Southwest Airlines Company (LUV) — Q2 2023 Earnings Call Transcript

Thank you, operator, and welcome, everyone, to our second quarter 2023 conference call. In just a moment, we will share our prepared remarks and then jump into Q&A. On the call with me today, we have our President and CEO, Bob Jordan; Executive Vice President and CFO, Tammy Romo; Executive Vice President and Chief Commercial Officer, Ryan Green; and Chief Operating Officer, Andrew Watterson. A quick reminder that we will make forward-looking statements, which are based on our current expectation of future performance, and our actual results could differ materially from expectations. Also, we will reference our non-GAAP results, which exclude special items that are called out and reconciled to GAAP results in our press release. So, please refer to the disclosures in our press release from this morning and visit our Investor Relations website for more information. With that, Bob, I’ll turn it over to you.

Thanks, Julia, and good morning, everyone. I appreciate you joining us for our second quarter 2023 earnings call. I am very pleased to report a solid quarter with net income of $693 million, excluding special items, and all-time record quarterly revenue of just over $7 billion. The demand environment, especially for leisure travel, continues to be resilient as we have seen solid bookings throughout the busy summer travel season. Further, we continue to expect $1 billion to $1.5 billion of pre-tax profit contribution in full year 2023 for our strategic initiatives that we outlined at our Investor Day last December. Based on our current outlook, we continue to expect record operating revenue and solid profits in third quarter 2023 and year-over-year margin expansion for full year 2023. I especially want to thank our people for doing such a fantastic job. They helped us get a record number of customers and a record number of bags on a record number of flights successfully to their destinations, as we experienced the lowest second quarter flight cancellation rate in the past 10 years. It wasn’t without trials. We had a lot going on in the operation related to weather, and weather has continued to be a challenge here in July. Despite that, our employees have continued to deliver a very solid performance. From our network ops control center to the front line, our people have worked together extremely well to minimize cancellations and produce a very reliable operation, and I’m just so proud of them for getting our customers where they need to go, despite a challenging operational environment. While our cost outlook has increased for the year, the change is primarily driven by updates to our market wage rate accruals for open collective bargaining agreements. And while fluid, we’re making progress. It’s obviously very hard work and I’m just very appreciative of the dedication of everybody involved in the negotiation process. Now, thinking about where we are with the business, since 2018, we have seen very significant swings due to the grounding of the MAX, demand fall-off, of course, from COVID, then the stress from the resurgence of demand, disruptions from post-pandemic supply chain issues, challenges with employee staffing, and most recently, uncertainty with our Boeing aircraft deliveries. The challenges we have faced since 2018 have made planning difficult, so smoothing out fluctuations is a must, and the best way to do that is with smooth and predictable capacity growth. We told you back in April that we were reflowing our order book to allow for orderly and measured growth, and we’re still finalizing the details of that with Boeing, but we remain confident that we will get the 70 deliveries in 2023 that are assumed for our published schedules, and we are working to build a 2024 plan that should be much more stable. We currently are planning to be flying the MAX 7 at some point next year, but if not, we’ll take MAX 8 instead just as we are doing now. Where that leaves us for full year 2023 capacity is unchanged for this year at up 14% to 15% year-over-year. As we shared this morning in our release, we are revamping our 2024 flight schedules. While our network is largely restored at this point, it is not optimized, especially for post-pandemic shifts in business travel. Those adjustments to the network will be largely complete by the March 2024 flight schedules, and we expect those efforts and the continued maturation of development markets to generate an incremental $500 million in pre-tax profit in 2024. The changes will also reduce the percentage of system capacity in development by more than half, returning to normal pre-pandemic levels by the end of next year. We already have our schedule published through March 6, 2024, and currently expect first quarter 2024 capacity to be up in the range of 14% to 16% on a year-over-year basis. Now, keep in mind that nearly 90% of that year-over-year growth is carryover from 2023. For the remainder of 2024, we are planning for a sequential deceleration in year-over-year growth in each quarter next year as we work our way back to our long-term goal of mid-single-digit growth year-over-year. We’ve made a lot of progress in the first half of 2023, completing several major milestones. We quickly developed and are on track for our winter operations plan. We have the staffing plan in place to fully utilize our fleet by the end of the third quarter and have the network restored by the end of the year. Again, to be clear, it’s restored but not yet optimized, and Ryan will share more on how we’re going to adjust the network based on post-pandemic travel patterns. But we have a lot of exciting things in the works that we believe are going to contribute to our 2024 financial results and help us deliver another year of margin expansion next year. In closing, our accomplishments in 2023 lay a foundation for us to shift our focus to restoring our industry-leading financial and operational performance, boost our operational resilience, and make advances in our industry-leading customer service through a focus on digital hospitality. I just can’t say this enough, I’m just so proud of our people. They are the heart of Southwest Airlines, and they deliver day in and day out for each other and for our customers. And with that, I will turn it over to Tammy.

Thank you, Bob, and hello, everyone. First, I’d like to extend another thanks to our employees for their commendable efforts this quarter, resulting in solid operational and financial performance, a hard-earned improvement from where we began the year. Overall, we had a really solid quarter. Operationally, we had a great completion factor, despite many weather challenges. Financially, bottom-line profits were in line with our expectations, despite pressure from market-driven labor accruals. We produced an all-time quarterly operating revenue record. We also generated double-digit operating margins each month during the quarter. All of this was made possible by the drive and hard work of our incredible employees. I just can’t thank them enough. Ryan and Andrew will speak to our revenue trends and operational performance, so I will jump right to cost, fleet, and then balance sheet. Beginning with fuel, our second-quarter jet fuel price was $2.60 per gallon, slightly above our previous guidance. Throughout the second quarter, crude oil prices stayed within a reasonable range, hovering for the most part around $80 per barrel. We are 49% hedged for the third quarter and estimate our third quarter fuel price to be similar to our second quarter fuel price, and that includes an estimated $0.08 of hedging gains. We now estimate our full year 2023 fuel price to be in the $2.70 to $2.80 per gallon range, including $0.09 of hedging gains. This is up a dime from our previous guidance due to higher refining margins. Of course, market oil prices and heating cracks can be volatile, which is why we hedge. We are currently 54% hedged in 2024, and over the last few months, we’ve added meaningfully to our 2025 portfolio and began building our 2026 portfolio. The total fair market value of our fuel hedge portfolio for third quarter through 2026 is $373 million. We will continue to seek cost-effective opportunities to expand our hedging portfolio with a continued goal to get to roughly 50% hedging protection each year. Moving to non-fuel cost, our second quarter year-over-year CASM-X increase of 7.5% was towards the unfavorable end of our guidance range due to incremental adjustments to market wage rate accruals for our open labor agreements. We have said this from the beginning, but our labor accruals are based on market, and in this environment market has obviously been dynamic. We are planning and eager to award our workgroups with well-deserved compensation increases. Looking ahead, our nominal third quarter cost trends remain fairly consistent with second quarter. We currently estimate our third quarter CASM-X to increase in the 3.5% to 6.5% range year-over-year. This increase is again largely driven by higher labor costs. We are also continuing to incur additional maintenance expense relative to 2022 for our -800 fleet as more engines come due for heavy maintenance, adding further pressure to our second half cost inflation. For our full year 2023, we now estimate CASM-X to decrease in the range of 1% to 2% year-over-year compared with our previous guidance of down 2% to 4%. The estimated 0.5 increase is due primarily to higher labor cost pressures as I’ve already covered. Turning to our fleet, during second quarter, we received a total of 21 aircraft deliveries and retired 11 -700 aircraft, ending the quarter with over 800 aircraft. We are working to reflow our order book with Boeing. However, for this year, we continue to plan for approximately 70 -8 deliveries and 26 -700 retirements, which takes the fleet to 814 aircraft at year-end. Likewise, our CapEx outlook remains unchanged at approximately $3.5 billion, which assumes approximately $2.3 billion in aircraft capital spend. Our 2023 capacity guidance also remains unchanged. We continue to expect full year 2023 capacity to be up approximately 14% to 15% year-over-year, and we have tightened our third quarter capacity guidance to be up approximately 12% year-over-year. As Bob mentioned, we are planning for first quarter 2024 capacity to grow 14% to 16% year-over-year. Now, keep in mind, we are growing 14% to 15% in 2023, and that alone drives nearly 90% of that first quarter year-over-year growth. So, the primary driver of that first quarter year-over-year growth is annualizing the additional capacity we are adding this year. But our long-term goal remains mid-single-digit year-over-year growth. Lastly, our balance sheet remains pristine and we remain the only U.S. airline with an investment-grade rating by all three rating agencies. We ended second quarter with cash and short-term investments of $12.2 billion, net of $67 million in debt repayments for the first half of the year. We continue to be in a net cash position and expect a modest $16 million in scheduled debt repayments for the remainder of the year. And currently, 2023 interest income is still expected to more than offset 2023 interest expense. We declared another dividend in second quarter which was paid just a couple of weeks ago. I am proud of what we have accomplished through the first half of the year. That said, we still have work to do to return to industry-leading financial performance, which is our priority as we work on our plans for next year. This includes managing the ongoing inflationary cost pressures, reflowing our order book with Boeing to support orderly, measured and profitable growth, and rebalancing and optimizing our network. We believe these plans, combined with our existing initiatives and the maturation of our development markets will help us expand both margins and return on invested capital in 2024 as compared with this year. Let me close by saying my confidence in our ability to achieve our financial and operational goals is anchored by my belief in the people of Southwest Airlines and their ability to create and inspire success. And with that, I will turn it over to Ryan.

Thanks, Tammy. I’ll walk you through our second quarter revenue results, provide context for our third quarter outlook, and update you on some of our commercial priorities. And for additional detail on our revenue performance, I’ll point you to this morning’s earnings release. Starting with second quarter, demand continues to be resilient, especially for leisure travel. Overall trends have remained steady with operating revenue for the first half of 2023, consistently well above 2019 pre-pandemic levels. Operating revenue for second quarter was an all-time quarterly record of just over $7 billion. And in fact, we had record operating revenue in every month of the quarter. Second quarter 2023 unit revenue or RASM decreased 8.3% on a year-over-year basis on a capacity increase of 14.1%. And while it’s a year-over-year decline, it’s still our second highest second quarter RASM to date, which points to the tough comp we were up against from last year. And as a reminder, year-over-year RASM was impacted by a 5-point headwind from approximately $300 million of higher-than-normal breakage revenue that was recognized in the second quarter of 2022, resulting from flight credits issued during the pandemic that were set to expire prior to our later policy change to eliminate flight credit expiration dates. Overall, second quarter revenue came in at the favorable end of our expectations as close-in leisure held strong. Second quarter revenue from corporate travel came in largely as expected, as we realized sequential and year-over-year improvement in managed business revenue. While travelers from some of our largest segments have reduced their frequency of their business trips from pre-pandemic levels, we’re very pleased with the gains we continue to make in the managed business space. Small and medium businesses, government, and education are strong points for us, and we are growing the number of accounts we have under contract. All of this has allowed us to continue to grow our share of the managed business travel. We gained additional passenger market share in the second quarter and exited the quarter seeing more unique travelers flying for business than we saw pre-pandemic. Moving to the third quarter, we’re seeing leisure booking and yield strength continue throughout the summer travel season with July revenue, which is essentially booked, expected to also be a record. Of course, much of the post Labor Day booking curve comes in closer but we’re very encouraged by the response to our June fare sale for off-peak fall travel and what that suggests for continued leisure demand. We had all-time record bookings the week of our fare sale with three booking days that were top 10 all-time records and included our record day for the most bookings ever taken. In fact, we have more passengers booked for third quarter travel at this point in the curve than we did at the same point in time for second quarter. Of course, on a revenue basis, nominal yields are typically weaker sequentially third quarter versus second quarter but the strength in passengers points to the continued demand for Southwest Airlines. We currently expect overall corporate travel to have a modest underlying trend improvement, and we expect to continue our gains in industry market share. Overall, however, we expect corporate travel demand will remain lower than leisure for the foreseeable future, particularly compared with pre-pandemic. So with a higher leisure mix, and as the number of business trips taken per traveler remain down for our most frequent customers, it gives us an opportunity to look at our current network design. Pre-pandemic, those travelers had a skew of short-haul travel with more frequent trips and also more midweek travel, and our current network is designed assuming those travel patterns would return. Moving forward, there is a revenue opportunity to adjust the network to adapt to the new travel patterns we expect to continue to see from our mix of business and leisure customers. Ultimately, this leaves us with third quarter unit revenue expected to be down 3% to 7% year-over-year on capacity up roughly 12% again on a year-over-year basis. The decline in year-over-year unit revenue is driven by capacity growing faster than seasonably typical as we restore the network and normalize the utilization of our fleet, as well as tough prior year comparisons from the post-pandemic domestic demand surge. So, while there is still room to optimize our unit revenue efficiency, this guide implies a third quarter record for operating revenue. So again, we are in the process of adjusting our network to support our imperative of industry-leading financial performance. Starting with the January 2024 schedules, we’ve made changes to the composition of the network such that it supports the customer travel behavior changes I just mentioned. We made changes that reflect where our customers are traveling and when they’re traveling, including time of day and day of week, and this optimization will be largely complete in spring of 2024. In addition, we have more than 10% of our markets under development, which will normalize closer to pre-pandemic levels over the next 12 to 18 months. So, as we said in the release and as Bob mentioned earlier, the go-forward revenue opportunity from the network is substantial. And of course, we also expect continued revenue contribution growth from our existing and fully implemented revenue initiatives. Finally, we have always worked hard to consistently deliver the best hospitality and customer service here at Southwest. Our customer service is, of course, legendary, and our customer policies are industry-leading. We are on track in deploying our onboard product initiatives, including Wi-Fi upgrades, larger overhead bins, and in-seat power. We are now focused on widening our customer service advantage through prioritizations of a series of initiatives that will improve our digital hospitality and allow our customers to serve themselves in most cases. We aren’t ready to provide you all the details there, but the initiatives will help us achieve our goal to deliver the best and most efficient hospitality with next-generation tools, airport layouts, and more. And now, with that, I’ll turn it to Andrew.

Thank you, Ryan, and hello, everyone. I’m going to provide some additional details on our operational performance and a brief update on our Winter Operations Preparedness Plan. Well, I’ll just start by commending our employees for their warrior spirits and the solid operational performance they delivered in an operationally challenging quarter. As Bob mentioned, we had record flight activity, record customers, and record bag counts. But we were ready. We were staffed up and we were prepared. Our completion factor in the second quarter was really pretty remarkable. We reliably achieved a flight completion factor of more than 99% in the second quarter. It was the highest second quarter performance in the past 10 years. And that is despite the challenging environment. June, in particular, had tough operating conditions. We had issues across the entire system with pretty much continuous weather disruptions. Safety is always our first priority, so we couldn’t avoid some flight delays, but we really excelled in getting customers to the destinations and with their bags. And when we had weather events, we managed to reset and be right back on track the next morning, which is a sign of good management through the regular operations by our people. Underneath that headline, we saw broad-based improvements in our operating metrics as on-time performance, long delays, early morning originators, turn compliance, flown as booked, and trip Net Promoter Score, all showed solid year-over-year improvements. This was against the backdrop of runway closures in Las Vegas and Denver, which are two of our largest operations. Another drag was our block time hit rate, which dropped over 4 points relative to the second quarter last year as our pilots had to take more circuitous routing because of weather. The broad-based improved performance against these headwinds is a testament to solid execution by our people. Looking forward, we’re also really pleased with our progress on the implementation of our Winter Preparedness Plan. Just a reminder, though the plan is detailed on a micro site, which is available on our website. The plan is on track to be fully implemented in the fourth quarter of 2023 in advance of our winter storm season. I won’t walk you through all the details today since it’s on the micro site. But I will say that everything is going really well, and we are already accepting delivery of new equipment and infrastructure as well as completing software implementations. We are conducting summer school to train new ramp agents on deicing and to train all ramp agents on new equipment. Obviously, the other thing we have going on is labor negotiations, where we continue to work diligently, and we continue to make progress. I do want to thank all the parties on both sides who work hard to negotiate these collective bargaining agreements. I’m grateful that we’ve been able to get so many ratified in the last 9 months, but we still have more to do with a couple that have been amenable for a while. We know the negotiations could be emotional as well as complicated, but we are committed to good faith negotiations to get new agreements in place as quickly as possible and to compensate our employees with market wage rates. So, in closing, I’d like to thank all of our employees for their hard work. It’s an honor to be part of this team and to have the opportunity to support them. And with that, I’ll turn it back over to Julia.

Thank you, Andrew. We have analysts queued up for questions, so a quick reminder to please keep your questions to one and a follow-up, if needed. Operator, please go ahead and begin our analyst Q&A.

Hey. Thanks. Good afternoon. So, wondering if you have any color on the pressure on load factors in the quarter? And then, guiding to a lot of pressure on RASM in Q3 as capacity accelerates. With Q4 capacity expected to accelerate further, do you think we should expect further RASM pressure? And given that, do you think about maybe moderating some of the capacity growth?

Yes, it’s Ryan. Looking back on the second quarter, I believe we had an excellent performance with record operating revenue for the quarter and for each month within it. When comparing this to the same period last year, we experienced significant pent-up demand, despite facing a 5-point headwind from the breakage adjustment, which is specific to this quarter and won’t continue moving forward. Overall, I think the performance was very strong. Adjusted for the breakage benefit from the second quarter of 2022, which affects passenger revenue, average fares in the second quarter have actually increased by 2% year-over-year. We are successfully managing and optimizing revenue in this favorable fare environment, although it could slightly impact loads. Comparing our domestic load factor to our competitors in the second quarter, we are in line with their performance as well. Considering all of this, I feel quite positive about the second quarter. Looking ahead to July, which is almost fully booked, we anticipate another record revenue month, despite tough comparisons due to last year's pent-up demand. We are effectively navigating a strong fare environment that typically brings some adjustments in load factors.

Scott, it’s Bob. We’ve implemented a new revenue management system that will be fully operational for pricing this fall. I’m pleased that we implemented it on schedule, and it considers your entire itinerary. One effect of this system is that it maximizes close-in demand, so it wouldn’t be surprising if you notice a slight decrease in load as we get accustomed to it; this was anticipated during our testing. Additionally, we recognize we are operating in a less than ideal environment. We have quickly restored our flying capacity and I’m proud of the team's efforts. All of our aircraft will be flying unimpeded by the end of the third quarter, which is ahead of our expectations, although not fully optimized. That’s why we are focusing on optimizing the network in the first quarter of next year. Lastly, as Ryan mentioned, we have a significant portion of our network—over 10%—in development, which includes new cities we introduced and our expansion in Hawaii during the pandemic, utilizing more than 100 aircraft for these investments. This will continue to develop throughout 2024, and I expect the percentage will gradually return to pre-pandemic levels by the end of next year. Regarding fares, the average fare impact from these developmental markets compared to normal is currently about $2, giving you a rough idea when thinking about average fare.

Helpful. So, I guess, just a quick follow-up, like to that. The network optimization, is that more of a cost opportunity or revenue opportunity? I guess, ultimately, I’m trying to figure out like if capacity is up high single next year, do we think CASM is up or down next year?

Yes. We’ll tag team on that. No, we believe that the network redesign will be beneficial to both our revenues as well as on the cost side. And as we look ahead to next year, we are absolutely committed to driving our unit cost down. And certainly, the network and our opportunities there to align our staffing and our fleet to our network design should be helpful in helping us to achieve that goal.

Yes. I would like to add that while we discussed the large capacity in the first quarter, which is estimated at 14 to 16, it remains capacity. However, with the restoration of all aircraft operations this year, we will see a significant increase in capacity due to previous constraints, particularly on the pilot side, which will be resolved by the third quarter. This will result in substantial carryover, especially into early next year. Approximately 90% of the growth in the first quarter will be due to this carryover from additions made in 2023. Regarding network optimization, as Tammy mentioned, it's an adjustment on both ends. It's evident that travel patterns after the pandemic differ from those before. This includes both leisure and business travel. I anticipate business travel will recover, but it will lag behind leisure for some time. Ryan mentioned that this will involve a more aggressive reduction of flights on days like Tuesday and Wednesday. Typically, those schedules would decrease by about 2 points from Monday, but now we expect a decline of around 8 points due to network optimization. We are also improving our management of early and late flights, which traditionally incur RASM penalties. In summary, this initiative is primarily focused on revenue but aims to align with the changing post-pandemic demand and travel patterns evident in our network.

Yes. To provide some insight on this, we have organized the network changes into four categories. The first is a shift in frequency from predominantly short-haul, high-demand routes to more medium and long-haul routes with a lower business mix. The second change involves a reduction in flights on Tuesdays and Wednesdays, which are down 7% to 10% compared to Mondays, Thursdays, and Fridays, depending on the season. The third adjustment concerns the timing of flights, specifically moving the latest and earliest flights, which typically perform the worst, closer together. Lastly, we are modifying our new markets in Hawaii based on our understanding of their seasonality and demand patterns. For example, let’s take Midway. In March 2024, we will have 225 departures compared to 229 in March of this year, which is just a decrease of 4 flights. Furthermore, we have 26 city pairs that are changing frequencies. For instance, the route from Midway to Columbus is down 2 frequencies from 6 to 4, while the Midway to Phoenix route increases by 2 frequencies to replace it. In Columbus, they will not lose 2 frequencies; instead, those are being transferred to Midway to Sarasota and Tampa. So, although everyone maintained their departures, the composition has changed slightly. Sarasota is strictly a leisure destination, while Tampa and Phoenix cater to both leisure and business travelers. This represents a slight mix shift, and when applied across our network, it leads to a significant overall change, even though each individual adjustment is modest.

Good afternoon. Can I ask maybe a high-level question, kind of tying in all the different things that you’re working on? And when do you think you can get back to 2019 level of profitability, not necessarily EPS, but just kind of pretax income type level? Like, what does it take to get there and how long does it take to get there?

Yes, hi Savi. We are currently working on our detailed 2024 plan, and our goal is to return to pre-pandemic levels of profitability. Adjusting our network to align with the current demand and business environment is a significant part of that plan. While we are not prepared to provide guidance for next year just yet, achieving those profitability levels is a primary goal. The first priority is to operate our entire fleet and optimize staffing levels according to our flight operations and the network adjustments we have discussed. Additionally, we expect ongoing contributions from our initiatives as we continue to expand the network, as well as from our fleet modernization plans. There are certainly many factors at play as we work to rebuild after the pandemic. It has been a bit chaotic, but the positive news is that we are nearly fully restored and will focus our efforts on achieving year-over-year margin expansion for 2024.

That’s helpful. And I was just wondering if I could ask a question on the labor accruals. Does that include what has historically been part of the kind of the ratification bonuses? So, in your case, anything kind of prior to April 2022 or any catch-up to kind of last year’s where you might be lower? Is that also included in kind of this year’s labor accrual, or is it just getting kind of the labor cost to what you think the market rates are?

We have made our best effort to adjust our market rates to align with the current market situation. There have been changes along the way, and we have been making adjustments as necessary. For the third quarter, we have considered all of this in our cost guidance to the best of our ability. It's an important point to note as you compare Southwest with others in the industry.

Yes. I mean, just in short, though, yes, we are fully accrued for what is the most recent market. And as you know, the market’s been moving. In fact, the change that we made for full year cost down 2% to 4%, we guided down 1% to 2%. That change was basically entirely updating our accruals across the quarter because the market moved.

And that’s pilots and that’s all labor groups…?

It’s all.

The increase was driven by all labor groups, but this quarter it was more influenced by pilots.

We observed an increase in areas where we have open contracts still under negotiation. As the market changes, we updated our accruals accordingly. Therefore, I believe we are fully accrued to the market. Additionally, we received good news this morning with the ratification of a new agreement with our mechanics and related employees in AMFA. They ratified a contract extension for four years through 2027. This marks our seventh positive update in the last nine months.

Could you discuss the geographic variation across the U.S., such as Hawaii, the Midwest, the West Coast, and the East Coast, as we consider the guidance for the third quarter? Which regions are performing stronger or weaker? Also, regarding the network changes, why start in January? If you've identified necessary changes, what are the reasons for not starting this process in September or the fourth quarter? What practical considerations come into play?

Yes, it's Ryan. Regarding the geographic aspects, the Hawaii franchise is part of our developing markets. Overall, we are very pleased with its performance, especially in the mainland areas of Hawaii. Load factors are high, and yields are improving, so we are quite satisfied with how Hawaii is doing. As for your comments on network changes, we've made some adjustments to the Intra-Cal network. Although the West Coast recovery is a bit slower, Intra-Cal is performing well. Florida and other leisure markets are doing strongly in this environment. This gives you an idea of what is performing well. As we restore our network, different areas will have varying levels of capacity, and we are actively working on markets where capacity is growing significantly. Southwest Airlines has the advantage of a diverse domestic presence, allowing us to navigate economic cycles better than some of our competitors. This gives us a distinct edge moving forward.

I’m sorry. Duane, it’s Andrew. I’d also add that when you make changes to your network, it’s important to understand the implications before implementing significant modifications. We have been making adjustments. In September, as part of our initial schedule, we altered our capacity for Tuesdays and Wednesdays compared to Mondays, Thursdays, and Fridays. This approach is not as aggressive as the one we started in January. We aim to gather insights before proceeding with changes, and we have gradually implemented some network adjustments throughout September and into the fourth quarter. We were pleased with the forward bookings, which led us to make complete adjustments starting in Q1. Essentially, this will be finalized by March, apart from the seasonal adjustments that will occur as that season approaches.

Well, Duane, if you consider our customers, the recent shift to an 8% reduction on Tuesdays and Wednesdays, compared to a typical Monday, is highly disruptive, especially with holiday schedules already published. We are committed to avoiding significant changes for our customers. While we occasionally adjust our schedules, we have pledged not to implement major alterations coming out of the pandemic. January was the first chance to introduce numerous changes in our new published schedule, following some adjustments as Andrew mentioned.

Okay, great. And then just for my follow-up, I wonder if you’d be willing to kind of quantify the excess training investment and I think the reliability investment, which I guess is actually bigger, you would know. But, can you give us a sense for the magnitude of those that are unlikely to kind of reoccur or maybe wind down next year?

Hey Duane, I’ll take that. In terms of the training, we’ll provide more details once we have our plan fully baked here and solidify our capacity plans, et cetera. But I can help you with regard to costs that we’ve incurred this year that we believe are onetime related to the ops disruptions, and that’s about $100 million to $150 million. So, that’s kind of onetime comp that won’t repeat next year. Beyond that, we’ll share additional details once we lay out our 2024 plan for you.

First question is of a modeling variety. So, Tammy, if we look at the third quarter X fuel CASM guide and then the full year guide of down 1% to 2%. And I realize there’s some wiggle room here, but it implies a fourth quarter outcome that’s pretty similar to the third quarter in terms of absolute X fuel CASM at least closer than what’s usually the sequential case. Fourth quarter is usually higher than third quarter. Just wondering how you’d address that.

Well, keep in mind, Jamie, that capacity is going to be a factor in that as we continue to add back capacity. So, I think that’s the primary driver.

Just curious on the RASM decline for Q3, is that just kind of like a return to seasonality and capacity going up? And are you seeing any sharp drop-off after, say, like mid-August, and how does that compare with 2022 and maybe more people were flying off-season? Thanks.

Yes, it's Ryan. There is certainly a RASM headwind due to capacity growth that is above seasonal norms in the third quarter. However, if we consider the third quarter overall and examine the demand currently in place, I am very optimistic about where we stand today. We expect to achieve record revenue in the third quarter over the next couple of months. We have more bookings now for the third quarter than we did at the same point in time for the second quarter. In June, we had an all-time record fare sale for fall travel, with some of the top 10 booking days occurring during that event, including our highest single-day bookings ever. We have a strong base of bookings in place for the fall, which indicates significant demand for the Southwest Airlines product, as we've mentioned on the call. In terms of fares, July is currently booked well, and the robust fare environment from the second quarter has carried into July. While RASM is slowing down in the third quarter due to capacity headwinds, when we compare our situation to some of our peers' domestic RASM, I believe our outlook is positive.

Okay. That concludes the analyst portion of our call. I appreciate everyone joining. Have a great day.

Thank you, Anthony, and welcome to the members of our media on our call today. We’ll go ahead and get started with our media Q&A. So, Anthony, if you would queue folks up to begin asking questions.

Hi everyone. Thank you so much for the time today. I wanted to revisit the conversation earlier about the pilot contract, because obviously, we saw United come out with their tentative agreement, and that ultimately brought American back to the negotiating table to try and meet those pay standards and benefits. Wanted to ask if there’s an update there and if Southwest is committed to kind of meeting those new pay standards and benefits and where you all are at with that.

Thank you for the question, Andrew, and feel free to add your thoughts as well. Negotiations are indeed complex, and we are eager to finalize agreements with all of our groups with open contracts. We are meeting frequently with SWAPA and are hopeful for progress, although there is nothing new to report. You may have heard about the strike authorization vote; this is a process defined by the NMB, and mediation is also a defined process. Therefore, I can say there is no strike or imminent strike at this time. Many steps are necessary before reaching that point, and we aim to make significant progress long before any such situation arises. We genuinely want to conclude all of our contracts, including the one with our pilots. They do an excellent job, and we are committed to achieving progress in those negotiations.

I’d say that it's a strong pilots market, making it a great time to be a pilot. This is evident in the wage rates that often make headlines. However, what stands out in the agreements I've observed is not just the wage rates but also the non-wage components, such as scheduling rules, which enhance the quality of life for pilots but can increase costs for the company. These rules can be complex and challenging, requiring significant time to address. Wage rates are straightforward, but the scheduling rules and their implications take longer to outline, model, and reach consensus on. In my opinion, this complexity extends the timeline of our current negotiations more than we would prefer.

I just wanted to clarify, when will you have everything under your winter plan, everything that was planned as a result of the disruption, when will you have all of that in place? And the $100 million to $150 million cost you mentioned earlier, that was for everything post disruption. Is that right?

I’ll handle the timeline. October is the deadline we've set to get everything ready. We expect winter storms to occur after that, but our internal deadline is October. That will also be when we report our third quarter earnings later in October, and we will provide a comprehensive review and status update on our progress. So far, everything is on track, we are taking delivery, and we are encouraged by the results.

Yes. And Mary, your question on the $100 million to $150 million, would you mind repeating that?

Yes. I was asking if that’s the cost for everything that you’ve put in place as a result of the disruptions or if that was just related earlier to the mention of additional training costs for ramp workers.

No, it didn’t. It’s our best estimate right now of what our onetime cost is. Some of the investments we made this year may carry over into next year, particularly in our technology investments. So that’s just our best guess of what the onetime costs are.

And Tammy, I think it also includes things like gratitude pay and some incremental customer reimbursements this year that are really a one-time related to the disruption and won’t occur again in 2024.

I have a quick question. Your competitors have been repeatedly discussing how the surge in leisure travel has led customers to pay more for premium seats. However, it seems you don't have anything significant to upsell. I'm curious if this trend has had any impact at Southwest. Can you provide any details regarding demand for upgraded boarding, EarlyBird boarding, or leisure purchases of Business Select? Thank you. Additionally, I’ve noticed you've been promoting A-List status more frequently recently; I don't remember that from the past. I'm interested in the strategy behind that as well. Thank you.

Hello Dawn, it’s Ryan. Great to speak with you. You're correct that some competitors have been discussing premium revenue and its positive impact on their RASM performance for some time now. This likely has a significant effect on their RASM results, but our business model doesn’t engage with that premium revenue stream to the same extent. That said, our ancillary revenue reached a record in the second quarter. It was an excellent quarter for EarlyBird, which had been lagging somewhat during the pandemic recovery, but it performed very well in the second quarter. We introduced the option to purchase upgraded boarding on mobile devices in the third quarter of last year, and since then, the take rates have tripled. Consequently, we've seen strong upgraded boarding revenue over the past year and have managed to increase prices for both upgraded boarding and EarlyBird. Therefore, while ancillary revenue was a highlight for us this quarter, we don't engage in premium revenue to the same degree as some competitors. Regarding your question about the ability to buy A-List status, we have historically run campaigns known as tier qualifying points that allow customers to pay a little to top off their tier points and attain A-List or A-List Preferred status. This is not new, and although we've recently run some of these campaigns, we have done so in the past as well.

Can you provide any information on EarlyBird revenue or the upgraded boarding revenue? It has been years since you shared any dollar figures. Can you quantify that at all, please? Thanks.

Yes, we generate hundreds of millions of dollars from those boarding products on an annual basis. And like I said, we just had a record here in the second quarter. So those revenues continue to grow.

Yes. And just for the second quarter, just to give you a little, EarlyBird alone was in excess of $100 million.