25-jan-2018 southwest airlines co./media/files/s... · southwest airlines co. (luv)q4 2017 earnings...
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25-Jan-2018
Southwest Airlines Co. (LUV)
Q4 2017 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.
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co.
Andrew Watterson Chief Revenue Officer & Executive Vice President, Southwest Airlines Co.
Thomas M. Nealon President, Southwest Airlines Co.
Laurie Barnett Managing Director Communications & Outreach, Southwest Airlines Co.
......................................................................................................................................................................................................................................................
OTHER PARTICIPANTS
Jamie N. Baker Analyst, JPMorgan Securities LLC
Jack Atkins Analyst, Stephens, Inc.
Hunter K. Keay Analyst, Wolfe Research LLC
Duane Pfennigwerth Analyst, Evercore ISI
Savanthi N. Syth Analyst, Raymond James & Associates, Inc.
Helane Becker Analyst, Cowen & Co. LLC
Brandon Oglenski Analyst, Barclays Capital, Inc.
Michael J. Linenberg Analyst, Deutsche Bank Securities, Inc.
Rajeev Lalwani Analyst, Morgan Stanley & Co. LLC
Mary Schlangenstein Dallas Reporter-Bloomberg News, Bloomberg LP
Conor Shine Reporter, The Dallas Morning News, Inc.
Dawn Gilbertson Senior Business Reporter, The Arizona Republic, Inc.
Robert Silk Senior Editor, Travel Weekly
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MANAGEMENT DISCUSSION SECTION
Operator: Welcome to the Southwest Airlines Fourth Quarter 2017 Conference Call. My name is Tom, 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'd like to turn the call over to Mr. Ryan Martinez, Managing Director of Investor Relations. Please go
ahead, sir. ......................................................................................................................................................................................................................................................
Ryan Martinez Managing Director, Investor Relations, Southwest Airlines Co.
Thank you, Tom, and welcome, everyone, to our fourth quarter earnings call. Joining me today, we have Gary
Kelly, Chairman of the Board and CEO; Tom Nealon, President; Mike Van de Ven, Chief Operating Officer;
Tammy Romo, Executive Vice President and CFO; and other members of senior management.
Please note today's call will include forward-looking statements. And because these statements are based on the
company's current intent, expectations and projections, they are not guarantees of future performance, and a
variety of factors could cause actual results to differ materially. As this call will include references to non-GAAP
results, which excludes special items, please reference in this morning's press release in the Investor Relations
section of Southwest.com for further information regarding forward-looking statements and reconciliations of non-
GAAP results to GAAP results.
Gary will begin with an overview of our performance, followed by Tammy with a detailed review of our fourth
quarter results and our current outlook. Following Tammy's remarks, we'll be available to answer questions.
And at this time, I'd like to turn the call over to Gary. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co.
Thank you, Ryan, and thanks, everybody, for joining our fourth quarter 2017 earnings call. It was an excellent
quarter all the way around, and I want to thank all our 56,000-plus employees for an exceptional year and
congratulate them on another very strong profitsharing for 2017 of $543 million, and that is in addition to the $70
million tax reform bonus that we shared.
After two years of modest unit revenue declines, we turned the corner in 2017, and that's despite a very
competitive industry environment. Unit revenues were up in the quarter 1.9% and just under 1% for the full year.
We're currently estimating 1% to 2% unit revenue growth on strong load factors and bookings for first quarter
2018, and our goal is for positive unit revenue comparisons again for this year.
Better revenue management tools and techniques enabled by our new reservation system will help mitigate any
competitive pressures for this year. I expect those benefits from the new system to begin in second quarter.
Fuel prices are up over the last quarter, and if futures prices become reality, we'll see some cost pressure there,
but the federal tax rate reduction more than offsets that pressure. And excluding fuel profitsharing and special
items, our unit cost outlook for the year is excellent with a goal of moving unit cost down slightly.
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Depending on fuel prices, our goal is to realize operating margin expansion for 2018. Given the tax reform, in
addition to that, we would realize even greater net margin expansion, and both of those will drive stronger future
cash flows. But it is worth repeating that in addition to the margin expansion, we reduced our federal income tax
liability at the end of 2017 by $1.4 billion. And that cash flow benefit will flow through in the future years in addition
to the cash flow benefit from future margin expansion.
Our growth plans for 2018 are unchanged. We end the year with 750 aircraft which recovers the Classic fleet
retirement over the third quarter of last year, grows our fleet by 27 airplanes effectively over a 24-month period.
So I'm simply measuring year-end 2016 to the year-end of 2018.
Work is well underway to begin flying to Hawaii, so that is the focus for this year. And we announced this morning
our intention to add Paine Field in Everett, Washington later this year, and that will complement our presence at
Sea-Tac. Aside from the modest growth plans, our focus for 2018 will be on the basics.
Unlike the past seven years, we have no major strategic initiatives that are landing in 2018, and that allows a
more intense focus on running a great airline, offering outstanding customer service and controlling our cost.
Capital spending will also be down this year. 2017 closed out on a very positive note. 2018 looks even better for
all the reasons I just outlined.
And with that very quick overview, I'd like to turn it over to Tammy Romo, our Chief Financial Officer, to take us
through the quarter. ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co.
Thank you, Gary, and thank you all for joining us today. I want to first thank our employees for their hard work and
congratulate them on another successful year, earning $543 million in profitsharing. 2017 was a year of many
accomplishments, and it ended with a strong fourth quarter performance. Fourth quarter net income was easily a
record with profits of $1.9 billion, yes, billion, or $3.19 per share. And as we announced in our 8-K filing earlier this
month, we recorded a very large tax adjustment as a result of tax reform.
In revaluing our deferred tax liabilities and assets to reflect a lower future tax rate, we recorded a one-time non-
cash tax benefit of $1.4 billion during the fourth quarter, which we called out as a special item. Excluding the tax
reform adjustment and normal hedge accounting special item, fourth quarter net income was a strong $459 million
or $0.77 per diluted share, $0.01 ahead of First Call consensus.
We were proud to celebrate the passage of tax reform with our employees and a $1,000 bonus to each of them
earlier this month. The employee bonus of $70 million was included in our non-GAAP results and impacted our
earnings per share by $0.07. With these strong returns and another year of strong operating cash flow in 2017,
we were able to make prudent investments in our business, take care of our people and return significant value to
our shareholders. We're off to a great start this year.
And in addition to covering more detail on our fourth quarter results, I will also provide an outlook for 2018.
Starting with revenues, we ended 2017 with record fourth quarter operating revenue of $5.3 billion, driven largely
by record passenger revenue of $4.7 billion. Strong demand for low fares resulted in a fourth quarter record load
factor of 85%. Passenger revenue yields were down slightly year-over-year, but improved sequentially from third
quarter as expected. And demand was strong during Thanksgiving and the December holiday period.
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Freight revenue also performed well during the peak season, resulting in a 7.1% increase year-over-year. Our
Rapid Rewards and EarlyBird revenues also were strong. In fact, our EarlyBird revenue for fourth quarter 2017
alone was approximately $100 million, which was our initial target for EarlyBird when we first rolled out the
boarding option.
Overall, we were pleased with our record fourth quarter operating revenue performance that outpaced our
capacity growth to produce a RASM increase of 1.9% year-over-year, which was in line with our expectation. We
were also pleased to achieve a goal of unit revenue growth for full year 2017, albeit modest, considering the
unprecedented national disasters and competitive industry environment during 2017.
Looking ahead to first quarter 2018, passenger revenues appear stable and travel demand and bookings are solid
and as we expect, favorable year-over-year trends in first quarter 2018 freight and other revenues. Based on
these trends and our current outlook, we expect first quarter 2018 RASM to increase in the 1% to 2% range year-
over-year.
Later this quarter, we will issue an investor update. This 8-K will reflect any typical guidance updates as well as
potential changes to our guidance as a result of accounting changes based on the new accounting standard
related to revenue recognition. We plan to utilize our investor updates on a quarterly basis as needed. And
therefore, we will no longer report RASM guidance in our monthly traffic releases beginning with the report of
January traffic results early next month.
Turning to fuel, our fourth quarter 2017 economic fuel price per gallon was $2.09. Fourth quarter's $2.09 per
gallon included $0.19 of fuel hedging losses. However, our fuel hedging losses are behind us now. And our hedge
portfolio for 2018 and beyond provides us a nice protection against catastrophic prices and energy prices without
the forward exposure. And it enables us to make prudent adjustment to our business in a rising fuel price
environment in order to maintain our financial goals and reduce volatility in our earnings.
For 2018, we plan to early-adopt an accounting standards update related to hedging, where we will begin
reporting fuel hedging premium expense within fuel and oil expense above the line rather than within other gains
and losses below the line on the income statement.
As such, we are providing our 2018 fuel price per gallon guidance including fuel hedging premiums as shown in
this morning's earnings release. And we'll recast prior periods later in the first quarter as part of our 8-K update.
Moving on now to our outlook on fuel, based on market prices and our hedging portfolio as of January 19, for first
quarter 2018, we expect our economic fuel price per gallon to be in the $2.10 to $2.15 range including
approximately $34 million or $0.07 per gallon in fuel hedge premium, and an approximately $0.05 per gallon
hedging gain.
For full year 2018, we currently expect our economic fuel price per gallon to also be in the $2.10 to $2.15 range,
including approximately $135 million or $0.06 per gallon in fuel hedge premiums and a $0.04 per gallon hedging
gain. At current market prices, our 2018 fuel hedge position began to produce modest gains at about $65 per
barrel Brent crude with more material gains kicking in at our $75 per barrel range and higher.
Before I move to non-fuel costs, I want to spend a moment on fuel efficiency. As you know, we retired our
remaining Classic fleet in third quarter 2017 and introduced the more fuel-efficient 737 MAX 8 into our fleet in
fourth quarter.
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As we've continued to modernize our fleet, we have seen a nice increase in available seat miles per gallon,
improving 1.3% year-over-year and fourth quarter. For 2018, we currently expect a 2% to 3% improvement year-
over-year in available seat miles per gallon.
Excluding fuel, profitsharing and special items, our fourth quarter unit costs increased 4.6% year-over-year.
Putting aside the year-end items for just a second, fourth quarter unit cost trends were in line with our original
expectations, as we saw expected increases in salary, wages and benefits, advertising spend that shifted from
third quarter, and incremental technology costs that included ramping up for ETOPS in preparation for Hawaii.
As disclosed in our January 2 8-K, we had 3.5 points of incremental cost pressure at year-end, primarily driven by
the employee bonus. Based on current cost trends, we expect first quarter CASM, excluding fuel, special items
and profitsharing, to increase in the 0.5 point to 1.5% range year-over-year.
The primary drivers of the year-over-year increase include inflationary increases in salary, wages and benefits,
which include higher costs related to an extended operating day driven by our Classic retirement and our current
fleet deficit.
We also expect increases in airport landing fees and rentals and maintenance. And then looking ahead to the full
year 2018, we expect our CASM, excluding fuel, special items and profitsharing, to be in the range of flat to down
1% year-over-year, which is a very solid performance. For 2018, our largest year-over-year costs tailwind is
approximately $200 million related to the Classic retirements and benefits and depreciation, aircraft rentals and
maintenance expense.
We also have some offsetting headwinds in the areas of maintenance of our aging 737-700 fleet as well as airport
costs. While the benefits of the Classics retirements are easier to see in depreciation and aircraft rentals, we do
have a 2018 Classic year-over-year benefit within maintenance expense. However, this Classic maintenance
savings is more than offset by the increased maintenance of our aging 737-700 fleet.
I'll just make a few comments on the balance sheet and our capital deployment. We ended 2017 with arguably the
strongest balance sheet in our history, and we're very proud of that. Our solid investment-grade rating is intact.
And we are pleased with the upgrades from both Moody's and S&P during 2017 as well as the recent positive
outlook revision by Fitch.
Our liquidity is strong with cash and short-term investments of approximately $3.3 billion at year-end. And during
the fourth quarter, we issued $600 million in unsecured debt at among the tightest spreads and lowest yields in
Southwest's history. With this additional capital, primarily to refinance existing debt, we continue to target leverage
in the low to mid-30% range.
Free cash flow for 2017 was a strong $1.8 billion, driven by $3.9 billion in operating cash flow and capital
expenditures of $2.1 billion. Our strong cash flow and financial position allowed us to return $1.9 billion to our
shareholders through share repurchases and dividends.
Our 2017 CapEx of $2.1 billion came in below guidance, primarily due to the shift of approximately $115 million
out of 2017 and into 2018 related to one MAX 8 delivery and several non-aircraft investments that were really just
a shift in the spend.
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We are still expecting our 2018 CapEx to decrease versus 2017 and are currently estimating 2018 CapEx to be
approximately $1.9 billion. Included in this total, we expect 2018 aircraft CapEx of approximately $1 billion and
non-aircraft CapEx in the $900 million range, including the shifting I previously mentioned from 2017.
We continue to effectively balance and manage our overall capital deployment, and we remain focused on
preserving our strong balance sheet and healthy cash flows, while returning significant value to our shareholders.
And with the expected future cash savings from tax reform, we'll continue to evaluate our investments in our
company, our people and our shareholders, including the mix of share repurchases and dividends with an
overarching goal to drive long-term value for our shareholders.
Moving on to fleet, of course, fourth quarter was our first quarter flying our all-Boeing NGs and MAX aircraft on the
heels of retiring the remaining Classic fleet, and actually fourth quarter was the first. And we ended 2017 with 706
aircraft with the delivery of 19 aircraft during fourth quarter. This is one fewer plane than expected with one MAX
delivery shifting into 2018.
We currently have 13 MAX 8 aircraft in our fleet. And as you saw in our January 2 8-K update, we made some
minor changes to our Boeing order book. We exercised 40 options for a MAX 8 firm orders to deliver in 2019 and
2020, deferred 23 MAX 7 firm orders to better align with our future 737-700 retirements, and accelerated 23 MAX
8 firm orders to be 2021 to 2022 timeframe.
We will have significant 737-700 NG retirements over the next 10 to 15 years based on their age and this order
book refresh, along with our remaining order book and options, which allows us to manage through those
retirements in a measured way while allowing flexibility for growth.
Aircraft CapEx remains very manageable at approximately $1 billion per year on average for the next five years.
Our 2018 fleet and capacity plans have not changed, and we continue to expect to end the year with 750 total
aircraft based on our current firm aircraft delivery schedules.
On the capacity front and in line with our previous expectation, we expect 2018's full year capacity to increase in
the low-5% range year-over-year. In our third quarter 2017, approximately 5,000 flight cancellations due to the
natural disasters is driving roughly 0.5 point of our full year 2018 ASM year-over-year growth.
We expect our first half 2018 capacity to increase in the low-3% range year-over-year as we firmed up our first
half 2018 schedule. The next schedule will be published on February 15, and that will go out through September
28. For second half 2018, we expect our capacity to increase in the low-7% range, with higher year-over-year
growth in fourth quarter 2018 due to the impact of last year's Classic retirements. We remain excited about our
2018 growth opportunities, and we have a prudent 2018 growth plan that produces positive year-over-year RASM
growth based on our current outlook.
So, in closing, we had a really strong 2017 performance, and 2018 is shaping up to be another solid year, which
will also benefit significantly from tax reform. And as we start the year, we are well positioned for margin
expansion excluding special items. Our employees continue to deliver a reliable operation and product, and they
have been proving that they are best in the industry for the past 45-plus years.
I was thrilled that we could recognize their hard work with the recent year-end tax reform bonuses, and I am very
proud that they continue to be recognized for their world-class hospitality. We have a bright future ahead at
Southwest, and I'm excited for our shareholders with the momentum we have coming into 2018.
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With that, Tom, I think we are ready to take questions.
QUESTION AND ANSWER SECTION
Operator: Thank you. [Operator Instructions] We'll now begin with our first question from Jamie Baker with
JPMorgan. ......................................................................................................................................................................................................................................................
Jamie N. Baker Analyst, JPMorgan Securities LLC Q Hey, good afternoon, everybody. Gary, I still consider Southwest to be a point-to-point operator that just sort of
happens to have a few very large bases of operations that sort of resemble hubs. And I'm thinking this might be
an outdated characterization. I'm curious, the degree to which you currently schedule and revenue manage for
connectivity over places like Baltimore, Nashville, Denver, how that's changed over time, particularly with the new
res platform, and how you think it may evolve from here? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Jamie, I think your view of Southwest is accurate. Some of the statistics that I remember well from the 1980s
when I joined is that in those days, at a much lower load factor, about 80% of our O&Ds flew non-stop. And then
the other 20% were split pretty evenly between through-traffic and connections. And in the 1980s and the 1990s
and really probably the early 2000s, we did not intentionally schedule for the convenience of connections.
Since 2009, we have had some percentage of our flights that will – we use the term internally, intentionally
connect. What is interesting is, when I started, the annual load factor was 58%. If you go back 20 years ago, if my
memory serves me right, it was 66%. Now, it's 85% – 84%, 85%. So there's been a significant boost, but the
boost of non-stop versus connecting traffic hasn't moved much at all, maybe 3 percentage points or 4 percentage
points.
So the net result of that is we are carrying more connecting traffic. We're carrying some of it more on purpose, if
you will, as opposed to by accident in the old days. But there's still a very – a real serious focus on point-to-point
non-stop. That's the way our network planners – it's the philosophy and that is the strategy.
What – I did want to use it as an opportunity though to complement them, because the load factors have gone up
20 to 30 points over a 20 to 30-year time period. And it's not because they have converted us to a hub-and-spoke
operation where we're more dominated by connecting traffic. It was really accomplished by optimizing the flight
schedule better and in some cases, thinning out some of the frequencies in our higher-frequency markets, but not
at the expense of the non-stop traffic.
Andrew Watterson, our EVP over commercial is here with us, and he may remember – I don't remember off the
top of my head exactly the percentage of whatever you think the relevant statistic would be that we intentionally
connect in terms of capacity. But it's obviously, Jamie, not the majority of our ASM. So, Andrew, do you recall
what that statistic is? ......................................................................................................................................................................................................................................................
Andrew Watterson Chief Revenue Officer & Executive Vice President, Southwest Airlines Co. A I would call slightly above 20%.
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Jamie N. Baker Analyst, JPMorgan Securities LLC Q Okay. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A And I think that was your specific question, but that – hopefully the background helped a little bit as well. ......................................................................................................................................................................................................................................................
Jamie N. Baker Analyst, JPMorgan Securities LLC Q Yeah, I know that, Gary. Thank you. That's terrific. And for a follow-up, the goal to maintain positive RASM for the
year, you're starting respectably at the 1% to 2% level. Presumably, the second quarter is no worse, probably
better. But given that capacity surge year-on-year in the second half, your annual aspiration would seem to imply
that you remain in positive territory in each of the four quarters. Assuming that's directionally accurate, what's the
driving factor that really gives you the confidence in second half positive RASM on at a higher base of year-on-
year capacity? Is there anything specific? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A I do think there are a couple of fundamental specifics. The – and, first of all, your direction, I believe, is correct.
Now, admittedly, 1% to 2% outlook for the first quarter doesn't give us a lot of cushion for things to go sideways.
So I'll admit that on the outset. And that I think obviously applies even more to quarters two, three and four, just –
we just don't have as much visibility there. But when we get to the second half of the year, we should have a
much better schedule.
What I'm real proud of quite frankly in the fourth quarter is that we achieved pretty healthy unit revenue gains with
a not-so-great schedule. Because what has happened is we have retired, Mike, 50 airplanes in the third quarter.
The fleet shrunk. We tried to maintain a schedule presence that wasn't that different. And you have to take into
account seasonality dips that we would have scheduled anyway.
But in order to generate roughly the same amount of flights with fewer airplanes, we had to extend the day of the
airplane into times of the day that aren't as profitable, quite frankly. So there is a fairly significant discount to have
a flight operating at 9 PM as compared to operating at 6 PM. So all that means is that we believe we'll have a
superior schedule in place that will yield better by the time we get to the second half of this year. So that's point
number one.
And then point number two, notwithstanding the angst that I note yesterday and today about the industry, we've
got a new revenue stream in effect, it's coming online this year, that Tammy and our team is still pretty confident
that will hit in the $200 million range. So that should pick up throughout the year.
And I think that those are both pretty significant points. And nobody ever knows what the weather's going to be.
We can't really tell you what impact we're going to have from competition or the economy. One would hope the
tax reform is at least a floor on travel demand. We're not doing anything overt to plan for a pickup in travel
demand because of that. But obviously, we're hopeful that that will be a lift as well. ......................................................................................................................................................................................................................................................
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Jamie N. Baker Analyst, JPMorgan Securities LLC Q Gary, this is great. Thanks so much. Take care, everybody. ......................................................................................................................................................................................................................................................
Operator: We'll take our next question from Jack Atkins with Stephens. ......................................................................................................................................................................................................................................................
Jack Atkins Analyst, Stephens, Inc. Q Hey, good afternoon, everyone. Thanks for taking my questions. Gary, just to start off, I have a couple of tax
reform questions. But Tammy referred to this in her prepared remarks, but would love to get your take on as well.
Southwest is really in this unique position among airlines, because you guys are the only airline that will benefit
immediately from the cash tax savings as well as through new lower corporate tax rate.
So I would love to get your thoughts for a moment on just how you all are prioritizing this increased cash flow?
We've already seen the special bonus to employees. But beyond that, are you all thinking about increased
reinvestment in the business? Or should we be thinking about a step-up in capital returns to shareholders
because it seems like your free cash flow could really step up quite a bit because of tax reform here? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A I'll just offer a unsolicited editorial comment that it's about time that we level the playing field competitively on this
matter, as well as comparing our industry to other sectors. And, obviously, Jack, you're well informed on that. But
we're very happy with that. It helps us lower our cost, and we're not going to squander these savings. It puts us in
a much better competitive position. So the priorities are – I don't know if they are equal, but clearly, we'll want to
use this as an opportunity to keep our overall cost structure low, so that we can keep our fares low, drive strong
load factors and to continue to support our growth plan.
There's enough money available to us where we can think about investments in the business. And Tammy
explained well what we did with our Boeing order. But in terms of putting additional capital to work in the business,
we have two basic options: We can buy more airplanes and use them to grow the fleet, or we can buy new
airplanes and use them to replace older aircraft. And we have opportunities certainly in the latter that we'll be
exploring aggressively. The Boeing order is an example of that. So there may be more opportunities there in the
future.
I do want to be clear and say that we are not today thinking that we are going to increase our growth rate by
buying more aircraft. If that happens because circumstances support that, I think we'll all be very happy, but that
is not what we're thinking today.
In terms of taking care of our – so I've talked about customers, I've talked about investing in the business. In
terms of taking care of our employees, we're 85% unionized. So labor, I've read some what I would call
uninformed comments in the media. All compensation has to be negotiated with covered employees. So that is a
separate issue.
And then finally, in terms of continuing to support our shareholders, it just puts us in a stronger position to
continue doing what we've been doing, which is for the past, I can't remember, Ryan, how many years we've
increased the dividend annually. And we have obviously sustained a very healthy share repurchase program.
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And I think it is worth mentioning, last year was a rough year in terms of Mother Nature and in terms of some of
the tragedies around the country. And it's a source of immense pride at Southwest that we're able to support our
communities, and I was very happy that we were in a position where we could actually boost that support also. ......................................................................................................................................................................................................................................................
Jack Atkins Analyst, Stephens, Inc. Q Great, Gary. Thank you for that. Thank you for that color. Asking about tax reform from another angle though, one
area that I think folks are sort of under-appreciating is the potential for boost to the economy in the relatively near
term from tax reform hitting folks' pocketbooks sooner rather than later in addition to increased business
confidence. So you said in your comments earlier, you're not preparing or planning for increased travel demand,
but as you think about how this sort of progresses over the next several quarters, as we go into the spring-
summer travel season and as we get into the peak travel season into the fall, it just seems to me like there is a
real opportunity here for a pickup in leisure travel in addition to business travel. Just would love to get some more
thoughts from you on that specific topic. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Well, Jack, I agree with you. Again, I just don't want to give people the wrong impression about what we're
committed to do today. But I realize there's angst amongst some about the growth rate of the industry, but I think
a lot of people expect that GDP growth will accelerate. I think it will be very logical to assume from that that you
could see a boost in travel demand. Honestly, I think people should calm down, and I think this could prove to be
much ado about nothing.
Now, we're growing this year, and we are planning to add new service to Hawaii. We're going to open up Paine
Field in Everett, Washington. And we're a growth company and we know how to do this, and we will want to
manage our growth very carefully. The success for us is dependent upon keeping our costs low, so we can keep
fares low and we can attract new customers either by stimulating or by moving them over to Southwest.
I think what you're talking about is, I don't know if it's a safety net, but it ought to provide some support for the
current growth plans. And, again, I just would reiterate that we haven't changed our growth plan because of tax
reform, but it should put us in a position where that is more of a realistic option in the future.
It won't happen for us in 2018, Andrew. I mean, we have the potential to push our utilization somewhat, but not
much, and probably not. So I think any future growth thoughts, in my opinion, would be beyond 2018 in any event.
And I'll just reiterate one more time what Tammy reported in terms of exercising the Boeing orders has no impact
to what our growth plans were or are for those years after 2018 as well. It's simply firming up options that we had
planned to exercise in any event, and now we have the right economics to go ahead and move forward and make
that commitment. ......................................................................................................................................................................................................................................................
Jack Atkins Analyst, Stephens, Inc. Q Okay. That's great. Thank you again for the time. ......................................................................................................................................................................................................................................................
Operator: We'll take our next question from Hunter Keay with Wolfe Research. ......................................................................................................................................................................................................................................................
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Hunter K. Keay Analyst, Wolfe Research LLC Q Hey, thanks, everybody. Hey, Gary, I kind of want to continue this talk of fleet that we've talked about a little bit in
the call. Would you consider a new fleet type if there was significant cockpit commonality and maybe just overall
commonality with the 737? Or did your experience with AirTran's 717 sort of totally sour you on that concept? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Hunter, no, it did not, but I just will repeat what I know you know. But the opportunity for us with the 717 versus
the 737 trade-off was an opportunity to replace a smaller airplane that was not common with a bigger airplane that
is common at the same cost. So it was a no-brainer, and that trade alone, Tammy, as I recall was worth couple
hundred million dollars a year. So that's part of the earnings boost that we're realizing over the past five years.
But no, we could have done it. Now, it might never got to the point where we integrated that aircraft into
Southwest Airlines. So every flight that it took after we acquired AirTran was on the AirTran operating certificate.
So we have – we never – we haven't realized what you're asking. I think the time horizon is important in
answering your question. I would assume that in a generation that we will be open-minded to what you're
suggesting in terms of my opening comments about thinking about 2018 and what's our focus, it's focused very
much on the basics, running a great operation, offering great customer service and managing our cost.
It is not anything that we are thinking about for 2018, 2019, 2020, 2021 as far as the eye can see. There is no
work underway here at all to think about a different airplane. I don't believe we have optimized our fleet mix yet
with a mix of 800/MAX 8 versus 700s, and of course, we don't have a MAX 7 yet. So I do think that there is an
opportunity to continue up-gauging here for some time.
And that also sort of puts off any serious thought about adding a different fleet type, because we don't have what
we consider to be the optimal fleet yet anyway. Boeing has other variations. They've got the MAX 9. Right now,
we don't – I don't sense that we have any interest in that airplane. There's a MAX 10 coming. And then there –
what's casually referred to in the media as the 797 or the 757 replacement. Both the MAX 10 and the idea of the
757 replacement are things that we'll talk to Boeing about, just to make sure we understand what those airplanes
do, what they don't do, but there's no serious effort to bring them on board.
And so, finally, Hunter, it would be a lot of work, I will admit to you, it would be a lot of work for us to take that on
because we are hardwired to operate the 737. We certainly have better capabilities today than we did when we
bought AirTran to take that work on, but it doesn't mean that it would still be free of cost or free of effort. And right
now, it's – we have immense opportunities to grow with the 737 MAX 8, MAX 7 that we're very excited about. That
will be our focus, I think, for a long time. ......................................................................................................................................................................................................................................................
Hunter K. Keay Analyst, Wolfe Research LLC Q Okay, that's very helpful. Thank you. And then just maybe a quick one, I appreciate the commentary on margin
expansion. And just to be clear, that's even with moving 150-some-odd-million-dollars of option premium expense
above the line. You are referring to EBIT margin when you talk about expanding margins this year. Is that correct? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Yes. Yes, that's correct, even with that.
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Hunter K. Keay Analyst, Wolfe Research LLC Q Great. Even with that. Okay, thank you. Appreciate it. And by the way, that $150 million, is that about right,
Tammy? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A That's – it's actually 135-ish for the year. And by the way, since you're asking about that, our goal would be to
bring that down in 2019, and we're budgeting somewhere in the $80 million range for that. So that will be a nice
tailwind for us as we move [ph] into 2019 (00:42:41). ......................................................................................................................................................................................................................................................
Hunter K. Keay Analyst, Wolfe Research LLC Q Okay. Thank you so much. ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Very welcome. ......................................................................................................................................................................................................................................................
Operator: We'll take our next question from Duane Pfennigwerth with Evercore ISI. ......................................................................................................................................................................................................................................................
Duane Pfennigwerth Analyst, Evercore ISI Q Hey, thanks. I wonder if you could – I know you haven't given guidance based on the new accounting standard,
but maybe just high level, what you think the impacts would be to revenue growth, unit cost growth and margins in
2018. ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Well, we're still looking at all of that. So I really would rather wait and provide all that for you in the 8-K. We're just
in the middle of finalizing all those results. So if you could just be a little more patient for us, we'll come back with
a very robust report later this quarter. ......................................................................................................................................................................................................................................................
Duane Pfennigwerth Analyst, Evercore ISI Q Okay. And then just how are you thinking about your cash tax rate under the new regime? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Our tax rates have been more in like the 20% range. And we'll – I wouldn't expect it to be any worse than that as
we move forward. We're still working through some of the technicalities on the depreciation rule. But by the time
we get to later this year, we're expecting full 100% expensing in the year that we acquire the aircraft.
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So we're still working through a little bit of that to finalize it, but obviously, it will have a very meaningful impact on
our cash taxes for the year. And as we noted in the earnings release, we expect that to be in the hundreds of
millions of dollars a year, and that's both on a P&L perspective as well as on a cash basis. So it's very significant. ......................................................................................................................................................................................................................................................
Duane Pfennigwerth Analyst, Evercore ISI Q Thanks very much. ......................................................................................................................................................................................................................................................
Operator: We'll take our next question from Savi Syth with Raymond James. ......................................................................................................................................................................................................................................................
Savanthi N. Syth Analyst, Raymond James & Associates, Inc. Q Hey. Good afternoon. Just on the – just a follow-up, Tammy, on the fuel hedge comment. And I was glad to hear
that the target is to bring the premium down. But just curious with lot of the – it doesn't seem like you're getting
much of a asset here in 2018, even though fuel has kind of ran up. So I'm guessing the kind of catastrophic levels
that you're pinning the hedges that are pretty high. Given that most of your competitors aren't hedging either, I
mean, what's – maybe a better question is, how are you shifting your hedging strategy because it doesn't seem to
be necessarily paying off? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A We just look at it differently, Savi. The hedging strategy is really insurance protection for us in the event we see a
spike in fuel prices. And it will start kicking in and showing some nice gains here, and in fact, we're already seeing
that. But it's really designed to provide protection should we see an unanticipated spike in the fuel prices.
So we set our premium budget every year and with the goal that we would have very meaningful protection
should prices rise to more catastrophic levels. But in the meantime, we're actually seeing some nice gains here.
And you'll see another jump up as you get into even the $75 per barrel range. And, Savi, if you look at our
sensitivity analysis that we normally provide, you'll see what I'm referring to. But it's really designed for us so that
should prices rise, we have time to adjust the business to those higher input costs. So we really think of it little bit
more as insurance protection.
Now, going forward, more tactically, the technique that we're using going forward, we're mindful of the downside
exposure and the way we have our hedges layered on, we do not have any downside risk or floor exposure over
– well, for our entire hedge book. So I think we are very well positioned. ......................................................................................................................................................................................................................................................
Savanthi N. Syth Analyst, Raymond James & Associates, Inc. Q And, Tammy, just a follow up, the targeted – the $80 million, how do you achieve that? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Pardon me, Savi? ......................................................................................................................................................................................................................................................
Savanthi N. Syth Analyst, Raymond James & Associates, Inc. Q
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How do you achieve the reductions to $80 million? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A That we've been layering on our – we've been layering on our hedges and where we are – by doing that, we've
had opportunities to build what I would say are very nice hedge positions at very reasonable fuel premium levels.
So, keep in mind, we've been building up to these levels and that's the result of the price of the options that we've
put in place. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A And, Savi, I didn't look back at the press release, but there's a heavier weight in 2018. So 2019 is a really good
hedge. It's got a nice balance between how much money we've spent on it, the coverage that we get and then the
sensitivity that Tammy has provided in there. So it's really a very clean hedge, as is 2020, we're off to a good start
with that one. 2018 has a little slop in it as I recall, Tammy, because we had to go in and unwind some of the puts
that were on. So there was little bit of penalty, if you will, in terms of the way that that year was built.
But if part of your question is do we think $135 million is the right number, no. Tammy and I both agree. That's
more money than we want to spend on the program, especially considering that our margins are handsome and
that we have opportunities to grow the margins in addition to that. So we're willing to absorb more risk with energy
prices going up than we were going back to 2012, 2013 when we had much tighter margins and a more ambitious
transformation plan that was underway. So we have a different time, we have a different opportunity, and I think
our folks have done a great job of taking full advantage of that. ......................................................................................................................................................................................................................................................
Savanthi N. Syth Analyst, Raymond James & Associates, Inc. Q That's all very helpful color. Thank you. And just a quick one on the unit revenue, you mentioned that the demand
– so the demand was strong in the peak period. Just kind of curious what you're seeing in the off-peaks. And just
wondering if this industry just has a little too much supply in off-peaks, and if there's anything we can do about
that as you kind of continue to layer on supply? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Demand for us, Savi, through the first quarter, as you could see from our load factor performance, was very
strong. We're generating record load factor performances. And, of course, the story there has been at lower
yields. Certainly, when we're in off-peak seasons, I think it's fair to say we all have to work a little harder for that
demand. But as you could see from our fourth quarter performance and based on the outlook that we've provided
you earlier in the call that we're seeing very nice demand even in the off-peak period. ......................................................................................................................................................................................................................................................
Savanthi N. Syth Analyst, Raymond James & Associates, Inc. Q Great. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A
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Andrew, you can comment on this too, if you would like. But the industry over time has gotten better and better at
varying capacity according to seasonality. And I think it's probably fair to say that we were a little late to that game
because we were just hardwired to have a constant schedule throughout the year, but now I feel like we have fully
caught up there.
So you have some – some of the competitors have a more pronounced peak and valley in terms of the scheduling
than others. But the capabilities are there, and I just – again, I'll speak for Southwest. I think we do a pretty darn
good job of matching that. Now, we felt like going back to 2017 that we had one schedule that maybe was a little
bit too long and didn't move into the seasonally softer period fast enough. I don't know that I would call it a
mistake per se, but it is a change that we've already planned for 2018 as an example.
So it's an iterative process. You learn as you go. And school in, school out, the timing of holiday, all these things
are fairly complex inputs. But I agree with what Tammy said, we're looking at a record load factor potentially here
again in the first quarter, so the demand is there and even with seasonality. ......................................................................................................................................................................................................................................................
Savanthi N. Syth Analyst, Raymond James & Associates, Inc. Q Okay. Very helpful. Thank you. ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A But one more comment just to add on to that with – particularly with some of our new international markets that
does provide us opportunity to maybe do a little more seasonal flying than what we've done historically as well. So
our commercials folks do a fantastic job managing through those off-peak demand periods. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Yeah. And what we don't do is we don't vary much by day of week. And that is something that we have on our to-
do list to get better at that. We do vary by day of week, but not as much as we know we could. So it's an
opportunity for us prospectively. ......................................................................................................................................................................................................................................................
Savanthi N. Syth Analyst, Raymond James & Associates, Inc. Q Okay. Great. Thanks, guys. ......................................................................................................................................................................................................................................................
Operator: We'll take our next question from 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. Gary, I have a question for you
about Houston and Dallas specifically. With oil prices up $20 in the last five or six months, are you seeing better
system traffic out of those two locations than perhaps elsewhere in the network? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A
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Well, Midland is the one that's so easy to see plus or minus, and it's really strong. I will say, after this really
tumultuous time in the energy markets over the past three to four years, we just haven't suffered in our energy
markets like you're remembering decades ago. So it has been interesting. And, of course, you've also seen the
U.S. oil and gas activity haven't collapsed. They've managed their way pretty effectively to $50 crude oil.
So I don't – Andrew, I don't think that we've seen a very significant variation there. I think what is – what you see
in a more pronounced way is where there's just a lot of competitive activity, and that, of course, is out in the West.
But Texas is an entity and Houston, Dallas specifically both look very strong. And again, I don't know that I would
attribute that to a change in the last quarter of oil prices up $10 a barrel. I don't think that that activity has
fluctuated all that much. ......................................................................................................................................................................................................................................................
Andrew Watterson Chief Revenue Officer & Executive Vice President, Southwest Airlines Co. A Over a long horizon both cities have become much more economically diversified. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A And then... ......................................................................................................................................................................................................................................................
Andrew Watterson Chief Revenue Officer & Executive Vice President, Southwest Airlines Co. A And even Houston itself with how it's going with southside of town, a significant medical industry in the southside
of town, it continues, no matter what the economy. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Yeah. ......................................................................................................................................................................................................................................................
Helane Becker Analyst, Cowen & Co. LLC Q Got you. Okay. And then, just a question on Hawaii. Tammy, you made a comment in your prepared remarks
about sort of a bit of a headwind with ETOPS qualifications, et cetera for this year. I mean, is that – given how big
the airline is and the comments that you guys just made about more diversification, is that a just de minimis cost,
or will we actually see that in the numbers? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Yeah, Helene, it's de minimis. And yes, and I was referring to – that was just the investment for – to get started in
Hawaii and the spend related to ETOPS. So I just want to be clear. We're on track with respect to ETOPS. And
it's all green at least at this point with respect to our plan to start service to Hawaii. And yes, the spend related to
that, it really isn't that significant. ......................................................................................................................................................................................................................................................
Helane Becker Analyst, Cowen & Co. LLC Q When... ......................................................................................................................................................................................................................................................
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Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A And just a... ......................................................................................................................................................................................................................................................
Helane Becker Analyst, Cowen & Co. LLC Q Go ahead. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A I was just going to give you an update on the when, W-H-E-N, that while I agree with Tammy that we are on track
with our work plan, we're just now – that means that we're at the point where we have submitted to the FAA an
application. And now the work begins with the FAA, if you will, although we've been partnering very well with them
on the application up to this point.
So we don't have any further update today on when we might be publishing and when we might be flying. Our
goal is to do both this year, but I think we're all very confident that we'll at least be selling by the end of this year.
But there's really no more information to offer up, other than we are at least on track with our own work plan up to
this point. ......................................................................................................................................................................................................................................................
Helane Becker Analyst, Cowen & Co. LLC Q That's great. Thank you so much. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Very welcome. ......................................................................................................................................................................................................................................................
Operator: We'll take our next question from Brandon Oglenski with Barclays. ......................................................................................................................................................................................................................................................
Brandon Oglenski Analyst, Barclays Capital, Inc. Q Hey. Good afternoon, everyone, and thanks for getting me on the call. Tammy, I just want to come back to the
comment about margins. When you say margins up, that's including the hedge gains and losses year-on-year,
right? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A That's right, to be very clear, yes. ......................................................................................................................................................................................................................................................
Brandon Oglenski Analyst, Barclays Capital, Inc. Q So if we were to back out the hedge loss last year and the hedge gains this year, then we're probably going to be
flat to down on margins, right? ......................................................................................................................................................................................................................................................
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Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Are you talking 20...? ......................................................................................................................................................................................................................................................
Brandon Oglenski Analyst, Barclays Capital, Inc. Q Right. Well, that's for us to do. I know you haven't guided to that. So I guess my question is, with your RASM
guidance for the first quarter, when do we start to realize the benefits from the reservation system? And can you
talk through what those are, again? Because I know we had some negative impact on the implementation in 3Q
and 4Q. I think you guys said on your last call that it should have been out of the run rate of revenue by now. But
can you give us an update on how we should see that progress through the year? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Sure, I'd be happy to. We don't have exact numbers to give you today, but certainly directionally, the impact here
in the first quarter; we're not expecting that to be significant at all. And then as we move into the second quarter,
we should start seeing some benefit, but we will just be picking up some steam there.
And then, really the bulk of the benefit will be in the second half of the year. So I'm hesitant to throw out any
numbers because we're in the middle of all of this. But by the second quarter, we're hopefully ramping up to
something more in the $50-million-plus range, and then with the bulk of the benefit again coming in the second
half. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Let me clarify your margin question though. The guidance that Tammy offered up and then I offered up is that
CASM, excluding all the items, would be flat to down, number one. So it excludes fuel. So then, number two, we
told you that we're in a positive unit revenue outlook for the first quarter, and that's our goal for the year. So that
margin expansion is coming without fuel. And I was careful to mention that fuel prices, it was excluding fuel
prices. So you'll have to factor fuel prices and on a hedge basis then to determine the operating margin effect of
that. But based on futures prices right now, we would have margin expansion for the year. ......................................................................................................................................................................................................................................................
Brandon Oglenski Analyst, Barclays Capital, Inc. Q Right. And I understand that. And I guess that would be my follow-up question. I mean, it's been a tough two days
for airlines stocks here. What I'm insinuating is that if we back out the hedges, like if we just took you to market
rates on fuel, it's pretty tough to get margins up, it's not even down this year. And that's the case for a lot of
airlines. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A No. No, that's not what I said. I said without fuel, our margins would be up. So I think in other words, keeping fuel
constant or however you want to think about it, our margins would be up. CASM ex-fuel right now is – our
guidance that we gave you is flat to down. And RASM, the goal is positive. That means margin expansion without
fuel. ......................................................................................................................................................................................................................................................
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Brandon Oglenski Analyst, Barclays Capital, Inc. Q Maybe we're not talking apples-to-apples here, but the input cost underlying all this, right, has gone up a lot. So I
think what investors are looking for is – and I don't want you to comment about other airlines obviously. But what
are expectations for how does the industry adapt to an underlying higher cost structure? And when should we
start to see that? Because if I go through the – your capacity growth is about the same as you've been effectively
guiding to now for maybe the past three or four quarters. But obviously, the underlying cost of business have
come up a lot. So what should be the proper investor expectations for when we start to see some adaptation to
what is fundamentally a higher cost structure now? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Yeah, I understand. Yeah, obviously, we're not in line with the rest of the industry. We have a better outlook than
they do, superior margins, superior returns. And what they will do, I can't tell you. So I don't know. What we're
going to do is, what we've shared with you, we think we have a very superb position and outlook for this year. And
I'm, again, very excited about the prospects for 2018. We should see operating margin expansion given the
current outlook for fuel prices. And then, it will be even easier for us because of the tax reform to see even better
net margin expansion. ......................................................................................................................................................................................................................................................
Brandon Oglenski Analyst, Barclays Capital, Inc. Q Okay. Thank you, Gary. ......................................................................................................................................................................................................................................................
Operator: We'll take our next question from Michael Linenberg with Deutsche Bank. ......................................................................................................................................................................................................................................................
Michael J. Linenberg Analyst, Deutsche Bank Securities, Inc. Q Yes, good morning or good afternoon. Hey, Tammy, two questions. One is just on the CapEx for the year. I
believe that you indicated that aircraft CapEx would be [Technical Difficulty] (01:03:19)... ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Hey, Michael, sorry, you're breaking up a little bit there. Would you mind trying that again? ......................................................................................................................................................................................................................................................
Michael J. Linenberg Analyst, Deutsche Bank Securities, Inc. Q I'm sorry. Oh, sorry. I was asking about CapEx. And I think you're guiding to $1.9 billion, and I think you indicated
today that the aircraft piece is $1 billion. When we go back to January when you had your 8-K, I think you
indicated that it was a little bit less – it was going to be less than $1 billion. So maybe there's some rounding
there. So when I look at the non-aircraft piece, knowing that you did push I think $115 million into 2018, it still
seems like that that's a pretty high non-aircraft piece. Normally I think you're sort of in that $500 million, $600
million range when you don't have big projects underway. So I was just curious what's driving that, call it, $900
million, $900-million-plus of non-aircraft CapEx? ......................................................................................................................................................................................................................................................
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Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Sure. The non-aircraft CapEx, we're seeing – actually our technology CapEx, we're expecting that to be down a
little bit due to the completion of the One Res, and we're seeing a little higher mix of our technology spend hitting
OpEx. So that's impacting that. But where we're seeing the increase is really more in facilities. And we had some
plans related to some of our hangars, and that's impacting that and some investments relating to pilots training
facilities. So that's up a little bit. So we're seeing our technology down little bit, but that's being offset by an
increase in facilities. So those are the major drivers there. ......................................................................................................................................................................................................................................................
Michael J. Linenberg Analyst, Deutsche Bank Securities, Inc. Q Okay. Okay. So those are the big ones. And then just on the unit cost guide to be sort of flat to down. And I know
last quarter you said you felt confident about flat. And since then, the only thing that I can think that has changed
is that we had the fourth quarter bump up in 2017 on the employee cost, and I think that was like 3.5 points. Is
that the primary difference between the guidance today versus where we were a quarter ago? Or are there a
couple other things that maybe are helping to drive a better CASM outlook? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A No, you really nailed it, Mike. There's really nothing significant from the last update that we provided. But as you
already noted, we did have higher expense due to the employee tax reform bonus. So that made our comps a
little bit easier. But with or without that, I feel really – I think our comps outlook for this year is very solid. And as
ever, we are very focused on our cost, and we'll continue to be very diligent there in our cost control efforts. But
that's the primary driver from our previous guidance. ......................................................................................................................................................................................................................................................
Michael J. Linenberg Analyst, Deutsche Bank Securities, Inc. Q Agreed. Yeah, thanks, Tammy. Thanks, everyone. ......................................................................................................................................................................................................................................................
Operator: And we have time for one more question. We'll take our last question from Rajeev Lalwani with
Morgan Stanley. ......................................................................................................................................................................................................................................................
Rajeev Lalwani Analyst, Morgan Stanley & Co. LLC Q Good afternoon. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Hi. ......................................................................................................................................................................................................................................................
Rajeev Lalwani Analyst, Morgan Stanley & Co. LLC Q Gary, a question for you. You've obviously seen the announcement by United. And they seem to be pushing little
more aggressively in important markets to you. Is that something that investors should be concerned about? Or
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do you think that maybe they're looking at a different type of passenger than you're focused on and so there
shouldn't be much of an impact? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Well, admittedly, any time flights are added or flights are subtracted from a market, there is an impact. So I
wouldn't want to ever try to put one past you. It's just not truthful to say that, so added capacity will definitely dilute
some traffic. But I think back to the future there with Jamie's opening question, we focus on non-stop, low-fare
traffic, and a high-cost legacy airline does not. And there are many, many historic examples where we might have
a share of seats in a market, but a significantly higher share of traffic in that market. And again, it's because they
don't want to fill up their segments with low-fare customers at the expense of choking off the higher fare
opportunity that they have or they're connecting passenger through their hub.
In your life time, we've gone from being a very small player in Texas to the largest airline in the country,
fundamentally based on what I just described. It is a cost advantage that translates to a fare advantage, and we
generate a dramatic number of customers, over 130 million for last year. And, Tom, I think that's the second
largest in the world. ......................................................................................................................................................................................................................................................
Thomas M. Nealon President, Southwest Airlines Co. A It is... ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A So the markets that I recall that they spiked out, we had a very significant presence in. In one case, we have a
different airport, and I would argue, an airport advantage. So will it impact us? Yes. Will it harm Southwest
Airlines, is bold talk, but we should always be humble and always respectful of our competitors, and we are in this
case. But I think we have all the tools we need to continue to perform well in every market that were impacted.
And I just will remind you that 10 years ago, we were barely starting in Denver. And 12 years later, we're the
number one airline in terms of the number of passengers in Denver. So I kind of rest my case. In this case, you've
got legacy carriers who were not prepared, went bankrupt, shrunk. They shed cost and as – are using that as a
strategy and now an opportunity when times are better to try to reclaim some that they lost and gave up, and that
will be very, very hard battle for them. ......................................................................................................................................................................................................................................................
Rajeev Lalwani Analyst, Morgan Stanley & Co. LLC Q That's great color, Gary. And then, just another quick one for you. This may be for Tammy. You talked about just
[audio gap] (01:10:34) dollars from tax reform, et cetera. Should we take that to mean that the capital – the CapEx
numbers that you've put out for this year may be the floor, and maybe we should look to – for that number to
either move up or stay where it is going forward? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Well, we – well, it's not going to – I guess it wouldn't go down from here, we'll start there. But we've given you all
of our plans, at least so far. And just pointing back to what Gary walked you through earlier, any opportunities on
the capital side would probably be more along the lines of fleet in terms of opportunities to continue to renew our
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fleet. But right now, you have our order book. And we are at very manageable levels. But outside of maybe the
fleet and potential opportunities there to modernize and invest in the business in that way, but for 2018, there's
really – I think that would be our big opportunity. And we'll explore that, but again, I don't know if they would have
a meaningful impact here on 2018. ......................................................................................................................................................................................................................................................
Rajeev Lalwani Analyst, Morgan Stanley & Co. LLC Q Okay. Thank you so much. ......................................................................................................................................................................................................................................................
Operator: That concludes the analyst portion of the call today. Thank you for joining. Ladies and gentlemen,
we'll now begin our media portion of today's call. I'd first like to introduce Ms. Laurie Barnett, Managing Director of
Communications and Outreach. ......................................................................................................................................................................................................................................................
Laurie Barnett Managing Director Communications & Outreach, Southwest Airlines Co. A Thank you, Tom. I'd like to welcome members of the media to our call today. Before we begin taking questions,
Tom, would you please give instructions on how everyone should queue up for a question? ......................................................................................................................................................................................................................................................
Operator: Yes, ma'am. [Operator Instructions] We'll now begin with our first question from Mary Schlangenstein
with Bloomberg News. ......................................................................................................................................................................................................................................................
Mary Schlangenstein Dallas Reporter-Bloomberg News, Bloomberg LP Q Hi. Thanks for taking my question. Gary, you referred to uses of the tax savings. You noted that compensation
with your unionized employees is something that would have to be negotiated. So what you're saying is that you
would not do a mid-contract pay increase for your employees using some of that savings? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Well, I didn't say that, but it – in other words, we can – if the two parties want to negotiate, we can negotiate at
any time. I'm just pointing out the obvious, which is unilaterally, we're not going to wage – or increase wages
across the board, because we can't by federal law. So, all that has to be negotiated. ......................................................................................................................................................................................................................................................
Mary Schlangenstein Dallas Reporter-Bloomberg News, Bloomberg LP Q Okay. But you wouldn't rule out the possibility that you could do either open negotiation to do some sort of a side
agreement to a contract on increasing pay before the next contract's negotiated? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A I don't see that anything is different in 2018 than ever. So we have contracts in place. They take quite an effort to
negotiate. We have several contracts, Mike, that are up for amendment this year. So that will obviously be the
priority. So I'm not suggesting, Mary, that I think all of a sudden that we or our unions would want to do that. I'm
just pointing out that if the two sides agree, we can always do that.
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And our outlook is what we've reported. And any long-term commitments we make will always be with an eye
towards just trying to be prepared for the unexpected. And I think there were several questions earlier today about
fuel cost increases, and I was interviewed earlier this morning about my concerns on the outlook. And it's those
kinds of things that I am mostly focused on and concerned about, in other words, fuel – oil price increases and the
impact that that would have. So while we have seen significant reductions in our taxes, there are always other
challenges that we have out there. And all those things would have to be factored into any long-term
commitments that we would entertain. ......................................................................................................................................................................................................................................................
Mary Schlangenstein Dallas Reporter-Bloomberg News, Bloomberg LP Q Great. And just if I could clarify one thing you said. You made a comment I guess on the 737 9, and I didn't catch
what you said. Did you say you might be interested in that aircraft? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A I've said that as it stands today, we don't have any interest in adding that aircraft to our fleet. That doesn't mean
that we won't change our mind at some point. But the net of a long answer was, we love the 737 MAX 8. We're
working with Boeing on the 737 MAX 7. I'm sure that that will be a wonderful aircraft when it's ready, and that is
our focus. And we're not working on anything else when it comes to the fleet, just those two. ......................................................................................................................................................................................................................................................
Mary Schlangenstein Dallas Reporter-Bloomberg News, Bloomberg LP Q Great. Thank you very much. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Yes, ma'am. ......................................................................................................................................................................................................................................................
Operator: We'll take our next question from Conor Shine with The Dallas Morning News. ......................................................................................................................................................................................................................................................
Conor Shine Reporter, The Dallas Morning News, Inc. Q Hey, guys, thanks for taking the question. I'm just looking for a little bit of help to understand exactly how these tax
changes are going to play out over a little bit longer term. I know you guys reported the $1.4 billion being realized
from 2017. Is that of a similar magnitude you guys are expecting in 2018, 2019? Was that a one-time thing
because of – just the timing of these changes? How much are you expecting this to reduce what you guys pay in
federal taxes going forward? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A So, Conor, as a very quick background, the tax return doesn't match our financial statements. So they're just
different rules. So there is a tax liability on our books at a 35% tax rate that was related to all the years leading up
to 2017. And we would have to pay that $1.4 billion based on the tax returns in the future. So since taxes are now
at 21%, that's what's driving – it's simply reducing that liability from 35% to 21%, and that – the cash amount for
that would flow out over years in the future. That is not a proxy for what we would save each year now
prospectively. And I would just put it in the – Tammy had hundreds of millions. It depends on what our earnings
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are for 2018. But if the earnings are close to what they were in 2017, it's $0.5 billion. So it's a big amount of
money. And I think our investors all do the arithmetic and understand that very well, but it's that order of
magnitude. ......................................................................................................................................................................................................................................................
Conor Shine Reporter, The Dallas Morning News, Inc. Q That's helpful. Thank you. ......................................................................................................................................................................................................................................................
Operator: We'll take our next question from Dawn Gilbertson with The Arizona Republic. ......................................................................................................................................................................................................................................................
Dawn Gilbertson Senior Business Reporter, The Arizona Republic, Inc. Q Hi. Good morning. Two questions, first for Tammy on – you mentioned that EarlyBird revenue totaled $100 million
in the fourth quarter. And I don't remember your exact words, but you said, just to put that in perspective, that was
your initial target. Did you mean that is what you thought you'd get annually from EarlyBird when it was introduced
several years ago? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Yes, going back when – yes, that – the point I was making there is that it's been very successful. It's in high
demand by our customers. But yes, the point was is, we achieved $100 million in one quarter, which when we
rolled it out was our target for the full year. ......................................................................................................................................................................................................................................................
Dawn Gilbertson Senior Business Reporter, The Arizona Republic, Inc. Q Wow. Is this the first time it's hit $100 million a quarter? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Yes, it's been... ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A I think so. ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Yes, this is – which is – it kind of popped out to me, and so... ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Yeah, it was notable. Now, Dawn, in fairness, we're a bigger airline today than when we launched it in 2009. But
still, I mean, it's definitely well exceeded our expectations. ......................................................................................................................................................................................................................................................
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Dawn Gilbertson Senior Business Reporter, The Arizona Republic, Inc. Q What about – what's the total figure for the year on EarlyBird, Tammy? ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A For the full year – I will pull that for you real quick, but it would be roughly – if you'll hang on, we'll get back and
report back. ......................................................................................................................................................................................................................................................
Dawn Gilbertson Senior Business Reporter, The Arizona Republic, Inc. Q Sure. Okay. And the other question related to that is, I mean, any plans – you went from $12.50 – I can't
remember what it started at, but I know then $12.50 and then $15. Is it likely to stay at $15? Or given the success,
might that be due for an increase? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Well, we have to have some secrets. We're trying to keep our cost under control. We're trying to keep our fares
low. So I think we've got a good opportunity to hold firm here at least for the meantime. ......................................................................................................................................................................................................................................................
Dawn Gilbertson Senior Business Reporter, The Arizona Republic, Inc. Q For the meantime. Okay. And then the other question, Gary, for you, as it relates to Hawaii. I mean, I know you
said from the very start there is no guarantee you were going to start flying this year. But just in reading between
the lines of what you just said briefly, it sounds to me like the chances that you're going to fly there this year
sounds very, very slim. Is that... ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Oh, no. No, no, no, that's – I didn't intent that at all. No, I think our goal has been from the outset to be flying by
the end of the year. We didn't necessarily share all that with you, but that was our goal. Achieving that goal is not
totally within our control. I think what is actually encouraging is that in terms of the work that we do control, we are
right on target. And gosh, Mike, we're what, six months into this, and I guess three months after our
announcement? So we are well underway. I think there is a chance that we can be flying by the end of the year,
and that will be our goal. I think what we're much more confident in saying is that we'll be at least selling by the
end of the year. But I don't think that we are less likely to be flying than we have been. If anything, we may be
more likely just because we know now what we've been able to get done over the past six months. ......................................................................................................................................................................................................................................................
Dawn Gilbertson Senior Business Reporter, The Arizona Republic, Inc. Q What would you put the chances of flying this year at? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A
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I don't know how to do that because again, we're working with the federal government. And now, it will be
dependent upon their timetable. And then they may come up with work that we may be underestimated. So I just
don't know that there's any way to handicap that. But what I've told, our team is, in the grand scheme of things,
whether we're flying late this year or early next year, it won't matter over the next generation. I think mainly we
want to do this work. We want to do it. We want to do it well. We want to launch when everything is all lined up.
And if we get it done and we're up and flying by the end of this year, I'll be happy. I think everybody will be. If we
don't, it won't be the end of the world. ......................................................................................................................................................................................................................................................
Dawn Gilbertson Senior Business Reporter, The Arizona Republic, Inc. Q Okay. That's fair enough. When is the next schedule extension after February 15? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A Roughly 60 days later. You want to call that... ......................................................................................................................................................................................................................................................
Dawn Gilbertson Senior Business Reporter, The Arizona Republic, Inc. Q Will that take you through the end of the year? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A April 15. No. ......................................................................................................................................................................................................................................................
Dawn Gilbertson Senior Business Reporter, The Arizona Republic, Inc. Q Will that take you through the end of the year? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A No, it probably takes you into November I would guess. ......................................................................................................................................................................................................................................................
Dawn Gilbertson Senior Business Reporter, The Arizona Republic, Inc. Q Okay. All right. Thanks for the time. I appreciate it. ......................................................................................................................................................................................................................................................
Operator: And we have time for one more question. We'll take that question from Robert Silk with Travel
Weekly. ......................................................................................................................................................................................................................................................
Robert Silk Senior Editor, Travel Weekly Q Good afternoon. Gary, can you talk to me about the – sort of the appeal of Paine Field? Is there anything other
than just the fact that Sea-Tac is constrained, or does it bring more to the table than that? ......................................................................................................................................................................................................................................................
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Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A I do think it brings more to the table. It's attractive from a handful of aspects. So one is, we're really good at flying
to alternative airports. And it – if you have low cost and low fares, it helps people become aware of that option.
And so it is bringing something new in that sense. And so I'm forgetting Sea-Tac for a second. And the second
thing is, there is a significant pool of customers north of the city that just ground traffic constraints are such that if
they have a more convenient flight option, I think that they will take that. And we've seen that benefit again
throughout our 46-year history, if we can provide a more convenient airport, and I think that that sort of fits several
criteria.
This airport is going to be, by definition, a lot smaller. And I think for customers, that's a more pleasurable
experience in some ways. You don't have as many flight options, which is a drawback sometimes of a really small
airport. But all those things I think are very meaningful. But you hit on it on the point also, which is Sea-Tac for us,
we're constrained. And we do want to increase our presence in the Seattle Metro area, and this is a really good
opportunity for us to do that. And then finally, if we – there's only five daily departures left with what the airport has
planned for in terms of the real estate, I think they've got two gates. So if we don't move on this, we may likely
lose the opportunity and we'll certainly be able to accommodate five more round trips with our capacity plans. So
I'm excited about it. It's something that two years ago really wasn't on our radar. And I think it will be a nice
opportunity and a real plus for our customers in the Seattle Metro area. ......................................................................................................................................................................................................................................................
Robert Silk Senior Editor, Travel Weekly Q Just one quick follow-up, the five left or the five you're taking, or is it those five plus five more? ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A My understanding is that this takes the airport to 24 daily departures, and that is the capacity that they have built.
So it's not a governmental constraint, it is just the practical capacity of the terminal. ......................................................................................................................................................................................................................................................
Robert Silk Senior Editor, Travel Weekly Q Fair enough. ......................................................................................................................................................................................................................................................
Operator: And at this time, I'd like to turn the call back to Ms. Barnett for any additional or closing remarks. ......................................................................................................................................................................................................................................................
Laurie Barnett Managing Director Communications & Outreach, Southwest Airlines Co. A Thank you, Tom. I'm going to turn it back to Tammy to provide that answer regarding EarlyBird. ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A Yes. Dawn, that – it was just at $400 million for the full year. ......................................................................................................................................................................................................................................................
Laurie Barnett Managing Director Communications & Outreach, Southwest Airlines Co. A
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Thank you. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A That's convenient. ......................................................................................................................................................................................................................................................
Tammy Romo Chief Financial Officer & Executive Vice President, Southwest Airlines Co. A It's very convenient. ......................................................................................................................................................................................................................................................
Gary C. Kelly Chairman & Chief Executive Officer, Southwest Airlines Co. A 100 times four is really good. ......................................................................................................................................................................................................................................................
Laurie Barnett Managing Director Communications & Outreach, Southwest Airlines Co.
Excellent. Well, members of the media, if you have any other questions, our communications group is standing by
at 214-792-4847. Thank you. ......................................................................................................................................................................................................................................................
Operator: And that concludes today's call. Thank you for joining.
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