As the scope of the pandemic became clear last year, the 'aha' moment came to the executive team at Spirit Airlines when they realized they could no longer focus on maximizing unit revenue. Even though that had long been the guiding metric of the discount airline — fill planes up with more seats, charge less for them, and fly the planes more frequently — the company had to pivot.
Now, it had to focus on maximizing earnings before interest, taxes, depreciation and amortization (EBITDA), a very different challenge, given the industry's high fixed costs and the steep drop in travel it faced in 2020.
"It took us a little bit of time to get there mentally, and to understand how the new math works," Scott Haralson, Spirit CFO since 2018 and an eight-year company veteran, told CFO Dive in an interview. "This shift from maximizing unit revenue to EBITDA changes the game."
That's because the drop in business changed what optimal results look like, he said.
Instead of trying to maximize the airline's unit revenue — traditionally either by increasing the unit price or by increasing the aircraft's capacity utilization — the focus had to shift to protecting the balance sheet. That meant cutting costs and generating cash — maximizing EBITDA.
"You may think we should only fly a small portion of the airline and maximize unit revenue," Haralson said, "but, mathematically, that would produce a worse EBITDA, burn more cash and destroy value."
"A lot of CFOs think they know their business and think it's very predictable, but once you drop almost 90% of operations, you find you didn't really know as much as you thought."
CFO, Spirit Airlines
The cost-cutting challenge stems from the mismatch between the short-term nature of the problem and the long-term assets of the carrier.
"We had to create different models that no longer considered fully allocated profitability," he said. "We had to think of the marginal cost of the business, and decide what's fixed in today's world. How do we maximize EBITDA in a world where all we're doing is covering marginal costs? How long does that mindset continue taking place? It's a slippery slope; if we think like that forever, we'll destroy value in the future."
In the short run, he said, "you're thinking, 'I have large fixed costs: airplanes and facilities I have to pay for, and people I have to keep. At some point, I'll have to reduce the workforce.'"
Ensuring it has cash has been easier, in part because the company went into the pandemic in a strong liquidity position and with a healthy balance sheet, but the executive team felt they needed at least four years of cash to survive.
That meant making some tough decisions, including structuring a capital raise that would dilute shareholders. However, not raising the money would have been worse.
"It [was] dilutive to the shareholder, which we thought long and hard about," he said. "We made sure we had enough capital to succeed, and come out of this with a healthy balance sheet."
"That was a tough pill to swallow," he added. "At the end of the day, it was the right thing to do."
In one of their capital raises, they closed a private offering of $850 million in principal amount of 8% senior secured notes, due 2025. The shares were offered by two newly formed Spirit subsidiaries. The notes were guaranteed by Spirit and secured by the company's customer loyalty programs and brand intellectual property.
At the end of the second quarter, the company had unrestricted cash, cash equivalents, and short-term investments of $1.2 billion.
"That's really where we said, ‘Okay, we feel good about where we are from a cash balance perspective,'" he said. "That's around four years of cash, twice as much as we started the year with. There's probably no need to raise any more capital."
Haralson's focus is now on the bigger picture — what the industry will look like going forward.
Every airline has taken a big hit this year, Haralson said. "We have debt on the balance sheet we didn't have before, and we're all burning cash right now. It's tough, but Spirit is healthy today, from a balance sheet perspective. We eventually will get past the pandemic, and Spirit will be in a good spot to take advantage of opportunities."
Historically, best-in-class companies, across industries, take advantage of disruption, Haralson said. "We want to make sure we take advantage, and being financially healthy allows us to do that."
Even so, the industry as a whole must be healthy for any individual airline to thrive, and it'd be very difficult for Spirit to thrive amid a foundering industry.
"Our job is to press the business forward, in the most diligent way we can, with what we have today," he said. "We can do that by mitigating risk, creating flexibility within our network and doing things we might not do in a normal world because they might be slightly less efficient and cost us money, but they'll provide the right economic outcome."
In the meantime, he wants to be as nimble as possible, and focus on efficiency and optimization.
"A lot of CFOs think they know their business, and think it's very predictable," he said. "But once you drop almost 90% of operations, you find you didn't really know as much as you thought. We've learned that some things are more fixed or more variable than we thought. And while it's very painful, it's a very educational experience for all of us."
In the end, Haralson says Spirit was buoyed by two things: pausing and taking an assessment of what they'd done and what they're thinking about doing, and not being frozen or imprisoned by what guided them previously.
"Question the things you thought were truisms," he said. "Stopping and rethinking those things can set the business up to be successful."
Motivating your coworkers is also vital. Haralson recalls telling his team, "Hey, this is terrible, but Spirit's going to do well, and we could come out better on the other side."
"Having positivity and looking for opportunities is helpful, as opposed to keeping your head down," he said. "Pause and look for the opportunities; they'll be there."