Southwest Airlines Company (LUV) — Q2 2024 Earnings Call Transcript

Thank you so much. Hello, everyone, and welcome to our second quarter 2024 earnings call. I am joined today by our President and CEO, Bob Jordan; Chief Operating Officer, Andrew Watterson; and Executive Vice President and CFO, Tammy Romo. Bob will get us started with an overview of the company's performance and strategy and will also provide color on the strategic initiatives announced this morning. Andrew will provide an update on the revenue and Tammy will cover our costs and balance sheet. Ryan Green, EVP of Commercial Transformation is also in the room with us today, as well as other executives to support Q&A. A quick reminder that we will make forward-looking statements, which are based on our current expectations of future performance, and actual results could differ materially from expectations. Also we will reference our non-GAAP results, which exclude special items that are called out and reconciled to GAAP results on our earnings press release. Our press release with second quarter 2024 results and a separate release announcing select strategic initiatives were both issued this morning and are available on our Investor Relations website. And with that, I'm pleased to turn the call over to you, Bob.

Thank you, Julia, and thanks, everyone, for joining us this morning. We have a lot to cover today, so let's jump right in. In my comments today, I will touch briefly on our results for the quarter and then provide detail on the plans we announced earlier this morning to implement meaningful changes to our business and better position Southwest Airlines to produce higher returns in a more competitive higher cost environment. As Julia mentioned, Andrew will provide details on our revenue performance, including the work underway to calibrate our revenue management system and processes, and Tammy will discuss our cost, CapEx and balance sheet. Starting with our overall results, they are not where we need them to be, and they are not reflective of what we are capable of delivering. We will cover where we fell short as well as our action plan in detail later on the call, but I'll hit on a few highlights first. Our frontline employees executed very well as we continue to improve in nearly every operating and customer metric. Once again, we ran a high-quality operation with a completion factor of 99.5% despite challenging weather. This was further evidenced by our performance following Hurricane Beryl earlier this month. We experienced an 8% cancel rate on July 8th as the storm moved through the Houston area but had only a 0.3% cancel rate the following day as we recovered quickly with almost no operational hangover from the prior day. I am very proud of our team. Following the global technology outages, we were able to recover very quickly and experienced a near-zero cancel rate. Investments made to advance core operations and modernize technology meant that we had redundancy in place for key systems that experienced issues. Time and time again, the purposeful investments we've made to improve our resilience and ability to recover from disruptions are demonstrating their value, and that investment will continue. Our exceptional customer service continues to improve as well and was recently recognized by J.D. Power, where we were awarded the leading Economy Class Customer Satisfaction distinction for the third consecutive year. Reliable operational performance and customer service are and always will be cornerstones of our business model. Moving on to revenue performance. Unit revenue for the quarter declined 3.8% year-over-year primarily as a result of domestic capacity outpacing demand. The decline was also a Southwest-specific challenge as we fully mature our usage of a new O&D-based revenue management system. Andrew will go into more detail later, but the bottom line is we sold too many seats for the peak summer travel period too early in the booking curve. It's not unusual to have growing pains with these types of systems. We are working quickly to action opportunities to drive performance improvement. We're also adding additional leadership expertise and support, including our plan to hire a Chief Revenue Officer to focus on revenue management and pricing. We continue to have confidence that the new revenue management system will drive long-term revenue improvement. The management team and I, with the support of our Board, are completely aligned on the imperative to produce results and ultimately deliver returns ahead of our cost of capital. Doing so requires an evaluation of all opportunities and a willingness to evolve some long-standing policies while staying true to our values. With that in mind, I'll discuss some of the changes we are making to further evolve Southwest Airlines. These are part of an ongoing strategic transformation of the business, and we will share more details during our Investor Day, where we will outline a comprehensive plan to deliver transformational commercial initiatives, improved operational efficiency, and capital allocation discipline. Our teams have been hard at work evaluating fundamental changes to our seating, cabin, and boarding procedures. It's clear that the open seating model that served us well for so many years is no longer optimal for today's customer. This decision was not made lightly. We have been very thorough and deliberate in how we approach the question, conducting multiple sophisticated research studies over many months that evaluated customer preference and looked at different types of cabin layouts and seating methods. Our research shows that 80% of our customers prefer an assigned seat, and 86% of our potential customers prefer an assigned seat. Further, when a customer defects from Southwest to one of our competitors, our open seating policy is cited as the number one reason why. The answer is clear; there is more demand for Southwest Airlines with an assigned seating model, and there is a significant ability to monetize the cabin more effectively with a premium seating option. By extension, these changes are expected to drive significant value for our shareholders. We feel confident that the solution we are implementing will retain the positive elements of the Southwest Airlines experience and enable us to evolve in a manner that's consistent with what today's air traveler is seeking. While specific cabin layouts are still being finalized, we expect roughly one-third of seats across the fleet to offer extended legroom. We're also designing a boarding process that retains the organized manner our customers enjoy today, but also complements an assigned seating model. We've been studying this in depth to preserve our operational efficiency and how quickly we turn an aircraft. We've conducted both live boarding tests to understand passenger movement in a real-world environment and also more than 8 million digital simulations to test different boarding options. These digital boarding simulations include data from real flights with real passenger manifests to understand differences in boarding times stemming from passenger mix, including families traveling together, customers who may need more time to board, and experienced versus inexperienced travelers. The data clearly indicates that any operational impacts are neutral or an enhancement to current performance. We're also approaching this change in a capital-efficient manner. New aircraft will be delivered with our improved RECARO seats beginning early next year. For existing aircraft where we must retrofit with a new configuration, we plan to use existing seats within our fleet to avoid a large capital expenditure. We're working quickly to realize the value of this new model as soon as possible. New seat configurations require FAA certification, which typically takes several months, and only then can we begin the process of retrofitting the fleet. We, therefore, expect to make bookings available beginning next year. The aircraft downtime should be minimal to complete the cabin changes, but keep in mind that we have a fleet of roughly 800 aircraft to retrofit, and that will take time. Changing from an open seating model to an assigned seating model will be a complex and transformational change that cuts across almost all aspects of the company and is one of several commercial initiatives currently underway to be detailed at our Investor Day. Given the significance of the changes, I’ve asked our Chief Commercial Officer, Ryan Green, to take on leadership of this initiative on a full-time basis. As EVP of Commercial Transformation, Ryan will lead this effort along with other commercial initiatives already underway. Ryan has led the work to this point and is steeped in knowledge regarding customer trends, and he has previously and successfully led efforts to transform our Rapid Rewards loyalty program and the digital customer experience, and Ryan will report directly to me. Additionally, today we are publishing a schedule that incorporates red-eye flying, which will phase in rapidly by summer 2025 and combined with ongoing reductions in turn time through new technologies and procedures will enable us to fund nearly all new capacity over the next three years through initiatives rather than additional aircraft CapEx. These initiatives are part of a comprehensive strategic transformation and reflect a commitment to deliver and implement a plan aimed at driving shareholder value and achieving ROIC well in excess of our cost of capital. We will provide more details around the timing and value of these initiatives and other tactical and strategic initiatives when we gather for Investor Day in late September, but we wanted to keep you up to speed on some of the decisions that we've made already and the deliberate plans we have in place to implement them. Before I close, I want to again recognize all the efforts from our incredible employees. Thank you for the excellence and the dedication that you bring to work every single day. And with that, I will turn it over to Andrew to provide a full update on our revenue performance and outlook.

Thank you, Bob. I'm very excited about the strategic initiatives we have coming. I am also very proud of our people for their continued focus on safety, running a quality operation with the lowest year-to-date cancellation rate in the industry, and our strong customer service performance trends. Moving to revenue performance, we have experienced challenges in managing demand across booking curves as we deployed efforts to address load factor underperformance. As a result, we experienced yields and ultimately revenue dilution from selling too many seats too early in the booking curve. As you will likely recall, back in the spring of 2023, we transitioned to a new and modernized revenue management system. The system is fundamentally different from and superior to our prior system. The new system manages revenue on an origin of destination basis compared with our prior leg-based system. The decision to implement this new system followed an extensive review of our options, including a comprehensive 18-month pilot to evaluate and test two new revenue management systems against our prior system. What we directly observed during the testing period was that the system we selected consistently produced superior results. The goal is to maximize the revenue performance of our flights, especially the best flights. The new system accomplishes just that by considering what customers are willing to pay at different phases of the booking curve, including taking note of the differentiation between business and leisure customers. However, adapting to a new system is not straightforward. Add to that, changing schedules from Boeing delivery shifts and what we got was a complicated rollout. Regardless, while we estimate about 2 points of year-over-year headwind to the third quarter from bookings already in place, we are taking decisive actions to recalibrate the system. The estimated impact is already built into our 3Q RASM outlook of flat to down 2% on a year-over-year basis. The outside experts that Bob mentioned are supporting our employees in getting the most from the capabilities of this new system. The good news is that we have confidence in the superiority of the new system, as evidenced by the month-long AB testing that we conducted. As we gain expertise in optimizing the system, we expect to see a noticeable tailwind to performance, likely starting in September of this year. Adopting a new revenue management system is a once-in-a-generation implementation, and we are committed to executing a successful turnaround in our revenue performance. In addition to the improvement we expect to see in our revenue management performance, our plan includes continued network optimization and capacity moderation moving into the back half of the year. Our summer, fall, and recently published winter-based schedules all include actions to target supply demand across geographies and calendar periods as well as scheduled quality actions to facilitate demand capture. By the fourth quarter, we expect less capacity oversupply as well as improvements in our revenue management. We are planning for our capacity to decline by 4% year-over-year in the fourth quarter, with seats and trips down roughly 8%, and therefore, we expect RASM growth to be positive year-over-year by the fourth quarter. We will deliberately and urgently pursue tactical opportunities to improve financial performance, including calibrating our revenue management process and continuing our work to optimize our network. Before I close, I want to thank our people again for doing an amazing job driving operational excellence and providing our legendary hospitality. I am so appreciative of their contributions. With that, I'll turn it over to Tammy.

Thank you, Andrew, and hello, everyone. As Bob mentioned, I will provide an update on our cost performance before turning to fleet and balance sheet performance. Overall, our second quarter CASM-X increased 6% year-over-year, and we continue to expect CASM-X for full year 2024 to increase in the range of 7% to 8% on a year-over-year basis. The higher year-over-year CASM-X growth in the second half of this year is driven primarily by a continuation of market-driven labor cost pressure from our new contracts as well as from the moderation of year-over-year capacity growth. We are urgently and deliberately pursuing opportunities to mitigate cost pressures, including the drag from overstaffing related to previously reported Boeing delivery delays. As discussed on our first quarter earnings call, we have expanded our voluntary leave and time off programs to further reduce labor expenses and bring staffing levels in line with our current fleet. We have halted all critical hiring, and we continue to expect to end this year with headcount down roughly 2,000 from year-end 2023. We continue to plan for headcount to be down again in 2025 as attrition levels exceed our controlled hiring levels. Our second quarter average fuel price of $2.76 per gallon was in line with our expectations. Our hedge portfolio continues to provide protection against spikes in prices, and we are continuing to opportunistically add protection with no change to our target of a roughly 50% hedge position. Turning to our fleet, we prudently adjusted our 2024 delivery expectations prior to our April earnings report to mitigate Boeing delivery risk to our internal planning functions. We, therefore, continue to plan for 20 -800 aircraft deliveries, 31 -700 retirements, and four -800 lease returns for the year. We remain committed to our fleet modernization benefit and our planned reduction in aircraft exceeds our planned delivery. We also remain committed to longer-term capacity discipline and ROIC production. We expect third quarter capacity to increase approximately 2% and fourth quarter capacity to decrease approximately 4%. Accordingly, our expectation for full year 2024 capacity continues to be up approximately 4% year-over-year. Looking beyond 2024, we remain committed to earning our right to grow and plan to keep any future growth at or below macroeconomic growth trends until we reach our long-term financial goal of returns on invested capital consistently in excess of our cost of capital. Our expected capital spending for 2024 is approximately $2.5 billion, which is in line with our prior guidance and well below our expectations of $3.5 billion to $4 billion at the beginning of the year. We are in ongoing discussions with Boeing regarding the financial impact of delivery delays, and as with past compensation, we expect any financial damages to be realized as a reduction in the cost basis of certain aircraft. Our balance sheet is obviously a critical competitive strength with an investment-grade rating from all three rating agencies. We continue to be in a net cash position as we ended the second quarter with cash and short-term investments of $10 billion versus $8 billion in outstanding debt. We expect a modest $29 million in scheduled debt repayments for the full year, and currently, 2024 interest income is still expected to more than offset 2024 interest expense. Following the pandemic, we have maintained elevated liquidity levels primarily to fund fleet modernization efforts, labor contract ratification bonuses, debt service considerations and to provide insurance against unforeseen business risks. With much of the uncertainty largely behind us, we intend to start normalizing our liquidity levels back towards pre-COVID levels targeting minimum total liquidity, including our undrawn revolver. Our long-term financial goals remain unchanged; maintain a strong balance sheet, investment-grade credit ratings, and ample liquidity; grow earnings, margins, and capital returns. As Andrew said, we intend to pay off 2025 debt maturities at least partially in cash and specifically plan to repay or refinance the first tranche of the payroll support program loans as the associated interest rates start to ratchet higher for the industry beginning next year. We also remain committed to our legacy of healthy shareholder returns. We are proud of our history of returning capital to our shareholders. We returned more than $13.5 billion through share repurchases and dividends since 2010, and we returned $215 million to shareholders through dividends in the first half of this year. We paid another dividend just a couple of weeks ago during the third quarter. We are actively reviewing our return of capital policies, and ultimately, our goal is to restore shareholder returns to historic levels. As I close, I want to reiterate that our financial performance is not reflective of what we can and must deliver. As shareholders, you expect us to lead the industry in financial performance, and we will be satisfied with nothing less. There are areas we need to improve, which we are owning and addressing as a management team. Despite these distractions, our employees remain steadfast in their dedication to the mission of the company and to providing our storied and world-class hospitality to our valued customers. I am both proud and grateful for our employees. I am excited about the plans we have in place to secure a bright future for Southwest and to share more about our tactical and strategic initiatives, as well as our capital allocation plan at Investor Day in September. We remain fully committed to executing on a plan to restore returns on invested capital in excess of our cost of capital, as this remains our guiding financial principles. And with that, I will turn it back over to you, Julia.

Thank you, Tammy. This completes our prepared remarks. We will now open the line for analysts' questions. We would like to get as many of you as possible, so we ask that you please limit yourself to one question and a brief follow-up, if necessary. We will now take the first question.

Hey, good afternoon and thanks for taking my question. Bob, we definitely appreciate the new product changes that you announced today, like extra leg room and red-eye flying. But I think you'd agree, these have been offered for decades at your competitors. So I guess can you give us insight into the timing of this? Why now? And why wasn't this with that maybe even just a few years ago when you did do like a cabin redesign?

Yeah, Brandon. I think a lot of things changed. I mean you have changing demand patterns. We have customer preferences that are always changing. It changed to some extent, also coming out of the pandemic. You can always debate when. At the end of the day, it's the right thing to do right now, particularly as we over time have flown longer and flights are more full. I think that is a large driver of this. One of the things that's obvious is if you have a longer flight, customers have a preference to know where they are sitting, just like they have a preference to have seat back power. And I'll admit, I was a bit surprised. We did extensive research here. Tens of thousands of customers surveyed, a lot of work, conjoint analysis to understand products, what customers prefer, and what they're willing to pay for. While I wasn't surprised that the preference ended up coming out for assigned seating and more premium options in the cabin. I was surprised at the level of the preference, 80% in favor of assigned seating amongst our customers, 86% amongst those who fly other carriers. Of course, we reported it was the number one reason that customers cited when they defect from Southwest Airlines. It's very clear that there's strong demand. But you can always pick the time and the place. I'm 100% forward-focused. In other words, we've done the work to ensure that this is the right change. The change is right to do now where you're not quite ready to share the timelines other than that we plan on selling the new seating in 2025, and we'll share all of that at our Investor Day in September, but it's clearly the right thing to do for our customers, for our employees, and for our shareholders.

Well, I think your investors appreciate the effort here to make changes. But I think some of the public criticism being levied on the company and the Board is that, it's been such an insular culture. These things couldn't even have been discussed years ago. I guess, what are you doing from that aspect? Are you looking to fill some of these executive positions externally?

Yes, hindsight often seems clearer, and it's easy to critique decision timing. However, I want to emphasize that we are fully committed to transformational change at Southwest Airlines and are moving forward with urgency. Today, we announced not only the changes to assigned seating and cabin configurations but also the introduction of red-eye flights, which we have already implemented and are included in today's published schedules. We have been diligently improving our operational systems, which I can elaborate on. This focus on operations helped us maintain a 99.8% completion rate during last week's tech outage, despite critical systems being affected. We are dedicated to transforming the company, advancing steadily, and executing a comprehensive plan that includes delivering impactful commercial initiatives, enhancing operational efficiency, and maintaining disciplined capital allocation.

Hey, good afternoon, everybody. On assigned seating, do you envision still being able to board an aircraft with just a single agent?

Yes, absolutely, that would be the intent. We're still working on product design and some of the specifics. We have a lot of line of sight to the layout of the cabin. A lot of line of sight right now to the product design. We're working on the boarding. One of the things that we get a lot of credit for today, Jamie, is the calm and order of our boarding. We board in an ordinal manner, and our customers that we survey really like that. So there's a lot of focus on maintaining the boarding form that our customers love, but doing it in a manner that it pairs with assigned seating. More to share at our Investor Day, but that would be the goal. We want to do this whole thing the Southwest way. We're known for things that make sense, common sense, not adding complexity. If you look at the cabin, again, we're not ready to share everything, but we'll have about one-third of the seats or so across the fleet in this extended legroom configuration, and there will be differentiation. It will be different than the rest of the cabin, but it won't be a different seat with a curtain and meals and ovens. We'll do this in the Southwest way. The same applies to boarding.

Perfect. Thanks. And second, I don't know if you've ever commented on this in the past. But from a Rapid Rewards perspective, how important is Hawaii? For example, could you disclose what percent of overall redemptions choose Hawaii, something like that? I'm just trying to model how important Hawaii is for getting credit cards into people's wallets and driving brand profits, that kind of stuff? Thanks in advance.

Jamie, it's very important, particularly as you think about the West Coast and the franchise, but I'll let Andrew take a crack at the details here.

Yeah, I can't recall off the top of my head, Jamie, but it is high. It's not as high as Aruba. Aruba is actually our highest redemption, and that goes for our East Coast customers who want a kind of aspirational vacation destination, and that allows under redeem for that. In the West, we have a very business-centric network with leisure options being Vegas and Phoenix in season. So Hawaii is important for our customer franchise in the Western U.S. who are closer geographically to Hawaii or to Florida for their beach and warm-weather destinations. It's important for that customer base who is a repeat purchase customer base. So Rapid Rewards reflects a brand identification, and we need to build a multipurpose travel network for them, and Hawaii fulfills that for our Western U.S. customers.

That's good detail. Thanks very much. I would not have guessed the Aruba nugget. That's a good one. Thanks.

Hey, good morning. Just on the O&D revenue management system, you kind of shared a lot of details. It seems like you've had revenue management changes in the past that have come up with some issues as well. But I was curious, I think, Bob, in your comment on CNBC, you mentioned that you just sold too many seats at too low prices. I don't know, Ryan, if you want to kind of talk about. You're seeing a lot of fare sales still out there, and that doesn't seem to jive with realizing that you've sold too many seats at too low prices. I was curious if you could talk about the fare sale activity you're doing today and how we should interpret that?

Yes. Maybe just talking about revenue management generally. The O&D systems are, by nature, more complex, and it's not unusual that they take time to be tuned and adapted. And we've had, not making excuses, but we've also had a lot of noise around demand with schedule changes adapting to Boeing delivery issues, and that's not helped. But clearly, we sold too many seats early for the peak summer travel period, which means you're going to take them in lower booking classes. It also means when you get to the summer and you have those strong flights, you have fewer seats to sell later in the booking curve, which obviously comes in higher booking classes. So we've had a strong diagnostic to understand what's happening. We've had experts, third-party experts, in to help. We have a strong action plan, and that action plan is being put into place right now. We're also adding more expertise and senior leadership over the area simply because it is more complex. Maybe tearing that apart a little bit from the fare sale. It's also clear that the RM system, it's clear that there's simply more capacity on the domestic side than demand right now. And so that's got to be a piece of what you're talking about. For Southwest Airlines, we're taking actions for ourselves here. Capacity was up about 8.6% in the second quarter. We're going to moderate that to 2% in the third. It will actually be down roughly 4% in the fourth, and underlying that, trips will actually be down about 8% in the fourth quarter. We are working down capacity aggressively on our part here. But yes, Andrew, you want to comment more specifically on RM?

I think I would say just in the fare sale that can be a red herring we get often. We distribute directly to consumers, which means you always have to be out there pulling them to your website, and promotional activity is the way that you do that. The frequency of our sales does not hold a special meaning. It's a depth of a sale that would give you indications about any kind of promotional level of discounts we're giving. In that situation, I don't think anything has really changed. If you look at the current sales, we always expect to be out there promoting to customers from our website. That has a number attached to it to get them there, but that's a normal course of business, and it's been that way through good times and bad over the years.

That's helpful clarification. I know there's more information coming at Investor Day, but I was curious about the process for changing the seating on the planes. Once the FAA approves it, how long does it generally take to implement that across a large fleet like yours?

You've got two, maybe three aspects to consider. First, we need to finalize the design of the layout, which is nearly complete. Then there's a lengthy certification process. Additionally, we have about 800 aircraft that require modifications. We'll approach this in a capital-efficient manner by utilizing the new RECARO seating from the upcoming aircraft starting early next year or existing seats. Modifying 800 aircraft will still take some time, even if the changes are relatively quick. This is a complex adjustment that involves technology, processes, training, and other necessary work, which will take time. We'll provide more detailed timelines in September. For now, our plan is to introduce the new seating format with assigned seating starting in 2025. The fleet modification isn't overly complicated; it just needs approval, and we then have to work through the 800 aircraft in the fleet.

I'm one of those 80% of passengers who like to see the change. So we'll have to see that. Thanks.

Hi, everyone. Thank you. Maybe just sticking on the premium stuff. So have you secured slots from an MRO perspective? And then you mentioned doing this on all 800 aircraft. I'm just curious on why you're doing the 700s if we're talking about retiring those over the next 10 years? And sorry for an extra question on top of this. Like when you think about the layout, are you expecting the same number of seats on each plane, not losing any seats by adding premium? Thank you.

We're still working on specific layouts and want to ensure we do this in a way that aligns with our values. Our goal is to maintain our customer-friendly policies while enhancing the overall experience, not just in the extra legroom section but throughout the cabin. We are still evaluating this aspect. The 700s will be part of our fleet for a significant time, and we will provide details on the financial advantages soon. It’s clear that modifications to the 700s will include extra legroom seats, and we aim to have a similar configuration across our entire fleet. This means it wouldn’t make sense for customers to experience a flight with many extra legroom seats on one flight and then find very few on another flight simply due to a different aircraft type. Our intention is to provide the extra legroom section on every flight to make it more convenient for our passengers.

Yes, I think that's the most important part, Conor, is that when you start wrapping seating benefits, premium seating benefits into your overall value proposition, whether you're selling it as an ancillary or a fare, the customer, when they go on to buy their flight from Dallas to Denver. They don't know if we're going to operate it with the 700 or a MAX 8 aircraft, and you want a consistent value proposition across the board to serve the customers' needs. So I think that's the most important piece of that equation to your question there.

Okay. And then on the comment of growing at or below macro trends in 2025, I'm trying to understand why growth is even on the table right now given where returns are? In that same context, like you're talking about unit revenue down today, but then seats down 6% to 8% that inflects unit revenue positive. I just try to understand why we should then ramp back up in line with the economic growth. And then in the context of all that, can you just frame up how you view the current demand environment in general? Thank you.

Yes, Conor, you bet. We are still working on 2025, so I wouldn't take anything as an exact number. That was a commitment, obviously, over the next years and commitment until we are able to earn our cost of capital here. We've not picked a number necessarily for 2025, but we are going to be managing our capital expenditures aggressively. Tied to that, we haven't talked about the red-eye flying, but we're also announcing that today which I'm really proud of. Our customers want it, but what it also does for us is it produces ASMs without having to buy extra aircraft. The aircraft are available overnight, and the sophisticated technology and processes going into turn management, but that's allowing us to take time out of the turn. The combination of those two things, the red-eye flying and turn compression will allow us to fund nearly all, if not all, capacity 2025, 2026, 2027 through initiatives and not by buying additional aircraft and spending incremental CapEx.

Okay, that’s helpful. Thank you.

Hey. Bob, I know you had mentioned earlier you talked about sort of capacity domestically running a bit higher than demand and maybe what was driving the price weakness. But how much of it do you think may also be attributable to just that more price-sensitive consumer who may be pushing back? I mean we are seeing that in other sectors, and I would think that you tend to carry a healthy amount of that type of segment. Are you seeing it?

Hey Mike, it's Andrew. We're not seeing any specific thing in regard to customer segments that are pulling back, so to speak. I think sometimes because we aspire to have low fares, people assume we're going for a lower affluent passenger, which is not the case. We want to have low fares and high quality. As I mentioned earlier, we have large parts of our network, which are very high business contributions, which implies a customer that's relatively more affluent. We're seeing business travel actually grow faster than capacity both in Q1 and Q2. So, you do see that part of the economy going well. It's just, I think, there's some choppiness with regards to off-peak times and how much leisure spending is going on there. That was a characteristic of COVID where people would take off trips for leisure reasons more frequently, and there's less of that now, and so that does create this kind of period of the year, where there's more capacity than demand.

And Mike, this is Ryan. To elaborate on what Andrew mentioned, when examining our customer demographic alongside our competitors in the industry, our customer base aligns more closely with our legacy peers than with LCCs or ULCCs. Specifically, when considering households with incomes over $100,000 and $200,000, our numbers are much more similar to legacy carriers than to the LCC and ULCC groups.

Great. Very helpful. And then just my last question, this may be for Tammy. When I look at your CASM guide for the year, which you were able to maintain, we come off the third quarter and at the midpoint, we're looking at, call it, 12% on a couple of percent of capacity. When we get to the fourth quarter, we're up maybe high single digits, but now that's on a capacity reduction of about 4%. So sequentially, there is a healthy improvement there. Is there something in 2023? I know there was a restatement, but is there anything in credits or one-timers that would allow you to see that sort of progression? Or maybe we're just anniversarying some of these various contracts and cost inflationary items? Thanks for taking my question.

Yeah. No, absolutely, Mike. There really isn't anything unusual to point out. We are anniversarying some of the contracts. So that is certainly contributing to that. Just to clarify on CASM-X numbers for last year. I know we've had some questions coming in on that just to make sure you all have the correct numbers. The specific numbers for the third quarter is $0.1067 and 4Q, it's $0.1097, bringing the full year to $0.1109. Just to make sure you've got all the right numbers in your model. But yeah, you got it. It's mostly anniversarying the contracts.

To break it down, looking at the midpoint of our Q3 guidance, the normal figure would be in the low 4s. We are facing nearly five points of abnormal labor pressure due to new contracts. As Tammy mentioned, as you begin to anniversary that, it has a significant impact. Additionally, between the direct effects from Boeing and overstaffing impacts, there's around three points involved. As these extraordinary items are resolved or anniversary, it proves to be very beneficial.

Great. Thank you.

Thanks for the time. I wanted to ask you about network changes versus product changes, things like assigned seats and which area you think will be the bigger contributor to your lagging margins here? Do you see a path on margin improvement before these product enhancements come on board? The only reason I ask is there are some carriers out there that have all the premium bells and whistles, but still have lagging margins, which suggests that premium in isolation is not a silver bullet. So is there a network issue and a new markets issue that we can address first?

Hi, Duane, it's Andrew. There is clearly a delay with implementing our initiatives. In the meantime, we are definitely working towards improving our margins. I would attribute this to three main efforts: changes in our network, many of which have already been made, and we will continue to implement more. You noticed some significant changes in Q1, and we still have several moderate ones planned for this year. Once our capacity is established in the short term, we are concentrating on enhancing yield. You saw this during the discussion about our revenue management system, where we are not only minimizing the negative impact observed in Q2 but also maximizing the system's potential. That’s one aspect. The other is addressing our load gap, and you can see our new advertising campaigns and our entry into Google Flights are part of our efforts to expand our customer base. We have seen a slight decline since our road load is not traveling as much per person as it did before the pandemic. These initiatives in the short to medium term will provide a boost to our load. Therefore, our marketing efforts, customer acquisition initiatives, and network changes are all areas we plan to focus on until our initiatives go live.

And in the spirit of your comment about looking at all opportunities, I wanted to ask you about bags, not from the traditional revenue perspective, but just from a Southwest take rate and cost per bag perspective. Do you have a feel for how much higher your bag take rate is versus the rest of the industry? How many more bags per flight you carry and what you estimate your cost per bag to be? Yes. I believe we carry about 2x the industry standard in checked bags. But bags that come out of the cabin also have an issue in terms of how you manage the operation. Just to be clear about bags flying free as a policy, I mean, we're not looking at this point to change that policy. Our industry-leading set of initiatives and customer-friendly policies are a big part of what attracts people to Southwest Airlines. After fare and schedule, bags fly free are cited as the number one issue in terms of why customers choose Southwest. So it's not something under consideration right now as we rethink our products related to the seating and the cabin.

I would say also, Bob, that as far as the cost, there can be breakpoints at certain volume scales in individual airports, but if you give any given flight having one or less bags or 10 or more or less bags, it doesn't necessarily change the cost profile to handle that as the number of people and equipment required to load and unload the aircraft is static in that range. So there's not a variable cost as far as the handling part. Of course, the weight is variable with the fuel burn, but that would be true if it was in the cabin instead of under the valley.

You need to consider that the bags can shift during operations. We are making efforts to reduce turnaround times, which we will discuss in detail at our Investor Day. By improving technology and processes, we can utilize the aircraft more efficiently throughout the day. Currently, we don't face significant problems with cabin overhead bags that slow operations. Moving bags from the cabin to the hold is a concern that can be managed, but it does take time. Many travelers have experienced last-minute transfers of bags into the hold, which can significantly increase turnaround times and waste aircraft availability. It’s a balancing act that we are constantly evaluating.

Just to add one other point on that. It's about twice as many checked bags than legacy airlines, and it gets closer to three times more checked bags than ULCCs. That just points to the popularity of the policy and indicates one of the reasons why customers choose Southwest Airlines.

I appreciate the thoughts. Thank you.

Thank you. Good afternoon. I know you're planning to quantify the changes in September, but could you provide some guidance on whether we should be thinking in terms of hundreds of millions? Additionally, can you help us understand how much capital expenditure this will entail? And more generally, some of the legacies might argue that it's not just about having extra legroom to achieve a truly premium experience. Are there other changes you are considering beyond just extra legroom?

Yes, Scott, you bet. Again, we're going to share a lot more in September, but just maybe to put a ballpark figure out there, our ancillary products today around boarding, like early bird boarding generate just shy of $1 billion for us. The opportunity in the assigned seating and extra-legroom world is substantially north of that. I'm not going to give you a range, but just maybe give you a little directional. And hopefully, giving you the stat that roughly a third of the seats in our fleet will be in the extra legroom configuration can give you kind of a ballpark there as well. There is very little CapEx to invest because we're not buying a whole different configuration, that kind of thing. It's mostly about adjusting the cabin, more than it is buying a lot of stuff to change the cabin. We already have a new seat coming from RECARO that customers really like. We're already working on some of the other components of the cabin anyway. So there's actually very little incremental CapEx related to this change. Maybe on your last point, we're still defining the products and exactly the detail around what we want to attach extra legroom to. But again, just to be clear, we're not looking at first class where you really have huge differentiation and a huge differentiation in cost. We're really taking a revenue per square foot view of a way to solve for this. You have so many fees in the cabin that you can deal with, and maximizing that revenue per square foot is how we attack the problem.

That's helpful. Just to clarify, when you mention substantially north of $1 billion, is that a gross number or a net number? In theory, does that mean we will lose things like early boarding for flights that we have today?

That's an additional figure. So, it represents a threshold that has to be surpassed, meaning that if those products are generating less than $1 billion, whatever actions we take must surpass that threshold. Any discussion will focus on the net change. However, we are not ready to share those details yet. Importantly, we wouldn't be making changes unless first, it aligns with what our customers want, second, it meets the expectations of our employees, and third, it provides significant financial benefits for our shareholders.

Great. Thank you, guys. I want to maybe ask about 2025 growth in a little different way. When you look at the contractual order book, it has 70 aircraft getting delivered plus ASMs from the red-eye aircraft. So how should we think about that in the context of at or below GDP growth? Are we getting to the point maybe where fleet growth needs to be net neutral? Do you accelerate retirement? How do we think about that?

Yes. Hi, Sheila. Yes, we have a lot of flexibility with our order book from Boeing. We're not ready yet to lay out all of our plans. We'll do that out at Investor Day. But we have ample flexibility to reflow the order book to meet our needs. We will balance all of that clearly, given all of our objectives, including CapEx spend and also our initiative to renew the fleet. So we'll lay out all those details for you at Investor Day.

We are still working with Boeing on settling up against the issues that we've seen here with delayed deliveries, and those late deliveries against plan continue into 2025. Again, more to share later on that as well.

Okay. And then maybe one on cost to follow by then. With the red-eye flying, how do we think about additional headcount required for that or any cost impact?

Yes. So Sheila, it's Andrew. The incrementality is quite low on this. Obviously, this fuel incrementality, but the nature of this is the aircraft apart the West, while it's still the operating day for those airports, then it arrives in the East during their operating days. So your staffing both in, it doesn't require ground operations. We have a situation where we have ample pilots right now. So it does not require us to hire additional pilots to be able to operate the red-eye. It's a way to kind of get more flying out of the current employee base and the current asset base for next year.

And Sheila was our final analyst question. Thank you, Tammy. This completes our prepared remarks. We will now open the line for analysts' questions. We would like to get as many of you as possible, so we ask that you please limit yourself to one question and a brief follow-up, if necessary. We will now take the first question.

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

Hi. Can you all hear me?

We can, Allie.

Yeah, this feels like a very historic step for Southwest with regard to the changes in policy today. I wanted to ask, are we entering a new era? Is this a step towards a new era for the company? And how is Southwest going to kind of differentiate itself from other major air carriers because that's been the history of Southwest? So I'm wondering if you can kind of speak to that.

We approach these changes thoughtfully and carefully, and we've always been open to adapting at Southwest. While we’ve had concerns about plastic boarding passes, we’ve implemented numerous changes. I genuinely believe our team views this as a strategic transformation for the company. We are making significant and ongoing investments in our operational capabilities, which are evident. For instance, we've eliminated 16 million pieces of paper from the cockpit. The turn is now completely paperless with the use of iPads. If you travel from Dallas and Baltimore or other locations, you’ll notice large ramp information displays that are enhancing the operational process. Our investment in core technology is enabling us to perform efficiently. For example, we experienced an 8% cancel rate during the hurricane in Houston, but had nearly no cancellations the next day, demonstrating our capability to recover effectively. You saw this when we faced a global tech outage last week yet managed to operate as normal. These operational investments are not just tactical; they represent significant changes in how we function, enhancing our resilience and reliability. The same approach applies to our commercial initiatives. We are unveiling seating and cabin changes today, which have been the result of a focused effort over the past two years to add power, larger bins, and Wi-Fi while also reworking the cabin and updating our crew uniforms. Our digital strategy has transformed significantly; for instance, you can now track your bags and manage same-day standby. There’s much more to come in our digital services. We view this as a fundamental change at Southwest Airlines to better serve our customers, improve efficiency, and enhance capabilities. Nevertheless, we will maintain the essence of what defines us: genuine hospitality, the best team in the industry, sensible customer policies, and transparency. We will continue to uphold the values that make Southwest beloved, while striving to make it an even better airline.

And then my second question, just for some of the Dallas passengers too, I've been noticing have been pretty vocal about concerns about how this will be implemented. And I know you're not sharing specifics, but one that they are rather interested in is family boarding, and that's like a prime reason why folks come into Love Field and have localized that to me. Can you share anything about how family boarding might be implemented with this new policy?

No. Ryan can discuss this further. There are many details that need to be addressed. When you think about families, especially during long-haul flights, the uncertainty of whether you will sit together is a significant concern and a common source of stress. With assigned seating, you have the assurance of sitting together, which alleviates that stress. If you prefer to sit together in an extra legroom section, that’s even better. We have gathered feedback on how the changes are impacting the experience. They are effectively reducing stress during both the boarding and seating processes, as most anxiety stems from the question of where you'll sit—specifically, whether you'll be near the people you want to be with. Introducing assigned seating eliminates that worry. Our aim is to blend the positives of our boarding experience with the benefits of assigned seating. Ryan, would you like to add anything?

I believe the current open seating arrangement has some friction points in the customer experience that we've been addressing by introducing features like our family boarding section. To provide some context, nearly 60% of customers check in within the first 30 seconds of the 24-hour check-in window opening, and this increases to about 75% within the first hour. For busy families who may not check in exactly on time, this can create anxiety. Our solution to these friction points in the open seating process aims to reduce that anxiety. Ultimately, we think families will appreciate this change.

And for employees, I mean our employees end up on the aircraft, if there is an issue, family boards late, there aren't seats together, the open seats together; our flight attendants end up having to manage that situation or police that situation. If you are customers that are in the last boarding group, and the flight is full, you get on board, and it's tough to see the open seats. You have what we call spinners, people going up and down the aisle spinning and looking for the open seat, because it's hard to see since the aircraft is full. That stressful situation is basically eliminated with assigned seating.

Great. Thank you.

Hi, Bob, can you provide an update on your discussions with Elliott Management, and do you expect a compromise with them that are threatening a proxy fight?

Rajesh, I can't speak for Elliott or speculate on what Elliott may or may not do. But so far, they've not shown any willingness to engage in any meaningful conversations with us. Most of that has been public personal attacks on leadership in the Board. Like any shareholder, we love to engage and hear their feedback. But so far, there's been no willingness on their part to do that. For our part here as a leadership team, we're focused 100% on moving the company forward on the plans that some of which we laid out today and on transforming this company ending our desired financial returns.

Bob, my second question is that about premium seating. Have you done any calculation on how much of an investment will require, and what kind of boost it will provide to your revenue and earnings next year?

Yes. I think Rajesh, we'll have more to share on the overall value opportunity of the premium seating and assigned seating initiative at Investor Day this fall. On the cost side of the equation, we're doing it in a very capital efficient way. We're using existing seats. So there's very little capital outlay here. On the revenue side, we'll have a value share here later in the fall.

Thank you very much.

Yes, hi. Alexandra covered some of my questions, but as a follow-up, I'm curious about how much the current manipulation of the system influenced your decision regarding the elimination of open seating.

Hey, Dave, we haven't called it the demise of open seating. It's a shift to assigned seating, but anyway, I would say that it didn't factor in terms of the analysis. This is all about trying to make the right decision and making it not in emotion, but in data. We did extensive surveying of our customers, or non-customers, to understand their preferences and to understand things like if you have status on Southwest today, you know your A-List preferred, what benefits how do you value benefits and what would be attached to your status in the assigned seating and extra legroom world, for example. A ton of effort there, and then a ton of effort to understand the operational impacts, if any, because we certainly don't want assigned seating to turn the aircraft slower, which everything that worked on proved that it will not. It was about the change itself that we do know for our employees, especially, managing the boarding process can be stressful and can be for some of our customers. That wasn't a direct item that we studied, but it could be that it is an indirect benefit.

Okay. I heard from your earlier remarks, Bob, that you were surprised by how much people wanted assigned seating. What baseline polling or surveys did you have on this? Did this realization come up recently? Is it related to encouraging more passengers to pay extra to move up in line? What was the timing for this?

Yes, customer preferences change over time, and it's evident that travel patterns and behavior are also evolving. Today, customers are taking fewer short-haul trips and opting for longer flights. As flight durations increase, the demand for assigned seating grows. We've focused on expanding our market share among corporate business travelers, who clearly prefer assigned seats over open seating. Additionally, the growth of premium products has outstripped the growth in main cabin revenue for a while now. In broader economic trends, consumers are cutting back on nonessential retail spending and investing more in experiences. We are adjusting to these shifts in travel patterns and customer preferences.

Okay. Thanks.

Great. I'm sorry for the delay. Thank you for pointing out of the queue. Sort of building on what David asked and what you just said, Bob. Customers are cyclical, right? Their preferences change. So are you worried that this is what everyone wants now a few years back, the legacies were moving to basic economy, right? Because that was the hot concept. Do you worry that you're going to make this change? And then a couple of years from now, people are going to want something different?

I don't think I said customers are unpredictable. Just joking. Preferences do change over time, sometimes over long periods. Philosophically, we can have beliefs, but if we don't understand our customers through data, we could drift away from them. It's important to challenge anything that isn't essential to us as an airline. We have periodically surveyed on assigned seating, and this analysis is the most comprehensive we have ever conducted. Over the decades, preferences have shifted towards assigned seating. The last time we assessed this, it was pretty evenly split. However, with new generations emerging, their preferences for travel could differ significantly from those of previous generations. This isn't a value judgment. We need to focus on what our customers will want in five or ten years. I'm not concerned about this because we're implementing these changes thoughtfully. We're not being extreme; we're gradually moving toward assigned seating and extra legroom in a way that aligns with the Southwest Airlines brand. We're making sensible enhancements rather than introducing extravagant features. I'm confident we're aligning with customer expectations and that their desires will remain consistent.

Okay. Can I sneak one more in? Because we have readers that are, of course, very engaged in this. Do you guys have you worked out yet what this is going to mean for A-List A–, the folks that have A-List status?

That's part of what we are hard at work finalizing. Now, I think it's safe to assume that just like our current A-List, A-List preferred customers, there's a boarding benefit associated with their status level. I think it's safe to assume there will be seating benefits attached. The exact nature of that and the details there are things that we're defining as we speak.