Yahoo Finance Southwest Airlines Co. (NYSE:LUV) Q1 2024 Earnings Call Transcript
Southwest Airlines Co. (NYSE:LUV) Q1 2024 Earnings Call Transcript April 25, 2024
Southwest Airlines Co. misses on earnings expectations. Reported EPS is $-0.36 EPS, expectations were $-0.34. Southwest Airlines Co. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Hello, everyone, and welcome to the Southwest Airlines First Quarter 2024 Conference Call. I'm Gary, and I'll be moderating today's call, which is being recorded. A replay will be available on southwest.com in the Investor Relations section. [Operator Instructions]. Now Mrs. Julia Landrum, Vice President of Investor Relations, will begin the discussion. Please go ahead, Julia.
Julia Landrum: Thank you so much. Hello, everyone, and welcome to Southwest Airlines First Quarter 2024 Conference Call. In just a moment, we will share our prepared remarks, after which we will be happy to take your questions. On the call with me today, we have our President and CEO, Bob Jordan; Executive Vice President and CFO, Tammy Romo; Executive Vice President and Chief Commercial Officer, Ryan Green; and Chief Operating Officer, Andrew Watterson. A quick reminder that we will make forward-looking statements, which are based on current expectations of future performance. and our actual results could differ materially from expectations. As we will reference our non-GAAP results, which exclude special items that are called out and reconciled to GAAP results in our press release.
So please refer to the disclosures in our press release from this morning and visit our Investor Relations website for more information. And now I'm pleased to turn the call over to you, Bob.
Robert Jordan: Thank you, Julia. Hello, everyone, and welcome to our first quarter call. Well, let me state right up front that I am disappointed with our first quarter performance. There are a lot of factors that I'll go into, and there's a lot to cover, including the latest Boeing challenges. More importantly, there are significant efforts and progress underway as we cannot, and we won't be satisfied until we are delivering the kind of returns you expect from Southwest Airlines. So before I go any further, I just want to sincerely thank our people for their extraordinary efforts as we work quickly to drive improvement. Turning to our performance. We achieved records for first quarter operating revenues and passengers continuing our streak of eight straight quarters of record top line performance.
We saw a nice acceleration in managed business revenues up 25% nominally year-over-year. We also continued our streak of solid operational performance. For a while now, we have been consistently running a great completion factor averaging right around 99%, and we continue to improve in nearly all operational and customer metrics. I'm also proud of the progress we made on our open labor agreements. It's been a long road, and I want to recognize everyone involved for continuing to work through to the finish line to reward our amazing employees for their contributions. Ryan will go into our revenue performance in more detail in a moment. And while our revenue trends were solid in the first quarter and are expected to be solid year again in the second quarter, we need to increase revenue production to offset cost inflation.
The biggest opportunity to improve performance and profitability and urgency is continued focus on network optimization and capacity. We opened 18 new cities during the pandemic and worked hard in 2023 to restore our network and fly our full fleet on the heels of the demand surge in 2022, while that boosted aircraft utilization, it added significant capacity. And when combined with 2023 business travel coming in below projections has resulted in a significant number of new markets under development and a material number of markets that are not performing at the level required in this higher cost environment. Network adjustments planned last fall are in place as of the March schedule, and they are proving to be largely on track. Those optimization efforts were primarily aimed to adjust for changing demand trends, including lower capacity on Tuesday and Wednesday, a reduction in short-haul business markets and a material reduction in flights during shoulder periods of the day.
The changes are beneficial and they contributed to us exiting the first quarter with healthy margins for the month of March, more as needed and we are continuing efforts to optimize the network and reduce the number of markets in development that aren't performing to more historic levels. Along those lines, we have made the difficult decision to eliminate service in four cities. Syracuse, New York, Houston Intercontinental, Cozumel and Bellingham, Washington. That is never an easy decision. We form bonds with the airports and the communities that we serve. These are wonderful communities, and we are very grateful for their support over the past several years. In addition, we are also restructuring several other stations. Most notably, we are reducing flights in Atlanta and Chicago O'Hare.
While it's never our desire to exit a city or shrink service to a market, we are committed to our financial performance goals and network and capacity actions will continue as a lever to improve overall financial performance. In addition to network optimization, we have a number of other efforts underway to increase revenue productivity. First, tuning our new revenue management system by better anticipating and optimizing demand and fares along the booking curve and unlocking additional capabilities that will further boost the contribution from the system. Second, focusing on increasing passenger volume including adding new attributes to our value proposition. We are working to ensure our current and future customers understand our terrific value proposition.
That includes a significant new brand campaign which started last week, highlighting our signature customer-friendly policies. Separately, we are considering more transformational options and follow-on initiatives. That includes work previously underway to study customer preference around seating and our cabin. It's been several years since we last studied this in-depth and customer preferences and expectations change over time. We are also studying the operational and financial benefits of any potential change. We remain committed to our industry best customer-friendly policies but we are also committed to understanding and meeting customer expectations. We have transformed before adding things like Wi-Fi, larger bins and in-seat power, and we will continue to adapt as needed.
It is too early to share the specifics of what we are exploring, but I want to be transparent and let you know that work is well underway. Of course, the biggest change we have experienced is the news from Boeing on deliveries. The Boeing issues are a significant impact, and we are taking quick action to re-plan based on expected 2024 and 2025 delivery delays. As I've said before, while it's impactful, I support Boeing taking the time to do the work to understand and fix the issues, a stronger Boeing company for the long term is good for Southwest Airlines. I visit Boeing in late March, and while there is much work to do, I am encouraged by the comprehensive approach that their leadership is taking. I will be back at Boeing this summer when they complete their plan, and I will be visiting Spirit Aerosystems as well.
I won't downplay the challenges from the Boeing issues. They are a big deal and contribute to changing capacity set. They're redoing schedules and forecasting now in accurate staffing levels. All of that is costly. It pulls people away from their regular work and it creates a significant financial drag. That said, it won't deter from our work to improve our results. We will continue to control what we can control and work our plan as they take the time to become a better Boeing company. Boeing issues aside, we already had aggressive plans in place to further optimize the network to improve profitability, moderate CapEx and capacity to improve free cash flow and ROIC and drive staffing and operational actions to improve efficiency. All of that work is now being accelerated.
As we continue our focus on capital efficiency, free cash flow generation and aggressively restoring our returns, we will continue to moderate both capacity and CapEx until we do so. Managing our CapEx is obviously key to improving free cash flow, which, along with ROIC, we are laser-focused on. Our bias will remain to retire aircraft as planned and any capacity growth that we have in the near term will come entirely from gauge and initiatives to drive aircraft utilization, including tightening turn time through process innovation and automation, and introducing a modest level of red-eye flying. Both of those initiatives boost aircraft utilization and create capacity without aircraft CapEx. The initiative to reduce turn time is going well and is a first step.
12 stations will see a 5-minute reduction in turn time in the November 2024 schedule with further reductions in early 2025. We will share details on the full plan, which includes these and other planned strategic initiatives at our Investor Day, now planned for September 26 when I look forward to welcoming everyone here to Dallas. On our cost control efforts, note that we already had plans in place to end 2024 with head count flat to down through efficiency efforts like deploying automation, and Gen AI solutions for greater productivity and some customer support functions and driving organizational efficiency by combining like functions. Further capacity reductions in 2024 and 2025 create additional head count and efficiency challenges, and we are moving quickly to address those through a combination of voluntary programs.
We have essentially frozen and stopped all hiring except for a limited number of critical positions and now expect to end 2024 with headcount down approximately 2,000 as compared to the end of 2023 and Head count will be down again in 2025 through continued efficiency efforts. We are already seeing the benefits of time off without pay program that in fact, the participation in these programs generated higher-than-expected savings in March which was one of the factors that contributed to us beating our first quarter CASM-X guidance. Last quarter, we laid out a plan that included providing a line of sight to cover our cost of capital in 2024. We are admittedly materially off that plan. Much of this comes from external factors, including headwinds from increased market prices for fuel and impacts attributable to the most recent delays in Boeing deliveries but we aren't accepting that as our fate and are taking swift action against what we can control.
So there's a lot going on right now, and we have a good grip and plan around areas of the business where we can improve. As a recap, we are continued to be guided by our goals to drive ROIC performance by making additional network adjustments to specifically address underperforming markets and adjusting capacity, enhancing revenue performance in the intermediate term through marketing and revenue management efforts, offsetting cost pressures with efficiency initiatives and programs to reduce headcount and lower discretionary spending. Curbing our capacity plans and managing down CapEx and investing in initiatives that create capacity without capital investment. And finally, by creating a new set of strategic initiatives to share with you at our Investor Day this September.
We will not tolerate underperformance of any kind, and everyone is committed to doing what it takes. I am truly blessed to lead the company with such passionate and dedicated employees, and I am confident that we can and will adjust as needed as we have in the past and work to hit our financial targets, which are not negotiable. So before I close, I just want to say thank you again to our employees for all that they do every single day. And with that, I will turn it over to Tammy for a more in-depth review of our financial performance and outlook.
Tammy Romo: Thank you, Bob, and hello, everyone. As Bob just covered, this year is not shaping up as we had initially planned. We have never and will never accept underperformance. There are a lot of things that contributed to our current position, the impact of continued delivery delays from Boeing, significant market-driven inflationary pressure from new labor contracts, volatile fuel prices and dynamic customer travel patterns. Those are all very real reasons, but we will not use them as excuses. Instead, our focus is to control what we can control, to take aggressive actions to adapt as required and to produce financial returns period. Bob mentioned the warrior spirit of our employees. It's a very real thing, and it will be the key to our turnaround.
So before I dive in, I want to thank our incredible employees for their resilience, their perseverance and their dedication as we gear up to tackle the challenge we have before us. Ryan and Andrew will speak to our revenue and operations performance in detail. So I'll start with our cost performance before moving to fleet and balance sheet. Overall, our unit cost, excluding special items, increased modestly, less than 1% year-over-year in first quarter. Our first quarter average fuel price of $2.92 per gallon came in a bit below our guidance range. Market prices have been volatile. And based on the April 18 market, we increased our full year fuel price guidance by roughly $0.15 to a range of $2.70 to $2.80 per gallon and we're anticipating our second quarter fuel price to fall within that range as well.
We are currently 55% hedged here in the second quarter and 58% hedged for the full year. We continue to prudently add to our fuel hedge position for 2026, now 26% hedged and are currently 47% hedged in 2025. Our treasury team continues to do a great job managing our program as we see cost-effective opportunities to expand our hedging portfolio with the continued goal to get to roughly 50% hedging protection in each calendar year. The purpose of our hedge is to provide protection from spikes when we need it most. Over the past two years, we have benefited significantly from our hedge portfolio, generating net settlement gains of $872 million and $145 million in 2022 and 2023, respectively. For 2024, we are currently expecting only a very modest loss, but as Brent gets above $90 a barrel, our position would begin to materially kick in that obviously is helpful insurance to have in this volatile environment.
Moving to nonfuel cost. Our first quarter unit cost, excluding special items, were up 5% year-over-year in first quarter. Of course, that was primarily driven by pressure from new labor agreement and an increase in planned maintenance associated with the -800s coming off their engine honeymoon. This was a point ahead of our previous expectations, primarily from favorable airport settlements, but also from some early benefits from our cost control initiatives like voluntary time off programs. I am very thankful to all the employees who are pitching in to help reduce costs. It's always been part of our culture and the contributions that our people are making across the company are a sign that our culture is alive and well. Throughout first quarter, we were reacting and adjusting to continuous information from Boeing on further aircraft delivery delays, causing some additional movement within our CASM-X guidance expectations as we quickly worked to revise our 2024 plans.
While Boeing's challenges continue to significantly impact us, I am immensely proud of the way our team continues to handle such a dynamic situation, running multiple forecasting scenarios for critical decision support, including support in adjusting capacity and reoptimizing the network. Looking to second quarter and full-year 2024, we continue to expect similar cost pressures throughout the year, driven primarily by elevated labor costs and maintenance expenses. We currently estimate our second quarter CASM-X to increase in the range of 6.5% to 7.5% year-over-year and our full year CASM-X to increase in the range of 7% to 8% year-over-year, elevated from our previous full year CASM-X guidance due to lower capacity plans in the second half of the year.
The estimated sequential change in nominal CASM-X from first to second quarter is largely in line with historical norms when adjusted for capacity levels. roughly 5 points of our full year CASM-X guidance is attributable to elevated salaries, wages and benefits expense and roughly 1 point is due to elevated maintenance and materials expense. While we continue to expect pressure from maintenance costs this year, we have reworked our maintenance plans given our new delivery expectations and we now expect lower full year 2024 maintenance expense compared with our previous expectations. We are also planning more voluntary leave and time off programs to further reduce labor expenses and address current overstaffing. Despite these added pressures, which are a direct result of the Boeing aircraft delivery delays, we are aggressively working to control costs, reduced inflationary pressures and cut discretionary spending across all cost categories.
I want to reiterate, we are far from satisfied with our current financial performance, and we will work relentlessly until we return to financial prosperity with our North Star being ROIC well exceeding our cost of capital. We will go into a lot more detail on our plans at Investor Day in September of this year. Now turning to our fleet. We have reacted quickly over the quarter to the updated Boeing delivery delays. We began the quarter with the expectation we received 79 of our 85 contractual deliveries in 2024. That number dropped to an expected 46-8 aircraft at the timing of our March 8-K and has since reduced even further to a conservatively planned 20-8 aircraft deliveries. Thus far, we have received 5-8 aircraft from Boeing during the first quarter and have retired 3-700 aircraft from our fleet.
To reduce distractions and impacts to the business and hedge against further potential delivery delays, we will now plan to hold on to an additional 14-700 aircraft that were originally planned to retire this year, bringing our expected 2024 total retirements found to 35 aircraft, including 4-800 lease returns compared with our previous expectation 49 aircraft retirements. While we remain committed to our fleet modernization, we feel it is prudent to retain some flexibility until we have better certainty around our aircraft deliveries and around the certification of the MAX-7. The updated Boeing delivery expectations has also impacted our capital expenditures and cash flow expectations for the year. As a result of these 20 expected aircraft deliveries, we currently expect our capital spending to be approximately $2.5 billion, well below our previous guidance of $3.5 billion to $4 billion.
Keep in mind, our 2024 CapEx guidance includes an estimate for progress payments based on our current contractual order book and CapEx estimates will be fluid until we finish working our plans and aligning on updated expectations for actual 2025 deliveries which we plan to share at our Investor Day this fall. A quick note on our capacity plans. The Boeing delivery delays did not impact our first quarter capacity finishing up 11% year-over-year on solid completion factor. Looking ahead, as we rework our capacity plans for the year, we now expect second quarter capacity to be up in the range of 8% to 9% year-over-year. The majority of the Boeing capacity cuts will occur over the second half of the year with third quarter capacity expected to increase in the low single digits and fourth quarter capacity expected to decrease in the low to mid-single digits, placing our full year 2024 capacity up approximately 4% all year-over-year.
Looking beyond 2024, we plan to keep any future growth at or below macroeconomic growth trends until we reach our long-term financial goals to consistently achieve ROIC well above our cost of capital. As a reminder, our aircraft delivery and retirement expectations are subject to Boeing's production capability and we will react as quickly as possible if any further adjustments are needed with the focus on taking care of our customers and aligning with our financial goals. Lastly, I am immensely grateful for our balance sheet strength as we move through another challenging year. We ended the quarter with $10.5 billion in cash and short-term investments with a nearly $1 billion reduction from the prior quarter, driven by the payout of a labor agreement ratification bonuses, which are onetime in nature.
In addition, we returned $215 million to our shareholders through the payment of dividends and paid $8 million to retire debt and finance lease obligations. Finally, and most notably, I am proud to report we remain the only U.S. airline with an investment-grade rating by all 3 rating agencies, both Moody's and Fitch affirmed our rating during first quarter, and S&P reviewed and moved our rating unchanged. As ever, maintaining an investment-grade balance sheet is our utmost priority. As I close, I want to reiterate that we are not starting the year as we had hoped, and that is undeniably disappointing. However, throughout my years as this wonderful company, I have come to know that a better Southwest is often formed on the heels of adversity.
I agree with Bob that is all because of the fight and warrior spirit of our people. And with that, I will turn it over to Ryan.
Ryan Green: Thank you, Tammy. As Bob mentioned, I'm going to provide you with details on our first quarter revenue performance and base trends. I'll also share an outlook for the second quarter and full year, along with what we are assuming in the guide. And most importantly, I will give you some color on the additional actions we are taking to further improve our revenue performance. Starting with first quarter, unit revenue finished roughly flat on 11% capacity growth, both on a year-over-year basis. The variance to our original guidance is driven by a balance of higher-than-expected completion factor, close-in leisure volumes that came in below our expectations in the month of March and underperformance in select development markets.
Development markets as a portfolio did not meet the maturation expectations, but the story isn't the same for all markets. Several development markets outperformed expectations, particularly Florida Beach destinations. But a few markets weighed down the portfolio. As Bob shared, we have made the difficult decision to address underperforming stations with closures effective August 4 and also to restructure and reduce capacity in other underperforming markets which are included in our updated June schedule. Despite coming in below our expectations, first quarter had strong demand, setting numerous records, including record first quarter operating revenue, ancillary revenue, passenger revenue and record first quarter passengers carried, and we also added a quarterly record number of new Rapid Reward members into the program.
In addition to these records, we were also really pleased to see the continued incremental benefits from our investments in managed business as first quarter managed business revenue grew 25% year-over-year and was roughly flat to 2019 levels. We continue to pick up market share year-over-year as we perform in line with or above the rest of the industry. Finally, from a geographical perspective, we saw the strongest year-over-year improvements coming from the West Coast and the Northeast, regions where demand has been slower to return post COVID. I also want to stress that we had a better than historically normal sequential trend in nominal unit revenue. We are seeing improvement in revenue productivity and demand. Nominal RASM in the first quarter came in flat to fourth quarter despite first quarter historically being seasonally softer than fourth quarter.
And this is particularly true in a post-COVID environment where peaks and troughs are magnified. To illustrate this point, consider 2018, the most recent year in which Easter fell in the last weekend of March. Nominal RASM declined sequentially 5 points. So even in the seasonally challenged quarter, the sequential performance was much better than our best holiday comparison. The most significant driver of this sequential improvement was our network optimization efforts, but we also saw a benefit from our other revenue initiatives especially managed business investments. Looking to second quarter, we expect our ninth consecutive quarter of record revenue performance. In fact, we expect an all-time quarterly record for operating revenue. Second quarter 2024 RASM after being calibrated for recent booking trends is now expected to decrease in the range of 1.5% to 3.5% year-over-year.
The year-over-year comparison includes a little over 1 point of headwind for holiday timing, both from outbound Easter shifting to the first quarter and for more outbound for the July travel shifting to third quarter. On a nominal sequential basis, this also implies another quarter of better than seasonally normal RASM improvement. Looking beyond second quarter, network planning teams are still reworking schedules in the back half of the year to accommodate Boeing delivery delays. After adjusting expectations for both current booking trends and for Boeing delivery delays, we are forecasting 2024 operating revenue growth to approach high single digits on a year-over-year basis. This expected revenue growth implies healthy RASM growth in the back half of the year driven by revenue initiatives as well as a reduction in year-over-year trips.
While our development market maturation efforts are off track, which I'll discuss in a moment, our other revenue initiatives are expected to continue to drive value over the balance of the year. In fact, network optimization benefits contributed roughly $100 million in incremental revenue in March alone, primarily from reductions to shoulder flying early morning and late evening flights and short haul flying. For full year, the incremental year-over-year pretax profits from our strategic initiatives is now estimated to be between $1 billion and $1.5 billion after being updated for first quarter actual performance, development market adjustments and capacity changes in the back half of the year. The vast majority of the initiatives delivering value in 2024 continue to be revenue related.
So while we are encouraged to see strong demand for our brand and solid sequential improvement, it is short of our goals. And as Bob and Tammy shared, it's simply not enough given the escalation of market-driven inflationary cost pressures. Therefore, we are taking actions to generate both immediate and longer-term revenue enhancements. We have stood up cross-functional teams to focus on things like accelerating the maturation of development markets further boost the value being delivered by our relatively new revenue management system and roll out new products and highlight our superior value proposition with our new brand campaign. We also have a larger team that is finalizing a more significant set of strategic initiatives, and they're tasked with delivering transformational streams of revenue productivity.
Of course, we'll have more to share on this topic at Investor Day. As we build our plans, we will focus on leveraging our strengths, including those of our network, which, while it has optimization opportunities, remains incredibly relevant and well positioned based on size and population migration trends. We continue to hold the top position in 22 of the largest 50 domestic markets, and we are by far the market leader in that regard. Also, we're well positioned for the future as population and GDP growth trends are forecast to be strongest in the Southern and Mountain West regions of the country, regions where we have significant leadership. We'll also lean into the customer experience we deliver. Year-to-date, our Trip Net Promoter Score is up over five points year-over-year.
And finally, we continue to enhance our award-winning Rapid Rewards program just this week, we began rolling out the ability to book and pay with part cash and part Rapid Rewards points, which I expect to be very popular with our customers. So in closing, we have a large and relevant network, a strong demand environment and a loyal and highly engaged customer base. We also have the best people whom I want to sincerely thank and we are committed to being aggressive and innovative as we adapt, adjust and evolve to meet the preferences of our customers and to unlock the revenue productivity required to meet our financial imperatives. With that, I'll turn it over to you, Andrew.
Andrew Watterson: Thank you, Ryan, and hello, everyone. I'd like to start out by thanking our incredible Southwest employees for continuing to deliver a strong operational performance. We produced a solid first quarter completion factor of 98.5%, our highest first quarter performance over the past five years. We delivered year-over-year improvement in early morning originators, turn compliance and turn differential and methanol and again saw a year-over-year improvement in our net Trip Net Promoter Score, as Ryan mentioned. Our on-time performance declined slightly year-over-year, largely due to weather challenges and delays driven by ATC programs. However, I'm pleased to report that we improved year-over-year on-time performance for the month of March.
I'm proud of the hard work and investments made to bolster our win preparedness and modernize our operations, and I'm encouraged to see these efforts pay off in our operational performance. Picking up with Bob and Tammy left off, I want to stress that we remain focused on bringing out operational inefficiencies, increasing asset productivity and creating operating leverage by reducing structural costs. Our Southwest Turn initiative, which Bob shared is tracking ahead of schedule is a critical component of these efforts. One of the key elements include eliminating the need for printing on every flight, reducing the number of employee trips up and down the jet bridge and we're covering faster during the regular operations. We reached an important milestone in this multiyear effort just last week with the launch of electronic fight folders, which modernized several of our flight planning processes by digitizing documents used by our pilots, dispatchers and ops agents.
We also continue to make progress on modernizing the airport experience, and that initiative is also coming together faster than originally planned. Our efforts for improving the lobby customer experience are on track to provide improvement to staffing standards ahead of the original schedule. We are working on updated schedules and look forward to sharing those with you as well. I'd also like to highlight a new application called SkyPath we recently implemented and led for pilots and dispatchers to provide better awareness of turbulence along the flight path. This industry-leading system uses iPad sensors and GPS data from pilot's electronic flight bags to turbulence in real time, aggregating and sharing data from across -- from users across several airlines in North America.
Our teams worked cross-functionally to accelerate the launch of this app for the spring season when we tend to see more turbulence across the network. And it's another tool we can use to support employees with additional information for decision-making, improve the onboard experience for customers and reduce operational risk. We look forward to sharing more on these and expensive of multiyear initiative-based efforts at Investor Day in September. Finally, I'd like to close by congratulating all of our employees who reached agreements on new contracts over the past year or a little bit more than a year plus. Each contract requires a significant amount of work. And as always, we remain committed to rewarding our deserved employees. With that, I'll turn it back over to Julia.
Julia Landrum: Great. Thanks, Andrew. That completes our prepared remarks. We will now open the line for analyst questions. To allow for as many calls as possible, we ask that you limit yourself to one question and a brief follow-up if needed. We will now take the first question.
Operator: Let's begin the question-and-answer session. [Operator Instructions] Our first question today comes from Michael Linenberg with Deutsche Bank. Please go ahead.
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