Southwest Airlines Co. (LUV) Earnings

Management highlights

### Transformational Results & Core Strengths - Q2 2026 marked the first full quarter with all major transformation initiatives fully contributing, delivering a 9% after-tax return on invested capital and a 6.7% adjusted operating margin, a 3.3 percentage point year-over-year improvement, despite a $900 million year-over-year increase in fuel expense. - Adjusted earnings per share was $0.94, up ~120% year-over-year, exceeding both initial guidance and analyst consensus. - Southwest maintains unique unreplicable competitive advantages: the largest domestic U.S. network with the most nonstop flights, a leading position in nearly half of the 50 largest U.S. airports, strong cost discipline, powerful brand loyalty, and top-ranked customer service, which was named number one in J.D. Power 2026 North America Airlines Satisfaction Study for the fifth consecutive year, and was named best U.S. airline by the Wall Street Journal in 2025. ### Customer & Commercial Engagement - Rapid Rewards loyalty program hit a record size of nearly 100 million members, with new member enrollments up 35% year-over-year and record tier qualification activity in the quarter. - The first Starlink-equipped aircraft entered service, new destination Anchorage launched in May completing the rollout of all five previously announced new destinations, and the airline partner network expanded to nine carriers with the addition of AirPremia. ### Operational Performance - Southwest ranked first among large domestic U.S. carriers in completion factor, improved mishandled baggage performance year-over-year even with higher gate-checked bag volumes, and maintained the lowest customer complaint rate among major U.S. airlines. - Trip Net Promoter Score improved throughout the quarter, reflecting positive customer response to operational execution and enhanced product offerings. ### Financial Discipline - CASM (ex-fuel) increased just 3.4% year-over-year on near-flat capacity, coming in below the low end of prior guidance, with hundreds of millions of dollars in incremental company-wide cost savings identified year-to-date. - The investment grade balance sheet remains a key strength, with liquidity above the $4.5 billion target and gross leverage within the 1.0x to 2.5x target range, improved from 2.4x at YE2025. ### New Post-Transformation Focus With all transformational initiatives now fully deployed, management has shifted focus to optimization to unlock full business potential, including: optimizing the network, refining new product pricing, growing managed business revenue, and expanding co-branded credit card opportunities.

Guidance

- **Full Year 2026 Adjusted EPS Guidance**: Revised to $3.25 to $4.25, down from the prior guidance of at least $4. The revision reflects elevated and volatile fuel prices based on the forward curve as of July 17, 2026, while assuming current demand and pricing trends remain broadly intact. Even with the update, full year 2026 earnings remain broadly in line with the start-of-year guidance and represent significant year-over-year earnings growth and margin expansion. - **Q3 2026 Unit Revenue (RASM) Guidance**: Expect 17.5% to 19.5% year-over-year growth, which includes a year-over-year comparison headwind from the 2025 implementation of bag fees and other new revenue initiatives. Excluding this base effect, unit revenue would be well above Q2 2026's 20.1% year-over-year growth rate, with no underlying deceleration in demand or pricing. - **Q3 2026 CASM (ex-fuel) Guidance**: Expect a 3.5% to 4% year-over-year increase, with capacity expected to be flat to down 1% year-over-year. - Capacity growth moving forward is expected to be modest, below peer levels, with growth focused on reinforcing existing points of strength in the network rather than broad expansion into new unproven markets.

Segment performance

Southwest Airlines is reported as a single consolidated operating segment for this quarter. Adjusted operating revenue reached a record $8.7 billion, up 20.3% year-over-year on just 0.2% capacity growth. Adjusted unit revenue (RASM) increased 20.1% year-over-year to an all-time quarterly record. Managed business revenue grew 30% year-over-year to a new quarterly record, representing approximately 15-20% of total adjusted operating revenue based on disclosed growth trends. Chase co-branded credit card revenue contributed to top-line results, with quarterly card acquisitions up 28% year-over-year. Operating cash flow for Q2 2026 was $0.5 billion, up 32% year-over-year, with total first half 2026 operating cash flow reaching nearly $2 billion. Total liquidity at quarter end was $5.3 billion, with a gross leverage ratio of 2.1x.

Risks & headwinds

- Fuel prices remain volatile and elevated, creating ongoing cost uncertainty that impacted the downward revision to full year 2026 EPS guidance. - Small-scale day-to-day delays have increased slightly due to slower turn times during the final 10 minutes of gate processing, driven by high load factors and post-product-launch process adjustments, though management is actively targeting process optimization to resolve this issue ahead of the holiday travel period. - Macro demand conditions could shift unexpectedly, though management notes current trends remain robust and the more diversified revenue model creates greater earnings durability than in past cycles. - Starlink installation is constrained by Starlink's antenna production output, limiting the speed of fleet-wide deployment of upgraded in-flight connectivity.

Analyst Q&A

• Q: Connor Cunningham (Milius Research) asked two questions: 1) What is the size of the 2025 initiative base effect headwind in the Q3 2026 RASM guidance, and how will this impact trends through H1 2027? 2) What is Southwest's approach to long-term network growth, and what should be inferred from the planned Q4 2026 and Q1 2027 capacity ramp? /

  A: On the RASM headwind: Q2 2026 RASM growth of 20.1% was an extraordinary result far ahead of industry peers. The Q3 2026 guidance range includes a clear base effect headwind from lapping 2025 initiatives, led by $1 billion annualized bag fees. Adjusting for this base effect, Q3 RASM would be well above Q2 levels, and robust demand and pricing strength from Q2 has continued into Q3. On long-term growth: Southwest will maintain capacity discipline with modest growth below peer levels going forward. All capacity growth will focus on strengthening existing core points of strength in the network, with capacity shifted to prioritize these high-return locations.

• Q: Sheila Kayoglu (Jefferies) asked: Why is Q3 2026 RASM guidance showing sequential deceleration from Q2 while peer airlines are guiding for acceleration, and what are the contributions from base effects, demand, and other factors? /

  A: The sequential deceleration in the year-over-year growth rate is solely from the base effect headwind of lapping 2025's new revenue initiatives implemented around this time last year. Bag fees alone contribute roughly 2.5 percentage points of this headwind. Adding this back to the Q3 guidance puts sequential growth above Q2's 20.1% rate. There is no underlying deceleration in demand, fares, managed business growth, or product performance.

• Q: Dan McKenzie (Seaport Global Securities) asked: What concrete data gives management confidence that current strong demand and pricing trends are durable over a 2-3 year horizon, and what is the appetite for additional shareholder capital returns? /

  A: On demand durability: First, the broader U.S. consumer is highly resilient, with travel a prioritized spending category that is showing broad, robust strength across all geographies and customer segments. Second, Southwest's product transformation is resonating extremely well: all engagement metrics (new loyalty members, tier qualifications, co-brand card acquisitions, managed business revenue growth) are well above expectations, which acts as a leading indicator of future sustained revenue growth. Third, Southwest continues to optimize and expand its product offering, creating additional long-term demand. On capital return: Management does not comment on specific near-term repurchase plans, but any capital allocation including share repurchases will follow existing communicated guardrails, with reinvestment in the business (particularly fleet replacement of older 737s with new MAX aircraft, which is highly NPV-positive) remaining a top priority.

• Q: Catherine O'Brien (Goldman Sachs) asked: How are basic economy sell-through and bag fee take rates trending relative to initial expectations, and what drove the better-than-expected Q2 cost performance? /

  A: On new product trends: While individual initiative results are not broken out, both basic economy penetration and customer sell-up to higher fare classes are outperforming initial expectations, and contributed to the Q2 revenue beat. Management will continue to refine pricing and product models going forward. On cost performance: The Q2 cost beat was broad-based across the entire company, driven by efficiency gains in technology, supply chain, and maintenance, as well as discipline on non-frontline headcount (which was held flat to 2025) and improved frontline labor efficiency. All aircraft gains on sale are included in the published quarterly EPS guidance.