Southwest Airlines Company (LUV) — Q1 2024 Earnings Call Transcript

Thank you so much. Hello, everyone, and welcome to Southwest Airlines First Quarter 2024 Conference Call. In just a moment, we will share our prepared remarks, after which we will be happy to take your questions. 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 current expectations of future performance, and our actual results could differ materially from expectations. As 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. And now I'm pleased to turn the call over to you, Bob.

Thank you, Julia. Hello, everyone, and welcome to our first quarter call. Let me state right up front that I am disappointed with our first quarter performance. There are a lot of factors that I'll go into, and there's a lot to cover, including the latest Boeing challenges. More importantly, there are significant efforts and progress underway as we cannot and we won't be satisfied until we are delivering the kind of returns you expect from Southwest Airlines. So before I go any further, I just want to sincerely thank our people for their extraordinary efforts as we work quickly to drive improvement. Turning to our performance. We achieved records for first quarter operating revenues and passengers, continuing our streak of 8 straight quarters of record top line performance. We saw a nice acceleration in managed business revenues, up 25% nominally year-over-year. We also continued our streak of solid operational performance. For a while now, we have been consistently running a great completion factor averaging right around 99%, and we continue to improve in nearly all operational and customer metrics. I'm also proud of the progress we made on our open labor agreements. It's been a long road, and I want to recognize everyone involved for continuing to work through to the finish line to reward our amazing employees for their contributions. Ryan will go into our revenue performance in more detail in a moment. And while our revenue trends were solid in the first quarter and are expected to be a solid year again in the second quarter, we need to increase revenue production to offset cost inflation. The biggest opportunity to improve performance and profitability with urgency is continued focus on network optimization and capacity. We opened 18 new cities during the pandemic and worked hard in 2023 to restore our network and fly our full fleet on the heels of the demand surge in 2022. While that boosted aircraft utilization, it added significant capacity. Combined with 2023 business travel coming in below projections, that has resulted in a significant number of new markets under development and a material number of markets that are not performing at the level required in this higher cost environment. Network adjustments planned last fall are in place as of the March schedule, and they are proving to be largely on track. Those optimization efforts were primarily aimed to adjust for changing demand trends, including lower capacity on Tuesday and Wednesday, a reduction in short-haul business markets, and a material reduction in flights during shoulder periods of the day. The changes are beneficial, and they contributed to us exiting the first quarter with healthy margins for the month of March. More is needed, and we are continuing efforts to optimize the network and reduce the number of markets in development that aren't performing to more historic levels. Along those lines, we have made the difficult decision to eliminate service in 4 cities: Syracuse, New York; Houston Intercontinental; Cozumel; and Bellingham, Washington. That is never an easy decision. We form bonds with the airports and the communities that we serve. These are wonderful communities, and we are very grateful for their support over the past several years. In addition, we are also restructuring several other stations, most notably, we are reducing flights in Atlanta and Chicago O'Hare. While it's never our desire to exit a city or shrink service to a market, we are committed to our financial performance goals, and network and capacity actions will continue as a lever to improve overall financial performance. In addition to network optimization, we have a number of other efforts underway to increase revenue productivity. First, tuning our new revenue management system by better anticipating and optimizing demand and fares along the booking curve and unlocking additional capabilities that will further boost the contribution from the system. Second, focusing on increasing passenger volume, including adding new attributes to our value proposition. We are working to ensure our current and future customers understand our terrific value proposition. That includes a significant new brand campaign, which started last week, highlighting our signature customer-friendly policies. Separately, we are considering more transformational options and follow-on initiatives. That includes work previously underway to study customer preference around seating and our cabin. It's been several years since we last studied this in-depth, and customer preferences and expectations change over time. We are also studying the operational and financial benefits of any potential change. We remain committed to our industry-best, customer-friendly policies, but we are also committed to understanding and meeting customer expectations. We have transformed before, adding things like WiFi, larger bins, and in-seat power, and we will continue to adapt as needed. It is too early to share the specifics of what we are exploring, but I want to be transparent and let you know that work is well underway. Of course, the biggest change we have experienced is the news from Boeing on deliveries. The Boeing issues are a significant impact, and we are taking quick action to replan based on expected 2024 and 2025 delivery delays. While it's impactful, I support Boeing taking the time to do the work to understand and fix the issues. A stronger Boeing company for the long term is good for Southwest Airlines. I visited Boeing in late March. And while there is much work to do, I am encouraged by the comprehensive approach that their leadership is taking. I will be back at Boeing this summer when they complete their plan, and I will be visiting Spirit AeroSystems as well. I won't downplay the challenges from the Boeing issues. They are a big deal and contribute to changing capacity set. They're redoing schedules and forecasting now with accurate staffing levels. All of that is costly. It pulls people away from their regular work, and it creates a significant financial drag. That said, it won't deter from our work to improve our results. We will continue to control what we can control and work our plan as they take the time to become a better Boeing company. Boeing issues aside, we already had aggressive plans in place to further optimize the network to improve profitability, moderate CapEx and capacity to improve free cash flow and ROIC, and drive staffing and operational actions to improve efficiency. All of that work is now being accelerated. As we continue our focus on capital efficiency, free cash flow generation, and aggressively restoring our returns, we will continue to moderate both capacity and CapEx until we do so. Managing our CapEx is obviously key to improving free cash flow, which, along with ROIC, we are laser-focused on. Our bias will remain to retire aircraft, as planned. Any capacity growth that we have in the near term will come entirely from gauge and initiatives to drive aircraft utilization, including tightening turn time through process innovation and automation, and introducing a modest level of red eye flying. Both of those initiatives boost aircraft utilization and create capacity without aircraft CapEx. The initiative to reduce turn time is going well. As a first step, 12 stations will see a 5-minute reduction in turn time in the November 2024 schedule, with further reductions in early 2025. We will share details on the full plan, which includes these and other planned strategic initiatives at our Investor Day, now planned for September 26, and I look forward to welcoming everyone here to Dallas. On our cost control efforts, note that we already had plans in place to end 2024 with headcount flat to down through efficiency efforts like deploying automation and Gen AI solutions for greater productivity in some customer support functions, and driving organizational efficiency by combining like functions. Further capacity reductions in 2024 and 2025 create additional headcount and efficiency challenges, and we are moving quickly to address those through a combination of voluntary programs. We have essentially frozen and stopped all hiring, except for a limited number of critical positions, and now expect to end 2024 with headcount down approximately 2,000 as compared to the end of 2023. Headcount will be down again in 2025 through continued efficiency efforts. We are already seeing the benefits of the time off without pay program that, in fact, the participation in these programs generated higher-than-expected savings in March, which was one of the factors that contributed to us beating our first quarter CASM-X guidance. Last quarter, we laid out a plan that included providing a line of sight to cover our cost of capital in 2024. We are admittedly materially off that plan. Much of the miss comes from external factors, including headwinds from increased market prices for fuel and impacts attributable to the most recent delays in Boeing deliveries, but we aren't accepting that as our fate and are taking swift action against what we can control. So there's a lot going on right now, and we have a good grip and plan around areas of the business where we can improve. As a recap, we are continued to be guided by our goals to drive ROIC performance by making additional network adjustments to specifically address underperforming markets and adjusting capacity, enhancing revenue performance in the intermediate term through marketing and revenue management efforts, offsetting cost pressures with efficiency initiatives and programs to reduce headcount and lower discretionary spending, curbing our capacity plans and managing down CapEx, and investing in initiatives that create capacity without capital investment. Finally, by creating a new set of strategic initiatives to share with you at our Investor Day this September, we will not tolerate underperformance of any kind, and everyone is committed to doing what it takes. I am truly blessed to lead the company with such passionate and dedicated employees, and I am confident that we can and will adjust as needed, as we have in the past, and work to hit our financial targets, which are not negotiable. So before I close, I just want to say thank you again to our employees for all that they do every single day. And with that, I will turn it over to Tammy for a more in-depth review of our financial performance and outlook.

Thank you, Bob, and hello, everyone. As Bob just covered, this year is not shaping up as we had initially planned. We have never, and will never, accept underperformance. There are a lot of things that contributed to our current position, the impact of continued delivery delays from Boeing, significant market-driven inflationary pressure from new labor contracts, volatile fuel prices and dynamic customer travel patterns. Those are all very real reasons, but we will not use them as excuses. Instead, our focus is to control what we can control, to take aggressive actions, to adapt as required and to produce financial returns, period. Bob mentioned the warrior spirit of our employees. It's a very real thing, and it will be the key to our turnaround. So before I dive in, I want to thank our incredible employees for their resilience, their perseverance and their dedication as we gear up to tackle the challenge we have before us. Ryan and Andrew will speak to our revenue and operations performance in detail, so I'll start with our cost performance before moving to fleet and balance sheet. Overall, our unit cost, excluding special items, increased modestly, less than 1% year-over-year in the first quarter. Our first quarter average fuel price of $2.92 per gallon came in a bit below our guidance range. Market prices have been volatile. Based on the April 18 market, we increased our full year fuel price guidance by roughly $0.15 to a range of $2.70 to $2.80 per gallon, and we're anticipating our second quarter fuel price to fall within that range as well. We are currently 55% hedged here in the second quarter and 58% hedged for the full year. We continue to prudently add to our fuel hedge position for 2026, now 26% hedged, and are currently 47% hedged in 2025. Our treasury team continues to do a great job managing our program as we see cost-effective opportunities to expand our hedging portfolio, with the continued goal to get to roughly 50% hedging protection in each calendar year. The purpose of our hedge is to provide protection from spikes when we need it most. Over the past 2 years, we have benefited significantly from our hedge portfolio, generating net settlement gains of $872 million and $145 million in 2022 and 2023, respectively. For our 2024, we are currently expecting only a very modest loss, but as Brent gets above $90 a barrel, our position would begin to materially kick in, which is obviously helpful insurance to have in this volatile environment. Moving to non-fuel costs. Our first quarter unit costs, excluding special items, were up 5% year-over-year in the first quarter. Of course, that was primarily driven by pressure from new labor agreements and an increase in planned maintenance associated with the -800s coming off their engine honeymoon. This was a point ahead of our previous expectations, primarily from favorable airport settlements, but also from some early benefits from our cost control initiatives, like voluntary time-off programs. I am very thankful to all the employees who are pitching in to help reduce costs. It's always been part of our culture. The contributions that our people are making across the company are a sign that our culture is alive and well. Throughout the first quarter, we were reacting and adjusting to continuous information from Boeing on further aircraft delivery delays, causing some additional movement within our CASM-X guidance expectations as we quickly worked to revise our 2024 plans. While Boeing's challenges continue to significantly impact us, I am immensely proud of the way our team continues to handle such a dynamic situation, running multiple forecasting scenarios for critical decision support, including support in adjusting capacity and reoptimizing the network. Looking to the second quarter and full year 2024, we continue to expect similar cost pressures throughout the year, driven primarily by elevated labor costs and maintenance expenses. We currently estimate our second quarter CASM-X to increase in the range of 6.5% to 7.5% year-over-year and our full year CASM-X to increase in the range of 7% to 8% year-over-year, elevated from our previous full year CASM-X guidance due to lower capacity plans in the second half of the year. The estimated sequential change in nominal CASM-X from first to second quarter is largely in line with historical norms when adjusted for capacity levels. Roughly 5 points of our full year CASM-X guidance is attributable to elevated salaries, wages and benefits expense, and roughly 1 point is due to elevated maintenance and materials expense. While we continue to expect pressure from maintenance costs this year, we have reworked our maintenance plans given our new delivery expectations, and we now expect lower full year 2024 maintenance expense compared with our previous expectations. We are also planning more voluntary leave and time-off programs to further reduce labor expenses and address current overstaffing. Despite these added pressures, which are a direct result of the Boeing aircraft delivery delays, we are aggressively working to control costs, reduce inflationary pressures and cut discretionary spending across all cost categories. I want to reiterate, we are far from satisfied with our current financial performance, and we will work relentlessly until we return to financial prosperity, with our North Star being ROIC well exceeding our cost of capital. We will go into a lot more detail on our plans at Investor Day in September of this year. Now turning to our fleet. We have reacted quickly over the quarter to the updated Boeing delivery delays. We began the quarter with the expectation we'd receive 79 of our 85 contractual deliveries in 2024. That number dropped to an expected 46 -8 aircraft at the timing of our March 8-K, and has since reduced even further to a conservatively planned 20 -8 aircraft deliveries. Thus far, we have received 5 -8 aircraft from Boeing during the first quarter and have retired 3 -700 aircraft from our fleet. To reduce distractions and impacts to the business and hedge against further potential delivery delays, we will now plan to hold on to an additional 14 -700 aircraft that were originally planned to retire this year, bringing our expected 2024 total retirements down to 35 aircraft, including 4 -800 lease returns compared with our previous expectation for 49 aircraft retirements. While we remain committed to our fleet modernization, we feel it is prudent to retain some flexibility until we have better certainty around our aircraft deliveries and around the certification of the MAX-7. The updated Boeing delivery expectations have also impacted our capital expenditures and cash flow expectations for the year. As a result of the 20 expected aircraft deliveries, we currently expect our capital spending to be approximately $2.5 billion, well below our previous guidance of $3.5 billion to $4 billion. Keep in mind, our 2024 CapEx guidance includes an estimate for progress payments based on our current contractual order book. CapEx estimates will be fluid until we finish working our plans and aligning on updated expectations for actual 2025 deliveries, which we plan to share at our Investor Day this fall. A quick note on our capacity plans. The Boeing delivery delays did not impact our first quarter capacity, finishing up 11% year-over-year on solid completion factor. Looking ahead, as we rework our capacity plans for the year, we now expect second quarter capacity to be up in the range of 8% to 9% year-over-year. The majority of the Boeing capacity cuts will occur over the second half of the year, with third quarter capacity expected to increase in the low single digits and fourth quarter capacity expected to decrease in the low to mid-single digits, placing our full year 2024 capacity up approximately 4% year-over-year. Looking beyond 2024, we plan to keep any future growth at or below macroeconomic growth trends until we reach our long-term financial goals to consistently achieve ROIC well above our cost of capital. As a reminder, our aircraft delivery and retirement expectations are subject to Boeing's production capability. We will react as quickly as possible if any further adjustments are needed, with the focus on taking care of our customers and aligning with our financial goals. Lastly, I am immensely grateful for our balance sheet strength as we move through another challenging year. We ended the quarter with $10.5 billion in cash and short-term investments, with a nearly $1 billion reduction from the prior quarter, driven by the payout of a labor agreement ratification bonus, which are onetime in nature. In addition, we returned $215 million to our shareholders through the payment of dividends and paid $8 million to retire debt and finance lease obligations. Finally, and most notably, I am proud to report we remain the only U.S. airline with an investment-grade rating by all 3 rating agencies. Both Moody's and Fitch affirmed our rating during the first quarter, and S&P reviewed and left our rating unchanged. As ever, maintaining an investment-grade balance sheet is our utmost priority. As I close, I want to reiterate that we are not starting the year as we had hoped, and that is undeniably disappointing. However, throughout my years at this wonderful company, I have come to know that a better Southwest is often formed on the heels of adversity. I agree with Bob, that is all because of the fight and warrior spirit of our people. And with that, I will turn it over to Ryan.

Thank you, Tammy. As Bob mentioned, I'm going to provide you with details on our first quarter revenue performance and base trends. I'll also share an outlook for the second quarter and full year, along with what we are assuming in the guide. Most importantly, I will give you some color on the additional actions we are taking to further improve our revenue performance. Starting with the first quarter, unit revenue finished roughly flat on 11% capacity growth, both on a year-over-year basis. The variance to our original guidance is driven by a balance of higher-than-expected completion factor, closed-in leisure volumes that came in below our expectations in the month of March, and underperformance in select development markets. Development markets as a portfolio did not meet the maturation expectations, but the story isn't the same for all markets. Several development markets outperformed expectations, particularly Florida Beach destinations. But a few markets weighed down the portfolio. As Bob shared, we have made the difficult decision to address underperforming stations with closures effective August 4 and also to restructure and reduce capacity in other underperforming markets, which are included in our updated June schedule. Despite coming in below our expectations, first quarter had strong demand, setting numerous records, including record first quarter operating revenue, ancillary revenue passenger revenue, and record first quarter passengers carried. We also added a quarterly record number of new Rapid Reward members into the program. In addition to these records, we were also really pleased to see the continued incremental benefits from our investments in managed business as first quarter managed business revenue grew 25% year-over-year and was roughly flat to 2019 levels. We continue to pick up market share year-over-year as we perform in line with or above the rest of the industry. From a geographical perspective, we saw the strongest year-over-year improvements coming from the West Coast and the Northeast, regions where demand has been slower to return post-COVID. I also want to stress that we had a better than historically normal sequential trend in nominal unit revenue. We are seeing improvement in revenue productivity and demand. Nominal RASM in the first quarter came in flat to the fourth quarter, despite first quarter historically being seasonally softer than the fourth quarter. This is particularly true in a post-COVID environment, where peaks and troughs are magnified. To illustrate this point, consider 2018, the most recent year in which Easter fell in the last weekend of March. Nominal RASM declined sequentially 5 points. So even in this seasonally challenged quarter, the sequential performance was much better than our best holiday comparison. The most significant driver of this sequential improvement was our network optimization efforts, but we also saw a benefit from our other revenue initiatives, especially managed business investments. Looking to the second quarter, we expect our ninth consecutive quarter of record revenue performance. In fact, we expect an all-time quarterly record for operating revenue. Second quarter 2024 RASM, after being calibrated for recent booking trends, is now expected to decrease in the range of 1.5% to 3.5% year-over-year. The year-over-year comparison includes a little over 1 point of headwind for holiday timing, both from outbound Easter shifting to the first quarter and for more outbound for the July travel shifting to the third quarter. On a nominal sequential basis, this also implies another quarter of better than seasonally normal RASM improvement. Looking beyond the second quarter, network planning teams are still reworking schedules in the back half of the year to accommodate Boeing delivery delays. After adjusting expectations for both current booking trends and for Boeing delivery delays, we are forecasting 2024 operating revenue growth to approach high single digits on a year-over-year basis. This expected revenue growth implies healthy RASM growth in the back half of the year, driven by revenue initiatives as well as a reduction in year-over-year trips. While our development market maturation efforts are off track, which I'll discuss in a moment, our other revenue initiatives are expected to continue to drive value over the balance of the year. In fact, network optimization benefits contributed roughly $100 million in incremental revenue in March alone, primarily from reductions to shoulder flying, early morning and late evening flights, and short-haul flying. For the full year, the incremental year-over-year pretax profits from our strategic initiatives is now estimated to be between $1 billion and $1.5 billion, after being updated for first quarter actual performance, development market adjustments, and capacity changes in the back half of the year. The vast majority of the initiatives delivering value in 2024 continue to be revenue related. While we are encouraged to see strong demand for our brand and solid sequential improvement, it is short of our goals. As Bob and Tammy shared, it's simply not enough given the escalation of market-driven inflationary cost pressures. Therefore, we are taking actions to generate both immediate and longer-term revenue enhancements. We have stood up cross-functional teams to focus on things like accelerating the maturation of development markets further boost the value being delivered by our relatively new revenue management system and roll out new products and highlight our superior value proposition with our new brand campaign. We also have a larger team that is finalizing a more significant set of strategic initiatives, and they're tasked with delivering transformational streams of revenue productivity. Of course, we'll have more to share on this topic at Investor Day. As we build our plans, we will focus on leveraging our strengths, including those of our network, which, while it has optimization opportunities, remains incredibly relevant and well positioned based on size and population migration trends. We continue to hold the top position in 22 of the largest 50 domestic markets, and we are by far the market leader in that regard. Also, we're well positioned for the future as population and GDP growth trends are forecast to be strongest in the Southern and Mountain West regions of the country, regions where we have significant leadership. We'll also lean into the customer experience we deliver. Year-to-date, our Trip Net Promoter Score is up over 5 points year-over-year. Finally, we continue to enhance our award-winning Rapid Rewards program. Just this week, we began rolling out the ability to book and pay with part cash and part Rapid Rewards points, which I expect to be very popular with our customers. In closing, we have a large and relevant network, a strong demand environment, and a loyal and highly engaged customer base. We also have the best people whom I want to sincerely thank. We are committed to being aggressive and innovative as we adapt, adjust, and evolve to meet the preferences of our customers and to unlock the revenue productivity required to meet our financial imperatives. With that, I'll turn it over to you, Andrew.

Thank you, Ryan, and hello, everyone. I'd like to start out by thanking our incredible Southwest employees for continuing to deliver a strong operational performance. We produced a solid first quarter completion factor of 98.5%, our highest first quarter performance over the past 5 years. We delivered year-over-year improvement in early morning originators, turn compliance and turn differential, and mishandled bag rate, and again saw a year-over-year improvement in our Trip Net Promoter Score, as Ryan mentioned. Our on-time performance declined slightly year-over-year, largely due to weather challenges and delays driven by ATC programs. However, I'm pleased to report that we improved year-over-year on-time performance for the month of March. I'm proud of the hard work and investments made to bolster our winter preparedness and modernize our operations, and I'm encouraged to see these efforts pay off in our operational performance. Picking up where Bob and Tammy left off, I want to stress that we remain focused on wringing out operational inefficiencies, increasing asset productivity, and creating operating leverage by reducing structural costs. Our Southwest Turn initiative, which Bob shared, is tracking ahead of schedule and is a critical component of these efforts. One of the key elements includes eliminating the need for printing on every flight, reducing the number of employee trips up and down the jet bridge, and recovering faster during the regular operations. We reached an important milestone in this multiyear effort just last week, with the launch of electronic flight folders, which modernized several of our flight planning processes by digitizing documents used by our pilots, dispatchers, and ops agents. We also continue to make progress on modernizing the airport experience, and that initiative is also coming together faster than originally planned. Our efforts for improving the lobby customer experience are on track to provide improvements to staffing standards ahead of the original schedule. We are working on updated schedules and look forward to sharing those with you as well. I'd also like to highlight a new application called SkyPath we recently implemented and planned for our pilots and dispatchers to provide better awareness of turbulence along a flight path. This industry-leading system uses iPad sensors and GPS data from pilots' electronic flight bags to detect turbulence in real-time, aggregating and sharing data from users across several airlines in North America. Our teams worked cross-functionally to accelerate the launch of this app for the spring season when we intend to see more turbulence across the network. It's another tool we can use to support employees with additional information for decision-making, improve the onboard experience for customers, and reduce operational risk. We look forward to sharing more on these and an expansive multiyear initiative-based efforts at Investor Day in September. Finally, I'd like to close by congratulating all of our employees who reached agreements on new contracts over the past year or a little bit more than a year. Each contract requires a significant amount of work. We remain committed to rewarding our deserving employees. With that, I'll turn it back over to Julia.

Great. Thanks, Andrew. That completes our prepared remarks. We will now open the line for analyst questions. To allow for as many calls as possible, we ask that you limit yourself to one question and a brief follow-up, if needed. We will now take the first question.

Tammy, I just want to ask about the bonuses for employees in the March quarter. Can you remind us what that number was? I thought I heard it. Also, will we see another bonus in the second quarter with the approval of the flight attendant contract? Congratulations on that, by the way. Will that be the only additional bonus for the year? Please remind me of those numbers.

Yes. Mike, thanks for the question. First of all, we are thrilled to have an agreement with our wonderful flight attendants. At the end of the quarter, we had roughly $625 million accrued for labor agreements that we expect to pay out for the remainder of this year.

Okay. Great. And then just my second question, Ryan, I recently, I've seen you give some presentations and talk about red eyes and red-eye flying coming to Southwest Airlines. And I think you said it's about a 2-year time frame. I'm just curious, what are the gating issues? What are the things that need to get done to be able to actually implement them? Because it does seem like a pretty long time, but I do realize it is something new for Southwest.

Yes. Mike, we can move technology timelines around by reprioritizing things here and there. Some of the gating issues include crew scheduling changes that need to be made from a red-eye standpoint. There are some changes that need to be made with some of our operational systems. We can choose how fast to do those things and what elements go before or after them. So the 2-year estimate was rough. We can go faster than that if we choose to do so, but it’s just a myriad of technology-related items.

Yes, this is Andrew. I'll add on. Some of the bigger issues that slowed us down were with our crew contracts and our reserve periods. We had 2 reserve periods for the pilots, in particular, and didn't allow for good coverage of red eyes. With a new contract, we'll eventually go to 3 reserve periods and allow us to better have reserve pilots on standby should there be a problem. We didn't want to have those flights exposed to problems. The new contracts allow us the flexibility to have extra reserve periods, which makes us much more comfortable proceeding.

Mike, you didn't ask this, but on the why, maybe not just the timing. But obviously, we've known for a long time our customers want red-eye flying. It's a little bit limited in scope, but there are red-eye flights that are very desirable for our customers. We want to do this. It also allows us to add capacity, just like this turn work where you can add the capacity, and there's no CapEx related. We are just using the aircraft at higher utilization. Any incremental flying like that, that makes sense, alleviates at least a piece of that overstaffing with our pilots.

So Bob or Ryan, I think last quarter, we were talking about premium on the call. You guys had mentioned this is something that's cyclical, it comes up, it goes down. People put too many premium products in the cabin, and then they have to take them away in the down cycle. Is the work that you're doing now in terms of looking at the product a sign that this shift could be something more permanent? Can you guys just help us understand how your view of the market may be changing a little bit that's precipitating this sort of more strategic review?

Thank you for the question. We're continuously analyzing our customers' preferences and any changes that may arise. Over time, we've implemented features like WiFi and seat power, along with larger overhead bins, to better align with what our customers want. We've been examining the onboard seating arrangements for some time. To address your point about current customer expectations, I believe our product is strong today, and our customers appreciate it. However, it was developed during a period of lower load factors, and as these factors increase, customer preferences and operations evolve. There's no specific update at this moment, but we are thoroughly exploring this matter.

I appreciate that. As a follow-up on the same topic, if you were to pursue this option, there will be costs associated with the cabin. From a technological standpoint, how complex would it be to manage aspects like seat assignments or separating the cabin in a more challenging way? Is this a significant technological hurdle, or is it something you already have the ability to implement but haven't chosen to do so?

I prefer not to go into specifics at this time since we are still assessing customer preferences. There are various factors to consider, including the technical implementation, the duration required, the operational impact, and the financial implications, all of which will influence our decision-making process. I want to emphasize that we are taking this matter very seriously, and we will provide more information during our Investor Day on September 26.

That's right. Our PSS is the industry-standard Amadeus tool, which works in those environments. The underlying system is not prohibited from doing that.

Just geographically, can you speak to how much differentiation you're seeing in unit revenue trends? You have a pretty broad-based domestic network. Could you just comment on relative strength versus relative weakness geographically across the country?

Duane, there is definitely regional performance. I mentioned in the prepared remarks that the West Coast did well. Particularly, intra-Cal RASM and margins are up double digits year-over-year. Phoenix is doing really well. Vegas is doing well. Of course, Vegas had some assistance there with the Super Bowl being there in February in the first quarter. But all those markets performing very, very well. The Northeast performed well. In Florida, there's been a lot of talk about Florida. Florida, we have above system average RASM. In Florida, it's come under pressure with some of the capacity growth there, but still, RASM is above system averages in Florida. So there's strength across the network. Of course, we've got some weaknesses in the development markets, which we've talked about. We have plans underway to address them with the station closures that we've talked about. We've restructured some of those development markets and some of the schedules that we've had to republish here as a result of the Boeing delivery delays. But yes, there's always a portfolio, and you've got markets that performed better than others. We're focused on making some improvements in those development markets.

Okay. Appreciate the thoughts. And then just on your capacity exit rate, why was it down low singles, low to mid-singles by the fourth quarter? How should we be thinking about early 2025? And are we still in a dynamic, where seats are down more than ASMs? In other words, I think that was by several points, maybe 5 points or so, that seats were trailing ASMs. Is that still the dynamic in the fourth quarter?

Yes, Duane, thank you. This is all very fluid as we work with Boeing on their delivery estimates. Obviously, '25 is more fluid than '24. As we get some indication from Boeing, we're considering how we're going to plan, which may be different because we don't want to disrupt our schedules over and over. So it's early to give you a signal on '25. That said, I would point out again that any capacity is going to come through either gauge or initiative-based additions. That said, it's too early, but I think you're thinking directionally correctly. I'll just stop there. Tammy, unless you want to add something?

No. The only thing I might reiterate is we'll look to align our capacity growth for 2025 with demand. We have a little bit of time here. One thing to point out is we do have fleet flexibility by design, so we'll continue to evaluate that. And at a higher level, we do plan to grow below macroeconomic growth trends until we get our financials going in the right direction to achieve our goals.

And the capacity discipline and network adjustments are not just about Boeing. We have to do those things to restore our financial progress, and we will continue on that path until we get there.

It does imply that our central tendency is for seats to trail ASMs, and for trips to trail seats. That's a natural consequence of those actions.

Yes. So Tammy, how should we be thinking about operating cash flow for the rest of the year? I mean, we've got the retro component in there with the flight attendants. But presumably, a weaker demand outlook suggests some pressure on the air traffic liability. And then related, I guess, somewhat to that, the dividend consumes, what, $450 million a year, $450 million of cash. Any idea how the Board is thinking about that in light of some of the challenges that you articulated today?

Yes. Jamie, we're focused, as Bob said, on generating free cash flow. Ultimately, we're working to restore our financial returns. This year, we're focused on what we can control. We are working on lowering our CapEx. That's already come down quite a bit, as we've already shared. Just in terms of the liquidity targets we have established with our Board, we do have a minimum cash target of $6 billion, which, of course, is on top of our revolver.

Okay. And then, Bob, question, when you report earnings, does management then break up and host town halls throughout the company? The reason I ask is that some airlines, some companies do that. I honestly don't know of Southwest. But I have to wonder, I mean, is the tone with the front line as somber as it is on this call? I mean, I guess it’s hard to answer. But if I was in Baltimore right now, chatting up employees, do they get what's going on right now and just how grim this guide is?

Yes, Jamie, you've raised a lot of points with your question. To start, our financial returns are not where we need or want them to be. However, the company is not in a dire state. We are experiencing strong demand for our product, we have excellent employees, our operational performance is improving, and we achieved the best completion factor in five years. The company has many qualities that our customers appreciate. I would differentiate between the seriousness of our financial returns and the overall state of the company. Everyone understands what needs to be done, and we have a solid plan with actionable steps that we are all committed to, aimed at improving our financial returns.

If I might, just on the business revenue, that was a good performance here. I was curious what your 2Q outlook is reflecting in terms of expectations and what you're seeing there.

Savi, yes, managed business was up very healthy in the first quarter, up 25% and reached a significant milestone in getting back to flat to 2019 levels. We were really pleased with that. That was driven by a double-digit increase in unique travelers traveling under a contract in the managed business space. We continue to pick up market share. As we look forward, we expect the performance to continue and to accelerate the sequential performance in the second quarter to be better than the first. It’s across the board, our top 15 industries, 11 of those had double-digit growth year-over-year.

That's helpful. If I might just ask just a question related to CapEx and given your current outlook. Thoughts, Tammy, on kind of free cash flow generation here and looking forward a little bit, what's realistic?

Yes, Savi. We're expecting CapEx this year at $2.5 billion, and that includes about $1 billion in aircraft spending. We are working through our plans for next year. So it’s a bit early to give you guidance for next year. We are working through that actively now. We'll update you on our CapEx spending plans as part of our comprehensive update in September at our Investor Day.

Is the view that free cash flow generation is important and possible? Or how are you thinking about translating that CapEx into what?

We are absolutely working with the view to generate free cash flow, so that will be part of the equation as we pull together our plan for next year.

Okay. That wraps up the analyst portion of today's call. I appreciate everyone joining, and have a great day.

Thanks, Gary. Welcome to the media on our call today. Before we begin taking your questions, Gary, could you remind us and share instructions on how to queue up for questions?

Can you all hear me? Okay, perfect. I'm wondering if we could hone in on the 4 airports that were announced today that would be cut, and same with Atlanta and Chicago that are being reduced in flights. Could you talk a little bit about the decision for those specific airports to be chosen?

It's never an easy decision to close a station or significantly reduce flights at one. We value our airports and the communities we serve, making these decisions challenging. However, some parts of our network are underperforming, and we need to address that for various reasons. It's important for us to achieve our financial goals, and tough decisions are necessary to focus on markets that are not delivering results. Our network must be financially sustainable at an appropriate level.

No, you covered it, I think.

And my second question, what kind of communications have been given to the employees at those airports?

We have a very thorough communication plan. We handle it with compassion. Our employees will be offered jobs in other cities. They have options. We handle this as you would expect Southwest Airlines to handle it.

Yes. We staged senior leaders there last night. Our leaders were there to explain the whys to the employees as well as the airports, and go through how that will work for them. There will be a range of emotions. People chose to relocate there, and they will have some natural disappointment in the short term, but we expect most of them to take advantage of the opportunities to relocate to other stations.

I appreciate it. I wanted to see if you could talk about the extent of the reductions in O'Hare and Atlanta.

We took about half of O'Hare down from about 30 something flights to about 15, 18 flights during the season. It's about a 50% reduction in Atlanta. It's unfortunate. We had been restoring Atlanta post-pandemic. We could never quite achieve the level of performance needed at that scale post-pandemic. It's still substantial activity there, it's just not as big as it was before.

Great. And if you could also address the impact of the new refund policies that were announced by the DOT yesterday, whether that's going to be a financial problem for Southwest? Or do you expect to have any trouble complying with those new rules?

Mary, it’s Ryan. It's new. As you know, it was just issued yesterday. We're digesting exactly what that all means. But based on our read, so far, I don't expect that it's going to be a significant impact. We already have the most customer-friendly policies in the industry. If there's a long delay or cancellation, customers can receive a refund from Southwest. There's no real change from our standpoint. We have unique policies like flight credits that don't expire.

I know that the overall demand environment remains very strong. But I am curious if you're seeing any indications of bookaway or traveler nervousness about Boeing or air safety more broadly?

We study, we survey to understand our customers' views and whether anything going on impacts their view of Southwest or the industry. We don't see any indication that this is having an impact on bookings or demand. It's not perfect, but we don't see anything material.

The only thing that I would add is that we look at cancellations and ask customers once they cancel a flight what their reasons are. Safety concerns or Boeing aircraft are only about 1% of our cancellations, which is very, very small and not material.

Interesting. And the 4 cities, the 4 markets that you're exiting, are those cities that you think would have been more successful if you had the MAX-7 in your fleet or had it coming soon?

I think the markets themselves were just performing at a level that we needed to make the tough choice to remove them from the network. I don't think that a smaller aircraft would have had a material difference on those markets.

About 6 months ago, you were asked about open seating versus assigned seating, and you mentioned that customer preferences would drive changes. Can you help us understand what has dramatically changed in the past 6 months on that front? Is there any financially significant change to boarding or seating you can do without assigning seats?

It's different because we've made work more accelerated. We've been studying customer preference more deeply. There’s a lot of discussions about cabin and premium products. We are committed to understanding our customers’ wants and needs, and we are looking at this very seriously.

The challenge is how we optimize for revenue from additional products and what exists in the current boarding process. Our ancillary revenue grew 18% year-over-year in the first quarter, exceeding O&D passenger growth. We are focusing on enhancing revenue management related to ancillary products.

If you could go into a little bit of explanation on the 2,000 headcount reduction. First, how many jobs do you think will be eliminated by the closure of those 4 airports? Can you rule out furloughs?

We have line of sight on the 2,000 that does not include furloughs or anything like that, that we don't want to put on the table. It also does not include the headcount that are effectively out of the workforce due to voluntary unpaid leave. This is really through attrition, and we're able to model out what that will look like, ensuring we are not backfilling positions that don’t need to be filled. We are committed to efficiency.

We don't give a breakdown by workgroup. There will be some back office and some frontline reductions, but it's through natural attrition and programmatic responses without needing to implement reductions in force.

Just knowing what you know now from these customer surveys about potential seating changes, are you thinking that it could be like a big front seat or bigger front seat-type product? Do you think there will be a curtain on a Southwest Airlines plane? Are you ruling out baggage fees entirely?

We will stay true to our brand. Interestingly, Southwest Airlines will remain customer-friendly. We've been clear that bag fees are not on the table for consideration. Our customers choose Southwest precisely because we do not have bag fees. It drives customer preference.

It may seem like a desirable product, but the revenue generated must be considered. So we'll take a strong review of generating revenue and whether our products fit that need.

Bob, all the additional voluntary time-off programs that you're considering, does that include the pilots as well?

Currently, the voluntary time-off has roughly been with our ground operations, flight attendants and some of our call center people. We do not have anything with our pilots at the moment. A provision of our contract requires us to consult with them before doing anything regarding that.

Bob, you said that you were encouraged by Boeing's approach. Can you please share some examples that make you feel encouraged about their approach?

We were impressed by how Boeing is putting quality ahead of short-term profit. They have many portions in their factory, and they don't allow anything to progress past certain stations if there’s troubled work, which creates quality in their process.

You want to see the tone at the top be appropriate, which recognizes that this is a big issue. They need to tackle it very broadly, and our view when visiting Boeing is encouraging in terms of the action taken.

And have you increased your inspectors at the Boeing sites following the last several incident?

In 2022, we increased from having just a representative to having a team of AMP-certified mechanics on site to inspect our aircraft throughout the production process. We also have executive engagement that has shown good results, and our heightened attention to Boeing has been ongoing.

You said that you're looking at changing customer preferences. Are you looking at this as something where customers are choosing to book other airlines over Southwest? Or are you missing opportunities to earn revenue on premiums?

You want to know all those things. You want to know why customers book Southwest, what they expect, and why they book others. You want to know what preferences exist, how it affects their desire to book Southwest. We are taking a robust approach to study this.

For any transformational change, we’re taking a scientific approach to understand the market dynamics and customer preferences deeply. We’ll remain true to who we are while studying this.

We are not ready to go into detail yet. If there’s something to be changed, we aim to share that at our Investor Day, planned for September.

Thanks to everyone who joined us today. If you guys have any further questions, our Communications Group is standing by. Their contact information, along with today's news release, are all available at swamedia.com.