Southwest Airlines Q4 2023 Earnings Call Transcript

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Provided by Quartr
January 25, 2024

There are 14 speakers on the call.

Operator

Hello, everyone, and welcome to the Southwest Airlines 4th Quarter 2023 Conference Call. My name is Gary, and I will be moderating today's call. This call is being recorded and a replay will be available on southwest.com in the Investor Relations At this time, I'd like to turn the call over to Ms. Julia Landrum, Vice President of Investor Relations. Please go ahead, ma'am.

Speaker 1

Thank you so much and welcome everyone to Southwest Airlines 4th quarter 2023 conference call. In just a moment, we will share our prepared remarks, after which We'll 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, Brian Greene and Chief Operating Officer, Andrew Watterson. A quick reminder that we will make forward looking statements, which are based on our current expectation of future performance, and our actual results could differ materially from expectations. Also, we will reference our non GAAP results, which excludes special items that are called out and reconciled to GAAP results in our press release.

Speaker 1

So please refer to the disclosures in our press release from this morning and visit our Investor Relations website for

Speaker 2

more information. With that,

Speaker 1

I'm pleased to turn the call over to you, website for more information. With that, I'm pleased to turn the call over to you, Bob.

Speaker 3

Thank you, Julie, and thank you everyone for joining the call today. As we close the books on 2023, I want to take a moment to reflect on how far we've come. And more importantly, I want to thank the people of Southwest Airlines for their dedication, their warrior spirit, their heart and ultimately for their incredible resilience. At this time last year, we were getting back on our feet from the disruption following winter storm Elliott. We quickly mobilized to put immediate mitigation efforts in place while simultaneously building a robust plan to prepare us for future extreme winter weather disruptions.

Speaker 3

We were also working to restore our network, address our staffing needs and return our aircraft to full utilization. And of course, we were in the middle of negotiations with the majority of our labor unions. I'm incredibly pleased to be on the other side of 2023 and to be able all the progress we made last year. We completed a comprehensive winter weather action plan, which has already been successfully tested in multiple winter weather events, including the extended nationwide winter storms we experienced this month, but also in other types of disruptions such as hurricanes, severe fog in Chicago and the Maui fires. Through all of those events, our aircraft and crew networks remained stable.

Speaker 3

We recovered quickly we were able to minimize the impact on our customers. We also got fully staffed, restored our network and reached full utilization of our fleet. Our network is in a healthy place and it shows in our operational improvement. In fact, we improved in nearly every operational metric. Our Completion Factor performance in particular was fantastic at 99% for the full year with 4th quarter being our best quarterly performance in more than a decade at 99.6%.

Speaker 3

We also made significant progress on our labor agreements, including ratification earlier this week of an agreement that secures industry leading pay for our best in class pilots. We have now successfully reached ratification on 9 contracts in a little over a year, demonstrating our commitment to providing competitive market packages for our people. This is a huge accomplishment, and I would like to thank all those who have tirelessly supported those negotiations. Of course, all this was in addition to a host of other accomplishments. The rollout of a new revenue management system, the launch of multiple customer experience improvements and the negotiation of a very cost effective order book with Boeing.

Speaker 3

The order book allows us to continue the modernization of our fleet and provides the opportunity to flex our growth plans up or down over the long term. We also made rapid adjustments to capacity for both 2023 and 2024 and put in place significant network adjustments in response to changing demand patterns. These changes reduced our planned 2024 year over year capacity increase to roughly 6%, all of which is carryover from 2023 network restoration. So there'll be no net new additional capacity in 2024 as we work to mature our route network. Moving to our performance, we continue to be very pleased with the core demand for our product.

Speaker 3

We saw close end performance strengthened in November and December for both leisure and corporate travel. This led Q4 2023 to be yet another record at just over $6,800,000,000 in operating revenue, and we are seeing that strength continue into 2024. This demand strength combined with about $1,500,000,000 in incremental year over year pre tax profit from our network optimization efforts And the contributions from our portfolio of strategic initiatives is driving us to expect additional revenue records and year over year operating margin expansion Despite cost pressures from new labor agreements and increased aircraft maintenance expense, our network changes are materially in place with the March where we expect to hit a profitability inflection point. While still early in the quarter, our initiatives are delivering towards our revenue target And we expect to exit the quarter with a strong operating margin for the month of March. While we have significant inflationary pressures from our new labor agreements, We have initiatives underway that will begin to help counter these pressures with efficiency improvements.

Speaker 3

These include everything from scheduling techniques to digital modernization and we planned in 2024 with headcount flat to down as compared with year end 2023. As we slow hiring to levels that are at or below our attrition rate. That will drive efficiency gains in 2024 with more to come in 2025. All of this supports a solid plan with a line of sight to improve our financial returns and earn our cost of capital in 2024. While this represents notable progress, I want to be clear, earning adequate and consistent returns, ROIC well in excess of WACC is our financial North Star and it's not negotiable.

Speaker 3

We will be relentless in executing against our plans and we will continue to make adjustments including capacity adjustments if needed until we deliver those results. Adequate and consistent returns is how we have created decades of shareholder value and it continues to be our key focus. Our current set of initiatives is tracking nicely and we will provide you a lot more detail later this year at Investor In addition, we're working on a next set of initiatives to support in support of sustainable returns over time. In closing, we made tremendous progress in 2023 and we finished the year a much stronger company. We will finish this year stronger again.

Speaker 3

We are fully committed to improving the customer experience and delivering on our long term financial targets, including generating returns for our shareholders. As always, I have confidence in our people and our business model, and I am particularly proud of our people for their dedication and their resilience. They remain our absolute greatest asset, the heart and soul of our company and the ultimate source of pride for me. And with that, I will turn it over to Tammy.

Speaker 4

Thank you, Bob, and hello, everyone. As Bob mentioned, 2023 wasn't without its challenges, but we are stronger and ready to take on another year And that is all thanks to our incredible employees. We delivered $986,000,000 in profits for the year and our 4th quarter net income of $233,000,000 both when excluding special items was on the better side of our expectations. We prioritized the restoration of our network operational reliability in 2023 which has taken a lot of resources and focus. With our operations now stable and the network restored, we can direct much more focus and energy to consistently delivering a strong financial performance along with delivering operational excellence.

Speaker 4

We have incredible strength to build upon and the levers we need to optimize and regain position as an industry leader. We will be steadfast in our efforts to make meaningful progress this year in support of our long term goal of generating consistent returns well in excess of our cost of capital. Brian and Andrew will the headway we've made with 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 were down 16% year over year in the 4th quarter. Our 4th quarter average fuel price of $3 per gallon was right at the low end of guidance primarily due to jet fuel prices in the LA market steadying after significantly spiking in mid November.

Speaker 4

Thankfully, market prices dropped As we moved into this year and our fuel price guidance of $2.70 to $2.80 per gallon for the Q1 And $2.55 to $2.65 per gallon for the full year is a welcome reduction in fuel cost compared with 2023. We are currently 60% hedged here in Q1 and 57% hedged for the full year with more meaningful hedge protection kicking in at Brent prices around $90 per barrel. That's a higher strike price than where Our 2023 hedges began to provide meaningful protection, which was closer to $70 per barrel. This is reflective of the current market position for 2026 nearing 20% hedged and are currently 46% hedged in 2025 in line with our goal to be roughly 50% hedged in each calendar year. While we are not Fully immune to the volatile energy market, I am grateful that our hedging positions provide meaningful protection against catastrophic increases while also allowing us to participate fully when market prices decline.

Speaker 4

Moving to non fuel cost, Our 4th quarter year over year CASM ex decrease of 18.1% was on the favorable side of our guidance range, driven primarily by elevated operating expenses and lower capacity levels in Q4 2022 as a result of the operational disruption. This was partially offset by general inflationary cost pressures including higher labor rates for all employee work groups as well as elevated maintenance expense, both of which are sticky as we move into 2024. I also want to congratulate our pilots on their newly ratified contract. Obviously, the market for pilot wages has increased significantly and it is important that we keep pace to reward our employees appropriately. As a result of the new agreement, we recorded a change in estimate for the pilots ratification bonus And you can find the details and breakout of the accounting treatment in this morning's press release.

Speaker 4

Looking to Q1 2024, we currently estimate our CASM ex to increase in the range of 6% to 7% year over year. Roughly 3 points to 4 points of this estimated increase is driven by higher overall 2024 labor cost and market wage rate accruals. The remainder of the Q1 CASM ex increase is primarily due to year over year pressure driven by rate increases as well as an increase in maintenance activity as our 800s are coming off their honeymoon period. Speaking to full year cost, our CASM ex guidance of a 6% to 7% increase year over year is also essentially driven by labor and maintenance cost pressures. Roughly 4 to 5 points is attributable to labor and roughly 2 points is from maintenance for the reasons I previously covered.

Speaker 4

While we accrue for market wage rates, The recently ratified pilot contract contributes the majority of the labor CASM ex increase this year due to a step up in wage rates, work rule changes and enhanced benefits. As Bob mentioned, we are steadfastly focused on regaining efficiencies to help counter some of the structural cost pressures as we look to control what's controllable. We are not satisfied with our current performance and we will work relentlessly until we produce the financial strength and returns you should expect from Southwest Airlines. We have a solid 2024 plan which includes the benefit of roughly $1,500,000,000 in incremental year over year pre tax profits from our strategic initiatives. The vast majority of the initiatives delivering value in 2024 are revenue related, contributing well over $1,000,000,000 of the $1,500,000,000 total expected incremental benefit And our network optimization and market maturation efforts are providing the bulk of that revenue lift.

Speaker 4

The balance of the revenue generating benefits come from incremental managed business initiative, primarily increased GDS participation. The incremental cost benefit relates primarily to fleet modernization and early yields from other operating efficiency efforts such as digital service modernization and our turn initiative. We will go into a lot more detail on our initiative at Investor Day later this year. While early, our plan provides significant progress towards our long term goal to generate ROIC well in excess of our cost of capital. Again, more details to come at our 2024 Investor Day.

Speaker 4

Now turning to our fleet, during 2023 we received a total of 86 Dash 8 deliveries, 1 more than planned and retired 39-700s, 2 less than planned, ending the year with a total of 8 17 We consistently mentioned the flexibility in our fleet modernization efforts being a key competitive advantage And the minor shifting of deliveries and retirements throughout 2023 validates our ability to thoughtfully plan and execute given the continued supply chain challenges facing Boeing. Moving into 2024, There is continued uncertainty around the timing of expected Boeing deliveries and the certification of the MAX 7 aircraft. Our fleet plans remain nimble and currently differs from our contractual order book with Boeing. We are planning for 79 aircraft deliveries this year and expect to retire roughly 45-700s and 4-800s resulting in a net expected increase of 30 aircraft this year. Taking our current plan into consideration, we expect our 2024 CapEx to be in the range of $3,500,000,000 to $4,000,000,000 After finalizing our 2024 plans and refining capacity levels to better reflect the current environment, we now expect full year 2024 capacity to be up about 6% year over year.

Speaker 4

And our 2024 capacity plans do not currently include any MAX 7 flying. So, if certification of that aircraft continues to push out, our 2024 capacity plans will not be impacted. In addition, we are also reducing our total fuel expense with our fleet modernization initiatives as we continue to bring on more fuel efficient aircraft and retire -seven hundred. We saw a nearly 3% year over year improvement in fuel efficiency in 2023 and expect continued improvement this year. In addition to fuel savings, our fleet modernization initiative is a key component and reaching our environmental sustainability goals.

Speaker 4

Lastly, I am proud to report that our balance sheet strength continues to be a financial backbone as we move into another year. We remain the only U. S. Airline with an investment grade rating by all grade ratings by all three rating agencies. We ended the year with $11,500,000,000 in cash and short term investments, Return $428,000,000 to our shareholders through dividend payments in 2023, paid $85,000,000 to retire debt and finance obligations in 2023 and continue to be in a net cash position.

Speaker 4

We expect to pay a modest $29,000,000 in debt payments this year and continue to expect interest income to well exceed our expected interest expense of $249,000,000 in 2024. So We are pleased to have a plan for significant financial improvement to be made this year. With some major milestones behind us such as restoring our network, becoming fully staffed, fully utilizing our fleet and so much more, our sights are set on margins and covering our cost of capital in 2024. And as I close, I'd like to sincerely thank our people for another year of hard work and dedication to the mission and vision of Southwest Airlines. I am so grateful for each and every one of you.

Speaker 4

You are truly my heroes. And with that, I will turn it over to Ryan.

Speaker 3

Thank you, Tammy, and hello, everyone. Let me start by sharing that I am very pleased with the overall demand for our business, the execution from our amazing people and the engagement of our loyal customers. 4th quarter unit revenue finished slightly better than expectations at down 8.9% year over year. The improvement was driven by a strengthening of close in revenue performance in November December for both leisure and corporate business travel as well as the continuation of overall strong holiday performance and market share gains from our managed business initiatives. I'm pleased to report that we saw no bookings impact from last year's operational disruption during this past holiday season, which speaks to the operational improvements we have made over the last year as well as the enduring loyalty from our customers.

Speaker 3

In addition, 4th quarter was another quarter with multiple records set, including record 4th quarter operating revenue and passenger revenue, as well as an all time quarterly record for passengers carry. Fares also performed well in 4th quarter with our average passenger fare up about 2.5 year over year. And all in all, our 4th quarter operating revenues were up over $1,000,000,000 relative to Q4 of 2019. And while we still have work to do on our revenue performance, I remain very pleased with our progress. Looking to our full year results, We grew 2023 operating revenues nearly 10% year over year to a record $26,000,000,000 accompanied by record passengers, record Rapid Rewards revenue and record ancillary revenue.

Speaker 3

And speaking of records, We set operating revenue records in each quarter of the year and for the full year of 2023. As we move into 2024, We are seeing the momentum continue and we're seeing early, but highly encouraging benefits from our network optimization efforts And we expect 1st quarter unit revenue growth of 2.5% to 4.5% when compared to the same period last year. This represents a solid sequential improvement in year over year unit revenue performance even when normalized for the 5 point tailwind from the prior year disruption impact. In fact, our guide would imply Q1 2024 nominal RASM to be about 5 points higher than our normal seasonal sequential average when compared with nominal Q4 of 2023 RASM. We currently have about 60% of expected bookings for Q1 already in place, slightly above normal and we are seeing better than normal sequential RASM performance, further demonstrating that our network optimization efforts are working.

Speaker 3

As we refined our capacity plans for this year, we've been able to pull in even more flying out of the shoulder periods, which we believe will be a tangible contributor in boosting our performance. While our forecast doesn't assume any material increase in demand for domestic air travel in 2024, we do have a line of sight to double digit operating revenue growth year over year, driven largely by the network and initiative driven revenue that Tammy detailed. Included in that of course is our efforts to drive managed business. We are very pleased with the performance of our managed business initiatives and the success of our Southwest business team. In the past year, we had a solid increase in market share, More than 3 points in the managed business space and I'm very proud we improved our business travel news ranking from 4th place in the industry in 2019 to 2nd place in 2023.

Speaker 3

We were the only carrier on the survey to receive an increased total score 2 years in a row, while each of our competitors' scores have declined over that same period. It's another example of the progress we're making against the industry in the managed business space. Of course, we're also continuing our efforts to improve our customer experience and our Rapid Rewards program. We are seeing improved customer satisfaction scores with our Wi Fi product as we proceed with our infrastructure investments there and more aircraft are joining the fleet every day with NC Power and larger bins on board. We've made several enhancements to our award winning Rapid Rewards program, including making it easier to reach our A List and A List preferred levels and we will soon be rolling out the ability to book travel with a combination of cash plus rapid reward points later this spring.

Speaker 3

We introduced customer bag tracking to reduce friction in our customers' travel experience and we look forward to sharing more on our larger digital modernization plan in the coming months. All of this is designed to make it easier to fly with us and give customers even more reasons to choose Southwest. As we enter 2024, we have a very solid plan that leverages the unparalleled strengths of our people, our product, our loyalty program and our route network and we look forward to delivering on continued progress towards our long term financial goals. With that, Andrew, over to you. Thank you, Ryan, and hello, everyone.

Speaker 5

I'd like to start out by recognizing our people for their efforts and successfully managing through 4 different named winter storms, which are spread over 11 days and impacted a wide portion of our route network with intense weather conditions and frigid temperatures this month. These overlapping winter systems definitely put our winter operations fairness plan to the test. Overall, I'm very pleased with how well we managed the storms. The sheer magnitude of these weather systems resulted in significant cancellations, the vast majority of which were proactive on our part. Our cancellations were made 14 hours in advance on average and 70% were canceled with at least 6 hours in advance.

Speaker 5

As you can imagine, providing that much notice improves the customer experience. In fact, we have found that it can result in NPS scores that approximate those with no disruption to the itinerary. Overall, our cancellation rates were in line with the industry and were primarily isolated to the operations directly impacted by the storms. With fewer than 2% of our cancellations tied to crew scheduling challenges. This is a significant contrast to what we experienced with Winter Storm Elliott in December 2022.

Speaker 5

The improvement is directly the result of last year's winter operations investments and protocols. I echo Bob's sentiments that we are in a much better spot today than a year ago. In the past year, we not only completed the winter operations preparedness plan, we also delivered a long list of initiatives to modernize our operation with benefits for both our customers and our employees. Our people have the staffing, equipment, tools and infrastructure to operate safely and at pace and winter weather. The good news is that all the hard work showed up in our operation performance.

Speaker 5

We closed out 2023 with only about 1% of our total flights canceled And we improved in basically every metric. Our completion factor, on time performance, early morning originators, turn compliance and turn differential and mishandled baggery All showed substantial year over year improvement, which in turn led to a year over year improvement in our TRIP net promoter score. As we enter 2024, we will focus on continuing to build on our 2023 priority of operating quality. We ranked 4th place in the 2023 Wall Street Journal Airline Quality Metrics despite several of the metrics covering the Winter Storm Elliott period. Our goal is to move up this ranking and ultimately be ranked number 1.

Speaker 5

We will also double down on 3 additional priorities, bringing out operating inefficiencies, increasing asset productivity and creating operating leverage by reducing structural costs. These are multi year initiative based efforts which will begin yielding material benefits in 2025. We'll share more on these in the coming months. Finally, I'd like to close by congratulating our pilots on their new contract. I'd also like to thank all the negotiating teams who have worked so hard to reach 9 agreements since October of 2022.

Speaker 5

These teams worked tirelessly and I am pleased we can reward employees with well deserved pay increases quality of life enhancements. We remain in negotiations with 2 union representative groups TWU555 and TWU556 and we look forward to reaching agreements to reward those employees for their contributions. So with that, I'll turn it back over to Julia.

Speaker 1

Thank you, Andrew. This completes our prepared remarks. We will now open the line for analyst questions. We would like to speak with as many of you as possible, so we ask that you limit yourself

Operator

The first question comes from Ravi Shanker with Morgan Stanley. Please go ahead.

Speaker 2

Thanks. Good afternoon, everyone. Maybe we can start with the $1,500,000,000 kind of initiatives. And any chance you can share more detail there, kind Got details on what the different contributing items are? And also how much visibility do you have into that?

Speaker 2

Trying to get a sense of how much of that may be in the bag so to speak?

Speaker 3

Hey, Robbie, it's Bob. I'll start and then maybe Ryan can jump in. Obviously, a lot of the year over year improvement counts on the initiatives And I feel very confident about that. I mean, some of this is our Investor Day initiatives continuing to perform. And then on top of that, you have new things, a lot of which the majority of which are the network improvements, which as you know are in place Materially beginning in March and then fully in place by early summer.

Speaker 3

And so we have a lot of confidence in Certainly, the Investor Day initiative is delivering. And while it's early in the quarter, we have some line of sight into Obviously, March and how well the network change and optimization is delivering and we're on track there. It's things like it's basically adjusting for new demand patterns. It's adjusting You know what they are, the Tuesday, Wednesday shoulder flying, those kinds of things. But no, I feel like we're on track to hit that incremental one $500,000,000 Again, most of that is revenue, about 2 thirds of that is revenue related.

Speaker 3

Ryan, you want to add anything? Yes. Of the revenue initiatives, There a lot most of that is the network optimization and then continuing maturation of some of our development markets. Development market percentage of mix continues to get more back to normal ranges by end of 2024. So that certainly will help.

Speaker 3

But obviously, we've been able to watch those development markets mature throughout their curve here over the last few years. As it relates to the other revenue initiatives that are in place, they will continue to mature and then also provide additional benefit as we as the airline grows. A significant portion of that is the managed business initiatives that we've been talking about. And I'm very confident in how that those sets of initiatives continue to perform. We're definitely on track.

Speaker 3

Managed business got better in the 4th quarter from how it was performing in the 3rd quarter and then we're expecting another sequential improvement here in the Q1 with managed business. We can see that in place and how bookings are coming in, in January and as we begin to get into the February booking curve here. So, yes, everything that we can see, how we finished the Q4 and then what we can see here in the Q1 and going forward makes me very confident.

Speaker 2

Very helpful. And maybe as a quick follow-up, I'd love to get your thoughts on the apparent premiumization of the domestic product. Obviously, you guys are committed to single cabin, but does that give you kind of more room to raise RASM Across the product or kind of just what would your response to that be?

Speaker 3

Well, premium certainly is a hot topic in the industry and it's something that we watch that we're watching closely. We also talk to our customers On a regular basis, this is one of the things that we continue to get their feedback on. And I think we talked about it some on The last call, as you think about premium historically in the industry, premium revenue has been highly cyclical. This is one of those times where carriers are adding premium seats into the cabin. But When the economic cycle shifts, they're pulling seats premium seats out of the cabin.

Speaker 3

And As we see kind of the recovery here from the pandemic, we'll have to see how these trends persist and go forward. I think overall RASM, obviously, We follow that and how we compare relative to the industry and we're working on improving that as we go forward here. I will say that ancillary revenue, the majority of which is boarding products, our early Bird product as well as our upgraded boarding product is doing very well. We're having record ancillary revenue performance. So I think, yes, we have a single cabin, but we're able to improve RASM and grow ancillary revenue through some of those boarding products as well.

Speaker 3

Very helpful. Thank you.

Operator

The next question is from Jamie Baker with JPMorgan. Please go ahead.

Speaker 6

Hey, good morning everybody. Obviously lots of discussion about domestic

Operator

sorry, I'm still there, right?

Speaker 2

Yes,

Speaker 6

Sorry about that. It was probably the tamest expletive that I've ever said. Lots of discussion about domestic capacity cuts, your own and others. Just curious though in markets where you overlap with lower cost competitors, Have you seen any changes in how they're competing other than just the capacity cuts? I mean, there's been speculation of lower OA seeing some of those airlines try to regain profitability.

Speaker 6

I'm not seeing any of that, but it's that sort of thing that I'm asking you about.

Speaker 3

Yes, Jamie, obviously there are I mean, there are probably as many moving parts right now as I've ever seen. You've got as Ryan talked about, you've got A focus on parts of the cabin that are outperforming or routes network that are outperforming, You've got a lot of capacity moving around in the industry right now. You've got mergers. So it's tough to tell That and on top of that, obviously, you've got capacity impacts due to aircraft delivery, the GTF issues, all those things. So I think it's Tough to tease out, my guess would be that all of those factors Probably get worse across the year.

Speaker 3

The impact of those are going to continue to increase especially as you see more impacts on capacity in aircraft due to potential Boeing impacts obviously the gear turbofan, so more to follow. On our end, obviously, we're focused on Southwest Airlines. I'm really pleased with 2023 and all that we got accomplished that we talked about. We ended the year a much better carrier than we were the year before. The area, of course, where I'm not satisfied is our financial performance.

Speaker 3

We're running roughly 4 points under our cost of capital right now and that is our focus here at Southwest. And we've got a really good plan here in 2024

Operator

Pardon me. This is a conference operator. We seem to have lost connection with the speakers' location. Pardon me. This is the conference operator.

Operator

We've regained the audio from the speaker's location. Please continue.

Speaker 3

Jamie, my apologies there. I don't know where we left off. But my point is, we are focused on Southwest. We're focused in 20 here on expanding margins, covering our cost of capital that sets us up for a lot of momentum to then make even more progress in 2025 And thinking about capacity for Southwest Airlines, Our capacity, our CapEx as we plan forward will obviously take into consideration the progress we are making against those financial goals. I just want you to know that.

Speaker 3

The backdrop of the industry, I think, is going to play out here across 2024 and we'll just have to see.

Speaker 6

Okay, helpful. And then second, you've disclosed in the past that you have seriously considered a complete type, but decided not to go down that path. I don't have to tell you that industry animosity towards your sole provider is obviously Crescendoing, would it be unreasonable to assume your single fleet conviction Might finally begin to wane from here or is that putting words in your mouth?

Speaker 3

Yes. Well, let me just back up a second. Obviously, there's a lot Going on with Boeing, I mean the MAX 8 is a great aircraft. We're very satisfied with it. And like Boeing, we support the work of the FAA and the oversight to improve quality, address any issues because at the end of the day, a better Boeing is good for Southwest Airlines.

Speaker 3

We periodically look at aircraft manufacturers and aircraft types. That's something we take up routinely here at Southwest Airlines, we've done that in the past. And our focus right now is on Our own fleet plan, our fleet plan with Boeing, obviously, working with Boeing to get the MAX 7 certified. But we do take that up periodically. You also have to understand, I know you know this, but there isn't There's no such thing as being able to de risk all of this.

Speaker 3

Even if you have multiple aircraft providers, say we were fifty-fifty, You'd have 400 aircraft of 1 type and 400 of another type. And so an issue still creates great risk for the company. So the best thing that we can do is work with Boeing to make them an even better company, which is exactly what's happening. We've got great confidence again in the MAX 8 and we're eager to get the MAX 7. We're not in charge of that certification date.

Speaker 3

But no, we have confidence that Boeing will get all this figured out with the FAA and we'll come out a better company.

Speaker 6

Appreciate the color.

Operator

The next question is from Catherine O'Brien with Goldman Sachs. Please go ahead.

Speaker 4

Hey, good morning everyone. Thanks so much for the time. Maybe just

Speaker 7

a couple of quick ones. On unit revenue going forward, underlying Your double digit top line forecast for the year. Can you just help us think about where we go from the 1Q unit revenue forecast? I'm assuming based on the full year Capacity outlook growth is going to slow from the Q1 into the remaining quarters of the year, so that'd be a sequential tailwind. You'll be lapping some of that easy comp from the book away as we move through the year, how does that all impact where you think unit revenue trends

Speaker 4

I'll start off and then Ryan, if you want to jump in with any thoughts that you have. Really there as you pointed out, there's a bit of noise year over year. So probably the best way to kind of help you think through that is sequentially. As you're aware, the Q1 is seasonally a tougher quarter, just in general for the airline industry. And we will have, and we will have our network changes materially in place in March.

Speaker 4

So

Speaker 2

and

Speaker 4

then following on into the summer, we expect to have that fully completed with our summer schedules. And then just as we continue to go through the year, we would expect our development market to continue to mature, you were 10% of our system is development markets And by the end of the year, we expect that to be more in line with our historical percentage of about, call it 5%. And then on top of that, as Ryan covered, we are we believe we'll continue to grow our Managed business revenue, we've been pleased with our GDS initiative and we would expect those

Speaker 2

benefits to steadily improve as we go

Speaker 4

through the year. So, as we go through the year. So we would expect we've got a lot of momentum coming into this year. We would expect

Operator

Pardon me. This is a conference operator. We've again lost audio from the speaker location. Please stand by as we try to regain it. Thank you.

Operator

This is the conference operator. We've regained audio from the speakers' location. Please continue. Thank you.

Speaker 3

Yes. And everybody, sorry about you. We're having some form of conference call issue here. My apologies. But I would just pile on just Simply,

Speaker 2

maybe

Speaker 3

talk to cover what Tammy did, which is you have decelerating capacity across the year, 10% Q1, 8% to 10% in the 2nd quarter, 3% to 5% and the 3rd quarter and then the back half of the year really is all just stays linked. Trips are down. Seats are down. On top of that, the initiatives and particularly the Network related revenue initiatives and the development market related initiatives accelerate Because they really started in March, accelerated through the summer. So you have decreasing capacity across the year and you have an accelerated contribution from the network initiatives That's an indirect answer to your question, but that's how I'm thinking about it.

Speaker 3

Yes. And I wouldn't add anything else other than to say that the revenue initiatives, that component of the plan, those are there's very little lumpiness in those as well. Those are pretty evenly spread throughout the year. So it's really about the decelerating capacity in the back half of the year and the network maturation and optimization efforts coming on.

Speaker 1

Makes a

Speaker 7

lot of sense. And then maybe just for my second question, We'd just like to talk about the unit cost side for this year and I know very early, but maybe like firstly into 25.

Speaker 4

Can you talk to us just about

Speaker 7

some of the incremental headwinds you're expecting for 2024 versus what you were thinking back earlier in 2020 when you're targeting unit cost to be down year over year, of course, at least a couple of points that's lower capacity, the pilot contract came in higher. It will be great if you guys walk us from that down year over year to up 6% to 7% and then again early, but into 2025, If we've lapped the big step up in wages and we're back to something more inflationary plus, I'm guessing you're going to get more efficiency back as going to year 2 of kind of the network recovery and you're in optimization phase like is that when we get the down year over year? Any color there would be great. Thanks so much for the time.

Speaker 3

Yes. Thank you. And I'll start and then I'm sure Tammy will pile in. I mean, the we were accrued for our labor contract increases here and we've got 9 done, 2 to go. It's really for the most part, it's rate increases here in 2024.

Speaker 3

So if you take the pilots, for example, they've got a 4% rate increase. We've got some benefit increases. That's the majority of the 6 to 7. On top of that, you have maintenance pressure that was known. It's really the 800 engines coming off holiday and that's a couple of points.

Speaker 3

Those are going to be things, wage rate pressure, maintenance pressure that most of the industry shares. Now on the efficiency side as we go across the year, we've peaked our hiring and we will Our target is to end the year in 2024 with fewer heads than we ended the year 2023, which will of course naturally make us efficient with the 7% growth. It's too early to talk about 2025. But as you maybe think about a forecast there, yes, You would naturally decelerate from the unit cost pressure this year and our goal we're not ready to give you a number of course for But our goal will be to dramatically control that headcount growth again in 2025 and be sharing a lot more about that at our Investor Day later in the year. Tammy, do you want to add

Speaker 4

anything? Yes. You really covered it all. But yes, the story is quite simple. It's labor cost, labor rate cost.

Speaker 4

Obviously, the inflation there is more than we would have anticipated initially. So we've With the pilot contract behind us, we've adjusted our accrual. So most of 2024 is associated with those step with the step up in scale increases, wage rate increases and enhanced benefits and Bob's covered the maintenance And we'll share more at Investor Day, but obviously, we're focused on bringing out those efficiencies as we move through 2024 and to a greater degree in 2025.

Speaker 7

Thanks so much.

Speaker 8

Thank you.

Operator

The next question is from Duane Pfennigwerth with Evercore ISI. Please go ahead.

Speaker 8

Hey, thanks. Appreciate the time. So Maybe just one more shot at this. Can you give us your best guess as to the contributors to the sequential improvement here? How much of that 5 points would you attribute to these network realignment initiatives?

Speaker 8

And how much would you attribute to just Better underlying demand. It's been challenging with airlines to really make a read about the macro based on what airlines are doing in given quarter. Just like in the Q3 of last year, I didn't think that was a particularly good read on the macro. But if you just look at this revenue outlook here, What is your business telling you about the macro? And are you seeing acceleration?

Speaker 8

And if so, where?

Speaker 3

Yes, Duane, it's Ryan. I think the macro environment for demand overall is very strong. I mean, the way that we closed the 4th quarter we saw a close in performance kind of accelerate in the holiday time period, which had us we came in above our expectations at that point. So I think that that was a good sign as we got into the year. And as you sit here in the Q1, the beginning of the Q1, we've got about 60% of bookings on hand.

Speaker 3

That's Plenty for us to get a good read on how the macro trends are performing. I think demand looks very strong. In January February, which are typically trough periods here, We're performing just fine. As you look into the stronger periods into March, I think spring break travel and the Easter travel period, That's booking very well. And then probably also as it relates to the overall macro environment, if you just look at managed business trends, I think I mentioned this earlier, 4th quarter was better than 3rd quarter and 1st quarter is expected to be better than the 4th.

Speaker 3

We've got very strong bookings in place on a managed business side here for February as we begin to get into that part of the curve. So I think the overall macro environment sets up well for us having a really good year.

Speaker 8

And just to follow-up there, any focus cities or parts of the country that are kind of waking back up for you?

Speaker 5

Well, I would say

Speaker 3

destination based markets are doing very well. International is doing very well. Hawaii, we beat our expectations in the 4th quarter. Phoenix, Orlando, Vegas, Those markets are doing very well for us. I think when you look, California was slower to come back.

Speaker 3

It's doing It's improving for sure. So it's definitely pockets across The network, but again, I think overall things continue to improve.

Speaker 5

Okay. Thank you.

Operator

The next question is from Brandon Oglenki with Barclays. Please go ahead.

Speaker 9

Hey, good afternoon and thanks for taking my question. So can I come back, I think, to the first Q and A here, which was about the premiumization of the industry? I think what we did observe through 2023 was some growing yield differential between yourself and maybe some low cost competitors Relative to the Network Airlines. And I guess I just want to ask the question maybe more bluntly or directly. Does products matter and Does it matter as you go further in distance and longer in flight length?

Speaker 9

And I guess I'd specifically ask about your experience in Hawaii as well. And I guess how do these initiatives that you guys are talking about in the commercial side start to try to address that? Thank you.

Speaker 3

Well, first of all, I would say absolutely product matters. And I think that Certainly from a coach product, Southwest Airlines has the best coach product in the industry. I would just echo what I said on premium component of this is highly cyclical. And I think that we want before we would take up that question, We would want to study that very closely as we think about that. Your question on how do we do relative In a long haul market like Hawaii, as I mentioned, we beat expectations we beat our own expectations for Hawaii in the 4th quarter.

Speaker 3

I think our yields continue to improve on the mainland to Hawaii component of that franchise. And we'll continue to develop those yields further. But no, I think that our product Fares very well even in long haul markets. But yes, on the whole, I think product matters. And I think when you look at the industry together I think that there's at least some evidence out there today that demand for Fares on the bottom end and lower products on the lower end of the segment, there may not be as much demand for those types of products today as what there once was.

Speaker 3

And Brandon, this is Bob. The only thing I would add is, and this is no prediction. Don't read more into this than is there. You've got to meet your customers' demand and their expectations. So as those change over time, You want to understand that.

Speaker 3

You want to be you want to carefully understand that. And we have a history of demonstrating that. So you go back 10 years, We wouldn't have been talking about Wi Fi. We would not have been talking about power on the aircraft. And I and we can go on and on and on.

Speaker 3

There was a time when we didn't even have a loyalty program here at Southwest Airlines. So as consumer demands and expectations change and you've got different generations of flyers coming into the system as well. We will constantly look at that, understand what our customers want. And then if that warrants change, we will look at that and we make the right decision. Again, we have a history of doing that with our product here and our customer experience.

Speaker 3

That's no predictor regarding premium in Evan, I'm just trying to make sure that you know that we aren't stubborn in this area, that as you see demands change, We'll understand that and we will react if needed.

Speaker 9

Bob and Ryan, I appreciate that. And then maybe if I can just get a quick follow-up in for Tammy. Any ability to tell us where you view your weighted cost capital today?

Speaker 4

Yes, sure. It's Sitting

Speaker 7

probably

Speaker 4

8 point it's the high 8s close between 8% and 9%. So we view it as about 8.6%, 8.7

Speaker 9

Okay. I appreciate that, Tammy. Thank you.

Speaker 4

But one thing, Brandon, just to add on, over the over our longer term, it's been closer to 9%. We certainly take a view, a longer term view when we're planning in terms of our returns on invested capital.

Speaker 9

Thank you.

Operator

The next question is from Helane Becker with TD Cowen. Please go ahead.

Speaker 10

Thanks very much, operator. Hi, everybody. Thank you for the time. As I look at your numbers for the Q4, your revenues were up, What 12.5% or something and your costs were up 10.5% and yet you weren't able to see significant margin improvement because of the things you already talked about where you have But as we look forward to the next 1 year, how should we think about the seasonality of your business now? Because It seems like you said everything was great for the Q4 and yet you didn't perform significantly better than you did last year.

Speaker 10

And I would have thought that last year given all the issues, you would have performed a lot better. So maybe you can help me bridge beyond just the obvious labor cost inflation and other inflationary pressures, how you get back to those margins you used to report? And then do you expect and then my other question is, do you expect any book away from the flight attendants asking for a strike vote.

Speaker 3

Yes, maybe Elaine, thank you. Maybe I can start and Yes, I'll try to remember everything. I think just generally, I think the biggest impact Sort of tearing everything aside in the 4th quarter is we did choose to restore capacity quickly. So basically That was a choice to, number 1, get our aircraft back to normal utilization, fly all of our aircraft, hire pilots, all that. And so our capacity, our ramp up was greater than normal and therefore we did have you could see it, we had a drop in load factor.

Speaker 3

I think that's the biggest contributor in terms of the performance right there that's different than normal. And our 2024 plan obviously is to get back to normal in that area as we normalize capacity. So to me that's the biggest thing and I don't attribute any of that. I'll get to your flight attendant question. We don't I don't attribute any of that to book away in the holidays, for example, related to Elliot or something like that.

Speaker 3

I think it really was the rate of capacity restoration. As we look at our consumer our customer behaviors, we look at our customer metrics, demand for Southwest airlines, there is no indicator or indication that we saw any hangover or book away. In fact, The holiday periods were the strongest periods of the quarter. Your question about the flight attendants and I'm really proud of our labor folks. We've ratified 9 agreements in just over a year.

Speaker 3

We have 2 to go. 1 of those is with TW556 or flight attendants. We are in federal mediation and in federal mediation you follow the mediator and the mediator determines your dates and when you meet and We're eager to get a contract done and just like our pilots who are in mediation, I'm confident we can do that. The SAV or the strike vote does not mean you are headed to a strike. There are many, many, many things that have to occur before you get to that point.

Speaker 3

So I am not worried about a strike despite the strike authorization vote. When we saw our pilots take an SAV or strike authorization vote, We did not see any very little customer even indicator that the customers were focused on it or aware. So I don't expect any kind of hangover from that here in terms of customer demand because of the flight attendant vote. Ryan, you want to add anything there? No, there's no evidence in anything that we track from a customer sentiment perspective that would make us concerned about That sentiment is fully recovered to at this point and our NPS scores, our customer satisfaction have recently have been records and certainly back to pre pandemic levels.

Speaker 10

Okay. That's really helpful. Thank you.

Speaker 5

Thank you.

Operator

We have time for one more question. We'll take that last question From Dan McKenzie with Seaport Global. Please go ahead.

Speaker 11

Hey, thanks for squeezing me in. I guess, on efficiency and further improvement to in 2025, for investors that want or that would like line of sight on where FTEs per aircraft could ultimately go, What prior year could serve as a good benchmark? I guess that's first. And then secondly, is that reasonable to assume Southwest could get there fully in 2025?

Speaker 3

Yes, I'll answer it directly. And Andrew, if you want to chime in. I think we're Not ready to talk about it in maybe as much detail as you want until we get to our Investor Day here later this year. But absolutely, it's just like the goal of covering our cost of capital this year And getting back to our historic returns and ROIC well above WACC, restoring efficiency is right alongside in terms The key goal or a key goal, we ramped up our hiring quickly to be able to restore the network and get all of our aircraft flying. That hiring peaked in October November and we have been decelerating that rapidly here in the last 60 days.

Speaker 3

The plan is to again to grow 6% or so this year and then to end this year with the same or fewer heads than we began the year, which will obviously help our efficiency quite a bit. Not ready to discuss 2025, but we would have certainly a directionally similar goal in 2025. We also have a significant number hate to be hate to tease here, we have a significant number of efficiency initiatives that we are planning around both efficiency of the aircraft, efficiency of our people and processes as we think about things like the turn and we'll be sharing a lot more about that again in our Investor Day later

Speaker 5

tier. I'd say, Bob, one element to add on that is the same kind of cross functional groups we use to kind of rapidly accelerate our hiring. That same team is now responsible for driving out these efficiencies. So that is something that is literally every week kind of meeting to get to achieve what you just said about where headcounts at the end of the year. And I'll also say that while we're conscious of the FTE for aircraft, we're actually managing to more of a labor or SWIB CASM because we think about aircraft, I could fly that different ways.

Speaker 5

We could say you'd have 2 flights a day and my ground ops needs are different if I flew it 6 times a day. And then the block hours for the aircraft would change the pilot pay if it was a longer block hours per aircraft or less for the less. So The ultimate, you know, CASM you get out of your aircraft depends on how you're flying it and how you're deploying staff against it. So The FTE for aircraft is a useful measure one can have, but it's, A, hard to compare across airlines because of the outsourcing, But B, depending on how you fly the aircraft, it can give some little bit of false signal, but you can really look at what we're going to try to do for the labor chasm and get that to a good

Speaker 11

Very good. And if I could just squeeze one last one in here, it's a question on the shift to the cloud. How much of Southwest has shifted to the cloud at this point? And once you complete that endeavor, what could the savings ultimately look like once that transition is completed? Is it tens of millions, 100 of millions?

Speaker 11

And is that an opportunity?

Speaker 3

Boy, I'll tell you what, you're stretching my technical abilities here. But I believe Like a lot of companies, we have a path to shift to the cloud, but again, it's to shift the appropriate things to the cloud. It's not as simplistic as it might sound. I think we have shifted something on the order of just below 50% is what I've got in my And we have a goal to shift a lot more. Some of that is cost savings, absolutely.

Speaker 3

And but I think that is more modest. A lot of what you gain is reliability and the ability to fail over systems and obviously support operations, support our systems, which is critical here in an airline. You have systems that can't be down 30 minutes before they cause you an operational problem. So a lot of the shift to the cloud is as much of resiliency effort and a modernization of the code base and all that effort as it is a cost savings. Certainly, you'll see cost savings and but I just don't My guess is it's more in the tens of 1,000,000 than it is 100 of 1,000,000.

Speaker 3

Yes.

Speaker 5

I think Bob, we I mean, our data center is a fraction of the size it used to be. So we made good progress. But we talk about internally, we're not talking too much of the cost. But you can take a hosted bigger system, break up into microservices that are in the cloud and allows you to and then get productivity in how you refresh and improve that application over time. So it's really the speed to market for these new products and support of the products is what drives the benefit.

Speaker 5

So it's elsewhere in the business you get the benefit, not so much in the kind of hosted costs, if you will.

Speaker 3

The other piece of that too and then we'll I'll stop is the there is a it's not a tech cost, But there is a very high cost, both revenue and expense and being down and having an issue. And you saw issues earlier this year or last year like the NOTAM outage that really hurt the industry. And so to the extent that you can reduce issues, reduce the number of the issues, the length of time of an issue or reduce them completely, My guess is that is more powerful in terms of cost reduction than even the technology reduction because reducing IROPS is very powerful.

Speaker 11

Very good. Thanks so much for the time you guys.

Speaker 3

And thank you.

Speaker 1

Okay. That completes the analyst portion of our call. A quick reminder that the transcript and a replay of the call will be available on our Investor Relations website. I appreciate everyone joining and have a great day.

Operator

Ladies and gentlemen, we will now begin with our media portion of today's call. I'd like to first introduce Ms. Whitney Eichinger, Chief Communications Officer.

Speaker 4

Thanks, Gary. I'd like to welcome members of the media to our call today. Before we begin taking questions, Gary, could you please give instructions on how everyone should queue up for

Operator

Our first question comes from Allison Snyder with The Wall Street Journal. Please go ahead.

Speaker 12

Hi, thanks so much. I just wanted to see what you made of Senator Duckworth today calling on the FAA to deny, the waiver Boeing has sought for the MAX-seven. Is that anti ice issue? Do you think that's something Boeing should have to address before they can start delivering those planes?

Speaker 3

I'll start, Andrew will pile in, Ali. Obviously, the certification of the MAX 7 and the issue there, that's really Boeing. I don't want to For Boeing or get ahead here, obviously, we want the MAX 7 and we want it on the best timing possible. So I don't want to talk for Boeing, but it is one more thing to consider here in the certification process and certification timeline.

Speaker 5

I would say that the certification is a technical process between the FAA and Boeing. I think they've been doing a good job. It's been slower than they would like, but it's been technically based and it's off of public comment. So it's an opportunity for people to comment and for technical analysis to be done. And so we're not a party to that.

Speaker 5

We want the aircraft. It's a question of when we'll get it, not if we'll get it. So we're Pleased that they're taking their time to make sure it's safe and we support whatever way the FAA wants to go.

Speaker 12

And I mean, do you have any plans to increase your own oversight of Southwest Plains on the Boeing production line?

Speaker 5

We have already done that. So in late 2022, we changed our posture up there. Previously, we had for a long time had representatives at the factory, we increased it to a team of A and P license mechanics whose job is to provide oversight of our aircraft in the production process. The Boeing provides customer quality people that is they're on their payroll, but our direction. And so they inspect at places where we asked in the factory, the few days that Boeing takes assemble an aircraft from the wings being built to rolling out.

Speaker 5

It's about roughly 80 areas where we have our requirements for things to be inspected. Those people inspect, Our people inspect and then several times a year, our quality assurance team goes up and inspects our inspectors to make sure everything is going well. So that provides Like really good oversight in the production process. Once it leaves the factory, there's a customary acceptance inspections that happen that the FAA oversees gives a final certificate of airworthiness. And so and then it comes on to our off spec and we've been in our maintenance program, which quite robust.

Speaker 5

And since we're the by far the largest operator of the 737, we have provided lots of data. Our continuing analysis and safety surveillance system allows for us to really understand the aircraft and make sure that it

Operator

The next question is from Leslie Joseph with CNBC. Please go ahead.

Speaker 12

Hi. I was wondering if you have any thoughts about how a Chapter 7 of an airline in the United States would affect the industry? Are there jobs for those employees should that happen? And then do you think that the Justice Department would ever let you buy another airline?

Speaker 3

Hey Leslie, it's Bob. We don't obviously like I said earlier, there is a lot going on in the There between mergers, potentials mergers and acquisitions and issues with Aircraft deliveries, the gear turbofan, I don't know in all my 36 years in the industry, I've seen more moving parts As you have right now, one thing that's consistent here is we stick to our business. So we're focused on Southwest Airlines, Improving Southwest Airlines being the best carrier that we can be, improving our returns and profit margins, all the things we've talked about. It's impossible to speculate on what might happen. Our history would say that These arise for Southwest, if they make sense, we take a look at that.

Speaker 3

But I wouldn't want to speculate on anything going on in the industry, certainly around any other

Speaker 5

I think with the benefit for Southwest Airlines, Bob, is that we have a plan and we control our destiny. We hit our plan. We get our returns where we need to be. We don't need to break our way or judge or anything else or anything. Our plan delivers our results.

Operator

Our next question comes from Rajesh Singh with Reuters. Please go ahead.

Speaker 13

Hi. Andrew, do you have any update on the timeline for the certification of MAX 7, earlier it was expected by April. So do you see any risk of the certification process getting slowed down due to the current events with Boeing?

Speaker 5

Well, we get weekly updates on the status of the certification process. So we know what's been submitted and what hasn't. But obviously then the FAA is the one who oversees that and inspects it and makes the ultimate decision. Previously, we've indicated that we had in our internal plan an assumption that it would be certified by April and that we would then spend time after that to get on our off spec and that could take us in the year and therefore wouldn't be flat until next year. But that is that was only the latest assumption.

Speaker 5

We've had earlier assumptions all along this process. And as Tammy mentioned, we will modify our plan based on the new information. So should that change, we will move our assumptions and adapt our plan. So by taking this kind of conservative approach and giving ourselves the lead time, we won't let any kind of short terms ups or downs affect what we have planned for this year.

Speaker 13

And Bob, I have a question for you. Do you have confidence in Boeing's currently asset to address basis facing the company?

Speaker 3

Hey, Raj, Boeing has been a partner with us for 52 years. And I have absolute confidence That between the FAA oversight work that's going on, the work that Boeing is doing, that Boeing will working with the They will address the quality issues and will obviously come out of this a better company. I've talked personally to their leadership. They're Committed to doing anything and everything it takes to be better and to address the problems. As I said before, A better Boeing is very good for Southwest Airlines.

Speaker 3

So, yes, I have absolute confidence that they will work their way through this and address the issues.

Speaker 13

Thank you.

Speaker 3

Thank you.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Ms. Eichinger for any closing remarks.

Speaker 4

Thanks, Gary. The news release and our contact information are available at swamedia.com. We thank everyone for joining.

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Earnings Conference Call
Southwest Airlines Q4 2023
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