25-jul-2019 southwest airlines co.investors.southwest.com/~/media/files/s/southwest-ir/2q19...
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Southwest Airlines Co. (LUV)
Q2 2019 Earnings Call
Southwest Airlines Co. (LUV) Q2 2019 Earnings Call
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CORPORATE PARTICIPANTS
Ryan Martinez Managing Director, Investor Relations, Southwest Airlines Co.
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co.
Michael G. Van de Ven Chief Operating Officer, Southwest Airlines Co.
Thomas M. Nealon President, Southwest Airlines Co.
Tammy Romo Executive Vice President and Chief Financial Officer, Southwest Airlines Co.
Laurie Barnett Managing Director Communications & Outreach, Southwest Airlines Co.
......................................................................................................................................................................................................................................................
OTHER PARTICIPANTS
Andrew G. Didora Analyst, Bank of America Merrill Lynch
Joseph William DeNardi Analyst, Stifel, Nicolaus & Co., Inc.
Helane Becker Analyst, Cowen & Co. LLC
Jamie N. Baker Analyst, JPMorgan Securities LLC
Duane Pfennigwerth Analyst, Evercore Group LLC
Rajeev Lalwani Analyst, Morgan Stanley & Co. LLC
Mary Schlangenstein Dallas Reporter-Bloomberg News, Bloomberg LP
Alison Sider Reporter, The Wall Street Journal
Tracy Rucinski Analyst, Reuters
David Koenig Reporter, Associated Press
Allison Schaefers Reporter, Honolulu Star-Advertiser
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MANAGEMENT DISCUSSION SECTION
Operator: Ladies and gentlemen, welcome to today's Southwest Airlines Second Quarter 2019 Conference Call.
My name is Greg and I'll be moderating today's call. This call is being recorded and a replay will be available on
Southwest.com in the Investor Relations section.
At this time, I would like to turn the call over to Mr. Ryan Martinez, Manager Director of Investor Relations. Please
go ahead, sir. ......................................................................................................................................................................................................................................................
Ryan Martinez Managing Director, Investor Relations, Southwest Airlines Co.
Thanks, Greg, and thank you all for joining us today. I need to cover a few disclaimers before today's comments.
First, we will be making forward-looking statements based on our current expectation of [Technical Difficulty]
(00:00:34) also reference non-GAAP results, which exclude special items and [Technical Difficulty] (00:00:39) our
earnings release [Technical Difficulty] (00:00:42). Also, given the ongoing MAX groundings, our current outlook is
based on the most recent guidance from Boeing and that includes an assumption of regulatory approval of the
MAX return to service during fourth quarter 2019.
Any changes to these assumptions could result in additional adjustments to our flight schedule beyond January 5,
as well as further aircraft delivery delays and that could result in additional financial impacts. Please also check
our IR website for more detailed information and disclosures. So we've got a great lineup of speakers today,
including Mike Van de Ven, our Chief Operating Officer, Tom Nealon, our President, Tammy Romo, our Executive
Vice President and CFO, and to kick us off, I will turn over the call to our Chairman and CEO, Gary Kelly. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co.
Thank you, Ryan and thanks everybody for joining us for our second quarter earnings call. This year has turned
out to be quite a wild ride. We had some subplots earlier in the year, but the story is overwhelmed by the MAX
grounding. The good news is, we were exceptionally well prepared for the unexpected. We are healthier than
ever. And that's despite the body blow from the MAX and we'll get through it and we will get back on track.
The frustrating thing since our last call is that the MAX grounding has extended much longer than we had
anticipated. Of course, that's no surprise now, given that this news was revealed last month. Boeing won't have
the latest software fix done until September and in the meantime, we will be operating a great airline and produce
very strong financial results, all without any amounts from a Boeing settlement. Our people have done a heroic
job and I don't use that word lightly. And not only are they resilient, they're tough, they are brilliant, they're
compassionate and I want to thank them for a job well done.
Our front-line employees have truly risen to the occasion, dealing with 20,000 flight cancellations. But you don't
hear a lot about our back-office folks and we had numerous unsung heroes, so I want to sing for them.
The front line has had a hard time. They certainly have a hard time completing their mission without a plan. And
our planners, that I'm going to have to rename re-planners, have done an amazing job and I would lead that off
with network planning, our operations planning, our financial planning groups, just to name a few. They have
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worked grueling hours, they have improvised, and they have really, really delivered, and I'm very proud of
everybody.
While the financial results are remarkably strong, strong margins, strong cash flow, revenues, and a really good
cost performance, there's a lot of news in the press release. You're going to get a lot of excellent insights from
Mike, Tom and Tammy, but I would like to point out just a few things.
Number one, it's really all about the MAX. That's the only issue that we are dealing with. And of course, it's helpful
just to have one thing to be able to focus on. So everything else within the company is rock-solid.
Secondly, business is strong. Second quarter came in as expected. We had strong RASM. Third quarter is
forecasted up 3% to 5%, which is right where it should be relative to second quarter. Thirdly, cost management is
solid. Taking into account the MAX and the out-of-service aircraft, we are where we expect to be, if not better, for
the second, third quarters and then the full year. We told you all at the beginning of the year that we were looking
at flat CASM-ex in the second half and that's where we think we will be, taking, again, the MAX into account.
Fourthly, Newark. Any student of Southwest will quickly understand our approach here. This is a tactical decision,
forced by the MAX groundings and the painful cut of 8% of our capacity. As a little bit of background, we acquired
18 Newark slot pairs in 2010. And that was a consequence of the United-Continental merger, where they were
required to divest some slots. So we did that deal in about 24 hours.
At that time, we had virtually no presence at LaGuardia and, in fact, had only been there for about a year. On the
LaGuardia side of things, in 2011, we acquired more slots at LaGuardia with our AirTran acquisition. In 2013, we
acquired yet again more slots from the divestiture caused by the U.S. Airways and American merger.
So we find ourselves with a significantly larger presence at LaGuardia than we had contemplated back in 2010
when we went into Newark. We also find ourselves in a magnificent facility, which is certainly significantly better
than what we started with in 2009.
So we currently offer 37 daily departures from LaGuardia that will be as of October. New York is a huge market,
but for us, it is a destination market. Given our relatively small position at Newark and LaGuardia, and our inability
to add any meaningful number of flights at either market, it makes sense for us to consolidate our New York City
flying into one airport. LaGuardia is the choice for the vast majority of our New York City-bound customers.
And it's not out of character for us. We consolidated our operations in a couple of Ohio locations in 2017. We
consolidated Flint, Michigan into Detroit in 2018 and then, with larger markets like Chicago, Houston, Dallas, we
serve one airport.
Newark underperforms financially and to offset our reduction in service there, we'll be able to add seats at
LaGuardia and be more productive with a superior financial result. So that's what's happening with Newark.
The other thing I could add is that as to the timing, it's very straightforward. We need the airplanes. We can't
afford in this highly-competitive environment where our capacity overall is cut to have underperforming assets,
which leads to my fifth point, which is Hawaii. We'll be resuming our expansion without having to wait on the MAX
any further, and as we described in the press release.
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Adding Hawaii and quickly becoming relevant is strategic for us and this move better supports execution of that
strategy. So, to be clear, we aren't backing off of New York City with this move, but we are accelerating our
growth in California and Hawaii.
So those are the high points and to kick us off with more details and better insights, I'm going to turn the call over
to, first, our Chief Operating Officer, Mr. Mike Van de Ven. ......................................................................................................................................................................................................................................................
Michael G. Van de Ven Chief Operating Officer, Southwest Airlines Co.
Well, thanks, Gary. I want to start just by reiterating what Gary said about our people. They are indeed resilient
and they make this company great by taking care of our customers, our operations, and each other and I am
immensely thankful for their efforts.
Well, in an environment where we had 34 MAX aircraft out of service, our performance for the quarter I believe
was very good. Most importantly, we took very good care of our customers. First, we used all of our spare aircraft
to cover any scheduled MAX flying through June 7. We then re-accommodated the remaining impacted
customers to other flights where possible, so we ran an all-time quarterly-record load factor of 86.4% and we did
that without any spare aircraft from April 1 through June 7.
And just to state the obvious, spares are important. They protect against unexpected events like the unforecasted
hail event we had in Denver on May 28 and that took 24 aircraft out of service for a period of up to two weeks in a
time where we were already without spares.
So, in that kind of environment, with no margin for recovery for any unexpected events like that, our people found
a way to get 85% of our customers to their destinations within 30 minutes of their scheduled arrival time, through
aircraft swaps, crew changes, extending the operating day, just whatever it took.
And just as a reminder, we schedule our operation with less block and turn time than any other carrier in the
industry to begin with. We carried 99.5% of checked bags on the flights they were checked on. We led all
marketing carriers with the lowest DOT customer complaint ratio and our Net Promoter Score was still industry-
leading at about 59% for the quarter.
Now, all those numbers were down a bit from last year. But given the impacts of the MAX grounding to have our
overall operational result still in the upper tier of the industry is really a testament to the people of Southwest
Airlines.
Going into the third quarter and the peak summer travel months, we're focused on continuing to improve all
aspects of our operational reliability. So we've operated with the appropriate spare levels beginning in June 8 and
we're going to carry that throughout the year and we're already seeing improvements in the reliability of our
service.
So, our on-time performance, which was really the most significantly impacted item, has rebounded nicely since
adding back the spares. We finished the month of June fourth place in the industry with respect to marketing
carriers and we expect to finish July either third or fourth.
And, of course, one of the carriers ahead of us is Hawaiian and they benefit by a large percentage of their
network being interisland service in Hawaii. So, in terms of delivering our product in a reliable and a hospitable
manner, I'm very pleased with the performance thus far.
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Turning to the MAX. While the operational challenges are manageable, they do grow in complexity as the
groundings extend. So Boeing, as Gary mentioned, still has work they must complete. The FAA must review and
approve that work before granting regulatory approval to return the MAX to service and we are in continued
conversations with Boeing and the FAA. And as Ryan said earlier, we are dependent on them for a timeline to
return the MAX to service.
As we mentioned in the press release, we're in the process of removing all MAX aircraft from service through
January 5. So I'll walk you through a high-level outline of our approach to reintroducing the MAX to our regularly-
scheduled service on January 6.
Before I start with that, just for context. When the MAX grounding is lifted, we're going to have three groups of
aircraft to address and each of them have a unique process. So first, we have the 34 aircraft, MAX aircraft that
Southwest has in long-term storage in Victorville, California. Second, we're going to have a group of aircraft that
Boeing is storing that have not yet been through the delivery process to Southwest Airlines. So we don't own
those airplanes and they're not on our operating certificates.
And then lastly, there will be aircraft coming from the Boeing production line after the grounding is lifted, which we
will want to accept as delivered in the normal course of business. The first step of the process, regardless of the
grouping, is instruction from the FAA as to the specific requirements that will be mandated to make the fleet
operational. That will likely include software uploads and/or other technical requirements to the aircraft along with
some required pilot training.
Now, we're going to assume that the pilot training requirements will not include additional simulator training. We
have an agreed-upon 30-day timeframe with our pilot union to complete the expected computer-based training.
And then, we plan to time the work to bring the aircraft back into the operational fleet to correspond to the end of
our pilot training period, so that every pilot is prepared to fly every aircraft in the fleet.
In addition to those mandated activities, there will be additional maintenance procedures to transition the aircraft
from long-term storage into an operational readiness state. And at this point, we believe that those activities and
approvals could take one to two months to complete for the Victorville aircraft and that we could intake up to three
Boeing-stored aircraft per week once they're ready to begin their storage deliveries.
So as I mentioned, we plan to take production aircraft as they're available for delivery. Our delivery schedule with
Boeing continues to evolve as their production schedules change and we expect the majority of our 41 contracted
deliveries for the remainder of this year, which by the way would have been in the Boeing storage grouping, will
likely be moving into 2020.
Assuming regulatory approval to return the MAX to service by early November, our baseline plan would be to
control the process, so we could provide the network at least 30 MAX aircraft to the operational fleet by January 6
schedule and then we would ramp up from there in a controlled fashion, depending on the delivery schedules.
So that approach is intended to balance as best we can aircraft availability with customer demand in early 2020,
then match the crew staffing to the aircraft availability.
In terms of the pilot staffing, given the removal of the MAX flying through January 5, we're going to defer our
October pilot new hire class and the associated captain upgrade class until March or April next year. And so,
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while there is some cost savings in 2019 from deferring those classes, the primary driver was to better match
flight crews with the flying needs to give them more productive schedules.
In closing, I'm very proud of our people and our performance this quarter. And as it relates to the MAX, we have a
plan to remove MAX flying for the remainder of the year. We have a detailed plan for the ungrounding of the fleet
once that occurs. We have an idea of how we can resume taking deliveries from Boeing and we're ready to make
adjustments to those plans if we need to.
So just as our people do in the summer, we really want to be prepared to provide exceptional customer service to
our customers for the holidays later this year. So we remain focused on running a safe, a reliable, an on-time and
an enjoyable operation and I really think we've got the best team in the industry to do just that.
And with that, I will turn it over to Tom. ......................................................................................................................................................................................................................................................
Thomas M. Nealon President, Southwest Airlines Co.
Okay. Well, thanks, Mike. Good morning. I guess, good afternoon, everybody. So as Gary and Mike have both
said, this has been a challenging quarter, but I think in spite of the issues we've had to deal with, our results were
very strong. We produced record passenger revenues, record operating revenues in the quarter, along with a
record load factor base of 86.4%, which I think by any measure is a pretty impressive set of results, especially
considering what we've been going through.
I think what's equally impressive, just to re-emphasize what Mike said was simply the quality of the operation in
spite of the MAX cancellations. Our on-time performance was strong. Our customer satisfaction scores, our brand
scores remain at the very top of the industry. I know that you guys hear this a lot, and you may think it's a throw-
away line, but these results truly are because of our people. Mike and Gary and I have spent a lot of time in the
stations this past quarter. I can tell you that morale is high and the focus of our people is very clear and that is on
running a great operation and taking care of our customers.
And you can see it in our metrics. And you can see it and read it and hear it in the feedback from our customers.
It's pretty amazing. From a schedule perspective, we've been very focused on maintaining the strength of our
network, albeit with significantly fewer aircraft than we planned. Our network team, as Gary's already alluded to,
has done an absolutely incredible job of adjusting and republishing our schedules and our revenue management
team has done an equally incredible job of managing the revenue environments. And there's no doubt that we're
continuing to benefit from the revenue management capabilities that were enabled by our new reservation
system.
Overall, I'm very pleased with our second quarter RASM result of 6.8% year-over-year growth, which is right in
line with the improved guidance that we provided in our June 19 investor update. And just as a reminder on the
April 25 earnings call, we expected Q2 RASM to increase in the range of 5.5% to 7.5%. And as you might recall,
there were several key things that went into that original guidance. Just a quick summary of that.
First, we were expecting improvements in leisure demand trends as compared to the first quarter. We also had
expectations of solid demand for both leisure and business travel and both of these held true throughout the
second quarter and actually improved each month during the quarter, so we're pleased with that.
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Second, we were expecting a strong yield environment, especially with close-in fares, which we did in fact
experience. And we actually saw a slight improvement in our base business as we progressed through the
second quarter, as supported by our system-wide fare increase in mid-May.
Third, we were expecting a 1 point year-over-year RASM benefit from our reservation system, which occurred as
expected. Next, we were expecting a 1 point year-over-year RASM benefit from the lower capacity due to the
removal of MAX flights from the schedules.
This actually ended up being about 2 points. Fifth, we had 3 points of year-over-year tailwinds from second
quarter 2018 items including Flight 1380 as well as last year's suboptimal flight schedule. And finally, no surprise,
we had a half point year-over-year benefit from the Easter shift out of Q1. So these six drivers net out to our 6.8%
RASM growth for Q2, which again is a very strong performance, especially considering the challenges.
Both our domestic and international businesses performed well in the quarter with international RASM
performance being especially robust, in particular in our Mexican beach markets. Obviously, Q2 was not without
execution risk. Our network planning team had the challenge of removing MAX flying from Q2 and we had to
manually work our way through March and republish our April and our June-based schedules in such a way that
best maintained the integrity of our network. Our revenue management team had to manage through a mid-March
grounding of the MAX, which reduced our higher-yielding inventory due to passenger re-accommodations, in
particular with close-in inventory during April, but the impact also carried into the first half of May.
So we had a lot of moving parts to manage to throughout the quarter and I think the commercial team's execution
was simply extraordinary. They were incredibly focused and the result was that they were able to produce flight
schedules that mitigated as much risk as possible and these schedules worked for our customers, but they also
worked for Southwest, both operationally and commercially.
Our ancillary products also performed very well in Q2, with other revenue being up 11% year-over-year and we
continued to have a lot of success with our EarlyBird variable pricing product which we implemented last fall and
which was enabled by our new reservation system. We also launched a new business-oriented credit card last
month as we planned, which is targeted at our small- to medium-sized business customers and so far, the early
results are very, very strong.
We had another extraordinarily strong performance from our Rapid Rewards program this past quarter. Our total
loyalty program revenue grew 15% in the second quarter and we continue to have strong credit card acquisitions
and our credit card retention rates also continue to be very high.
So we're obviously very pleased with the performance of our Rapid Rewards program, which by the way
continues to be recognized most recently as Program of the Year by the Freddie Awards for Best Loyalty Card,
Best Airline Redemption Ability and Best Customer Service.
The economics of the program are very, very strong. The customer benefits are best-in-class and we see a
tremendous number of opportunities to significantly grow the Rapid Rewards program going forward.
So that's it for Q2. So let's talk about Q3. So our third quarter business trends continue to be very strong as well.
We continue to see healthy leisure and business travel demand across the booking curve and a positive year-
over-year yield trend thus far. And we're expecting a strong Q3 RASM performance in a range of up 3% to 5%.
And just as a reminder, the MAX aircraft are already out of schedule through the entire third quarter, which means
we don't have the same close-in re-accommodation challenges we had coming into Q2.
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Our Q3 RASM outlook does have a 1 point benefit due to headwinds from Q3 2018, which is made up of half a
point from 1380 and half a point again from our suboptimal schedule from last year. Similar to the second quarter,
we are estimating a year-over-year RASM benefit in Q3 of about two points from the reduced capacity due to the
MAX grounding. And we expect a half point year-over-year RASM benefit from our new reservation system.
We are seeing a slight negative impact to Rapid Reward redemptions and ancillary revenue as a result of MAX-
related flight cancellations, but we still expect another strong year-over-year performance in both categories.
Turning to Hawaii, well, I can tell you this, Hawaii is off to a fantastic start and although we're early on in our
expansion, our results so far are exceeding our expectations in every category. So we're now up to 14 daily
flights, 6 from California to Hawaii and 8 interisland roundtrip flights. Demand for our service to Hawaii is very,
very strong and our load factors are far exceeding our system average. Our Hawaii inflight product and customer
experience is performing extremely well with our Net Promoter Scores above our system average which, as you
know, are also very high.
Demand for our interisland service is also very strong and is made up of a very strong mix of local customers and
the brand and customer experience scores for the interisland service is actually above our total system
performance which, again, leads the industry. And our fares are where we would expect them to be at this point.
And it's fair to say that we're seeing the Southwest effect in the markets that we're serving and this is obviously
enabled by our low cost structure.
Regarding the eventual transition of Hawaii flight to MAX, we're obviously very eager to realize the cost
efficiencies, but we can fly the 800 NGs to Hawaii as long as we need to while the MAX is grounded. As we
announced this morning, we have more Hawaii service planned to go on sale soon, so we'll talk about that more
later.
Now, looking forward, our commercial team will continue to be very proactive in managing any additional MAX
flight cancellations and network adjustments through the end of the year and as you would expect, we'll continue
to be very focused on our execution. And our 2019 RASM outlook continues to be year-over-year growth in
excess of 3%.
Now, regarding the capacity impact to Q4 RASM, we'll be at a point where we are approaching a 75 MAX aircraft
deficit by year-end and as such, the estimated revenue penalty from second quarter grows sequentially into the
third quarter and grows further in the fourth quarter. So when combined with normal seasonality and the peak
versus off-peak nature of Q4 and the complexity of the holiday schedule, we simply still have work to do over the
next month or so, so it's too early for us to give any guidance or perspective on the impact to our fourth quarter
RASM. But one of our priorities clearly is to protect holiday travel and minimize the impact to our customers. But
as you know, the schedule changes and the decisions get tougher as our fleet deficit grows.
And finally, despite the challenges that we faced, the Southwest brand remains very strong. Our Net Promoter
Scores are tremendous and we remain at the very top of the industry in spite of our challenges. And we expect to
continue to grow revenues despite declining year-over-year capacity here in the near term and as with our Q2
results, our Q3 RASM outlook should also put us at or near the top of the industry.
So with that update, I'll turn it over to Tammy. ......................................................................................................................................................................................................................................................
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Tammy Romo Executive Vice President and Chief Financial Officer, Southwest Airlines Co.
Thank you, Tom, and hello everyone. Thank you for joining us today and I'd like to add my thanks to all of our
terrific employees for their focus and hard work. Our people are simply the best and they have proven that time
and time again.
Gary, Mike and Tom have outlined the challenges that we've been managing through with the MAX grounding
and I will round out our remarks with some commentary on the MAX impact on our cost, fleet and capacity plans
and our balance sheet and cash flow.
Starting with cost, I'd like to commend our people for a great job managing cost in a challenging quarter. Our
second quarter nominal costs, excluding fuel and profit sharing, came in a little better than we expected at the
beginning of the quarter. On a unit basis, ex-fuel, special items and profit sharing, our costs increased 10.9%
year-over-year.
The impact of the MAX groundings drove 6 points of this year-over-year increase with the remainder of the
increase primarily related to planned increases in salaries, wages and benefits, maintenance spend and airport
costs.
Our second quarter CASM-ex increase was favorable to the guidance we provided in our June investor update
when we were expecting a year-over-year increase in the 11.5% to 12.5% range. Following our investor update,
the combination of the grounded MAX aircrafts and weather resulted in a lower completion factor than expected,
which drove ASMs down further. However, the incremental unit cost pressure was more than offset by lower than
expected airport cost, shifting of advertisement and maintenance expenses to future quarters and solid cost
controls.
Turning to third quarter, the year-over-year unit cost pressure due to the Max groundings continued. We started
the year expecting about 2 points of inflation in CASM-ex in third quarter 2019. We now expect 7 points of the
year-over-year CASM-ex impact from the groundings in this quarter compared with the previously communicated
3-point impact I mentioned on our April earnings call, when we had the MAX aircraft removed from our flight
schedule through August 5.
When combined with about a 1-point increase in year-over-year CASM-ex from cost shifting from first half 2019,
we now expect our third quarter 2019 CASM-ex to increase in the 9% to 11% range year-over-year. Sans shifting
and the MAX impact, our third quarter CASM-ex is relatively in line with our cost plan at the beginning of the year.
The good news is that we have gained some nonfuel cost offsets for third quarter as our flight schedule changes
were well in advance of our flight crew bidding process and we also have temporarily lowered landing fees.
As Mike mentioned, we've also temporarily delayed some flight crew hiring. These offsets pale in comparison to
the year-over-year unit cost penalty, but we are doing what we can to mitigate near-term pressure and we will
continue to do so.
Looking at the full year, our current guidance is based on MAX cancellations through January 5. The MAX
groundings are driving an incremental 6 points to full-year CASM-ex year-over-year as we are 6 points to 7 points
off our original capacity growth plan to grow 2019 ASMs nearly 5%. Therefore, we currently estimate annual 2019
CASM-ex to increase in the 8% to 10% range year-over-year.
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As a reminder, our annual CASM-ex increase also includes the previously-communicated 0.5 point increase year-
over-year from costs related to the ratified agreement with our mechanics and approximately $10 million of
incremental maintenance expense for seven of our 737-700 aircraft that we have decided to keep instead of retire
this year, which I'll cover in a moment.
I won't spend too much time on fuel as the market held fairly steady through second quarter. Our second quarter
economic fuel price was right around the midpoint of our most recent guidance at $2.13 per gallon, which included
hedging gains per gallon of $0.06 and premium expense per gallon of $0.05. We have a great fuel hedging
protection in place this year with about a 65% hedge in both third and fourth quarters. Our hedging premiums for
this year remain at approximately $95 million or about $0.05 per gallon and we have a 58% hedge position for
2020. So we are well prepared.
For third quarter 2019, based on market prices as of July 19 and given our current hedge, we expect our fuel
price per gallon to fall in the $2.05 to $2.15 range.
As I mentioned last quarter, our fuel efficiency has been significantly impacted by the MAX groundings. Second
quarter ASMs per gallon declined 1.7% year-over-year and third quarter ASMs per gallon are also expected to
decline year-over-year in the 1% to 2% range. This decline highlights the fuel efficiency of the MAX, which is
about 14% better than the 737 NG fleet. Once the MAX returns to service, we expect to get back on track with our
desired fuel efficiency gains.
Turning to fleet and capacity, we have not taken delivery of any aircraft since the MAX groundings in mid-March
and we didn't retire any aircraft this quarter, so we started and ended the quarter with 753 airplanes.
We don't have an update to our contractual delivery schedule with Boeing at this point, which shows 41 remaining
deliveries this year, but we expect the majority of these will shift to 2020. We have been working through the
delivery delays with Boeing. Based on their guidance, we are currently assuming we will get 16 aircraft deliveries
during fourth quarter 2019, which includes 7 leased aircraft.
To help mitigate the impact of the delivery delays, we are postponing the retirement of 7 of our owned -700s. With
this in mind, we now expect to retire 11 -700s this year versus our original retirement plan of 18.
Turning back to second quarter, our ASMs declined 3.6% year-over-year. For third quarter, given the absence of
the MAX aircraft for the entire quarter, we expect capacity to be down in the 2% to 3% range year-over-year. With
the extension of the MAX cancellations through year-end, fourth quarter 2019 capacity is expected to be flat to
down 1% year-over-year.
So looking at our second half 2019 plans, versus where we are now, the impact of the groundings is far greater in
the back half of the year. And of course, that's a function of the growing number of MAX aircrafts we had planned
to have in our fleet. For full year 2019, we now estimate capacity to be down in the 1% to 2% range year-over-
year.
And finally, turning to the balance sheet and cash flows, we ended the quarter with very healthy cash and short-
term investments of approximately $4 billion. We originally estimated our total 2019 CapEx spend would be in the
$1.9 billion to $2 billion range, with approximately $1 billion in aircraft-related spend.
Based on Boeing's most recent guidance for our remaining deliveries this year, we now expect total 2019 CapEx
to be in the $1.2 billion to $1.3 billion range, with aircraft-related CapEx to be in the $400 million to $500 million
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range. The $500 million to $600 million reduction in this year's aircraft CapEx will shift to 2020, assuming the
delivery delays are caught up next year.
Despite the year-to-date operating income penalty of $225 million from the MAX groundings, $175 million of which
was in the second quarter, we generated strong operating cash flows in the first half of the year of $2.1 billion with
free cash flow of $1.7 billion, allowing us to return $1.2 billion to our shareholders through share repurchases and
dividends.
In closing, I'd like to extend another huge thank you to all of our employees, who are managing through all the
challenges the MAX groundings have presented. I am tremendously pleased with our financial results this quarter.
Despite the negative financial impact and operational challenges from the MAX groundings and the 20,000
canceled flights, we still managed to produce strong margins and all-time high quarterly revenues, load factors
and earnings per diluted share.
Our pre-tax return on invested capital was a strong 23.4%, even with a 1 to 2 point year-to-date penalty from the
MAX groundings. Our balance sheet and cash flows remained strong, allowing us to continue to provide
meaningful shareholder return.
Our revenue production is strong and we continue to benefit significantly from our new revenue management
system, our Rapid Rewards Program and ancillary revenues. We have a great fuel hedging protection in place in
2019 and beyond to mitigate fuel price pressure. While lower capacity is putting year-over-year pressure on our
nonfuel unit costs, we remain diligent on controlling the costs we can. Based on what we know today, we continue
to expect solid margins in 2019 at or near industry-leading, at that, even with the MAX penalty, with the
opportunity to continue delivering stellar returns on capital.
We will get past our near-term challenges from the MAX grounding and our second quarter 2019 financial results
demonstrate the strength of our low-cost business model, our network and our amazing people.
With that, Greg, I'll turn it back to you now to take questions. Thank you.
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QUESTION AND ANSWER SECTION
Operator: Thank you, ma'am. [Operator Instructions] All right. Ladies and gentlemen, thank you for waiting. We'll
now begin with our first question from Andrew Didora with Bank of America. ......................................................................................................................................................................................................................................................
Andrew G. Didora Analyst, Bank of America Merrill Lynch Q Hi. Good afternoon, everyone. Thank you for taking the questions. Gary, I know you got versions of this question
on the last call. But just given everything that's going on with the MAX, I thought it was important to ask again. I
guess, when does the risk tied to having a single fleet type offset the economics of that single fleet type? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Hey, Andrew. Yeah. Thanks for the question. It's something that we'll want to explore. There's no way to avoid
risk with a fleet. Period. If we had one manufacturer is 50% today and the other is 50%, 50% of our fleet being
grounded would be a huge problem. So I don't have anything new to tell you today. We think that Boeing is a very
strong company, a great partner, and we believe that the MAX 8 is the best airplane in its category.
We haven't learned anything different in 90 days to change our view on that. I think the nuance of your question is
something that we'll want to explore. Because in the current scenario, some of our competitors who do have a
diversified fleet aren't having their growth plans impacted as drastically as we are. But the odds of having this
unique scenario again and then executing a plan that's so narrowly focused on avoiding this, I don't – right now, I
just don't think that would be very wise.
But the short answer is right now, we don't see that we need a change in strategy. The longer answer is I think it's
something that needs be fully explored and debated, and that's not something we're going to do in 90 days. As a
practical matter, if we wanted to diversify the fleet, it would take us years. So absent going out and acquiring
another carrier and operating a separate airline in that sense, there's just no easy way around that. ......................................................................................................................................................................................................................................................
Andrew G. Didora Analyst, Bank of America Merrill Lynch Q Fair enough. Thank you for that color there, Gary. My second question, maybe for Tammy, just want to get your
thoughts around IMO 2020 and your hedging policies. The 58% hedge in 2020, how much of that is just in WTI as
compared to jet cracks and just curious to get your expectations for the potential impact of this regulation on jet
fuel. Thanks. ......................................................................................................................................................................................................................................................
Tammy Romo Executive Vice President and Chief Financial Officer, Southwest Airlines Co. A Yes. No. Thanks for the question. We've been contemplating IMO 2020 for quite some time and that has certainly
informed our hedging strategy. We have about a 10% position in heating oil for 2020 and we have a combination
of Brent and WTI. So we have a diversified portfolio and we feel like we're positioned well should we see prices
increase or the crack spread, rather, increase from current levels. And just in case you missed it in our earnings
release, we have a 58% hedge for 2020, so again, very well hedged. ......................................................................................................................................................................................................................................................
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Andrew G. Didora Analyst, Bank of America Merrill Lynch Q Okay. That's it from me. Thank you. ......................................................................................................................................................................................................................................................
Tammy Romo Executive Vice President and Chief Financial Officer, Southwest Airlines Co. A You're welcome. ......................................................................................................................................................................................................................................................
Operator: Moving on from Stifel, we have Joseph DeNardi. ......................................................................................................................................................................................................................................................
Joseph William DeNardi Analyst, Stifel, Nicolaus & Co., Inc. Q Yeah. Thanks. Good afternoon. Gary, I'm wondering if you could just talk about given the plan that Mike laid out
for reintroducing the MAX, how we should think about capacity growth and if you'd like to discuss it, CASM-ex
kind of into next year, just given all the moving pieces. Thank you. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Mike has a lot of work to do. When you think about the variability in the Boeing delivery schedule from here, so all
we can do at this point is put a stake in the ground, make some assumptions. I think we've been clear at what our
assumptions are here for the near term. I think when you then, under the assumption that we hit those dates,
Mike, where Boeing is done in September, FAA signs off in October, and we begin taking deliveries, I guess that
would be some time in December, let's say.
Right now, we're making assumptions as to how many airplanes we can physically unground ourselves, how
many Boeing can physically unground and then how many Boeing can deliver. So there's three different sources
of MAX 8s and there's only so many we can do in a day or in a week and we just don't know. We're in
unchartered territory there.
So I think that has some bearing. We've got a retirement plan for some number of, [ph] Tammy MAX (00:43:43) or
rather 737-700s planned for next year. We have some interest in either accelerating or decelerating the
retirements, so we'll just have to see.
At this point, I'll tell you our overarching goal is we want as many MAXs as we can practically deploy as soon as
possible. And if we don't like the resulting capacity, then I think we would then lean more heavily to perhaps
accelerate some of the -700s.
As we look at all of our route performance, just market after market after market, it is obvious that we're short
capacity, that we're spilling traffic, and leaving money on the table and helping our competitors, and I will also tell
you that that is not anything that we will leave unattended.
So if there's a range of behavior that you would expect from us next year, never reckless, from being aggressive
to being passive, I can assure you we're going to want to restore our operation and our system just as quickly as,
again, we can safely and efficiently do that.
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But a lot of questions and right now, it's unproductive to try to give you any number about what that might be. My
goal would be by the time we get to the end of next year to hope that we're back smoothly on our delivery
schedule and our operation. And I think it's possible that we beat that by six months, just depending on, again,
whether we meet the current timeframe and whether Boeing can deliver at the rate that we're assuming next year. ......................................................................................................................................................................................................................................................
Tammy Romo Executive Vice President and Chief Financial Officer, Southwest Airlines Co. A And just to maybe jump in to help with what all this means for our 2020 costs, well, the MAX groundings are
obviously creating a material impact on our year-over-year ASM growth and CASM-ex trends for 2019 and our
long-term unit cost target is unchanged.
Our unit cost goal, excluding fuel and profit sharing, is annual year-over-year growth below 2% as I discussed on
last quarter's call. And I just do want to point out that this cost target includes our estimates for salaries, wages
and benefits and increases for our people.
We are experiencing a pressure on our 2019 unit cost due to the lower capacity as a result of the MAX
groundings and that's about, again, 6 points to the full year. And while this does create some near-term
challenges for us, these pressures are onetime and will pass. The year-over-year comparisons for next year,
obviously, would be more favorable, given this year's impact from the grounding. So, in terms of just a target for
next year, it would be to absolutely drive towards declining year-over-year CASM-ex in 2020. ......................................................................................................................................................................................................................................................
Joseph William DeNardi Analyst, Stifel, Nicolaus & Co., Inc. Q That's very helpful. And then, Gary, just another one for you. Given your tenure at the airline, can you talk about
over the last 25 years how the economics of your partnership with Chase have changed? What that means for
helping the durability of your business over a cycle? And then, where your economics are now relative to the
industry given that you most recently did the deal in 2015 and it's pretty clear that the economics have become
more favorable for airlines over the past few years? Thank you. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Yes, sir. I'll give you a quick comment and then, Tom, would love for you to opine on that topic. But just starting
with 25 years, I think 25 years ago we didn't have an affinity card and saw that as a great opportunity. So in the
industry, I don't know that I have as much of a perspective there, but certainly for us, we've come a long way in 25
years.
When I started as CEO in 2004, we quickly concluded that the number one enhancement that we needed to make
for the Southwest brand was to overhaul our frequent flyer program. And Tom covered a lot of material in his
remarks, but I'll just cover it again.
It is an award-winning, industry-leading frequent flyer program and that is the foundation for the, obviously, driving
the revenues. We have a great plan. Our customers love it. They take our credit card in droves. And we,
obviously, factor all of that into our economics.
So we are far more stable, I would say, in terms of our revenue generation today than we were before, the new
program was launched in 2011. Very proud of that. That may be the single biggest accomplishment that
Southwest had over the last 10 to 15 years. It was really, really significant.
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Tom, anything you want to add on the economics? Obviously, we hold a lot of that very close to the vest, but... ......................................................................................................................................................................................................................................................
Thomas M. Nealon President, Southwest Airlines Co. A We do hold the economics really close to the vest. What I can tell you is just the growth of the program continues
to be incredible. It's just a massive growth engine for us. The retention, the customer affinity, the value of that
customer is just so much greater than our non-card holding customer, but we don't get into the economics of it.
What I can tell you is we are really thrilled with the partnership. We've been thrilled with them for a long time. We
did, as you know, well, not going to get into that either – but we are really thrilled with Chase, it's a good
partnership. ......................................................................................................................................................................................................................................................
Joseph William DeNardi Analyst, Stifel, Nicolaus & Co., Inc. Q Thank you. ......................................................................................................................................................................................................................................................
Operator: Next, we have Helane Becker with Cowen & Company. ......................................................................................................................................................................................................................................................
Helane Becker Analyst, Cowen & Co. LLC Q Thanks very much, operator. Hi, everybody. Thank you so much for the time. I'm not sure who can answer this
question, but when you talk about the pilot training and taking one to two months, do you have to put them
through the simulator? Can you just sort of maybe address that? ......................................................................................................................................................................................................................................................
Michael G. Van de Ven Chief Operating Officer, Southwest Airlines Co. A Hi, Helane. This is Mike. No. We're not expecting to have to put them through the simulator for pilot training on the
MAX. What we believe is there needs to be an awareness of the MCAS system, how it works, what it's doing in
the airplane and that there can be – my understanding is there can be sufficient computer-based training that
shows the pilots what is going on there.
We have – at Southwest, we've been doing training with our pilots in terms of hand-flying the airplanes since
really the inception of the airline. And over the last two years, we've introduced this training called Extended
Envelope Training. And our pilots have been through scenarios where the airplanes are at the boundaries of their
performance limits and they've been in situations like the Ethiopian and the Lion Air incident and they've already
been through simulator training for those kinds of things, so this will be the second year that they've completed all
of that.
So when you bundle all that together, that's why we think that the computer-based training coming out of this
grounding is appropriate and then, supplement that ongoing with the recurrent training in the simulator. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Helane, the other thing that I would add, which is really beyond your question, but it does – it sort of explains the
environment here. I think Southwest is the gold standard for the industry. We hire first officers that on average
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have 6,000 hours of flight experience. And in addition to that, we have first officers that have captain experience.
So you start with a very experienced cockpit crew.
Then, we obviously only fly the 737. We are the industry leader when it comes to training and operations and
Mike covered our philosophy about flying the airplane and training for certain scenarios.
So we'll be very well prepared to take on this new training requirement. Our pilots – I think, more importantly, our
pilots are very comfortable and love the MAX and are looking forward to restoring it to service, and they'll play a
key role obviously when we communicate and when we're reintroducing the MAX to our customers. But we
factored all of that into our plans.
We're allowing more than ample time for the training and the reintroduction of the fleet. And I think as we were
talking earlier, what is going to be as much of a challenge, and maybe not more of a challenge, is just the
maintenance and the reintroduction of all the airplanes back in service will be a task. And again, I think that Mike
has allowed more than enough time for that with our January 5 target date. ......................................................................................................................................................................................................................................................
Helane Becker Analyst, Cowen & Co. LLC Q Got you. And then, can I just ask you one question about Newark, so I understand this? So this is not just a
suspension of service and when the MAXs come in, you're going to go back. This is just leaving the market,
returning the slots. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Yes. And right now, it's not slotted anymore. It was when we acquired them in 2010, but the FAA, whatever the
term is, they unslotted them several years ago. But no. No. This is a decision, and that's why I like the word
consolidate. So we'll have a significant New York City presence. It will be focused where our customers want to
go, which is LaGuardia and we have actually – with the new facility and the 800s and the MAX 8, we have an
opportunity to grow our seat capacity there by, I don't know, 10%, 20% over time. So we have ample opportunity
to do that and we'll have a far more efficient, cost effective operation and revenue production by consolidating into
one airport as opposed to having it diluted over two.
So again, it's two relatively small operations today that will consolidate into a much more efficient and arguably
larger operation at LaGuardia. ......................................................................................................................................................................................................................................................
Helane Becker Analyst, Cowen & Co. LLC Q That's very helpful. Thanks. Thank you, everybody. Thanks, Gary. ......................................................................................................................................................................................................................................................
Operator: And next, from JPMorgan, we have Jamie Baker. ......................................................................................................................................................................................................................................................
Jamie N. Baker Analyst, JPMorgan Securities LLC Q Hey. Good afternoon, everybody. Gary, I'm already kicking myself for asking this question last quarter, because
I'm basically going to ask it again today and probably will continue to do so for as long as the MAX remains
grounded. Have you given any further thought to how long you can tolerate or would choose to tolerate year-on-
year capacity declines before you potentially consider nonorganic growth? You're clearly agitated by funneling
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profits and market share into your competitors' coffers. You've said as much today and I respect that. So I've got
to imagine there's a breaking point out there somewhere. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Does that mean I get to kick you, too? Just kidding. ......................................................................................................................................................................................................................................................
Jamie N. Baker Analyst, JPMorgan Securities LLC Q And right after you said nice things about my employer for a change on an airline call. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Well, I say nice things about you, too. Again, I'm just trying to be pragmatic without being overly legalistic here
with you. Obviously, we can't comment on anything like that in substance. But just trying to play the game a little
bit. As a practical matter, we came into this in March with a view that this was a short-term problem.
And one of the things that I think we've tried to emphasize or clarify here today is that we've got a strategy, we're
executing the strategy, and this is really not affecting any of that. So all of that is a view that it's going to be
ungrounded by the summer. And again, it was disappointing to find yet another delay, which essentially pushes it
out to early next year.
But all that we can handle and we can manage. So, I think the tolerance, in fairness to your question, the
tolerance for this scenario goes well beyond that because then the nature of your question moves into a huge,
strategic question. ......................................................................................................................................................................................................................................................
Jamie N. Baker Analyst, JPMorgan Securities LLC Q Correct. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A And that – so, hopefully, I've answered your question. We can work our way through this. Obviously, the financial
results that we've got right now are superb. Even relative to our competitors, it's actually incredible that we
compare so strongly and we'll get through this. We're going to end the year healthier than we started the year and
we've actually exercised a few new muscles here and they're in really good shape. If we have to continue to
manage a ragged schedule, we're doing pretty well with that. So I just don't think that that's going to be an issue
for us. ......................................................................................................................................................................................................................................................
Jamie N. Baker Analyst, JPMorgan Securities LLC Q Okay. Fair enough. I appreciate that. And just as a follow-on to that, and then I have a real quick question for
Tammy, you talked about some soul-searching as to the sole fleet type structure. Should we assume that Boeing
competitors are circling you more aggressively in the current environment than they ordinarily do? Or is that not
the case? ......................................................................................................................................................................................................................................................
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Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Oh, that's always the case. ......................................................................................................................................................................................................................................................
Jamie N. Baker Analyst, JPMorgan Securities LLC Q Okay. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Yeah, that's always the case. And, again, we've been open. Mike has been looking at other airplanes and there's
nothing – that's a duty we have. We want to know what's out there in the marketplace and we need to be
comfortable that we've made the best decision for our company, our shareholders, our customers, on and on and
on. So, hopefully, I've answered that question. ......................................................................................................................................................................................................................................................
Jamie N. Baker Analyst, JPMorgan Securities LLC Q And then a quick follow-up or a quick housekeeping for Tammy. How should we think about the engine overhaul
expense on the 700s that you're keeping? Just wondering if that will hit the P&L or if the plan is to run them down
before you park them. I suppose the MAX timing might impact that calculus and thank you both. It's been an
exceptionally thorough conference call. Best one this season. ......................................................................................................................................................................................................................................................
Tammy Romo Executive Vice President and Chief Financial Officer, Southwest Airlines Co. A Well, thank you, Jamie. And I don't want to kick you after that. So, on your question on the maintenance expense,
there's about $10 million associated with pushing those seven aircraft and that's all contemplated in the guidance
that we provided to you this morning, and that's going to hit fourth quarter, at least largely. ......................................................................................................................................................................................................................................................
Jamie N. Baker Analyst, JPMorgan Securities LLC Q Okay. Perfect. Thank you. ......................................................................................................................................................................................................................................................
Tammy Romo Executive Vice President and Chief Financial Officer, Southwest Airlines Co. A Thank you. ......................................................................................................................................................................................................................................................
Operator: And next, we have Duane Pfennigwerth with Evercore. ......................................................................................................................................................................................................................................................
Duane Pfennigwerth Analyst, Evercore Group LLC Q Hey. Thanks. So just this re-planning challenge that you've been managing through, in broad brush strokes, you
were going to grow mid-single digits in 4Q. By our math, the MAX was more than 100% of that. The MAX was like
11 points of that growth. So ex-MAX your plan was actually to shrink the fleet, maybe shrink stage, maybe shrink
utilization. So, can you just talk about how you practically unwind that? I assume in 4Q, some of the aircraft were
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going away related to maintenance events that are due. Just in broad brush strokes, how do you unwind that and
minimize the schedule damage? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Tammy, do you mind if I take a swing at that? You can clean it up. Is that okay? ......................................................................................................................................................................................................................................................
Tammy Romo Executive Vice President and Chief Financial Officer, Southwest Airlines Co. A I do not mind at all. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Well, we're in the middle of the sausage making with that. I would say that if we were to take the MAX out of the
schedule, gross, for the fourth quarter, I believe that is close to 11%. So again, as a reference point, we're talking
about a reduction in the second quarter because of the MAX of 7%, 8% in third quarter, so it goes up because we
have more airplanes.
Now, the holiday schedules are really complicated because of the vast difference between a peak day and an off-
peak day and it's really complicated for our network planners and they really honed those schedules over the
years and it's fully automated and so this scenario blows all that up and they have to go back and now try to do it
manually.
We don't want to eliminate 10% to 11% of our capacity. And because of the off-peak days and the off-peak nature
of some of the days, there's an opportunity to add back some flying, maybe fly the day longer and a few things
like that, where we could trim that back instead of being down 10% or 11% to something less. And until we figure
out what that is, I'd rather not give you a number. But we do have that choice. It won't be the greatest schedule. It
might come with some RASM penalty, because some of those flights won't be optimal for our customers. But we'll
deal with and without here.
What's more productive from a profit perspective versus narrowly focusing on CASM or RASM independently and
that's the way we're thinking about it. But I don't know if that's where you were coming from with your question,
but you are correct that the fourth quarter's more complicated because of the number of different schedules and
because I think Tom said we're looking for 75 airplanes at that point. And that's why, as time goes by, it gets more
challenging for us.
So having said all that, no matter what, we're still going to have a solid quarter. We'll have a solid profit. We will
publish the schedule that we're proud of in the sense that Mike can operate it. It will be well staffed, et cetera, et
cetera. It just won't be tuned and operated or optimized rather like it normally is. Tom? ......................................................................................................................................................................................................................................................
Thomas M. Nealon President, Southwest Airlines Co. A Yeah, I just want to add to that. I think part of your question was so how are you going to unwind this, not just
financially, but from a quality of the schedule perspective. I think that's how I interpret it. Obviously, you want to
get the customers where they need to be and that kind of thing, but the way we're thinking about it, just to add on
to Gary's comments, we're going to take a shorter-term view perhaps of some routes that have lower RASM
performance, as well as routes that are poor CASM performers.
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And the way we're working through with our network team is just, as Gary said, they're having to go through this
manually. There's not a process to do this on this kind of scale. So we've had to pair back some of our long-haul
routes that are underperforming against the average.
There were also routes that were long-haul routes where there are alternative options, we can pare those back
and we're also adjusting some of the international frequencies. So, we're being very opportunistic. We're having a
look at it line by line and that's how we're doing it. But it's about profitability, it's about getting our customers where
they need to be. But to Gary's point about the unsung heroes, that's the network planning role right now and they
are the heroes. That's what they're doing. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Tammy, anything you want to clean up there? ......................................................................................................................................................................................................................................................
Tammy Romo Executive Vice President and Chief Financial Officer, Southwest Airlines Co. A No. I don't think there is much to add to all of that. Just in terms of what we're expecting for capacity, just to
maybe put a bow around all of that. And again, we're obviously still working through all of this as we sit here
today, but we did give you our full-year ASM guidance of down 1% to 2% year-over-year. So just backing into
that, it does imply exactly as you're coming up with there, Duane, that we'd be maybe down a little bit, maybe
down a point or so for fourth quarter. But again, it's a lot of moving parts and we'll firm up any of that guidance as
we go here. ......................................................................................................................................................................................................................................................
Duane Pfennigwerth Analyst, Evercore Group LLC Q Great. Thanks for that generous answer. And then, just real quick on the follow-up. Really appreciate all the
moving parts on 2020 outcomes and appreciate your commentary about that you want to make up any lost
ground that you gave up this year. But based on your current knowledge of the approvals, based on your current
knowledge of Boeing's ability to deliver, do you really think you'll end next year at the same shell count you
expected to end 2020 before this MAX grounding? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Well, based on what we know today, we're aware that six deliveries, Tammy, would slip into 2021, so just trying to
take your question literally here. And yeah, it will be less than what we thought. But I think – I'm fine with that.
That's plenty close enough. And as everybody is aware, we're talking about putting a lot of airplanes into service
next year. So, if six slip out of 2020 into 2021, from that perspective, that's fine as well. It's not going to make a
huge difference.
I think what's more in play again is whether we want to try to accelerate some retirements and there's just work to
be done there. And our teams do a tail-by-tail analysis to see what maintenance costs could be avoided and
where that's sensible and whether it really is profit-accretive to try to do that. There's just a lot that goes into that.
Our staffing plan for next year looks really good, Mike, so we haven't slowed our hiring such that we have a real
snapback next year to catch up. So it's another – I guess a fancy way of saying we're a bit overstaffed. I don't
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think it's unproductive, but we have had to defer a couple of flight attendant, pilot classes as you've pointed out
earlier into next year.
So all the way around, again I think we're set up very well. We can manage this. We're getting good at it. So,
hopefully, it will – hopefully, we'll hit the assumed timeline that we shared with you. And I think if that's the case,
we'll be reasonably back in line with where we should have been by midyear, if not earlier. So we could potentially
recover quickly, which would be very welcome. ......................................................................................................................................................................................................................................................
Tammy Romo Executive Vice President and Chief Financial Officer, Southwest Airlines Co. A Yeah. And just to add onto what Gary has said and we talked about this a lot. We have tremendous flexibility in
our fleet plan. So we'll work through this and obviously with a goal to produce financial results that we'll all be
proud of and do it in a way that takes care of our customers. So, as Gary said, we're working through our
retirement plan, but we've got a lot of flexibility there. And so, we'll work through all that and I think you'll be really
proud of the results when it's all said and done. ......................................................................................................................................................................................................................................................
Duane Pfennigwerth Analyst, Evercore Group LLC Q Thank you very much. ......................................................................................................................................................................................................................................................
Operator: All right. And we have time for one more analyst question. We'll take that last question from Rajeev
Lalwani with Morgan Stanley. ......................................................................................................................................................................................................................................................
Rajeev Lalwani Analyst, Morgan Stanley & Co. LLC Q Thanks for squeezing me in. Gary, Mike, a question for you on the obvious with the MAX. Can you talk about the
plan to make sure you get confidence from passengers in terms of flying the plane and how you're going to tackle
that, so you don't have load factors and yields that are suffering in the first couple of months? And then, relating to
that, can you talk about any dialogue that you're having with the FAA and any color about whether you sense
urgency on their part to sort of move this along, given some of the pressures that you're obviously highlighting? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Well, maybe we'll take them in reverse. And, Tom, if you want, you can talk about the reintroduction. So – and
Mike, can you help me out here on the FAA?
Yeah. The answer on the FAA is yes. We have daily dialogue with the FAA and I think that the FAA is – well,
these are Gary's words. I believe that the work of Boeing on MCAS is done. And I believe that the FAA is signed
off on it, although they are – they will clearly tell you that they're not going to sign off on the MAX 8 until it is, "all
done", but I think the MCAS component is done.
I'll be shocked if we learn anything different on that and I'd be disappointed to learn anything different. But I don't
sense that the FAA is at all motivated to extend this grounding. I think they want to make sure that everything is
covered and they're doing their job, quite frankly.
This other thing came up and it is such a remote chance that anything would go wrong. But in this environment,
no one wants that remote chance. So Boeing readily agreed with that and we're fine with that as well by the way. I
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wish we had known it sooner, so it could have been worked on sooner. And I will admit to those thoughts, but no.
I think it's all set up very well. And so, unless we learn something new, it feels like our assumed timeline is a
reasonable one.
Anything you want to add there, Mike? ......................................................................................................................................................................................................................................................
Michael G. Van de Ven Chief Operating Officer, Southwest Airlines Co. A I think that's right. I think the FAA is just – they're focused on high-quality review, dotting their I's, crossing their
T's, making sure that they've addressed any type of unknown risk out there. And once they're comfortable with
that, they will issue the guidance to go forward. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Tom, do you want to talk about the reintroduction? ......................................................................................................................................................................................................................................................
Thomas M. Nealon President, Southwest Airlines Co. A Yeah. I think, Rajeev, there's just so much media on the topic. I think it's going to increase as the aircraft begins to
be reintroduced into service. And I think there's certainly going to be some people, who book away from the MAX
for some period of time. I think it's going to be less than we might expect, maybe shorter duration than we expect.
And I think we've done a pretty good job honestly of understanding, where not just our customer, but even non-
Southwest customers' heads are at with respect to the MAX aircraft and their intent to fly and all those kinds of
things.
And what's really interesting is our customers, so there's different ways to break all this stuff out, but we're
spending a lot of time actually with customers. And our customers' perception of Southwest has not changed one
iota, not at all in terms of their intent to fly, their trust in Southwest, the confidence they have in Southwest, et
cetera, et cetera.
So, obviously, based on all that, we're working through a very robust – part of our return to service plan, if you will,
there's a big piece for Mike in the operational side, there's a big piece for the commercial side and there's a big
piece for marketing and communication in terms of how we want to communicate and we're going through that.
It's going to be a very robust plan.
I think one of the questions that I've been asked several times is what if a customer doesn't want to fly, are you
going to be flexible? And obviously, yeah, we're going to be flexible if a customer has an issue flying on a MAX
initially. And to be honest with you, we have customers that change flights all the time, so it's not a big change for
us. In fact, I'm not sure of the percent, but a massive percent of our itineraries change. So, that's not a big deal for
us.
I think that we're just going to have to be flexible for a while as our customers get comfortable for those that aren't.
But we're very aware of it. We're thinking through it all and I feel pretty comfortable where we are. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A
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Yeah, and I do, too. And we're going to have to have a communications campaign. We're good at that and just
know that our pilots will play a key role in this communication and they're the ones obviously that have to be
comfortable and they're the ones that are credible. So nobody in this company, especially our pilots, is going to do
anything that they deem to be unsafe. So then it's just a matter of convincing our constituents of that and we're
going to work hard to do that. ......................................................................................................................................................................................................................................................
Rajeev Lalwani Analyst, Morgan Stanley & Co. LLC Q I'll leave it there. Thank you. ......................................................................................................................................................................................................................................................
Ryan Martinez Managing Director, Investor Relations, Southwest Airlines Co. A All right. Well, that does it for the analyst portion of the call. Thank you guys for joining us. And of course, if you
have follow-ups, just give me a ring. ......................................................................................................................................................................................................................................................
Operator: All right. And ladies and gentlemen, we will now begin with our media portion of today's call. I'd like to
first introduce Ms. Laurie Barnett, Managing Director of Communications and Outreach. ......................................................................................................................................................................................................................................................
Laurie Barnett Managing Director Communications & Outreach, Southwest Airlines Co. A Thank you, Greg. I'd like to welcome members of the media to our call today. And before we begin taking
questions, Greg, would you please give instructions on how everyone should queue up for a question. ......................................................................................................................................................................................................................................................
Operator: Of course, ma'am. [Operator Instructions] And ladies and gentlemen, thank you for waiting. We'll take
our first question from Mary Schlangenstein with Bloomberg News. ......................................................................................................................................................................................................................................................
Mary Schlangenstein Dallas Reporter-Bloomberg News, Bloomberg LP Q Hi. Thanks for calling on me. I just had two really quick questions. The first is, Gary, in your earlier remarks you
mentioned 20,000 cancellations. Are those all MAX cancellations and over what timeframe did those occur? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Mike, that was total. I think normally you'd have 3,000 cancellations, so to put it in perspective. But I would
attribute the vast majority of that excess to the MAX principally... ......................................................................................................................................................................................................................................................
Michael G. Van de Ven Chief Operating Officer, Southwest Airlines Co. A Mary, when we talk about the 20,000 cancellations, they really come in two forms. We had a schedule out there to
sell the MAX and we had to change the schedule. So before we operated that schedule, we pulled a lot of flights
out and the flights we pulled out, we included in that 20,000 cancelation number.
And then secondly, once we did operate the schedule, because we were so close in to the booking curve and
tried to re-accommodate as many customers as we could, we operated April and May without any spare aircraft,
which I would attribute to the MAX.
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And so, as you have weather events or unexpected maintenance events or hailstorms or other things like that, we
just had no way to recover the airplanes and that drove the cancellations up also. So, as Gary said, that was
around 12,000, 11,000, 12,000 cancellations for the quarter just in the operations and those numbers are
normally under 3,000. So the vast majority of that 20,000 cancellation number is MAX-related. ......................................................................................................................................................................................................................................................
Mary Schlangenstein Dallas Reporter-Bloomberg News, Bloomberg LP Q And that 20,000 is just for the second quarter? ......................................................................................................................................................................................................................................................
Michael G. Van de Ven Chief Operating Officer, Southwest Airlines Co. A That's right. ......................................................................................................................................................................................................................................................
Mary Schlangenstein Dallas Reporter-Bloomberg News, Bloomberg LP Q Okay. Okay. My other question real quick was on the Newark gates, what happens to those? Are you able to
sublease those gates to somebody else? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A It's a month-to-month lease, so no. ......................................................................................................................................................................................................................................................
Mary Schlangenstein Dallas Reporter-Bloomberg News, Bloomberg LP Q Okay. And are you leasing them from United? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A I don't know. I don't think so. But it's – no. It has to be – it's month to month and with the Port Authority, so. ......................................................................................................................................................................................................................................................
Mary Schlangenstein Dallas Reporter-Bloomberg News, Bloomberg LP Q With the airport. Okay. Great. Okay. Thank you very much. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Yes, ma'am. ......................................................................................................................................................................................................................................................
Operator: Next from The Wall Street Journal, we have Alison Sider. ......................................................................................................................................................................................................................................................
Alison Sider Reporter, The Wall Street Journal Q Hey, everyone. My question is... ......................................................................................................................................................................................................................................................
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Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Hi. ......................................................................................................................................................................................................................................................
Alison Sider Reporter, The Wall Street Journal Q Do you think – do you feel – hi. Do you feel like Boeing misled or provided any incomplete information to
Southwest about the MAX, either about the AOA disagree alerts, about MCAS more broadly, about whether it was
safe to fly after Lion Air or really anything else? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Well, I don't think there was any malintent at all. Alison, obviously, in hindsight we wish that this never happened.
We wish that all the things that are being done now were done then. And all the knowledge that we have now,
yeah, we wish we had it then. So there were judgments made about the remoteness of the risk and I think that's
why Boeing behaved the way they did. ......................................................................................................................................................................................................................................................
Alison Sider Reporter, The Wall Street Journal Q Got it. You don't feel, from your perspective, see that there was anything criminal that happened? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A No. No. Now – and again, I get asked about Boeing a lot. Boeing is a great company and Boeing is important to
not just Southwest but our country. And they have a problem, they recognize the problem, and I'm very confident
they're focused on addressing the problem and taking care of their customers. So it's a tough situation and I have
no doubt that mistakes have been made.
Some are harder for us to evaluate than others. But my focus at this point is to get the problem solved, get the
MAX restored to service, have Boeing do its job in terms of establishing confidence with customers, as in the
flying public and obviously, we just need to be comfortable that all the issues that have been raised have been
adequately addressed and I think that's where, with what Mike was covering earlier, we'll want to see what the
airworthiness directive provides for. We'll want to go through the training and we'll want to validate for ourselves
that it all works as intended.
But, they're a great company. They're great people to work with. This is a terrible situation and I hate that they're
in it. And obviously, there are many of us that have been affected. Not just Southwest. There are a lot of people
that have been affected here. So we just – we need to keep our eye on the ball and solve the problem and move
forward. ......................................................................................................................................................................................................................................................
Alison Sider Reporter, The Wall Street Journal Q Thank you. ......................................................................................................................................................................................................................................................
Operator: And next, we have Tracy Rucinski with Reuters. ......................................................................................................................................................................................................................................................
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Tracy Rucinski Analyst, Reuters Q Hi. Good afternoon. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Hi. ......................................................................................................................................................................................................................................................
Tracy Rucinski Analyst, Reuters Q You said that you expect some of your MAX deliveries to slip into 2020. How confident are you that you will
receive those planes when you need them given that planes are stacking up at Boeing's facilities? And can you
tell us a little bit more about the technical kits that Boeing is preparing to help that delivery process? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Mike, I'll let you talk on the latter. Well, we're – so if there's sort of a range that if we're not confident to, we're
100% confident, I don't know where to put a percentage on it, but no, there's no way we could be 100% confident
that we're going to hit our assumed timeline and this is new territory for Boeing to unground airplanes, so we're
not quite sure of that – we have to support that with our own resources and so does the FAA.
So, yeah, all that has to be estimated at this point and with a view towards – we're going to have to be flexible. So
we'll learn as we go, I'm sure. And I would assume that we'll get better at it as we start ungrounding the airplanes
and that maybe it will accelerate. But, no, I mean, there's a lot of uncertainty surrounding exactly what that will
look like when it starts. ......................................................................................................................................................................................................................................................
Michael G. Van de Ven Chief Operating Officer, Southwest Airlines Co. A So, Tracy. This is Mike. We have 41 airplanes on a delivery schedule to take in 2019. And just my preference is
certainty and so if they made all those airplanes and they put them in a Boeing storage facility, that just increases
a pile of 700-ish airplanes out there. And to get those out of storage, we have – we're part of a bigger cog. So it
makes sense to us to have some of those airplanes rescheduled into 2020, where we can take them right off of
production line in our normal course of business. That would give us more certainty and less complexity.
As the airplanes that are coming out of storage, what I understand is that most of the [ph] stakes (01:23:53) at
least at this point are software upgrades to the airplane. So there will be a service bulletin that will come out from
Boeing that the FAA will mandate as an airworthiness directive and that we will take that requirement and we will
perform hopefully a software upgrade to the airplane. That is not complicated to do.
There may be other work that we may need to do and if we will, we'll do those things also. And then, as I
mentioned earlier, there's a second piece in terms of the Airworthiness Directive, which will be associated with
pilot training. And so long as it does not require simulator time, we will get our pilots through that training in 30
days. ......................................................................................................................................................................................................................................................
Tracy Rucinski Analyst, Reuters Q
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Okay. Thanks. So the technical kits, are those related to the software upgrade? ......................................................................................................................................................................................................................................................
Michael G. Van de Ven Chief Operating Officer, Southwest Airlines Co. A I'm not for sure what the technical kits are right now, because I don't know what the final fix is going to be for the
airplane. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A But at least my interpretation of your question is what Mike is describing as the software is the technical package,
so I don't know what else – I'm with Mike. I don't know what else it would be. So all we know is that they're going
to update the MCAS software and then the software piece of firmware in the flight control system. And then the
only thing I want – I don't know if you heard our earlier analyst call, but the simulator training we don't feel is
necessary because our pilots are extensively trained in the simulator and for the kinds of scenarios that the
software is being modified for. So there will be training, but we think that it can be done on a computer-based
approach and that's what the FAA seems to be leaning towards anyway, but we're comfortable with that. ......................................................................................................................................................................................................................................................
Tracy Rucinski Analyst, Reuters Q Thank you. ......................................................................................................................................................................................................................................................
Operator: Next, from the Associated Press, we have David Koenig. ......................................................................................................................................................................................................................................................
David Koenig Reporter, Associated Press Q Hi, yeah. Really quick for Gary, just to clarify. I think it was the last question on the analyst portion. That FAA that
– you said that FAA has reviewed MCAS and signed off on it and all they've got left to check is that issue that
came up last month. I wasn't clear. Did you hear that from Boeing or did you hear that from the FAA? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A And, David, that's not exactly what I said. Those were Gary's words. That's not the FAA telling – in fact, they will
not tell us whether they have, "signed off" on MCAS, because they want it all comprehensively together and I
don't blame them.
I think all I was saying is that based on the status reports that we've gotten from Boeing and from the FAA on
where they stand, I don't sense that there is any more work to be done by either Boeing or the FAA on that piece.
I'm not speaking for them. I'm just telling you that we're not getting any sense that there's any work continuing on
those functions by either Boeing or the FAA. What is still now in suspense is Boeing has gone off to work on this
second issue. And until they get that done, we're all sitting here waiting for that construction to be completed. And
then, I suppose they'll show it to us and they'll show it to the FAA and we'll know more, but I'm not expecting any
activity on that with us until September. ......................................................................................................................................................................................................................................................
David Koenig Reporter, Associated Press Q
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Okay. All right. So you don't want to explain where you got that sense that you're reading of the situation? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Well, I thought I did. Based on discussions that we've had with Boeing and the FAA. They've implied that, if you
will. But I've asked them if they would separate it, and they told me we will not, so hopefully made that clear. They
won't tell us officially that they have signed off. And like I said, I don't blame them. They want to get the rest of it
done and see it all together and make sure all those systems work as planned. But the good news is it's our
sense that all of that work is in fact done and we're just waiting on the second piece. ......................................................................................................................................................................................................................................................
David Koenig Reporter, Associated Press Q Okay. Thank you for clarifying that. ......................................................................................................................................................................................................................................................
Operator: All right, and we have time for one more question. We'll take that final question from Allison Schaefers
with Honolulu Star-Advertiser. ......................................................................................................................................................................................................................................................
Allison Schaefers Reporter, Honolulu Star-Advertiser Q Aloha from Hawaii. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Aloha. ......................................................................................................................................................................................................................................................
Allison Schaefers Reporter, Honolulu Star-Advertiser Q I just wanted to see if you could be a little bit more specific about when you anticipate selling flights for Southwest
Hawaii service for previously-announced San Diego, Sacramento, Lihue and Hilo routes and is actual service on
those routes expected to start this year or not likely until 2020 based on the ramp-up time needed? ......................................................................................................................................................................................................................................................
Thomas M. Nealon President, Southwest Airlines Co. A You should try to get us to disclose our schedule intent, huh? ......................................................................................................................................................................................................................................................
Michael G. Van de Ven Chief Operating Officer, Southwest Airlines Co. A I think I'm not going to do that today. ......................................................................................................................................................................................................................................................
Thomas M. Nealon President, Southwest Airlines Co. A But thank you for wanting it... ......................................................................................................................................................................................................................................................
Michael G. Van de Ven Chief Operating Officer, Southwest Airlines Co. A
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Yeah, but we're real excited. ......................................................................................................................................................................................................................................................
Thomas M. Nealon President, Southwest Airlines Co. A Yeah, we will be making some announcements soon. I will tell you that all the things we said previously, we still
mean. So we still intend to serve Hawaii from Sacramento and San Diego and we still intend to serve Kona and
Lihue and we still intend to have interisland between Hilo and the other islands. So everything we said is still spot-
on.
So we just have a little more work to do still and we're working on our schedules right now. We're not ready to
announce it, but we can't wait to begin those flights as well, so – and I'll tell you, the reception we've had from the
local communities has been phenomenal and we could not be more excited as you heard from our very robust
aloha when you said that. So thanks... ......................................................................................................................................................................................................................................................
Allison Schaefers Reporter, Honolulu Star-Advertiser Q Okay. Any way you can elaborate a little bit with some statistics on the demand that you've seen for Hawaii? ......................................................................................................................................................................................................................................................
Thomas M. Nealon President, Southwest Airlines Co. A Well, I don't have any – at my fingertips, I don't have any specific demand numbers. What I can tell you is that, as
I said in my comments earlier, the load factors are significantly higher than what we're experiencing across the
system. And keep in mind, we just announced record load factors for the entire company and our Hawaii business
is surpassing that.
In terms of actual demand, I kind of think about it in terms of load and it's just phenomenal and that's true for
interisland, as well as for the California to the island's routes. So as I said, we have six mainland California to the
islands and we have eight round trips and it's going phenomenally, it really is. So... ......................................................................................................................................................................................................................................................
Allison Schaefers Reporter, Honolulu Star-Advertiser Q Okay. Thank you, gentlemen. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Okay. Thank you. ......................................................................................................................................................................................................................................................
Operator: Ladies and gentlemen, that does conclude our question-and-answer session. At this time, I'd like to
turn the call back over to Ms. Barnett for any additional or closing remarks. ......................................................................................................................................................................................................................................................
Laurie Barnett Managing Director Communications & Outreach, Southwest Airlines Co.
Thank you. If you all have any other questions, our Communications Group is standing by to assist at 214-792-
4847. Thank you. ......................................................................................................................................................................................................................................................
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Operator: And ladies and gentlemen, that concludes today's call. Thank you for joining.
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