Southwest Airlines Company

Good morning and welcome to the Southwest Airlines fourth quarter and annual 2021 conference call. My name is Chad and I will be moderating today's call. This call is being recorded and a replay will be available on southwest.com in the investor relations section. After today's prepared remarks, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. At this time, I'd like to turn the call over to Mr. Ryan Martinez, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Chad, and thank you to everyone for joining us today. In just a moment, we will share some brief remarks and then open it up for Q&A. And on our call today, we have our Chairman of the Board and CEO, Gary Kelly, Executive Vice President and incoming CEO, Bob Jordan, Executive Vice President and CFO, Tammy Romo, Executive Vice President and Chief Commercial Officer Andrew Watterson, and President and Chief Operating Officer Mike Vanderman. Just a few quick notes. First, we will make forward-looking statements today, which are based on our current expectations of future performance, and our actual results could differ substantially from these expectations. And second, we had a few special items in our fourth quarter results, which we excluded from our trends and for non-GAAP purposes. and we will reference these non-GAAP results in our remarks today. So please see our press release from this morning and our IR website for more information and our cautionary statement, which covers these topics in more detail. So with that, I have the pleasure of turning it over one last time to my friend Gary Kelly. Thank you, Ryan, and good morning, everybody, and thank you for joining us for the Southwest Airlines fourth quarter 2021 earnings call. And first and foremost, I'm delighted to be able to say there were earnings and better than we thought yesterday last month. It's obviously a great way to end a tough but much improved year, a great way to start a new year. We're, of course, finding our way through the Omicron surge in January, February, and looking forward to a strong rebound in March and thereafter. And as always, that's barring any unforeseen events. I expect we'll make great progress in 2022, and we'll enjoy another much improved year. As we all know too well, it will not be without its challenges, but our people and our leadership are more than up to the task. I'm enormously proud of all of them, and I thank them profusely for their resilience and their perseverance through these myriad of challenges that we've faced the last two years. They've just done a phenomenal job. Southwest is on top because our people deliver great service to low payers. And our business model delivers consistent profits, enhanced returns on capital. And we've emerged from two years of pandemic with our balance sheet strength and our liquidity intact. And we are perfectly positioned to restore, to expand, and compete aggressively in the coming years. I could not be more enthused and more excited about our future. So with that, I'm going to turn it over to our outstanding CEO and waiting for five more days, Mr. Bob Jordan. Well, thank you, Gary. Hello, everybody. We were last together on December 8th in Investor Day, and a lot has happened since then. But before I get to that, I want to thank my friend Gary Kelly. Gary is a phenomenal leader, has done so much for Southwest and for me personally. There's just no way to say thank you enough for his 18 years of leadership as our CEO, and I'm thrilled that he will be our executive chairman. I'll take over the CEO responsibility for investor meetings going forward. So this is Gary's last turning call. And my friend, I just want to stop and say a huge thank you and I love you. Well, 2022 has had a challenging start, but that doesn't change our goals for the year. Getting properly staffed, focusing on our people, making meaningful progress, returning to our historic operational reliability and efficiency, providing our legendary hospitality and returning to consistent profitability. We made significant progress in 2021, including a profitable fourth quarter despite the pandemic. That's all strong demand. Eighty-eight percent of 2019 revenues restored and managed business demand ahead of our expectations for December. While we don't expect to be profitable this quarter, the Omicron impact does appear to be isolated to January and February, and we expect a profit in March. Expect to be profitable in the remaining quarters and for the full year 2022 based on our current plans. Our people performed just really well during the fourth quarter, as they always do, and particularly during the holidays. And demand held up well through the year end, despite the Omicron variant. Beginning in early January, we experienced a very difficult environment due to rapidly rising COVID cases and a decrease in available staffing levels. It's amazing that in the first three weeks, we had roughly 5,000 employees test positive for COVID. with employee cases roughly two and a half times what they were during the Delta period. The resulting staffing stories, combined with winter weather, caused a spike in flight cancels and a significant disruption to the operation. I'm pleased to report, though, that over the last few weeks, the operation and staffing have stabilized, and we've seen performance even better than during the holiday. Yesterday, for example, we were 95% on time, which I'm just hugely proud of. To maintain sufficient available staff, We extended in-city pay programs for office employees through early February. While that does add temporary cost pressure, it's imperative that we have sufficient staff to operate our schedule and minimize our flight cancellations. COVID case counts are on a downward trend, and we intend to normalize our staffing and pay structure as a result. Hiring is part of the equation, of course, and we met our 2021 hiring goals, and we are on track with plans to add at least 8,000 employees this year. We're also raising our starting wage rates to be competitive in the market and due to the impacts from Omicron and the variant in recent staffing challenges. And we're further moderating our first half 2022 capacity plans to provide additional buffer for the operation. We're encouraged by the recent improvement in bookings across the booking curve, especially in the March timeframe, and we are hopeful that business travel will resume the 2021 trend. It appears that Omicron impacts are pretty well contained to January and February from a revenue perspective, and we believe our temporary approach to boost available staffing is working. We'll stay flexible, of course, and we'll be willing to further adjust our plans if needed. So several things have transpired since Investor Day, all driven by the pandemic, though. But for Omicron, we would be on our Investor Day Q1 and four-year 2022 guidance. However, I want you to know, make no mistake, we are laser-focused on preserving our low-cost position in the industry and returning to 2018 productivity and efficiency levels by the end of 2023. We believe Q1 CASMX is a peak, and our plans call for unit costs to ease from here into 2023. Looking at 2023, based on current growth plans, we expect CASMX to be down at Restoring both the network and our fleet efficiency are key to returning to historic efficiency levels. And beyond that, I'm really excited about opportunities that continue network growth as we add gates in key cities such as Denver and Phoenix and Las Vegas, Baltimore, Nashville, and even more. Beyond 2023, we see opportunities to meet and then beat our historic productivity and efficiency levels as we continue to grow the company. and focus on modernizing our operational tools and processes, and Mike will talk more about that. But I want to repeat my main message from Investor Day. Despite the near-term noise, we have a superb business model with substantial underlying competitive advantages. We have a great five-year strategy and a strong set of initiatives that will drive significant value. Our new co-brand credit card agreement is in place with our partner, Chase. Our GDS expansion is complete, and our Southwest business team is armed with the tools they need to grow our business customer base. We continue to work on our new air product and our revenue management system optimization, some more to come there, but both should begin producing value this year. And as we continue retiring older 737-700 aircraft and taking the MAX aircraft this year in support of our fleet modernization initiatives as well. All combined, these initiatives are expected to deliver incremental EBIT of $1 to $1.5 billion in 2023, and we continue to expect roughly half of that value this year, given the initiatives in place. Like Gary said, last but not least, I just want to thank our amazing people. There have been all kinds of challenges, and they have performed just superbly. They continue to do an incredible job and manage through all of these challenges, and I am just in awe of them. And together, we will emerge from the pandemic, and we will see the opportunities in front of us. And with that, I will turn it over to Tammy.

All right. Hello, everyone, and thank you, Bob. I've worked with Bob for a long time, and I agree with Jerry. He is going to be a great CEO. And my friend, Jerry Kelly, you are amazing, and I just want to thank you for all that you've done. for our company and for all of us and for all of our shareholders. And I'm not going to say anything else because I will get choked up. So instead, I'm going to provide a quick overview of our financial results and share some additional color on our outlook beyond what we provided in our press release to you all this morning. And I also just want to thank our employees for their support. incredible resilience as we manage through this dynamic environment. It is their hard work, dedication, and focus that enabled us to achieve an important milestone in our recovery with our first quarterly profit since the pandemic began. We reported a $68 million profit in fourth quarter, our 11 cents per diluted share, and excluding special items, we reported an $85 million profit or 14 cents per diluted share. As Bob mentioned, our fourth quarter profit was driven by strong leisure demand during the holidays, business travel momentum, and incremental revenue from our new co-brand credit card agreement with Chase. Our fourth quarter results were all within the guidance ranges provided last month at Investor Day. For full year 2021, our net income was $977 million, or $1.61 per diluted share, driven by $2.7 billion of payroll support program proceeds. Excluding the temporary benefits and salary wages and benefits expense and other smaller special items, our full year net loss was $1.3 billion, or a $2.15 loss per diluted share. Andrew will cover our revenue trends and outlook here in a minute. Taking a look at cost, we continue to experience inflationary cost pressure experienced in fourth quarter, primarily in salary, wages, and benefits and airport costs as expected. A portion relates to hiring, and we made great strides toward our hiring efforts in 2021 and remain on track with plans this year. And of course, the labor market continues to be a challenge, which continues to pressure wage rates across the board. Since Investor Day, we have experienced additional cost pressures related to Omicron and winter weather. As a result, our first quarter unit cost inflation compared with first quarter 2019, and excluding fuel special items and profit sharing, has increased about 10 points. Roughly half of that increase is driven by the $150 million of additional incentive pay we are offering to operations employees through early February, and the other half is associated with why fewer ASMs' families were planning. In light of the significant impact from the Omicron wave on available staffing, Extending the temporary incentive pay and further reducing our capacity were necessary steps to stabilize the operation. Aside from these impacts, we would be on track with our previous unit cost outlook. Market fuel prices have continued to rise here, which also resulted in a 10-cent increase in our fuel cost per gallon guidance. Our estimated first quarter fuel price in the $2.25 to $2.35 per gallon range is also roughly 25 cents higher than our first quarter 2019 fuel price, and that's inclusive of an estimated 35 cents of hedging gains here in the first quarter. Turning to our four-year guidance, As of yesterday, we were planning for capacity to be roughly flat versus 2019 levels with no material impacts from the Omicron variant on either revenues or costs at that time. Fast forward to today, the impact from the Omicron variant on available staffing has led us to re-evaluate our first half of 2022 capacity plans. In particular, March through May. Our planned flight schedule adjustments take some capacity upside optimism off the table for this year and reduces our full year 2022 capacity outlook by about four points, from roughly flat to down 4% versus 2019. I've already covered the $150 million of additional incentive pay in first quarter, and in order to be more competitive on the hiring front, in particular for ground operations, we are raising starting wage rates from $50 per hour to $17 per hour, which is estimated to be a $20 to $25 million total impact for this year. And, of course, we have contemplated labor rate inflation in our guidance as best we can for this year, understanding that the market is somewhat uncertain This is clearly not where we hope to be along our recovery curve nearly two years into this pandemic, but we are making great progress. While we must remain nimble in this environment and take the necessary actions to take care of our employees and provide a reliable product for our customers, we are very focused on the long term, and determined to get back to 2018 levels of productivity and efficiency as we shared with you all at Investor Day. As Bob said, our goal is to get there by the end of next year. Although it is early based on our current plan for 2022 and preliminary plan for 2023, we expect 2023 CASMX will decline year-over-year compared with 2022. Longer term, our framework that we provided at Investor Day remains unchanged, and that includes a post-pandemic target of mid-single-digit ASM growth accompanied by low single-digit CASMX growth. I want to be clear that our longer-term CASMX framework includes an estimate for labor rate increases as best we can estimate today. Trying to fleet, we currently have 77 MAX firm orders and 37 MAX options with Boeing this year. While our plan assumes we will exercise the remaining 37 options this year, we maintain the flexibility to evaluate that intention as decision points arise. We continue to believe that taking the additional options this year will yield a positive NPV on aircraft replacements, if we don't deploy them in the network. As I have mentioned to you all before, we won't incur a material captain X penalty from holding on to extra aircraft in the event we temporarily park some of our Dash 700s while capacity is moderated this year. As we work our way back to an efficient utilization of the fleet, we remain in the fortunate position to have the flexibility needed with our retirement plans without a financial penalty. I'll wrap up with a quick note on our balance sheet stream. We ended 2021 with liquidity of $16.5 billion. Our leverage is at a very manageable 54%, and we continue to be the only U.S. airline with an investment-grade rating by all three rating agencies, which I believe is one of our key competitive advantages. We have ample liquidity that allows us for further cushion in the event of further COVID waves. Overall, our balance sheet strength puts us in a category of one in terms of our ability to withstand shock and remain financially healthy. With that, I will turn it over to Andrew.