How Southwest Plans to Shrink by 25 Percent But Not Lay Off Workers

It’s been a point of pride for Southwest Airlines that it has never laid off or involuntarily furloughed a single employee in its 50-year history. Through crisis after crisis, as its competitors slashed headcount, negotiated difficult concessionary contracts with unions, and filed for bankruptcy, Southwest has kept is workforce intact.

The Covid-19 pandemic and its resulting decimation of the airline industry won’t change that, CEO Gary Kelly said on the company’s second-quarter earnings call. But that could change.

Southwest, like all U.S. airlines that took payroll support funds through the federal government’s CARES Act stimulus, is obligated not to furlough or lay off employees through Sept. 30. And while its competitors, notably American Airlines and United Airlines, have warned that furloughs and layoffs are likely on Oct. 1, Kelly said Southwest does not anticipate having to do so this year, although it has drawn up plans in case demand for travel should fall further.

Instead, Kelly said almost 17,000 employees — or 27 percent of the company’s workforce — have availed themselves of voluntary separation and long-term leave options the company provided. Of these, 4,400 employees decided to leave the company, and 12,500 opted to take leaves-of-absence of a year or longer.

Using employees as a rough guide to the size of the airline’s network, Kelly said with one-quarter of the airline’s employees gone by the end of the year, the airline itself will offer one-quarter fewer flights than it did last year. Southwest could adjust this upward or downward, depending on demand, but given trends now, that is the size he forecasts the company to be on Dec. 31. The airline has some flexibility if it needs to spool up, he added, because the 12,500 employees on long-term leave can be recalled quickly.

Demand trends have been grim in the second quarter. The first quarter of this year was a tale of two halves for the U.S. airline industry, with travel demand strong in January and most of February, falling off rapidly in March. The second quarter played out in a similar way. April was particularly bad, and Transportation Security Administration checkpoint data show that passenger traffic through its airport checkpoints dropped more than 90 percent in that month, compared with April 2019.

Southwest reported demand started to recover in May and June, as quarantines began to ease around the U.S. But by the second half of June, and as the disease rampaged in areas of the country that had been spared or resurged in areas that had had it under control, demand began to fall off, and so far in July, have fallen off a cliff. Using load factors — an industry term for the percentage an aircraft is full — to track demand is instructive.

In April, Southwest’s load factors were 8 percent; in May, 30 percent. June’s load factors rose to 50 percent, but July’s are expected to fall back to 40-45 percent, and August’s are forecast to be between 30-40 percent. Demand for the fall, measured in bookings, has fallen precipitously, and the carrier will have to be aggressive in managing its network to match demand. In other words, the recovery will be “a long, saw-toothed slog with a lot of unexpected twists and turns,” Kelly said, adding “I have never seen anything like this in my life.”

Southwest forecasts leisure travel to fuel much of its demand for the balance of the year. Business travel had been expected to start recovering in the third and fourth quarters of this year, but Southwest now sees business travel beginning to return in the first quarter of next year.

safety first

From next week, Southwest will require passengers to wear masks and facial coverings on board, with no exceptions, medical or otherwise, for passengers over the age of two. Passengers may remove their facial coverings only while eating or drinking. the more stringent policy was necessary, because noncompliance put the airline’s flight crews in a “really tough spot,” Southwest President Tom Nealon said.

The carrier already has installed HEPA filters on its aircraft and plexiglass shields at its counters,  and earlier this year it launched a more robust aircraft cleaning program. Kelly, when asked if he thought the federal government should mandate masks onboard aircraft, said he did not want the airline industry singled out. Rather, if the government is planning to mandate masks, it should mandate masks everywhere, not just on aircraft. The company is trialing temperature checks at airports, and wants to see this become a standard part of air travel. “I can’t speak for the administration, but I wish they would take [temperature checks] up,” Kelly said. “I’m anxious to get moving on this…the missing piece is temperature checks.”

‘committed’ to the max

The pandemic forced Southwest to park 400 of its more-than 700 aircraft in April. In June, the carrier had returned all but 100 of those aircraft to service. The Boeing 737 MAX fleet, of course, remains parked until the Federal Aviation Administration (FAA) clears the aircraft for service. Southwest remains committed to the fuel-efficient aircraft and plans to take delivery of 48 through the end of next year.

But when regulators clear the MAX for commercial service, it will take between 9-10 weeks to train pilots to fly the aircraft. This period also will allow Southwest to conduct any maintenance the aircraft will need after being parked for so long. The Boeing 737 MAX was grounded worldwide last year in the wake of two fatal accidents, in Indonesia and in Ethiopia, thought to be caused by flight-control software. The FAA has been working with Boeing on test flights this year, although it remains unclear when the aircraft will return to commercial operation.

And now, the numbers

By any measure, the second quarter, usually summer travel fuels profits, was awful for Southwest and the entire U.S. airline industry. The first quarter was buoyed by the strong first two months of the year. The second quarter, on the other hand, included the historically bad month of April. Southwest lost $915 million in the second quarter, compared with a $741 million profit in the same period last year. Operating revenues in the quarter were down 83 percent to $1 billion. A silver lining is that fuel costs — typically one of an airline’s largest expenses — fell to $1.20 per gallon from $2.07 per gallon last year.

Southwest has signed a letter of intent for a government loan through the CARES Act, but Kelly said the company has no plans to take the loan. There are too many strings attached, he said, including prohibiting payment of dividends and share buybacks. But the company is keeping its options open in case it needs the loan. Southwest also has plenty of cash on hand and has thus far not faced difficulty raising funds. Southwest has $14.5 billion in cash and unencumbered assets, including $10 billion in aircraft.

“Our founder, Herb Kelleher, always reminded us: we manage, in good times, so that all of us will be protected from bad times,” Kelly said.”By living Herb’s basic credo, we entered this crisis prepared with the U.S. airline industry’s strongest balance sheet and most successful business model.”