Southwest Airlines Company (LUV) — Q2 2025 Earnings Call Transcript

Thank you. Hello, everyone, and welcome to Southwest Airlines Second Quarter 2025 Earnings Call. In just a moment, we will share our prepared remarks, after which we will move into Q&A. I'm joined today by our President, CEO and Vice Chairman of the Board, Bob Jordan; Chief Operating Officer, Andrew Watterson; and Executive Vice President and CFO, Tom Doxey. A quick reminder that we will make forward-looking statements, which are based on our current expectation of future performance, and our actual results could differ materially from expectations. Also, we will reference our non-GAAP results, which exclude special items that are called out and reconciled to GAAP results in our earnings press release. Our press release with second quarter 2025 results and supplemental information were both issued yesterday afternoon and are available on our Investor Relations website. And now I am pleased to turn the call over to you, Bob.

Thank you, Lauren, and thanks to everyone for joining us today. Southwest is on a transformational journey, the largest in our history, as we work to evolve our product and deliver increased value for shareholders and more choice for our customers. Our plan remains on track, and I have high confidence in our transformational journey and the significant value it brings. And that value accelerates this year and then more meaningfully in 2026. Additionally, I'm happy to report that we are seeing signs of improvement in industry demand. Changes and enhancements are being implemented very rapidly. In the first quarter, we amended our agreement with Chase. We implemented enhancements to our Rapid Rewards program and launched Expedia, which continues to exceed our expectations. We began 24-hour operations with our first red-eye flights and launched our partnership with Icelandair. We accelerated our cost reduction plan and continue to execute very well on cost with broad-based cost discipline across the company. Moving to the second quarter, the pace and quality of execution continued. We began charging checked bag fees. We reintroduced the expiration of flight credits and implemented our basic economy product and enhanced fare structure, which lays the foundation for meaningful product differentiation when assigned and premium seating become available. Those changes were announced in March and successfully launched in less than 100 days. I'm just extremely proud of our operations, commercial, and technology teams for their work to support an exceptional operational rollout. The revenue contribution from bag fees has exceeded our expectations so far, and we've experienced no negative impact on the operation. Additionally, during the quarter, we began retrofitting aircraft for extra legroom seating with about 1/4 of our fleet now modified. Moving on to the third quarter. Earlier this week, we announced that we will begin selling assigned and premium seating on July 29 for flights beginning on January 27. We announced service to St. Thomas, which will begin operations early next year. And just this morning, we announced new and enhanced benefits to our co-brand credit cards offered through Chase. These benefits align with our new product offering and are designed to incentivize increased spending with perks like more points for everyday spending on things like groceries, gas, and dining purchases. I'm pleased with the pace of the execution, and we are not slowing down. Our initiatives will continue to roll up and ramp, and we expect them to deliver a more meaningful contribution in the fourth quarter of this year and a much greater contribution in 2026 once we begin operating assigned and premium seating along with this year's enhancements. I want to reiterate that our current initiatives are not the endpoint in our product strategy and evolution. As we've stated before, we are committed to evolving further to meet the needs of our current and future customers. Turning to the macro environment, industry demand stabilized in the second quarter. While it's early, our recent bookings show clear signs of improvement. This improving demand environment, along with moderated capacity in the industry and the accelerating ramp-up of the contribution from our Southwest-specific initiatives provides a constructive backdrop for the second half of the year and into 2026. We have provided an updated full-year EBIT guide of $600 million to $800 million and a reconciliation to our previous guide of $1.7 billion. This includes nearly a $1 billion drop from the precipitous decline in the macro environment that's being felt by the industry, net of some inflection back up for the rest of the year, and a $100 million decrease from higher fuel costs with our $1.8 billion portfolio of initiatives and relative domestic unit revenue outperformance continuing to drive incremental value for the year. Our updated full-year EBIT guide still represents meaningful year-over-year improvement, and we continue to expect significant EBIT expansion in 2026 as the value contribution from our slate of initiatives continues to accelerate. On top of that, given our overweighting to the domestic market, we would expect to be an outsized beneficiary of any recovery in the domestic demand environment. Our strong and efficient investment-grade balance sheet continues to provide support and flexibility as well. Underscoring the belief in our transformational plan, strong management execution, and the ability to deliver significant value for our shareholders, our Board of Directors has authorized a new $2 billion share repurchase program expected to be completed over a period of up to 2 years. Tom will provide insight into our strong capital allocation framework, which balances a strong and durable investment-grade balance sheet with the capacity for further share buybacks at what we believe are attractive levels. I'm very excited about the future that we're building here at Southwest, and we will continue executing on our plans with urgency and purpose. Above all, I want to recognize our incredible employees for their excellence and their one-of-a-kind hospitality as we all work together to deliver on our vision. And with that, Andrew, I will turn it over to you.

Thanks, Bob. I'll start by also recognizing our people for continuing to run an excellent operation. I'm especially proud that we led the industry in on-time performance for the first half of this year. We continue to have a strong completion factor, canceling fewer flights during regular operations compared with our larger peers and recovering very quickly with little to no hangover in the days that follow. I commend our teams for rising to the challenge during this transformational time. We reached a key milestone with the launch of our basic economy product and check bag fees on May 28. A tremendous amount of work enabled that rollout, including training for our people on new policies and tools. The operational rollout was incredibly smooth. Implementing these changes in May was designed to set the foundation for our product differentiation ahead of beginning to sell assigned and premium seating. Today, the incentives to buy up are primarily flexibility and free check bags. When we begin selling the assigned and premium seating next week, more enhancements and choices will exist, allowing for incremental product differentiation for customers. As we've previously shared, we did not see a measurable customer impact in the period between the announcement of these changes back in March and the implementation in late May. The day before the changes were implemented, we did see a modest pull forward in bookings. And in the days following May 28, we experienced a temporary decline in bookings, primarily in basic economy. Starting from day 1, the team has worked continuously to optimize our approach to selling basic economy. There has been an ongoing effort to optimize the product descriptions and the basic economy booking flow, which initially included barriers to booking basic economy that resulted in reductions in overall website conversion. We quickly refined the booking flow and product descriptions to reduce friction, and bookings have returned to expected levels, with promotional activity backfilling gaps from this brief period of lower conversion. This resulted in an impact to second quarter 2025 year-over-year RASM of nearly 0.5 point, and we expect an impact to third quarter 2025 year-over-year RASM of approximately 1 point. Moving to checked bags, while over half of our customers are now flying on bookings made beginning May 28, we are encouraged to be seeing higher-than-anticipated take rates for paid bags. At this early stage, we're already trending at the higher end of the bag revenue per passenger rate of our larger peers, which is in excess of our estimates. We've seen a modest increase in gate check bags as expected, but have experienced no negative impact on the operation. We prepared for this change by implementing new systems and processes, which have supported the exceptional operational rollout. For example, we're using a machine learning tool that predicts the number of gate check bags needed for each flight, which enables our teams to act early and keep the operation running smoothly. Overall, we're pleased with the product changes and look forward to the continued ramp of these initiatives according to our plan. We're excited to begin selling assigned and premium seating on Tuesday and look forward to operating these new products beginning January 27. As Bob mentioned, we've modified about 1/4 of our fleet. We've already started to monetize these retrofit aircraft by notifying customers that will be on a flight with extra legroom seats and inviting them to take advantage of our existing upgraded boarding product. We've been very pleased with our co-brand agreement with Chase, and we're excited about the new and enhanced benefits on our credit cards announced this morning, which align with our new product offering. New benefits include one free check bag, pre-flight seat selection, and upgrades to extra legroom with any fare bundle as well as earlier boarding. Even before these new products and card enhancements, we've seen increased sign-ups with our existing card. Beginning in our August schedule, we're providing more connecting opportunities to drive load factors. We will still have the largest point-to-point network in the industry, but with additional connection options layered in, driving improved network utility and more options for our customers. The connection opportunities will vary by season, day of week, and time of day with less structure connectivity in peak times. We're expanding our network and look forward to launching service to St. Thomas early next year. This is our first new destination to launch since 2021, and we expect to announce at least 2 more new destinations later this summer. We recently announced our second airline partner, China Airlines, and plan to launch operations with them early next year. We also announced 3 new gateways for our Icelandair partnership, Pittsburgh, Orlando and Raleigh-Durham, bringing us to a total of 6 gateways. We've made progress with our getaways by Southwest product, which is planned to launch this quarter. Through the combination of our turn and red-eye initiatives, we have exceeded 2019 aircraft utilization levels while at the same time improving the quality of our operation. After a steady trend of deteriorating demand starting in the first quarter, the macro environment stabilized at lower levels during the second quarter and resulted in 2Q RASM down 3.1% year-over-year, including the nearly 0.5 point impact from the decline in bookings following our May 28 policy changes. I'm pleased that we again outperformed our large industry peers on domestic unit revenue. Our 3Q RASM guide of down 2% to up 2% year-over-year assumes a modest sequential improvement in demand, includes roughly 1 point impact from the decline in bookings following our May 28 policy change, a 1-point headwind from lapping last year's CrowdStrike incident, and is partially mitigated by our initiatives continuing to ramp. Looking to 4Q RASM, we assume further sequential improvement from third quarter, both from anticipated improvement in domestic leisure travel trends and accelerating incremental revenue from our initiatives continuing to ramp. We will provide more specific RASM guidance for the fourth quarter during our next earnings call. We remain committed to our reduced capacity plan for this year with full year capacity up just 1% year-over-year, with trips down roughly 2% this year, with the modest growth driven by our turn and red-eye efficiency initiatives. We've made tremendous progress, and we're not slowing down. With that, I'll turn it over to Tom.

Thanks, Andrew, and hello, everyone. As you've heard from both Bob and Andrew, we remain on track for our slate of initiatives. We are reiterating our incremental initiative EBIT contribution targets of $1.8 billion in 2025 and $4.3 billion in 2026. Of the $1.8 billion initiative EBIT in 2025, we have successfully executed and met our plan expectations in both the first and second quarter of the year, already realizing roughly 1/3 of this year's expected value. We continue to expect the remaining 2/3 of this year's EBIT contribution to be achieved in the back half of this year as the ramp of the initiatives continues to accelerate according to our product rollout and plan. We feel confident in our ability to deliver against these targets and the Southwest-specific levers we have to mitigate the current industry demand environment. We'd like to provide more detail into some of the early successes that we are seeing from several of our initiatives. First, checked bags. As Andrew mentioned, we are already trending at the higher end of the bag revenue per passenger rate of our legacy peers. We currently estimate that checked bag fees will result in more than $350 million of EBIT for the full year 2025, which compares favorably to our initial estimates and has a run rate of approximately $1 billion of EBIT had it been in place for the full year. Second, we remain on track with our cost savings target of $370 million for 2025 based on actions we have taken to date, most notably, the headcount reductions in the first half of this year and the related salaries, wages, and benefit savings and additional cost savings that have been identified. Leaders across our organization are highly engaged in our cost reduction plan, and we are seeing cost discipline across the company. Third, the evolution of our marketing and distribution strategy. As Bob mentioned, bookings through our new channels have exceeded our expectations, in particular with Expedia, which now represents roughly 5% of our passenger volume and more than half of that 5% being customers that are net new to Southwest. These items, together with other initiatives such as our loyalty program earn and burn changes, our amended Chase deal, new credit card sign-ups, flight credit expiration, network changes, the creation of additional connection opportunities, red-eye flying and more give us high confidence in our ability to achieve our target this year. Finally, our new basic economy product is now in place and sets the stage for the additional product differentiation that will come from the operation of seat assignments and extra legroom seats that will start in January. We expect EBIT contribution to continue to increase into 2026 as our current year initiatives mature and as we launch new initiatives. We're pleased to have provided the full year 2025 EBIT guidance that Bob walked you through, and we'll remain focused on strong execution to drive meaningful EBIT expansion in 2026. Turning to non-fuel costs. Second quarter CASM-X came in at up 4.7%, near the midpoint of our guidance range and included a headwind of roughly 0.5 point from a noncash mark-to-market adjustment for nonqualified deferred compensation plans, which was driven solely by the recent strong stock market performance. I am pleased with our management of controllable cost items in the second quarter. We expect third quarter CASM-X to be in the range of up 3.5% to 5.5%, sequentially in line with the second quarter, but on a lower capacity base and includes roughly 0.5 point from aircraft retrofit costs to support our extra leg room seating, which launches in 2026, and roughly 1 point of year-over-year pressure from the timing of engine overhaul expenses in the quarter. Fourth quarter CASM-X, excluding the impact of book gains from fleet transactions in the fourth quarter of both years, is expected to be in the low single digits. As a reminder, we had a large sale-leaseback transaction that resulted in a $92 million book gain in the fourth quarter of 2024. We also expect aircraft retrofit costs to drive up to 1 point of 4Q CASM-X pressure. We will provide more specific cost detail for the fourth quarter during our next earnings call. Overall, we are managing costs very well. And again, I am very pleased with our overall cost management and cost reduction efforts, which create good momentum as we head into 2026. Moving to fuel, we recently terminated our remaining hedge portfolio for cash proceeds of $40 million, which reduces our future premium expense through 2027. Further detail is included in yesterday's press release. We now have no active fuel derivative contracts and currently estimate third quarter fuel cost per gallon to be in the $2.40 to $2.50 range. Turning to fleet, we've updated our 2025 aircraft delivery assumption from 38 to 47 deliveries this year as Boeing continues to ramp up production. We continue to be encouraged by the progress being made by Boeing and are pleased to have received 17 aircraft deliveries in the second quarter. As we have previously communicated, additional deliveries of new aircraft give us increased fleet flexibility. As Bob and Andrew stated, we're committed to keeping our full year capacity growth at up about 1% this year. With these incremental deliveries, we now expect to retire roughly 55 aircraft in 2025, an increase of about 5 from the previous estimate. This also includes 5 737-800 aircraft that we expect to sell this year. Recently, we also executed agreements for the sale of 8 737-800 aircraft that will occur in the first half of 2026. We're in the process of negotiating additional sales transactions. We continue to expect 2025 capital spending to be in the range of $2.5 billion to $3 billion, which includes the additional aircraft deliveries expected this year as well as the expected proceeds from aircraft sales. Moving to the balance sheet, we repurchased the remaining $1.5 billion under the previously announced $2.5 billion buyback and expect final settlement of shares to complete by the end of this month. We're pleased with the expected outcome of this program, having purchased shares at prices well below current levels. Completion of this share repurchase authorization effectively offsets the dilution from our common stock offering in May 2020. Yesterday, we announced that our Board of Directors has approved a new $2 billion share repurchase authorization, which we expect to be completed over a period of up to 2 years, demonstrating our continued optimism around our plan. I'd also like to provide more detail on the capital allocation framework that we will use as a guide as we move forward, which will support our continued commitment to a strong and efficient investment-grade balance sheet. We will be shifting from a cash target to a liquidity target, which will be $4.5 billion, comprised of $3 billion in cash and an upsized revolver of $1.5 billion, which is an increase of $500 million from the previous revolver size. We completed the upsizing of the revolver earlier this week. This target provides appropriate liquidity levels to cover near-term business needs with access to additional liquidity available through a significant amount of unencumbered assets. We will target a gross leverage range of 1 to 2.5x adjusted debt, meaning gross debt plus operating leases to adjusted EBITDAR. After paying off $2.6 billion of debt for the prepayment of the first tranche of the payroll support program notes and the payoff of our convertible notes, we ended the quarter with leverage of 2.1x. We will prioritize our use of capital to: one, continue to invest in the business; two, reduce leverage and maintain balance sheet strength; and three, provide returns to shareholders through repurchases or dividends through free cash flow, surplus cash, or surplus debt capacity. And with that, I'll hand it back to Bob.

Thank you, Tom. Before we move on to Q&A, I want to leave you with a few key points. First, we are performing well on a relative basis and are encouraged with the recent signs of improvement in the demand environment. We continue to execute on our initiatives. We had an exceptional operational rollout of bags and basic, and we are making rapid progress to sell and operate assigned and premium seating, which will bring many of our initiatives together. Second, we are confident we have an appropriate capital allocation framework and guardrails in place to operate as efficiently as possible and maintain our relative balance sheet strength and position, which we view as a significant strategic advantage. Finally, we remain committed to the plan we have in place, including successful execution and implementation of our transformational initiatives. All of this is focused on controlling what we can control to not only deliver exceptional customer value and continued loyalty, but also restore the financial returns we are known for while maintaining our unique and differentiated culture with much more to come as we roll out further enhancements to our product offering. And with that, I'll pass it back to Lauren to start our Q&A.

Thank you, Bob. This concludes our prepared remarks. We will now open the line for analyst questions.

I just had a question on how we should think about the EBIT initiatives ramping up over 3Q and 4Q. I realize 2/3 of the initiatives are coming back half of the year. But on my math, your guide implies an EBIT loss in the third quarter, which taken in conjunction with the first half means the majority of this year's expected EBIT will be produced in the fourth quarter. What drives that 4Q versus 3Q ramp? I'm just trying to understand how much of it is ramping initiatives versus industry assumptions.

Yes, Catie, thanks for the question. I'll give it a start and then pass it over to Andrew, but you've got a combination of, obviously, initiatives ramping up like bags. We gave you an annualized number on bags at $1 billion in EBIT. And with the booking curve, most of that's in place in the fourth quarter. You have flight credits and rapid rewards optimization and a long, long list of initiatives that ramp across that period. You also have some assumptions around the continued sequential improvement in the demand environment. And I think split between kind of those two, you've got about 4 points of improvement between the initiatives ramping and the assumptions around sequential improvement. But it's really that. But Andrew, I take you a little more detail.

In Q3, RASM remained flat, but the guidance suggests about a 6-point increase in RASM. To break it down, 2 points are due to a lack of negative factors, including the basic economy headwind and CrowdStrike comparisons in Q3. This leaves us with 4 points that Bob mentioned, divided between macro improvements and initiatives. Looking at the macro side, we are observing a better environment now, with noticeable improvements from June to July. This implies that Q4's booking curve is less vulnerable to weaknesses compared to Q3, providing a consistent tailwind moving forward. Additionally, we expect capacity to increase in the marketplace after the summer. The combination of announced capacity reductions and macro improvements offers tailwinds into Q4, indicating potential for stronger trends than anticipated. On the initiatives front, Tom and Bob provided the bag fee numbers. These initiatives will increasingly influence the booking curve, as all of Q3 was largely free from bag fees while Q4 will see significant impacts due to the timing of bookings. Other initiatives that have already been implemented will also come into play during this period. The earned burn change will be fully reflected in Q4, alongside the full effect of flight credit expirations. Together, these initiatives should result in a sequential improvement from Q3 to Q4. However, basic economy factors are not expected to significantly change. We anticipate a positive effect in Q1 when we implement assigned seating, which could lead to a stronger shift from basic economy to choice. Should we achieve a positive impact sooner, it will further benefit us in the second half of the year. Tom, do you have anything to add?

I think you said it well.

Okay, great. And maybe just one follow-up on the bag fees. So I guess you said that it's tracking ahead of plan. Is that just a volume thing, the rate you're able to charge? How do we think about that? And then on the other side, how are you tracking any potential book away from bag fees? As customers were used to your fare, including a bag fee, has there been any impact to sold fares post bag fee rollout? Like can you talk about book PRASM pre and post bag fee? That was a loaded question. I'm sorry. So please go wherever you want.

The rollout of bag fees and basic economy went smoothly, and I want to express my gratitude to our team. From the initial decision to the implementation on the 28th, it took us just 91 days, which reflects excellent execution. We were well-prepared for the launch and didn't experience any operational issues. We're checking about one-third fewer bags, with very few turning into gate check bags, indicating we were operationally ready. We haven't seen any customer impact, certainly no reduction in bookings. There was a brief period of tweaking our digital sales flows for basic economy, but that was more about our selling process than customer reluctance to buy. The strong performance is mainly due to our unchanged pricing and the fact that we're checking more bags per passenger than anticipated. Our bag check figures position us around the middle to above the midpoint of the industry. This consistent performance has seen us maintain an annualized figure around that $1 billion mark since we started on the 28th. Andrew?

I would like to add, Bob, that if customers were unhappy with our services and lost their preference for Southwest Airlines, they wouldn't visit our website. We did not notice a change in website traffic before and after the policy change on May 28. However, during the booking process, we experienced lower conversion rates for the basic economy fare from May 28 to June 15. During that couple of weeks, the reduced conversion rate was seen as customers booking basic economy were making travel plans further out, where uncertainty exists, combined with increased restrictions associated with switching to basic economy. Our teams were able to adjust the language and booking process on the website, employing a combination of digital and marketing efforts. The conversion rate then improved, and by June 15, we returned to normal business operations. There was a period of disruption, and we needed to address missed bookings, which led to increased promotional activity to recover those sales. By the end of June, specifically around June 28, we observed a significant increase in our bookings. Overall, this was a brief disruption related to conversion rates, particularly involving basic economy bookings focusing on longer-term travel plans.

The impact that we've talked about, the 0.5 point in 2Q and the full point in 3Q, just to be very clear on Andrew's comments, those are bookings for flights or bookings that occurred during that temporary time period immediately following that Andrew just outlined or should have occurred or would have occurred for flights that would have been flown in second quarter and third quarter. The point that is the impact for 3Q is not about a continuation of that dislocation. It's from that period of when the bookings should have occurred for flights that would have been flown in 3Q. So that is behind us.

Building on the EBIT figures, you're anticipating $1.8 billion in incremental EBIT, but at the low end, you're projecting a total EBIT of $600 million. This clearly indicates that $1.2 billion of your core earnings may have faced a decline. Bob, I understand you mentioned the macroeconomic situation. It seems the basic economy started off on a difficult note, regardless of how you frame it. Does the combination of the macro environment and the basic economy account for the entire $1.2 billion decline or perceived decline in your core earnings? Or could there be additional factors at play?

Thank you, Jamie. I believe everything has been explained clearly. We reiterated the $1.8 billion contribution from our initiatives, which are all performing well and are on schedule both financially and timing-wise. When we discuss the impact of the temporary conversion of basic period, including the 0.5 point in Q2 and the full point in Q3, this is included in our reiteration of the $1.8 billion. Essentially, we are offsetting that with other initiatives as part of the total. As for the $1.7 billion guidance for the year, we currently see a midpoint of $1 billion. This is primarily due to a slight increase in fuel costs and broader macroeconomic factors. We noted that all competitors are experiencing a similar macro impact in the range of 5% to 6%. This situation began around February 1 and declined in March and April. By analyzing booking curves and the associated calculations, we estimate the macro impact at $1 billion. It's clear that this is entirely attributed to the 5% to 6% macro impact, without any other issues affecting our core business.

All right. Got it. And then a quick one for Tom. So cash is down to its targeted level. You've got the new repurchase plan. You've got CapEx. It looks to us like Southwest might need to raise debt. If that's the case, should we be thinking unsecured public bonds or aircraft debt?

I think there's an opportunity if we decide to go that route, I think there's an opportunity for us to do either. And again, this is where the balance sheet strength comes in. We saw an issuance from one of our competitors a couple of months back that was really well received in the market. Maybe even just taking a step back from that. We were very deliberate about the time period with which we're rolling out this next round of share repurchases. We, over the next couple of years, have a lot of incremental EBIT generation that we're expecting based on these initiatives as they roll in. As that occurs, that gives us that flexibility that we would want to use that free cash flow that comes from the business that excess debt or surplus debt capacity that would be there within the framework that we've communicated today, but it's about doing that in conjunction with the improvements in the base business. If that means that we raise some debt or refinance some debt as it matures, we'll do that.

This is Hillary calling in for Mike. I just have a quick question on other revenue. That line was lower despite the start of back season late May. Was there any accounting or noncash revenue recognition changes impacting that line or any impact from royalty changes?

Yes, I would say that our loyalty program hasn’t performed as well as we would have hoped recently. However, this is also related to our enhanced card portfolio initiative, which aligns with the product changes we've made. We anticipate an improvement in this area starting in Q3 with the launch of a new card portfolio that will offer new benefits. These benefits will include a seating benefit, which is unique in the industry, along with a bag benefit that is more common, and improved bonus points for dining, gas, and groceries. This is expected to increase card usage and move it to the top of customers’ wallets. These enhancements are part of our new agreement with Chase, which should lead to more acquisitions and increased spending per cardholder. We expect to see these results starting in Q3 and continuing beyond that. This is one of the initiatives I mentioned earlier in response to Catie's question.

We made announcements today about additional benefits on the Chase card, really seating benefits. But even before that, when we began to talk about the bag benefit in the card, we've seen a meaningful step-up in an increase in sign-ups for the co-brand card. I expect that to accelerate with the announcements today around the seating benefits that come with the card.

It started on 528. So people knew about it after we announced it in March, but really, we saw the behavior change the day it went live.

Sure. Better questions will probably be for Boeing next Tuesday. However, we are observing good stability from Boeing. They have ramped up the 737 production to rate 38 and have managed to maintain that. The next step should be rate 42, and the quality is looking good. Overall, everything we see from Boeing is moving in a positive direction. While our production and deliveries are still not meeting our contractual plan or requirements, the important takeaway is that we are seeing an upward trend instead of a decline, which is encouraging. We have adjusted our expectations from 38 to 47. Our retirements remain fixed at around 55 this year. As we receive additional aircraft or deliveries from Boeing that exceed our initial plans, we have considerable flexibility in how we address those, particularly in replacing older planes. We are currently making sales into the market of 800. The developments from Boeing indicate positive progress. Although you didn't ask, there is no fresh news on the -7 certification. We still anticipate that to occur sometime in the first half of 2026, which would allow us to enter service at the earliest late in 2026. However, there is no new information on that certification as of now.

With the increase in deliveries coming from Boeing, as you know, we're not changing our capacity plans. You saw in the release that we talked about an incremental 5 aircraft, which gets to the 55 Bob referenced that we'll be selling later this year and then an additional 8 aircraft that we'll be selling at the beginning of next year. This gives us the confidence to be able to execute those sorts of sales as we start to see these deliveries come in with a higher frequency.

I have a quick question and then a broader one. Are you suggesting that you're expecting around 4% capacity growth in the fourth quarter?

Yes. The fourth quarter of last year was kind of abnormally low because of fleet shortages. So it was down lower. If you look at sequentially from Q3 to Q4, we're about 1 point high, but that's because Q2 to Q3 is about 3 points low. We are modulating that capacity versus peak off-peak, which creates kind of like slightly abnormal sequential changes. Particularly, we wanted to reduce exposure to August, September but keep exposure to the strong parts of Q4, which was in October, November, and December. They all have good peak periods in them. As we're taking that 1% growth we promised, we're putting that in places where it gives us the most return on our capital.

I understand you are concerned about the expectations for a much stronger fourth quarter this year. Your capacity is increasing in Q4, and we've noted that American Airlines plans to increase their capacity as well. Is there a risk that while capacity is ramping up in Q4, we are depending on RASM to improve significantly during that same period?

I think it's a comp issue, not necessarily what the market bears. Right now, what we see in the bookings, we like what we see. We've only modified October, by the way. November, December has not been modified in our promised reduction to get to our 1%. And so October is not 100% firm, but it's the one that had the reduction that we promised at Q1 earnings.

Yes, I was going to mention that final schedules are not visible yet. We are expecting full year capacity to increase by 1%, with a projected decrease of around 1% to 5% in trips, which are down by 2%. Overall, this creates a positive environment regarding capacity, particularly as we hope for a continued improvement in domestic demand.

Yes, because our seats in Q4 are kind of going to be up like 0.7%. So what we need to sell is not actually a big Herculean lift because we introduced red and some longer haul and utilization, the ASM seems bigger, but the kind of lift to sell our capacity is much more modest than that.

I'm just curious on the aircraft sales, just a follow-up on there. Just how you plan on handling that in terms of kind of cash flow and P&L?

Yes. So the aircraft sales will flow in, and you've got the book side of it, but you've also got the cash proceeds side of it. These are largely aircraft that are fully paid for. As we sell these aircraft, of course, the market continues to be very strong for used aircraft. A lot of the values for the aircraft are in the engine value. This becomes from a cash flow standpoint, basically flowing through kind of fully accretive to us. There are book gains that are there as well. One thing to clarify, we continue to guide without any book gains in any of our guide. The numbers that we gave you for the full year do not include any gains from sale. We'll continue to do that as well. The book gains are less than the cash that will come to the business just with the net book values that are still on the aircraft.

And then maybe I can ask on the recovery side, you're seeing demand. Is that kind of leisure? Is that corporate? Could you give a little bit of color on what you saw corporate do in 2Q and how it's progressing?

Certainly, I'll start with the corporate, which we saw in Q2, May was the worst. June was better than May. July is better than June, and August is off to a strong start, even though it's kind of good for corporate. So good inflection in Q2 for corporate. And then also leisure, it was the same thing. We saw leisure customers really come alive there just before the 4th of July holiday.

I think just generally, but I was saying, again, it's 4 or 5 weeks of trend. It's always hard to tell. But what I think what feels really different is just overall, it's that it was just tough to get volume. I mean you could get yield close in on the flights that we knew were very strong. Even with promotions, it was tough to get volume going back several months. We're starting to see the volume return. I think that's a strong sign that it's a broad-based recovery, again, a short period of time. But to me, that's very encouraging.

A couple of questions here on revenue segmentation. First, what percent of tickets today are clearing at an ultra-low-cost carrier fare? What would you expect it to look like in 2026 once assigned seats are offered?

I actually don't have that down off the top of my head. I apologize. We are seeing kind of a reduction in basic economy fares sold versus want to get away, you will buy up in a choice. We like the momentum of people deciding to voluntarily buy up. We have bags now with it. So at the margin, it would give you incentive to sell a slightly lower fare if you thought a bag would come with it. It really doesn't change our pricing strategy at the moment. We want to use this to segment customers into those who are flexible in their travel and those who are not flexible in the travel. Those who are not flexible give them different options to buy up quality enhancements to the fare product.

It's primarily about providing a reason for customers to choose an upgrade. We'll highlight this again next week when we introduce new products that include seating benefits, giving customers more motivation to buy up. Along with various other advantages, customers will enjoy benefits such as a seating map and additional legroom access that come with these products. Andrew mentioned this, but to clarify further, we haven't provided specific numbers yet; however, previously, a significant portion of our seats was sold within certain categories. There was a limited number of seats sold in the “want to get away plus” category. Presently, it's still early in the process, but roughly half of the seats being sold are in what we now call the basic economy category. This reflects a noticeable shift in customer preferences and increases in upgrades. I anticipate this trend will continue, as the reasons to upgrade due to seating benefits are likely to attract even more customers. We're already finding that a large portion of our sales reflects this change, moving closer to a fifty-fifty split.

Yes. Regarding the current initiatives, which represent an ongoing evolution of our strategy, I understand that the focus is on the fleet aspect and specifically on the MAX 7. However, is there any interest in the MAX 10 aircraft once it receives approval and potentially exploring further segmentation of premium demand?

Yes. I'm not trying to be evasive, but I've suggested ways we could enhance our offerings. You can guess what those might be since there are only so many options. We could further segment our current cabins to provide more premium choices, which could include additional services like lounges. There’s also the potential for network expansion, allowing us to reach destinations that our existing aircraft cannot serve. While I’m not outlining specific plans right now, the key takeaway is that we are committed to following customer preferences and working diligently to ensure you have no reason to choose competing airlines. While customers currently love Southwest Airlines, we know they might need to look elsewhere in some markets because we can’t provide all the desired options, particularly long-haul international routes. We are focused on our journey towards improvement, but this is not the final stage. Just as a quick aside, I'm pleased with our progress over the past five months. We've established a new agreement with Chase, made enhancements to Rapid Rewards, launched Expedia, started offering red-eye flights, added new partners, increased our cost-saving plan significantly, introduced bag fees and basic economy options, reintroduced flight credits, and will begin selling assigned seats and extra legroom next week. That's a lot accomplished in just five months, and there is much more to come this year. My point is that we are not pausing; we will keep finding ways to serve our customers and meet their needs. This is just the beginning, and while we are focused on the current changes and improvements, it isn't the final destination.

Most of my questions have been asked and answered already, but just one for Tom and just on the new liquidity and balance sheet targets. When we look at them versus kind of where Southwest was pre-pandemic, they both seem a little bit more aggressive here. I guess how did you get comfortable with these new targets, particularly in a much more difficult macro and at a time when you're going through a pretty significant brand revamp? Just curious how you thought about that.

Yes. Thanks for the question, Andrew. Our balance sheet is a big differentiator for us. To my knowledge, there are 3 investment-grade airlines in the world. There are a lot of benefits that come along with that. That's something that we need to protect as we move forward. As you look at the various metrics, whether it's a debt-to-EBITDA ratio, cash levels, those sorts of things, we want to set a framework that sets us strongly in that investment grade. We feel like what we're seeing here does that. We want to have a strong and efficient balance sheet as well. You'll continue to see us work within that framework. As we continue to improve the business through all of the things that we've talked about today, that list that Bob just went through is a really impressive list. To think that in less than 100 days, we're rolling these different things out, they will ramp up as the year goes on and into next year, they create additional free cash flow for us that gives us the ability to also return capital to shareholders. It was important that as we were sort of on the front end of this journey that we've been talking about today that we put a framework there so that our investors understand the guardrails that we want to work in as we move forward.

I wanted to ask about your perspective on the load factor. It has decreased by a little over 400 basis points year-over-year, which seems to be relatively low compared to other major players in the industry. Is this something you believe is not a current priority for optimization, as you're focusing more on bag fees and other aspects, with the expectation that it will improve over time? Or is the improvement dependent on supply and demand? Does this affect your plans for capacity growth in the future? I’d like to hear your thoughts on this, as there are several positive developments, but the load factor seems to be a significant issue.

Yes, Tom, there's a lot to discuss, and I'll let Andrew add his thoughts as well. Our load factor change year-over-year was similar to what we observed from our competitors, but we are starting from a position where we need to close a gap. This gap is a primary focus for us. In the first half of the year, we concentrated on improving yields, and you're starting to see the results of that effort. However, our main objective for the latter half of the year will be to target the load factor. Starting next month, we will implement a series of network changes aimed at enhancing connectivity, particularly during the early and late parts of the day, which is when we typically see the load factor gap. Improving connectivity will really help address this issue. The number of what we call intentional connections, designed to create connecting opportunities, is projected to increase by 40% year-over-year starting in August. This initiative is solely focused on generating itineraries that will help fill the load factor gap. Andrew, would you like to add anything? It is definitely a priority for us.

We have emphasized for nearly a year that in the first half of this year, our focus would be on yield, primarily by maximizing revenue from our best flights. In the second half, our attention will shift to load factor, particularly through the intentional connecting opportunities and the introduction of basic economy. These strategies, as discussed by Tom, will help increase our volume at the top end of the funnel. Currently, August's load factor is only down 0.5 points compared to last year, and last August itself was up by 1 or 2 points compared to the prior year. During this period of macroeconomic weakness, we prioritized not excessively discounting our fares. Our year-over-year RASM performance relative to others indicates that focusing on yield was a prudent choice rather than chasing after declining figures. As we adjust the available volumes, we are working to improve that load factor. It is important to note that the drop in load factor does not indicate a loss of customer interest. Instead, as we've switched from MAX 7s to MAX 8s, our seats per trip have increased by about 7% from pre-pandemic levels, while the number of customers per trip has only risen by 1%. Although there is a slight increase in customers, it has not been enough to fully occupy the additional seats. Our discussed efforts present opportunities to fill those seats, which could benefit us. We have been adjusting our capacity from peak to off-peak periods. While our seats per trip are up 7%, our trips per nonstop market have decreased by 10% post-pandemic. We are reallocating capacity to address the supply-and-demand imbalance. As Bob noted, these adjustments are primarily related to timing, and we are taking steps to resolve the issue. August represents a promising start, showing positive movement in our load factor.

I just want to clarify one other thing. You're seeing demand across the board as both leisure and corporate, or is it one more than the other? Just curious about the macro mix.

Yes, we're seeing both. There was a significant improvement in corporate and leisure travel in June and July. Corporate performance was especially better compared to May as conditions improved.