Southwest Airlines Company (LUV) — Q3 2023 Earnings Call Transcript

Thank you so much. And welcome everyone to our third 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. We also reference our non-GAAP results, which exclude special items that are called out and reconciled to GAAP results in our press release. 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.

Well, thanks Julia, and good morning everyone. Before we jump into the financials, I wanted to acknowledge that there have been heart-wrenching challenges around the world the past several months. We’ve had natural disasters in the communities that we serve. Earlier this quarter, I visited our team in Maui and witnessed firsthand the impact from the catastrophic wildfires on the island. Our hearts go out to all those who are suffering, and we’re really proud of the support we are providing, including the volunteer efforts of our employees. Now moving to the results, operating revenues for the third quarter were just over $6.5 billion, up nearly 5% from the same period last year and a third quarter record. Despite the recent uptick in fuel prices and other inflationary pressures, we are again profitable with net income of $240 million excluding special items. Revenue strength was driven by solid leisure demand throughout the quarter and by managed business continuing to come in largely as expected, and Ryan will share more details with you, but overall, demand remains healthy. As we close out this quarter and look ahead to the end of the year, we are very pleased with our accomplishments. We are running a great operation, reaching significant milestones, completing important initiatives, and delivering great customer experience enhancements. We’re making great progress on labor agreements, including yesterday’s announcement of a tentative agreement with our incredible flight attendants. The team will walk you through many of these accomplishments, but for now, I want to talk to you about immediate actions we are taking to adapt to the current demand environment and solidify our path to operational and financial excellence. Perhaps the biggest milestone is completion of our network restoration plan in the fourth quarter of this year. Reaching this milestone has obviously been a years-long effort and has taken heroic coordination across the entire organization. It’s just incredibly challenging, and I am so appreciative of every single employee. It truly was a whole company accomplishment. With this behind us, however, we are set up really well to focus on optimizing our business. That starts with reflowing the fleet order book to support orderly growth, and to that end, we just announced a new order book with our partner, Boeing, yet another milestone. This sets us up for orderly and measured growth and gives us flexibility to adapt in a dynamic environment and we have a lot of options as we move forward and we will plan in a way that allows us both the flexibility to move up or down, and this order book combined with opportunities to retire -700s and modernize our fleet supports that really well. Finally, as we move into 2024, we are carefully evaluating the current macro environment and post-pandemic travel behaviors to create the best possible plan for the Company. We are now planning for a sequential quarter-over-quarter decline in nominal ASMs in the first quarter of 2024. This will result in capacity growth on a year-over-year basis of approximately 10% to 12%, all of which is carryover from growth this year. Note that this is a reduction from what we shared in July which was an expectation to grow approximately 14% to 16% on a year-over-year basis. In the back half of 2024, we expect a nominal decline in seats relative to the same period in 2023. Therefore, for the full year, our network plan will focus on absorbing current capacity, maturing development markets, and designing schedules for current travel patterns. This plan offers us the ability to redirect the teams that have worked so effectively to get us staffed and restored to now focus on better optimizing the operation. We will be relentless in our focus to wring out inefficiencies, drive productivity, and increase reliability, with our goal to return margins to historic levels. We are still hard at work on both our 2024 and long-term plans, but we are building them with a priority and a focus on generating value, value for our employees, value for our customers, and of course, value for our shareholders. And with that, I will turn the call over to Tammy.

Thank you, Bob, and hello everyone. First, I would like to extend another thanks to our wonderful employees for their continued hard work this year, especially in a challenging environment. Ryan and Andrew will speak to our revenue trends and operational performance, so I will jump right to cost. Beginning with fuel, our third quarter jet fuel price was $2.78 per gallon, towards the higher end of our guidance as crude oil prices consistently rose throughout the quarter, peaking to nearly $100 per barrel in late September, and rising refinery margins added further pressure to our third quarter fuel price. Moving into the fourth quarter, we currently estimate our fuel price to be in the $2.90 to $3 per gallon range, which includes an estimated $0.19 of hedging gains. We now estimate our full year 2023 fuel price to be in the $2.85 to $2.95 per gallon range including $0.14 of hedging gains. The total fair market value of our fuel hedge portfolio for the fourth quarter through 2026 is $538 million. We added modestly to our fuel hedge position for 2026 during the third quarter. We continue to be roughly 50% hedged in 2023 and are currently 55% hedged in 2024, in line with our goal to be roughly 50% hedged in each calendar year. While we are not immune to rising oil prices, I am grateful that our hedging positions relieve some of the additional pressure. We continue to look for prudent opportunities to build out our hedge position for future years. Moving to non-fuel cost, our third quarter year-over-year CASM-X increase of 4.4% was right in line with our previous guidance range, driven primarily by higher labor rates for all employee workgroups and the timing of planned maintenance expenses. Looking ahead to the fourth quarter, we currently estimate our CASM-X to decrease significantly year-over-year. There is a lot of noise in the year-over-year comparisons and the magnitude of the decrease is primarily due to impacts from elevated operating expenses and lower capacity levels in the fourth quarter of 2022 as a result of last year’s operational disruption. Our guidance range is inclusive of wage rate increases associated with the recently announced tentative agreement with our flight attendants. You can find additional details in this morning’s press release. Given inflationary pressures, particularly labor rates, combined with moderated capacity growth, we are expecting increased headwinds to our 2024 year-over-year cost. While we hit major milestones this year, our margins are not where they need to be and we intend to be relentless until we deliver. We therefore plan to adapt our network and capacity plans to support both a reliable operation and improved returns on investments. Given our company’s commitment and history towards maintaining a competitive cost advantage, our goal will always be to manage costs accordingly. Now turning to our fleet, during the third quarter, we received a total of 18 -8 deliveries and retired 4 -700s, ending the quarter with a fleet of 817 total aircraft. And we just finalized a new order book with Boeing which funds our long-term mid-single digit growth plan and provides us the ability to phase out the -700 fleet over time, that really gives us just a lot of flexibility. We provided full details on the new order book in this morning’s release. We now expect to receive 85 -8s this year and plan to retire 41 -700s. This leaves our net expected increase of 44 aircraft unchanged from our previous guidance. Taking all this into consideration, our 2023 CapEx outlook remains approximately $3.5 billion. Looking to 2024, reiterating what Bob shared, we are planning for capacity levels that better match the current environment. We now expect 2024 capacity to be up 6% to 8% year-over-year. With our new order book, we have the fleet flexibility we need to organize the Company around a disciplined financial plan, one that we can adjust up or down to adapt to the current environment. We continue to expect our five-year capital spending on average to be in line with our previous guidance of roughly $4 billion per year. Lastly, our balance sheet remains strong. We are the only U.S. airline with an investment grade rating by all three rating agencies. We have $11.7 billion in cash and short-term investments, and we continue to be in a net cash position. Year-to-date, we have returned more than $400 million to our shareholders through dividend payments and made debt repayments of nearly $80 million. Closing out the year we expect to pay a modest $7 million in scheduled debt repayments and continue to expect our 2023 interest income to more than offset 2023 interest expense. Let me close by saying, I am tremendously proud of our people and their hard work. As we look ahead, it is imperative we remain focused on building our 2024 plans and beyond to provide a resolute path to prosperity for our company, our employees, and our shareholders. We have a history that proves we do not rest on our laurels, and I’m confident we have all the elements needed to bring about the success you should expect from Southwest Airlines. And with that, I will turn it over to Ryan.

Thank you, Tammy. I’m going to walk through a review of our third quarter revenue results, provide context for our fourth quarter outlook, and share some exciting commercial updates with you today. For additional detail on our revenue performance, please see this morning’s earnings release. Starting with third quarter, demand continues to be healthy. Operating revenue was a third quarter record of just over $6.5 billion, and on a year-over-year basis operating revenue was up nearly 5%. And that's on a tough compare period given pent-up domestic travel was still underway last year. When you compare revenue performance versus the third quarter of 2019, operating revenue is up nearly 16% on 12% capacity growth. Also, average fares were up 2.6% year-over-year and are up over 7% over third quarter 2019. So, while we have work to do to cover our unit cost challenges, I am pleased we are moving in the right direction. The nearly 5% operating revenue growth year-over-year on a capacity increase of 12.5% had unit revenue or RASM declining 6.8% for the third quarter of 2023. July 4th and Labor Day travel came right in line with our expectations. However, bookings for non-peak August and September, while stable, came in at the lower end of our expectations. This performance aligns with fall start dates for primary and secondary schools continuing to shift earlier in much of the country. For example, in our markets, a third of schools were back in session by the second week of August, which is nearly double what it was pre-pandemic, and nearly 95% of schools were back before the Labor Day weekend. We are planning for these back-to-school trends to continue as we work on our August 2024 capacity plans. In addition, we had multiple records set from our ancillary products and our loyalty program. We had an all-time best quarter for ancillary revenue with 24% year-over-year growth, and Rapid Rewards set a third quarter record for revenue generated from the program. New Rapid Rewards member acquisitions were a quarterly record, and the number of engaged members grew 10% on a year-over-year basis. Rapid Rewards point redemptions were up 16% compared to the same period last year, and retail spend on our co-brand Chase Credit Card was also a third quarter record. Our customers love the benefits they get from the card as evidenced by our low cardholder attrition, which continues to be below pre-pandemic levels. Overall, we see a resilient consumer and high engagement with the Southwest Airlines brand. Consumer spending trends still favor services, particularly travel experiences, and we expect that will continue. Moving to the fourth quarter, we are seeing a continuation of healthy leisure booking demand and stable business travel patterns. As a result, we expect a nominal sequential increase in operating revenue, resulting in record fourth quarter revenue and passengers which would bring us to three consecutive quarters of record operating revenue. October performance has been strong to date, and bookings for the holidays as a whole are also strong. RASM, however, continues to be impacted by higher than seasonally normal capacity, driven by our network restoration plan, a larger than normal investment in development markets, and business travel that while improving is still below historical levels. We also expect the close-in leisure trends we saw in non-peak August and September to persist into the non-holiday periods of the fourth quarter, and our guidance range does contemplate potential challenges from this year’s holiday placement including the expectation that a portion of return travel will spill into January. I am encouraged, however, that we have higher booked load factors for the December holiday period this year than we had at the same point last year, which indicates to me we’re not experiencing significant booking away as a result of last year’s operational disruption. All-in, we expect RASM in the fourth quarter to finish down 9% to 11% on a year-over-year basis on capacity up approximately 21%. Again, we are steadfastly committed to addressing RASM performance to ensure a revenue plan that is appropriate. For the current near-term, we are continuing to execute a strategy of fare sale campaigns to address low demand flights with meaningful advanced purchase requirements. This helps build load factor in suboptimal capacity without impacting higher demand flights or diluting close-in yield strength. Looking to 2024, as Bob mentioned, we will address RASM by moderating capacity to better match demand and optimizing our schedules to accommodate current travel behaviors. Our current set of strategic initiatives including GDS participation and the new revenue management system will also contribute incremental pre-tax profits to 2024 as they mature and hit their full run rates. Finally, we’re tireless in working to make customer experience on Southwest Airlines even better and drive even more loyalty from our customers. Earlier this month we announced several exciting updates, and the first involves several enhancements to our award-winning Rapid Rewards program. We will add the ability for customers to combine Rapid Reward points with cash next spring, which increases the ubiquity of our loyalty currency and makes it easier to book additional flights on Southwest Airlines. We also made it easier to reach our A-List and A-List Preferred levels in 2024 and are looking to reward our customers for their loyalty and entice them to fly with us whenever they travel. We have an imperative to win more customers and drive more travel from our most frequent travelers, and these enhancements are designed to give them even more reasons to choose Southwest Airlines. We also launched a new product for our corporate customers last week that will help us continue to grow our market share in the managed travel space. Our new product streamlines the process to book group travel for meetings, incentives, and conventions, which is one of the fastest-growing segments in the managed travel space. I’m very pleased with the response to the product so far as we already have millions of dollars in travel booked on the new tool in just the first few days. Finally, we recently introduced customer bag tracking, which gives our customers the ability to track their checked bags throughout their day of travel, both at the airport and in flight. This improvement was one of the investments we accelerated following last December’s disruption. By providing additional transparency and information to customers about where their bags are during their travel journey, we’re elevating the travel experience and removing friction for our customers. This enhancement is an early release of our larger digital hospitality modernization plan. So, congratulations to the teams that worked so hard to bring these great enhancements and solutions to market for our customers. Ultimately, we have to continue to win customers while taking into account the challenges of higher cost inputs as we build both our long-term commercial strategies and our near-term revenue plans, and we are committed to doing just that. With that, I will turn it over to Andrew.

Thank you, Ryan, and hello, everyone. I will conclude our prepared remarks with a quick recap of our operational performance, an update on our winter operations action plan, and additional information on our capacity and network plans for the next year. Before I get into those specifics, I want to acknowledge the negotiating committees that worked hard on the tentative agreement just reached with our flight attendants, which will soon be voted on by our employees. This agreement provides industry-leading pay increases and enhancements to quality of life. I am very pleased with our significant improvements in operational performance and grateful for our Southwest Warriors. We observed widespread improvements in our operating metrics, which our customers recognized through higher trip Net Promoter Scores. Our early morning originators, turn compliance and turn differential, completion factor, mishandled bag rate, long delay rate, and on-time performance all showed notable year-over-year advancements. If it weren't for longer-than-expected block times due to congestion, weather, and runway construction, our performance would have been even better. All of this led to a trip Net Promoter Score that is nearly 4 points higher than last year. This is certainly driven by our proven reliability but also our customer experience initiatives, including enhanced Wi-Fi. We are thrilled about this positive trend and it gives us many reasons to be optimistic for 2024. Speaking of positive momentum, I am eager to provide an update on our winter preparedness. The disruption we experienced last winter was very tough on our customers and employees. It weighs heavily on all of us at Southwest Airlines. We take great pride in our more than 50-year history. Therefore, preventing a repeat of that situation was and remains a priority. While the disruption was caused by an unprecedented storm affecting multiple key stations simultaneously, there were several factors involved, not just one. Consequently, our action plan is segmented into three areas: winter operations, cross-team collaboration, and accelerating operational investments already on our roadmap, including technology. One significant factor during the Elliott storm was that 25% of our crew is based in Denver and Chicago. When we are unable to maintain adequate throughput during winter operations, it limits our ability to deploy our crew across the network. When this occurs, it puts a strain on our crew network, as was the case with Elliott. Therefore, a crucial part of our action plan is to enhance winter operations, ensuring we reliably get our crews deployed during adverse weather. We have invested in key stations, gauging the required throughput to sustain our crew network. We've added de-ice pads, de-ice trucks, increased glycol storage and mixing stations, as well as enhanced snow removal, heater carts, and additional equipment necessary to operate safely and effectively in winter conditions. We have also conducted de-icing training for ramp agents to ensure they are well-prepared. These are just a few examples of the tangible steps we have taken, and we are now much better equipped for extreme weather events. Moving on to cross-team collaboration, we have reorganized our network planning and operations teams to function under the same organization for better coordination and faster decision-making. We created a special operating group, termed the Network Disruption Pod, to manage decision-making in our control center during high-risk disruption events and have utilized this group during events this summer. Additionally, we've conducted several operations-wide tabletop exercises, often referred to as War Games, focused on winter weather scenarios to better prepare our teams for the season. As we mentioned earlier, we have focused on the immediate modernization and enhancement of our systems. Initially, there was a misunderstanding that technology issues led to operational disruptions. In reality, operational problems caused technology issues. Since the disruption, we have strengthened those systems with upgrades specifically designed to resolve the challenges we faced during Winter Storm Elliott. We are also implementing a unique new system in the industry that adopts a crew-first approach for solutions involving both large-scale and routine operations. I share these details to provide insight into the level of action we have undertaken. We are better prepared than ever and feel confident as we prepare for the upcoming winter holiday travel season. Finally, I would like to touch on what we are doing regarding capacity and the network for next year to ensure we achieve operational and financial excellence. Back in April, we committed to measured and orderly growth. Consistent growth helps us regain efficiency, manage our hiring, develop our workforce, and enhance our operational performance. We also need to consider demand levels and travel patterns as we set our growth trajectory and build our network. In shaping our 2024 capacity plan, we are doing just that. In recent years, our focus on growth to restore our network and fully utilize our fleet, along with changes in business travel trends and our investments in Hawaii and new cities, has created challenges for our current unit revenue performance. Therefore, as we look ahead to 2024, we will moderate our capacity to enable adequate growth absorption. As we mentioned last quarter, we are taking steps to accelerate the development of our growing markets and to optimize our schedules in line with current travel patterns. A recent example is the announcement today that we are transferring the majority of our international service from Fort Lauderdale to Orlando. This change will provide improved connectivity within our domestic network through nearly 140 daily departures from Orlando. We are fully dedicated to implementing a plan that ensures operational excellence, enhances operational efficiency, and, as Bob highlighted at the start of the call, generates value for our employees, customers, and shareholders. With that, I will hand it back 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. Please go ahead and begin our analyst Q&A.

If I might on the 2024 plan, you talked about inflationary headwinds to unit costs. And you historically don’t necessarily adjust capacity once schedules are loaded. I was wondering if you could provide a little bit more color on how we should think about unit costs in 2024. Is this going to be up year-over-year, and some of the kind of bigger drivers of the unit cost trends?

I want to start by discussing our performance for the quarter. It was a strong quarter with record operating revenues, a high number of passengers, growth in our Rapid Reward program revenues, increased retail spending on our card, and more new members joining the program. I am very pleased with these results. Another important achievement was successfully restoring our network and getting all our aircraft back in service. We have increased capacity both sequentially and generally, which is above typical levels. While travel demand remains robust, we are noticing some shifts in leisure and business travel patterns. The final 10 to 15 points of business recovery is proving to be somewhat challenging. As we adjust our capacity, we want to be mindful not to overextend ourselves. Therefore, we are reducing capacity in the first quarter. The shoulder periods of January and February tend to be more difficult. We are currently working diligently on our full 2024 plan, but for now, our overall capacity planning for the year has been adjusted to a range of 6 to 8, primarily reflecting the carryover from restoring capacity in 2023 into 2024. This means we will have fewer nominal seats available in the latter half of next year compared to 2022. I just wanted to clarify our approach to capacity, which focuses on maturing and accommodating the capacity we've built up. As we reduce capacity, we will face cost pressures, which is always the case. We are actively developing our plan and will address both cost management and efficiency improvements. We see significant opportunities to enhance efficiency as we moderate growth and decrease hiring while transitioning employees out of training. We will also focus on the revenue side of the equation. However, I acknowledge that reducing capacity does create some pressure on our costs, as it traditionally does. Tammy, do you have anything to add?

You did a great job covering everything, Bob. Savi, to provide a bit more detail on the cost pressures we’re facing, we’ve seen higher inflation in labor this year as we finalized many agreements with our labor group, leading to increased wage rates. We’ve been accounting for those throughout the year. Additionally, we anticipate some inflationary pressures in maintenance as our 800 fleet transitions off the holiday. I wanted to highlight that as we move forward. Nevertheless, we are focused on our 2024 plan and will work diligently to drive efficiencies while leveraging our network opportunities. It’s a bit early to offer guidance for the year, but we are committed to managing our CASM-X costs effectively. We remain aligned with our commitments from the 2022 Investor Day, aiming for low single-digit growth in CASM-X alongside mid-single-digit capacity growth.

That’s all very helpful. I appreciate that. And maybe kind of following up on that. Just on the fleet side, I know you have a contractual fleet here. Is your goal to again take as many aircraft and then offset it with retirements or how should we think about the aircraft deliveries next year, and maybe Boeing’s ability to meet it?

Yes. Our primary goal has been to achieve orderly and steady growth in our fleet plan with Boeing. We encountered delays that led to a backlog of aircraft, pushing our delivery expectation for 2024 beyond the planned 143, which we are not pursuing. I'm pleased to say that Boeing has been an excellent partner, and we now have a new fleet plan that ensures orderliness through 2031 at competitive pricing, with considerable flexibility in our new order book. This allows us to adjust our fleet in response to changing demand trends. For 2023, we've committed to controlling our order and delivery plan, intending to take 70 aircraft this year. However, it appears we can now take 85 from Boeing, which we will offset with retirements for a solid financial outcome. Our goal for next year is to also take 85. Tammy, would you like to add anything?

You covered it all.

Maybe just a follow-up on the cost question, if you don’t mind. Two things. I know you’re not prepared to talk about exact guidance on 2024, and I totally appreciate that the growth plans have changed. But I think last quarter you said you were committed to driving costs down year-over-year. Are we just back at the drawing table for that? And then on the labor inflationary pressures you’re talking about, I know you’ve been accruing this year. So, what’s driving that incremental into next year? Is that just wage rate increases are higher than they used to be or something else in the pay package?

To clarify, there are two main factors at play. Firstly, we have scaled back our capacity growth plans and are experiencing pressure on labor rates. To help you with your forecasts for the first quarter, if we remove the 15-point year-over-year disruption-related impact from our fourth quarter CASM-X outlook, we would actually see a reduction of 1% to 4% year-over-year. As Bob mentioned earlier, despite some structural cost increases, we still maintain a cost advantage compared to the industry and legacy carriers. However, if we look at the transition from the fourth quarter, the primary cost pressures we face are due to overall inflation, particularly driven by labor costs, which is our biggest inflationary concern. Even with our current labor accruals, we foresee year-over-year pressure in the coming year from standard annual step and scale increases, as you would expect. Additionally, beyond labor cost pressures, we anticipate ongoing year-over-year cost increases due to accelerated depreciation as part of our fleet modernization efforts and already discussed maintenance costs. It's important to note that our moderated capacity plans for next year are adding further pressure to our unit cost. Nevertheless, we are still fine-tuning our 2024 plan and are not satisfied with our cost outlook. We are committed to improving it and actively working on reducing cost inefficiencies and enhancing productivity as we temper our growth plans next year. We have a strong history of managing our costs effectively and remain determined to continue doing so as we have for over 50 years.

Labor cost increases are something we are all experiencing as we renegotiate contracts, and the timing may vary for different people. These costs are expected to be widespread. It typically takes time to adjust to a higher cost structure over time. On a positive note, we are fully committed to taking action on our network. Last quarter, we announced a complete restructuring of the network, which is expected to generate over $500 million in pretax profit contribution in 2024. Now, we are adjusting our outlook for the first quarter and the full year. In the latter half of the year, we anticipate that seat availability will decrease slightly compared to last year. This approach is aimed at aligning the network with demand, which should ultimately enhance revenue production and increase RASM.

Maybe just my follow-up. We’re going through another earnings season where there’s quite a lot of focus on premium products. I guess, is your view that those will still prove to be cyclical in the next downturn, whenever that might be? I guess, really just interested in hearing how you’re assessing demand for premium products and what data points could change your mind on your current product offering?

I’ll begin, and then Ryan can add to my comments. While I don’t want to speak for others and predicting the future is challenging, there is certainly an outperformance in long-haul international and premium segments right now, reminiscent of last year’s domestic leisure demand. Generally, trends tend to stabilize over time, which has been the case in this industry for many years. We’ll see how it unfolds. Regarding Southwest Airlines, we offer a strong coach product with excellent seating, a great rewards program, Wi-Fi, and various amenities including larger overhead bins and bag tracking. We're actively enhancing our offerings, which differs from premium services, but I believe we provide the most competitive coach product in the market. Additionally, we continuously monitor our customers’ preferences and feedback, and if those preferences evolve, we'll evaluate what that means for Southwest Airlines. Ryan?

Yes. I would like to emphasize that premium revenue has historically been quite cyclical in the industry. The recovery from the pandemic has shown some unique trends compared to previous periods, so we are monitoring it carefully. If there are changes in consumer demand that we need to address, we will adapt our product accordingly. However, we must approach this with caution and analyze it thoroughly, given the historical cycles of premium revenue. As we have done throughout our 50-year history, we pay attention to our customers and their evolving preferences. We have adapted our product over time and will continue to do so as needed in the future.

Probably a question that’s been asked a handful of times over the last few years. I understand the plan is to get margins up over time over the long run. But, is there a specific plan to get margins up in 2024? We hear a lot of pushback from investors about your unit revenue kind of exit rate, and I think folks are kind of extrapolating that into the future, and they’re having a hard time seeing that path in 2024. So, what does that path look like? And what will be required to get margins up next year? And is that explicitly a plan?

Yes, Duane, our plan for 2024 is indeed focused on improving margins, and we are dedicated to achieving our long-term performance and operating margin goals. We are in the process of adjusting to new cost levels, which will take some time, but we are making swift progress. A key aspect of this is adapting our network to meet customer demand and the evolving trends in demand for both business and leisure travel. We have significant opportunities to eliminate cost inefficiencies through operating leverage, utilizing new tools, and managing our workforce. We currently have many employees engaged in training, and as we reduce hiring and limit our growth, we will see cost reductions. We have several cost strategies in place and are still finalizing our plans for 2024. Rest assured, achieving growth in 2024 and returning to industry-leading margins that our shareholders expect is a firm commitment. Tammy, would you like to add anything?

Yes, I thought that was very well said. We recognize that there is work to be done, and we are fully committed to executing a 2024 plan that promotes our operational excellence. We will focus on driving operational efficiency. As Bob mentioned earlier, we are addressing both sides of the equation. Please stay tuned as we continue to work through this. We will provide more details soon. I also want to remind you that, as we have previously mentioned, we anticipate the benefits of our network optimization efforts, along with the ongoing development of our markets. We are still finalizing our plans, but we expect this to result in over $500 million in additional pretax profits year-over-year next year. However, there is clearly more work to be done, and we are actively working for you.

Thanks. I appreciate those direct answers. But maybe just to throw out an alternative, if you can’t get your margins going in the right direction next year, if it’s more like 25% or 26%, what might you consider strategically or put on the table that hasn’t been on the table before? So if you think about things like seat assignments, base economy, bags fly free, historically, those have been sacrosanct. I mean, would there be more of an urgency to more aggressively take a look at the product and the service offering if you can’t get there next year?

We are currently developing our 2024 plan, so we aren't ready to share all the details yet. The initiatives we implemented a few years ago, aimed at achieving $1 billion to $1.5 billion in EBIT this year, are yielding positive results, and we will have new initiatives coming. Some of these should make complete sense. We are also looking at opportunities to increase operational efficiency by adding flights in areas where we can lower costs. Additionally, we are focused on generating revenue beyond just ticket sales, particularly through the enhancement of our Rapid Rewards program. We also see chances to optimize aircraft usage and increase available seat miles without incurring the costs associated with new aircraft. However, at this time, we're not prepared to disclose the entire plan. I want to emphasize that we are diligently working on this, and there are many possibilities ahead. Regarding your question about customer preferences in the cabin or during boarding, I would echo Ryan's comments that we will prioritize the needs and desires of our customers. Ultimately, if our customers express particular wants, we will address those, but we're not ready to make any declarations just yet. It's important to understand that we are consistently evaluating these aspects.

I appreciate that. I guess over the years, you deserve the benefit of the doubt when you’re printing industry-leading margins and saying we’re going to go with what our customers want. But if you have lagging margins, it may require a harder look. But, I appreciate you taking the questions. Thank you.

Yes. I understand. We will be relentless in achieving our goals. This involves increasing efficiency and productivity, enhancing our revenue, and returning to industry-leading margins. You have my commitment.

Two here. I guess, first one to Andrew, if I caught you correctly, you had indicated that you were moving up your international service from Fort Lauderdale to Orlando. I mean, Fort Lauderdale, I think, has been one of your original international gateways. What were the factors that drove you to move up? I mean, I know you have a pilot domicile in Orlando, but it is a smaller local market. That seems to be a pretty meaningful move.

Thank you, Mike. I appreciate your question. As we mentioned earlier, we reevaluated our network and adjusted our capacity. This involved both the volume and type of capacity. We implemented these changes with a focus on reconfiguration, as Tammy mentioned. In Orlando, we now have significantly more northbound flights. Although international destinations are important to us, they are generally smaller markets that require sufficient connectivity to be fully utilized. Orlando, being further north and having more flights for Southwest Airlines going north, allows us to effectively serve both the local market and the flow of passengers. Many international routes cater to our customer base for vacations since we thrive on repeat business. We aim to provide flights for business, leisure trips to Orlando, Vegas, family visits, and beach getaways. This can be through nonstop flights or connections, particularly for international travel where connections are necessary for our northern cities. Therefore, the mix of the local market in Orlando and access to our large customer bases in the Upper Midwest and Northeast optimizes our network given the limited capacity. This approach makes sense overall. Additionally, having our crew base in Orlando reduces operational costs since we don’t need to position crews in Fort Lauderdale. As Bob noted, considering both revenue and costs, it makes more sense for our international focus in the Southeast to shift to Orlando.

Andrew, just to sort of follow up on that, like 1.5 years ago, 2 years ago when you guys talked about some of your initiatives. One of the focuses for longer term was to increase your connectivity. Is this a bit of a trial run in sort of focusing on this one market? And if it succeeds that type of connectivity, you’ll look at applying that to other gateway cities. Is that sort of the plan here?

No, during COVID, we experienced a significant drop in demand, and since we operate larger aircraft with fewer regional jets, we had to rely more on connectivity than usual to fill our planes. After COVID, we returned to our usual operation, which sees about 25% to 30% of our customers using connecting flights. This has remained quite stable but is concentrated in specific areas, helping us maximize capacity during peak times and support certain regions. For instance, our gateways in Hawaii enable us to serve customers traveling to the islands. Similarly, combining services from Baltimore and Orlando enhances our international access across our network. Connectivity has always been a supplementary aspect of our service, and we have been deliberate about how we utilize it.

Yes, we had a strong performance in ancillary and loyalty in the third quarter, and I expect this to continue into the fourth quarter. Ancillary revenue is growing significantly faster than our passenger growth, primarily due to our improved boarding benefit, which has allowed us to raise prices while maintaining take rates. EarlyBird is also performing well, with increased prices following our August adjustments, including fees for excess baggage and pets. Ancillary is definitely a highlight, and I anticipate it will keep outpacing passenger growth in the fourth quarter. Loyalty is a crucial part of our future strategy. Rapid Rewards stands out as the most preferred loyalty program, as customers can effectively utilize the points they earn, leading to increased spending on our cards. We set a record for card spending in the third quarter and expect the program to grow over time. Recently, we made changes to Rapid Rewards aimed at boosting customer engagement by making it easier for them to gain value from the program. When customers redeem points, they tend to fly with us more often and increase their spending. Features like the ability to combine cash and points are designed to facilitate the use of Rapid Rewards points, which in turn benefits Southwest. We are also lowering the tier requirements for A-List and A-List Preferred, which is contrary to the industry trend of making access to benefits more difficult. This strategy provides more value to consumers while also generating value for Southwest. As customers aim to qualify for A-List, A-List Preferred, and Companion Pass, they tend to fly and spend more before reaching those thresholds. Thus, our approach to bringing those requirements closer improves the customer experience and benefits Southwest as well. We plan to keep investing in Rapid Rewards and our ancillary offerings, and I expect to see ongoing growth.

Just a couple of questions to follow up. With the changes in Rapid Rewards and making it easier to earn what you would call status, isn’t that kind of amounting to fare cuts across the board?

Amounting to fare cuts across the board?

Yes. I mean if it makes it easier for me to redeem my points, I mean, don’t you wind up selling fewer revenue seats?

We have designed the loyalty program and the value exchange for customers in a way that makes it irrelevant whether they are using Rapid Reward points or paying cash. We have set aside that equation. The main change since the pandemic is that the number of customers traveling for business is the same as it was before, while leisure travel has actually increased. The distinction is that those traveling for business are flying less frequently. By making it easier to reach the threshold, we are simply taking advantage of this situation, allowing customers to achieve A-List and A-List Preferred status more easily, which ultimately benefits us as it adds value.

Got it. Okay. That’s really helpful. For my follow-up question, I remember that at one point you estimated a $1 billion to $1.5 billion EBIT contribution for 2023. Do you think that’s a more manageable target given last year's performance with Elliott?

Helane, we are making progress on our initiatives, which include our fleet modernization, investments in GDS, and our new revenue management system, among others. These initiatives are progressing as expected, and we are continuing to invest, as Ryan explained. These investments lead to increased customer engagement and loyalty. The initiatives we've discussed are creating additional value, and we are on track with what we've communicated. However, we are not satisfied with our current position as we approach 2024. While we are working on our 2024 plan and are not ready to share all the details today, we will provide more insights soon. Please stay tuned for further updates.

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

Thank you, Jamie. I’d like to welcome members of the media to our call today. Before we begin taking questions, Jamie, would you just give them instructions on how everyone can queue up.

I wanted to ask about the flight attendants reaching their tentative agreement yesterday and the pilots picketing at headquarters today. Can you give us an update on when a deal for the pilots might be reached and what the expected timeframe could be?

Alexandra, I appreciate your question and I assure you I will address it. I'm thankful, as are all of us, for the tentative agreement we have with our dedicated flight attendants. There's still work ahead. The union is preparing materials and training to ensure that our flight attendants receive the necessary information quickly so they can vote. I’m very pleased with this achievement. Over the past year, we've seen significant progress, marking our eighth agreement in twelve months, and we remain committed to concluding the others. Our negotiations regarding the swap agreement are ongoing, and there has been progress. I believe we are meeting weekly, but we still need to finalize the details. Would you like to add anything?

I have been very encouraged over the past few months by the pace and quality of negotiation meetings held weekly, both with and without mediators. We have seen improved leadership involvement in negotiations from both sides, which has been effective. Our mediators have been actively engaged, and achieving a deal requires agreement from both parties, so it's difficult to predict when this will conclude. However, we have made significant progress, with only a short but challenging list of issues left to resolve. I am confident in our team and the SWAPA and negotiating committees to conclude this in a timely manner. The mediator has scheduled more dates for us throughout the rest of this month and next month, provided there is no government shutdown. Additionally, we are looking to engage with our ramp union, TWU 555, in the coming weeks for the next steps, which would be the final deal for us to finalize.

Just curious about your discounting strategy. You have fare sales frequently, but it seems like the fares are pretty low currently. Could you kind of put that into context with previous fare sales and how that compares and how you’re thinking about the fourth quarter?

Yes. We are finalizing restoration and have additional seats to fill. I would describe our promotional activity as slightly above normal. It’s not a dramatic change from our historical approach, but there is a bit more emphasis on promotions. When we offer fare sales, we utilize sophisticated tactics to target demand effectively. These sale fares are always available when we have excess inventory, while higher-demand flights are excluded from the promotion. This strategy helps us increase load factors without lowering yields. Regarding your observation about low fares, our average fare in the third quarter rose by 2.6%. If we were excessively discounting, we wouldn't see an increase in average fares. Overall, our strategy is functioning as intended. We have many seats to fill and are using discounting to sell our excess inventory while safeguarding our higher-yield flights.

And are there any specific routes or regions where you’re seeing you’re having to discount more or even times of the week or month or recent months?

It’s less about the markets in different geographies and more about travel patterns today. Tuesdays and Wednesdays are more challenging, and the shoulder periods of the day are also tougher. A lot of the discounting is occurring in that inventory. We’re adjusting to those travel patterns and trends as we move forward with our network optimization starting after the first of the year to reduce some shoulder flying and to decrease Tuesday and Wednesday flights to help address that. It is more related to those patterns than to specific geographies.

I was going to ask a question about how you are adjusting capacity to help with the reshaping of the business travel and the way it hasn’t come back as you expected. And Ryan may have just answered that question, but I wanted to see if you could put a little bit more specifics out there on those adjustments, days of weeks, times of days, cutting frequencies, things like that.

Yes, Mary, I’ll provide an overview, and then Andrew and Ryan can add their insights. We are indeed making adjustments to our network, as previously mentioned, which is projected to generate over $500 million in profit next year. Additionally, we are implementing new capacity adjustments in the first quarter and continuing throughout 2024 during the nonpeak periods. This is focused on optimizing the shoulder periods, which are becoming more pronounced than before. For instance, some of this adjustment is being offset by an increase in business travel, which, while steadily improving, has not yet returned to pre-pandemic levels. Specifically, the reductions planned for January and February 2024 are closely aligned with emerging trends in business travel demand. This strategy will extend into 2024.

You heard Bob mention that overall business travel is down about 10% to 15% compared to 2019. This indicates a slight adjustment rather than a drastic change in our approach. We're focusing a bit less on business travel and shifting more towards leisure or a mix of leisure and business travel. Historically, Tuesday and Wednesday have been heavy travel days for business, but we expect those days to be much lower in comparison to Monday, Thursday, and Friday. This is a significant aspect of our strategy. Additionally, when examining specific cities and route combinations, some routes that were primarily for business travel have been replaced with others that cater to leisure or a combination of leisure and business. Therefore, it's a modest adjustment in our route portfolio, along with a reduction in overall capacity on Tuesdays and Wednesdays.

I was wondering if you could just expand a little bit on the lower-than-expected close-in bookings. Do you think this is a lengthening of the booking curve again, sort of a return to the pre-pandemic booking trends, or is this a one-off that maybe has something to do with the present environment?

I would say we are returning to more pre-pandemic norms. However, managed business travel is still down compared to pre-pandemic levels. The managed business segment is experiencing a slow and steady recovery, and we are gaining market share through our initiatives in this area, which we feel positive about. In terms of leisure travel, there is still more close-in leisure now than before the pandemic, but it's not at the level we saw at the end of last year or earlier this year. So, it seems like we are seeing a reversal of trends back to normal as workplace return initiatives evolve. I mentioned this in my prepared remarks; specifically, in the third quarter, there were factors affecting close-in leisure. Notably, the changes in school calendars were significant in August. A third of schools in our markets reopened in the second week of August, which is double the pre-pandemic rate. Families with children typically do not travel the week before school starts, which significantly reduced August travel for a third of our market. There are various macro factors at play. Overall, we are seeing a return to normal patterns.

At the risk of being repetitive, all of these factors relate to adjusting our network and business to meet new demand trends and behaviors resulting from the economy not being fully recovered and emerging trends from the pandemic. There is no issue with demand. Once again, Southwest is experiencing record operating revenues, record passengers, record participation in Rapid Rewards, record retail spending on our card, and record new memberships. We anticipate further records in operating revenues and passengers in the fourth quarter. This indicates that we are indeed generating strong demand. The focus is on aligning more accurately with the new travel patterns and managing the rapid growth we've experienced due to the restoration of our network in the latter half of the year, which led to an increase in seats and capacity. Now it’s essential to stabilize and manage that growth, which is why we are intentionally slowing our growth rate in 2024 to allow for this adjustment. I want to emphasize that while there are areas for improvement, much of this involves fine-tuning and adapting to new trends. It’s clear that we do not have a demand problem.

And then just following up, you excluded the holidays specifically when you mentioned this during your prepared remarks. What’s the booking curve looking like for that? Where do you think we are in the curve sort of right now?

Holiday bookings are strong. Compared to last year at this point in the curve for the December holiday period, we are booked ahead, which indicates that customers have moved past our operational disruptions, and there is no sign of demand weakness for December. I would also describe the Thanksgiving period as strong. We have significant capacity to manage in the fourth quarter, but I am pleased with how the holiday bookings are shaping up.

I appreciate the extra question. I wanted to ask about the new order book you presented today, where you're taking on over 200 additional aircraft in that timeframe. Could you comment on the reasoning behind this decision, especially since it hasn’t been long since you placed an order for MAXes?

Yes, I'll start, and then Tammy can add on. I think it’s really about a couple of points. Boeing is a great partner, but we’ve all faced supply chain issues. The delivery challenges have pushed many aircraft deliveries forward, and we want to clean that up to ensure our order book reflects steady and appropriate growth. That’s why you see a consistent number year after year, around 80 to 90. Next, the new aircraft market is tight, and we need to secure access to aircraft in the future, which we have done through 2031. We also locked in attractive pricing with Boeing, which is important. Lastly, there’s been more variability in our industry than I have ever seen. Because of this, we need to maintain flexibility both ways. We have many options that allow us to adjust those annual numbers as demand changes. So, it’s about reducing future uncertainty and ensuring we have access to aircraft at good prices. Tammy?

Yes. You hit it all, Bob. Yes. We’re very thrilled to have wrapped up our discussions with Boeing. It’s everything Bob covered. And certainly, one of our key initiatives, just to add on is our fleet modernization efforts. So again, we believe this order book supports our quarterly growth plan and our fleet modernization initiative provides significant flexibility for us and also gives us a great path to retire our -700 fleet over the coming years. So, we are just thrilled to have a cost-effective order book that meets our needs going forward.

Thank you all for being with us. Members of the media, if you have any follow-up questions, you can obviously reach out to our communications team at 214-792-4847, or on our media website at swamedia.com. Thanks so much for joining us.