already operating at pre-pandemic load factors in the low to mid-80% range, our revenue improvement outlook is primarily due to higher passenger yields, both leisure and business. We expect another solid contribution from our revenue initiatives, in particular with GDS as managed business revenues are expected to improve sequentially. April managed business revenues are expected to be down 30% versus April 2019, and we expect to see sequential improvement in May and June. We also expect our new fare product to roll out this quarter, which we call Wanna Get Away Plus. Having 4 fare columns displayed on our website is a natural evolution that is geared toward offering customers the attributes they want to choose while not taking anything away. The general attributes of Wanna Get Away Plus are: the introduction of transferable flight credits; more flexibility with same-day confirmed change in standby benefits; and a higher earned multiple for Rapid Rewards points. At the same time, our Anytime fares will gain the Express Fly By Security Lane and priority check-in perks where available, as well as EarlyBird Check-In benefits. We believe this will better represent the product offerings that our customers want and are going to pay for, and it has the added benefit of generating incremental revenue for the Company. Given the timing of the rollout, we aren't expecting a material benefit in Q2, but we are expecting a solid revenue contribution in the second half of 2022. Lastly, on our revenue initiatives, our revenue management system continues its progressive rollout. Before I wrap up, I want to share some color on our capacity and published flight schedules. We continue to expect our Q2 capacity to decline 7% versus Q2 2019. While this is a 2-point sequential increase in Q1, we expect a 5-point sequential decrease in stage length from Q1 as we establish trips in shorter-haul markets aimed at business travel and in an effort to provide more recoverability to the operation with more frequencies. We have now adjusted our published flight schedules through Labor Day to match flight activity to our 2022 capacity guidance. In terms of network restoration, we will be roughly 80% restored by June based on trips. And based on our full-year capacity guidance of down 4% versus 2019, we expect to be roughly 85% restored by December. As we have discussed, it will take us some time to rebuild the network that we want given current staffing constraints. We will continue to expect to restore the vast majority of our network by the end of 2023. And with that, I will turn it over to Mike.

Well, thank you, Andrew, and hello, everyone. On our last earnings call, I walked through the availability of staffing and our challenges that we face due to the Omicron variant and the roughly 5,000 employees that became sick in the first 3 weeks of January. As a result of that, we reinstated an incentive pay program that ran from January 9 through February 8. The incentive pay program worked as designed. Our employees responded very well. They picked up extra shifts that helped us cover the flight schedule for those employees out sick. While the program cost us $127 million, it afforded us an opportunity to stabilize the operation more quickly. In the first 7 days of January, our on-time performance was 41.2%. From January 8 through mid-February, that on-time performance jumped to 85.1%. That put us #2 for on-time performance in the industry, and that was a monumental feat after the start of the year that we had. What I think is most impressive about our people is that they not only stepped up to cover the extra shifts during what can only be described as an Omicron crisis, but they put Southwest Airlines in the top spot for customer satisfaction in January for the DOT's Air Travel Consumer Report, and we remained in the top spot among market shares in February as well. Our people have been through a lot these last few years, and just to accomplish that in the first 2 months of this year is just superb. My sincere thanks to everyone out there on the front line that's working hard for Southwest and are taking great care of our customers. I am very pleased that our employees and our customers can now make a decision for themselves as to whether or not they want to wear a mask on board our aircraft. I know that enforcing mask compliance has been a tough endeavor for our employees for a long time now, and they deserve a break. The science supports the mask mandate expiring. So great news on that front. Relative to early January, our operational performance in February and March improved. Our February flight levels stayed relatively low at 3,300 flights per day, and then they increased to roughly 3,400 flights a day in March. And as Andrew mentioned, travel demand in March surged with load factors in the mid-80s. We anticipated a ramp-up in demand, but we did run into a few challenges during March related to weather and ATC delay programs. In mid-March, we had Winter Storm Quinlan. That impacted many of our Mid-Atlantic and Northeast airports. And then we also had a line of severe thunderstorms that stretched from the Gulf of Mexico and across Florida, and that resulted in air traffic management programs, operational adjustments, and then resulting flight cancellations. In early April, we experienced a technology outage that caused similar issues, and it took a couple of days to work through that event. We've had a tough time during irregular operations given our center network and some of the unanticipated air traffic control slowdowns. The good news is that we've made some adjustments to our network starting this month that we believe will help, and I'll speak to them more shortly. On the staffing front, we continue to aggressively hire. And as Bob mentioned, we're now targeting over 10,000 new employees this year, net of attrition. The majority of this hiring is in the operations group, and it's imperative that we are properly staffed. The goal with the majority of these hires is to cover our published flight schedules and our capacity plans this year. But also, we intend to build some buffer so that we're ready to resume growth in the near future and get ahead of our spring and summer 2023 staffing needs. We are making great progress with hiring, but we have thousands of employees that are in training, and they're still gaining proficiency. So it just takes time before we'll have a full complement of frontline employees that are on the job versus either being a new hire and still in the training pipeline. So we've made trade-offs with lower capacity in order to support operational reliability. The combination of this and the continued hiring should help us as we move into the summer. On behavior trends and hours worked per employee, we continue to lag pre-pandemic metrics. We're still experiencing higher sick time, more employees on inactive status, and overall staffing availability challenges. We've also had some constraints on training throughput, but we believe we have a path to get the sufficient headcount in our key operational groups this year. It remains a work in progress, and it's one of our top priorities. Until then, our capacity will remain muted versus the aircraft that we would like to return to service to accelerate the network restoration. Lastly, Andrew mentioned that we expect our average stage length to decrease by about 5 points from the first quarter to the second quarter, and that should help us with our operational recoverability in Q2. We're adding short-haul flights in the business-oriented markets. That provides us more options when we have weather or ATC delays. We won't snap back to a historical network composition overnight, but I believe that our operational performance will continue to improve as we restore the network through the end of next year. That should provide the foundation to recapture better operating leverage, and we're also working on other initiatives to improve overall efficiency and return to our historic levels of productivity. And so with that, Ryan, I'll turn it back over to you.

Thank you, Mike. I believe we have analysts queued up for questions. And just a reminder, that please keep your questions to one and a follow up if needed. So Chad, please go ahead and begin our analyst Q&A.

A quick question on the corporate side. Can you just give us a little more detail on what you expect the corporate ramp trajectory to be through the rest of the year and the next year? And also, we're hearing from some corporate accounts that they expect a fair bit of competition in the second half of this year going into '23 when it comes to negotiating corporate travel agreements just given that we're coming off this trough and everyone is going to be fighting for a slice of pie. Or do you have any visibility into that or not?

Ravi, it's Bob. I'll start, and then I'll let Andrew provide more specifics. Our managed business recovery has lagged behind leisure, which is significantly ahead of 2019 at this point. We've seen a strong recovery. In March, we were down about 36% compared to 2019, but that's a 34-point recovery from January, indicating a significant trend. It appears that in April, we'll be down around 30%, and I'm optimistic that the trends will continue to improve through May and June. While it's still a forecast, I wouldn't rule out the possibility of our managed business revenues fully recovering to 2019 levels by the end of this year. I'll let Andrew add some details as well. Andrew?

Thank you, Bob. I would like to add to that initial macro perspective by noting that if we look back to before January, particularly around April of last year when corporations resumed traveling, we observed a strong upward trend, despite some fluctuations due to COVID waves. Now that we have moved past the Omicron variant and are experiencing a significant recovery, this trend continues on its upward path, which supports Bob's outlook. We are quite confident in this growth as it has shown resilience and a strong recovery through at least two COVID waves so far, which is certainly encouraging. Regarding corporate contracts, many have become outdated due to the lack of renegotiation opportunities during the pandemic. We anticipate a substantial renewal season for contracts this fall, as mentioned. Additionally, during the transition from pre-pandemic to now, we have significantly enhanced our managed business offerings through the GDS we discussed and by bolstering our Southwest business team with resources for TMCs and CTMs, along with increasing the number of account managers. We believe this broad renewal will be beneficial for us as we aim for a larger share of this market. Therefore, we are optimistic about the upcoming renewal season this fall.

Maybe one for Andrew. Sorry to stay with you. Just regarding the strong implied yield improvement in 2Q. If we assume a stable macro backdrop, so stable economy, stable fuel, how do you think about the progression of yields for the balance of the year? I'm not asking for explicit guidance or anything like that. But if the economy does not change and fuel does not change, is there anything you're thinking about which would cause yields to change seasonality or otherwise?

What we observed is that today's economic data wasn't favorable, so I'm unsure how long we can maintain the stance that our comments remain unchanged. However, consumer spending still appears strong in underlying details. The overall picture shows that demand for air travel, particularly for leisure, is exceeding 2019 levels, as Bob noted. On the other hand, supply has not returned to those levels. We don't anticipate a return to 2019 supply levels until much later this year. This scenario of demand surpassing supply has led to widespread price increases, largely due to the absence of discount fares and increases in fare structures. This trend is a positive factor for us. The uncertain element is the economy and its impact in the near term. There are certainly challenges like the Federal Reserve's rate hikes, but consumer spending fundamentals seem robust. Therefore, I feel quite confident that demand will continue to outstrip supply, at least within our guidance range. Does that address your question?

That's helpful. Yes, I couldn't get you to completely agree to no change on macro, but I think that's helpful color. Just as a follow-up, is there any way to think about yields on this 2019 baseline on a same-store basis? I mean I know the network looks very different than it did back then, and you alluded to that, but how much of this RASM expansion is the result of not flying lower marginal RASM routes because of your constraints right now?

It's difficult to generalize because the network and demand for leisure and business travel differ significantly. However, business fares have increased compared to 2019, indicating that overall demand is outpacing supply, regardless of route structure. While there may still be variations from one route to another, the overarching trend is a strong demand coupled with insufficient supply. A more detailed analysis would not reveal any different trends beyond this general observation.

Duane, I want to add that in the second quarter, we're forecasting overall operating revenue performance to increase by 8% to 12% even with a 7% decrease in capacity. This indicates a significant level of strength, especially considering that our managed business is still down, as mentioned in April, by around 30%. Additionally, as we work on restoring our network, we have 125 aircraft to integrate over this year and next. This restoration comes with lower than normal risks since these are routes we've previously operated and are connecting cities where we already have a presence. Therefore, we can expect to launch these routes without facing typical yield drags. Furthermore, if current trends continue, our business recovery is occurring at an accelerated rate, which should also benefit yield. However, we remain uncertain about the macroeconomic climate, as various factors could influence it, including Fed policies and the possibility of a recession. Nonetheless, despite these uncertainties, consumer savings remain more than double what they were before the pandemic, indicating significant consumer strength in their savings and potential spending. I hope this provides some clarity.

Maybe this one is for Bob or Mike. But can you guys just help us understand where the constraints are right now on operating more capacity? Because I hear you that you need to restore the network to pre-pandemic levels, but your stage length is only down maybe 2%, your FTEs look like they're almost back to 2019 levels, now maybe with a lot more new folks that need to be trained up. But is this really a pilot issue? Are you guys having trouble filling trainee classes? Can you speak to some of the constraints and what it's going to take to get back to where you want to be?

Yes, Brandon, let me respond first, and then Mike can provide further details. Our hiring progress since we resumed in the fall has been outstanding. We've brought on thousands of new employees and now expect to hire over 10,000 this year. While we do have some attrition, I’m really proud of our people department and hiring teams for achieving this from a complete standstill last fall. However, it's important to note that we are still below our total full-time equivalent headcount from 2019, so we haven't fully recovered to that level yet. Additionally, among the new hires, not everyone is currently working or performing efficiently. We've onboarded about 8,000 during this time, but around 1,600 are still in training and not yet on the frontlines. This affects our ability to operate more efficiently since they don’t contribute to our capacity at this stage. Furthermore, over 15% of our workforce has been added since the fall, and while they are out there working, they are still in the learning phase and not yet proficient. This impacts our capability to restore capacity effectively. As for our most significant constraints, they are primarily related to pilots and, to some extent, flight instructors for their training. Several thousand pilots took long-term leave due to COVID, and another 640 opted for early retirement. Our first priority was training and returning those on leave to active flying, which we completed in February of this year. The next step is to replace the pilots who retired early, and we are about two-thirds of the way through that process. So, currently, the main constraint we face is on the pilot side. Mike, please go ahead and provide additional details.

Yes, Brandon, most of the other work groups we hire operate through a simple one-step process where we find and interview candidates. However, for pilots, it’s a two-step process. The first step involves ensuring we have flight instructors ready to help us reach our full capacity for flight training. Currently, our focus is on filling training slots with flight instructors to achieve maximum hiring capacity by the end of this year and into next year. Regarding access to pilots, we are an airline that pilots prefer to join, with a long track record of success. This enables us to fill our training classes and maintain access to pilots, particularly in the coming year or two.

Just two questions. The first question is on the crew members who worked extra hours. Are you concerned that as the year goes on, especially at the end for the peak, there won't be enough crew hours for them to fly during the busy year-end season?

Yes. Helane, are you talking about pilots running up against their block hour limits for the year?

Yes.

Yes. I don't think that we're at risk of that at all. We've got our schedule adjusted for the capacity that we have. We'll see more pilots coming online in the second half of the year. And so I don't think we'll have an issue with that.

Okay. That's very helpful. And then maybe, Tammy, one for you since you've been so quiet during this Q&A. On cash and liquidity, how are you thinking about bringing cash down to whatever your new minimum liquidity or cash level is going forward?

Yes, thank you for the question, Helane. Our liquidity is significantly higher than it has been historically. If we have learned anything from the pandemic recovery, it can be unpredictable. However, we are making substantial progress, as indicated by our second quarter outlook. This progress, combined with our fuel hedge protection, positions us very well for the future. We want to navigate comfortably past the pandemic and maintain ample cash reserves for business investments, which we have previously communicated. Over time, we plan to gradually reduce our cash levels. Currently, we aim to maintain around $10 billion in cash, but we believe we can lower that moving forward. We may need to return to historical levels, estimated to be between $2 billion and $3 billion, possibly higher. Our immediate priority is to achieve consistent profitability, which looks promising. We also intend to invest in the business and ultimately return value to shareholders. We are eager to reinstate our dividend and will consider share repurchases as appropriate, based on our free cash flow and profitability. In summary, Helane, we aim to return to the performance we had before the pandemic, which starts with solid capital returns and profitability. We believe we are making good strides towards that goal and want to get back to pre-pandemic levels.

Just a question on the stage length. You mentioned kind of 5 points of contraction here in this quarter. And I would assume that a lot of those other markets that you're adding on short haul as well, that might continue to contract. Any color you can give us over the next few quarters on how that will trend? Or was there something kind of unique about the network restoration this quarter that had a bigger jump than you expect going forward?

Yes, it's good to talk to you, Savi. I'll start with an overview, and then Andrew can provide insights from a network perspective. As we redesigned our network during the pandemic, it became clear that leisure travel would recover more quickly than business travel, so we focused on that. We started flying longer routes and made adjustments in areas like intra-California. Now that business demand is returning, we want to position our network to capitalize on that. We're adding more short-haul flights to build a network that aligns with the anticipated business demand. This added depth not only meets the business needs but also improves our ability to serve customers effectively, particularly when operations are regular. Andrew can elaborate on how we see this evolving, but it's important to note that the shift we've experienced—a five-point change in stage length quarter-over-quarter—is significant. Although you didn't ask about it, this fluctuating stage length impacts our costs as well. We've seen costs rise, and our CASM-X projection has gone up by 14% to 18%. About half of that increase is due to rising labor rates and typical inflationary pressures at airports, while the other half stems from inefficiencies in the system and the impact of the reduced stage length from Q1 to Q2. Andrew can offer additional details about our stage length and future outlook.

Yes, certainly. If you kind of break down our network into short, medium, and long hauls, what's really going on here is we're adding back lots of short haul and even more medium haul versus 2019 in order to kind of restore the network. It also happens to be kind of business-oriented as we see business demand recovering. And then also, as Mike mentioned, helps the network, all things being equal, for recoverability. So really, it's a case of what's missing, and that's the long hauls that will probably be the last to be restored. Because they'll be attractive to customers and they do well financially, they don't add as much to kind of network resiliency or kind of business travel recovery. And so we kind of prioritize those. And so you'll see stage length for a period of time be down as a result of this. And then towards the end of restoration, you should expect it to start to come back up a little bit as those long hauls get restored.

That's helpful. Is there kind of a general on that just the stage-length level that you think you'll get back to when it's fully restored?

Yes, I believe that by the end of next year, we should be largely restored, and our goal is for many of the network metrics to resemble those from just before the pandemic. That's our target. In this new phase, we have introduced elements during the pandemic that could enhance the network's overall appeal, but the balance of short, medium, and long routes, as well as point-to-point versus connecting services, will revert to the network structure we appreciated before the pandemic.

Can I ask a quick follow-up on the pilot responses earlier? I was curious about your comments on setting up for more material growth in 2023. It seems like for Southwest, hiring isn't the issue; it's clearly an attractive destination, but training class sizes and the associated bottleneck seem to be on the training side. When you refer to material growth next year, are you expecting your training class sizes to increase? What changes will support you in achieving growth next year, particularly regarding pilots?

Yes. Well, Savi, we've got a 26-bay training facility out there. Currently, we have 23 of those bays filled. We're going to have three additional simulators coming online later this year, and they'll be ready and fully operational for next year. So we have that capacity growth there. And then as I said, if we can get our instructor level up to our targeted levels, we'll have plenty of capacity in terms of our training to produce more pilots next year, even balancing out our recurrent training with the new hire training and the upgrade training.

I don't know who it's for, but I'll pose it anyway. You had really good growth in ATL; maybe just 10% below Q1 '19 levels, but the big three at 50% to 100% higher ATL growth in the first quarter this year versus 2019. And I guess my theory is that it's because of the policy change on change fees, but curious if you have a perspective on that relative performance.

No. Really nothing to do with any policy change fees at all because we have not really changed that.

Sorry. I meant fare change fees changing.

Yes. The demand environment is obviously very strong. We experienced a surge in bookings in March, demonstrating solid and robust demand. This trend is evident on both the leisure side and the corporate side, which I would attribute to strong bookings.

No, I think it's just that our training capacity has improved slightly, and that's really the main difference. There's no other significant change. It will take time into 2023 to fully restore our network and operate all our aircraft, and the sooner we can achieve that, the better. I'm really proud of our hiring team because we've ramped up from a complete halt to hiring approximately 1,500 people a month within six months. Essentially, it's an improvement in our hiring capability rather than a change in our target hiring.

Maybe just staying on the labor front, labor availability has been a major theme this quarter. It seems like you guys got ahead of the curve realigning your outlook for this year. So, asking a longer-term one. When we get beyond 2023, I know there'll be some lumpiness with changes to this year, but beyond 2023, is your five-year guidance for mid-single digit capacity growth and low single-digit unit costs still doable in your view based on what you can see for your own hiring pipeline and then what you're hearing from airports and your third-party vendors?

There's a lot of uncertainty out there. We have unknowns regarding the workforce, such as who will return and what factors are influencing those currently outside the workforce. Inflation concerns, Federal Reserve policy, and the possibility of a recession create additional complexities. These elements significantly impact the macro economy, which in turn affects the workforce. We have limited control over these factors, and our projections are quite varied at this time. However, while hiring is more challenging, we have not encountered difficulties in finding quality candidates. I spend considerable time with new hires, and I'm proud to welcome them to Southwest Airlines because they align well with our values. We will need to continue to work hard and adjust our hiring strategies, utilizing faster processes and new channels like social media for recruitment, including instant interviews and offers. Looking beyond 2022 and 2023, I do not anticipate that the labor market will hinder our growth ambitions. Our primary objective is to maximize the utilization of our aircraft and fully restore our network. Moreover, we have new aircraft on the way and numerous opportunities ahead, as demonstrated by our expansion into 18 cities, which we plan to capitalize on.

Yes, Bob. And the only thing I would add to that is just in terms of our five-year targets, I agree. I do think we were out ahead. We were certainly expecting inflationary pressures this year, and that's certainly playing out here as we go. But I think we all have confidence in our plan, and so nothing that we're sharing with you today would change any of the five-year targets that we shared with you back at Investor Day.

I understand your question. In terms of our aircraft mix, we have significant flexibility with our network. As we've discussed this year, we're focused on restoring it, which requires a variety of aircraft. We're quite confident about incorporating the MAX 8, and as mentioned earlier, we've confirmed 81 orders for this year. We'll keep monitoring the situation as we move forward, and I don’t foresee any issues from a network standpoint even into next year. We will continue collaborating with Boeing to finalize our positions. Overall, we are very satisfied, have plenty of options, and believe we can manage everything effectively as we work to restore our network and grow.

Catherine, my perspective is that we have two main goals with the fleet. We aim to modernize the fleet and also require additional shelves to restore the network. Ultimately, I believe we are comfortable with a split between the 8s and the 7s, whether it's 60% to 40% one way or the other. It may be somewhat inconsistent as Boeing gets the MAX 7 certified, but as you plan for the next couple of years, we expect to stay within that range, and we do not want to give up delivery slots in the near term because modernization and restoration are very important to us.

Quick one here for Andrew. Can you just walk through some of the considerations what drove sort of your thinking in expanding the Hawaiian interisland operation? And as a consequence of that, are you going to have to establish either a pilot and/or flight attendant domicile there?

I'll begin with the last part first. Typically, we have significantly larger operations before we create domiciles. Additionally, as I mentioned earlier, we restructured our operations in Hawaii during both the summer and fall. A key aspect of this was reallocating more capacity to the business market due to its strong recovery. We also made adjustments to our Mainland Hawaii flying, focusing on optimizing our connectivity, as it primarily operates on a point-to-point basis with some additional connections. We are determining where to establish gateway connections to the neighbor islands in Hawaii. Consequently, we are reducing flights from the Mainland to Hawaii while increasing flights between the islands. This adjustment benefits business travelers by providing more opportunities for day trips, particularly since the previous schedules did not support reliable travel for business purposes. For example, when traveling for business in Hawaii, especially to Maui, there aren’t many business hotels, which necessitates returning the same evening. Therefore, our service pattern now accommodates early morning departures and evening returns, which is appealing to business travelers. This increase in flight frequency serves multiple purposes and is part of a broader plan that includes a 20% reduction in Mainland to Hawaii flights.

There are two main aspects to our hiring process. First, we need to catch up to the current fleet and network restoration. We're still below our 2019 headcount overall, and many of our new employees are either in training or still developing proficiency. Typically, it takes six months to a year for them to become fully proficient as longer-term employees. So, we need to improve in that area. Second, we want to get ahead because we have 114 aircraft coming in this year and 90 more next year, with some retirements affecting our total. Restoring the network is a significant task. Part of the 10,000 we plan to hire is aimed at catching up, while another part is to get ahead of our needs. Ultimately, our primary goal is to operate all our aircraft, restore our network, and ensure reliable operations. By the end of 2023, we aim to return to our historical operational reliability and regain the productivity levels we had in 2018. I can't provide an exact number for 2023 hiring due to factors like attrition. However, given the deliveries and net retirements, it seems reasonable to expect that overall hiring in 2023 may be a bit lower. But again, our focus remains on utilizing all resources, flying all aircraft, and returning to our historic efficiency and reliability by the end of 2023. On the pilot hiring front, Mike can provide more precise numbers, but I estimate that we hired roughly 1,200 pilots in 2022. Mike, could you share more details about the pilot hiring?

Yes. Just a couple of things. In terms of the hiring, just the way I think about that, I'd always rather go faster than slower. When we get behind on staffing, it just takes a longer time to catch up with that. And then if we can have staffing with some cushion, it gives us a better cost profile with less premium pay. It gives us a better operational recovery profile. And if you find yourself in an overstaffed situation, you can just dial back the hiring and you can solve that pretty quickly. So just as a frame of reference, the faster that we can hire and get up to speed for us, the better. In terms of the pilot hiring, Bob is right. We've got somewhere just north of 1,000 pilots here this year. And then if we can get up to full capacity, we can produce probably close to 2,300 pilots next year if we needed to. Bob?

Just two questions. The first question is on the crew members who worked extra hours. Are you concerned that as the year goes on, especially at the end for the peak, there won't be enough crew hours for them to fly during the busy year-end season?

Yes. Helane, are you talking about pilots running up against their block hour limits for the year?

Yes.

Yes. I don't think that we're at risk of that at all. We've got our schedule adjusted for the capacity that we have. We'll see more pilots coming online in the second half of the year. And so I don't think we'll have an issue with that.

Okay. That's very helpful. And then maybe, Tammy, one for you since you've been so quiet during this Q&A. On cash and liquidity, how are you thinking about bringing cash down to whatever your new minimum liquidity or cash level is going forward?

Thank you for the question, Helane. Our liquidity is significantly higher than it has been in the past. We've learned that the recovery from this pandemic can be unpredictable, but we are making solid progress, as reflected in our second quarter outlook. We feel encouraged by our direction, especially when considering our fuel hedge protection. Overall, we believe we are well positioned. We aim to move comfortably beyond the pandemic while maintaining sufficient cash reserves for business investments. As we've communicated, we currently have an agreement to keep around $10 billion in cash, but we plan to gradually reduce that amount. Ideally, we would like to return to historical cash levels, which were around $2 billion to $3 billion, although they may need to be higher. Our immediate focus is on achieving solid profitability, and we also want to reinvest in the business and return value to shareholders. We have a strong desire to reinstate our dividend and will look at share repurchases when appropriate, depending on our free cash flow and profitability. To summarize, we want to return to the performance levels we had before the pandemic, which begins with ensuring adequate returns on capital and profitability. We are making good progress and are committed to reaching those pre-pandemic benchmarks.

Just a question on the stage length. You mentioned kind of 5 points of contraction here in this quarter. And I would assume that a lot of those other markets that you're adding on short haul as well, that might continue to contract. Any color you can give us over the next few quarters on how that will trend? Or was there something kind of unique about the network restoration this quarter that had a bigger jump than you expect going forward?

Yes, it's great to speak with you, Savi. I'll start and then let Andrew provide his insights from a network perspective. As we redesigned the network to adapt to the pandemic, it became clear that leisure travel would rebound more quickly than business travel, so we focused our efforts there. We increased our longer flights and made adjustments in specific areas like intra-California. Now that business travel is starting to return, we want to ensure our network is positioned to capitalize on that. Essentially, we are reintroducing more short-haul flights to better align our network with the anticipated business demand. Fortunately, in addition to catering to business travelers, this enhancement in our network will also improve recovery for our customers, offering greater network depth. When operations are normal, this is particularly beneficial. Andrew can share more about the future outlook on whether this trend will persist, but we have observed a notable shift—a significant 5-point change quarter-over-quarter in stage length. Although you didn’t ask, it plays a role in our cost narrative for the second quarter, with costs rising and our CASM-X projection climbing by 14% to 18%. About half of this increase is attributed to labor rates, airport expenses, and general inflation, while the other half relates to system inefficiencies and the impact of the reduced stage length from Q1 to Q2, which has also had a significant effect. Andrew, please feel free to add more detail regarding this and our forward-looking stage projections.

Yes, certainly. If you kind of break down our network into short, medium, and long hauls, what's really going on here is we're adding back lots of short haul and even more medium haul versus 2019 in order to kind of restore the network. It also happens to be kind of business-oriented as we see business demand recovering. And then also, as Mike mentioned, helps the network, all things being equal, for recoverability. So really, it's a case of what's missing, and that's the long hauls that will probably be the last to be restored. Because they'll be attractive to customers and they do well financially, they don't add as much to kind of network resiliency or kind of business travel recovery. And so we kind of prioritize those. And so you'll see stage length for a period of time be down as a result of this. And then towards the end of restoration, you should expect it to start to come back up a little bit as those long hauls get restored.

And can I ask a quick follow-up on the pilot responses earlier? I was just curious; in the opening remarks, you mentioned setting up for more material growth in 2023. Just curious like how—because it seems like, again, for Southwest, hiring is not the issue; clearly an attractive destination, but training class sizes and that bottleneck seems to be on the training side. So when you talk about kind of material growth next year, I mean, are you expecting your training class sizes to get bigger? Or like what's going to change that helped you get back to kind of growth next year, especially on the pilot side?