Southwest Airlines Company (LUV) — Q4 2015 Earnings Call Transcript

Thank you, Tom and good morning everyone. And welcome to today’s call to discuss fourth quarter 2015 results. Joining me on the call today, we have Gary Kelly, Chairman, President, and CEO; Tammy Romo, Executive Vice President and CFO; Bob Jordan, Executive Vice President and Chief Commercial Officer; Mike Van de Ven, Executive Vice President and Chief Operating Officer. 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 excluding special items, please reference 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. At this time, I’d like to go ahead and turn the call over to Gary for opening remarks.

Thank you, Marcy and thanks everybody for joining us today for our year-end 2015 earnings call. This was another superb and critical year for Southwest, and I am very grateful to all of our people for their hard work. I want to especially thank them for these terrific results. Tammy is going to take us through the quarter, but I want to offer up, not a comprehensive overview, but at least a few highlights. Of course, this was by far our best year of earnings in our entire history, and that includes a record return on invested capital of 32.7%. We no doubt benefited from 29% lower economic jet fuel prices. Obviously, that was a major component of our earnings. But so were record load factors, and revenues were up also very solid 5.6%. It was a strategic year for us in that we had secular growth opportunities at Dallas arising from the refuel of Wright Amendment and of course that has been a phenomenal success. We’ve also had secular growth opportunities out of Washington Reagan and LaGuardia arising from the acquisition of slots. It was also a year that followed the end of 2014, the completion of the AirTran acquisition and integration. A lot of new markets resulted from that. And then, of course, it was also a year where we had a unique opportunity to build an international terminal and launch international flights out of Houston Hobby. That was for the first time since 1969, by the way. All of that added up to capacity growth of 7.2%, and then of course we were delighted that traffic was stronger than that. It grew 8.8%. And as a backdrop, the economy for last year was solid travel demand was solid, and of course energy prices moved even lower. So the convergence of all of these things made 2015 a very successful year, but again one that was also very strategic for us. And we accomplished virtually everything that we set out to do, and in some cases where we didn’t, we at least laid significant progress. I'm very happy about that, but certainly that includes generating record operating cash flow, strong free cash flow, and we also returned a record $1.4 billion to shareholders in the form of share repurchases and dividends. So I want to make sure that I highlight two announcements from this morning's release. First of all, we announced that we will soon launch a $500 million accelerated share repurchase program. I'm sure you all saw that. And then second, we recently ordered 33 new 737-800s from Boeing, and that is spread out for delivery in '16, '17 and '18; the sole purpose for that is to further accelerate the retirement of our Classic fleet. So mechanically we did that by exercising six options, and then on top of that we placed new orders for 27 more. So you get to 33 more new airplanes. And then in addition to that, on our fleet chart, you'll also see that we have committed to two more used aircraft. But I just want to reiterate that our capacity plans for the next five years are essentially unchanged by this announcement. We're replacing the Classics with next generation airplanes. And then, in particular, our capacity plans for 2016 are unchanged and we still plan to grow this year between 5% and 6%. So the financial, operational, and customer service effects of these fleet announcements are all very favorable and Tammy will take us through all that. Work continues along three basic themes this year, as far as investment goes for the future. One, we have significant airport renovation and infrastructure projects underway across the country, some we're managing, some we're not. But big projects at LAX, Fort Lauderdale, Chicago Midway, and New Orleans. In Fort Lauderdale in particular will bring on new capacity for us in 2017. Number two, we've got significant commercial technology programs underway, and the headline on that, of course, is the replacement of a reservation system that's also targeted for 2017. And then finally, we have a major program underway with our operations technology, and the headline on that is the new 737 MAX, along with other very significant technology improvements that have been planned, and that is also a 2017 deliverable, at least with respect to the MAX. So for this year, in addition to focus on these investment programs, we want to do a handful of things. We want to continue to manage our network growth and mature our developing markets. Number two, we want to compete vigorously in an increasingly competitive environment. Number three, we want to continue to work on and improve the reliability of our operations. Next, we want to continue our focused hospitality of our customer service, and through all of this, we want to continue to grow our unit revenues, our margins, and our earnings. So there is nothing really fancy about our 2016; pretty basic blocking and tackling things. But clearly, 2017 is shaping up to be a pretty big year for Southwest Airlines. I just want to highlight for our Southwest people finally that our profit sharing for 2015 will eclipse last year's record and increase by 74% to an all-time record of $620 million, and I am very pleased about that. I'm very proud of them and their hard work, and I am very pleased that they're being justly rewarded with that. So Tammy, with that quick overview I'd love to turn it over to you and have you take us through the quarter.

All right, thank you Gary and welcome everyone. We're very pleased to report a standard year of record performance in 2015, representing our 43 consecutive year of profit. Our annual earnings, excluding special items were a record $2.4 billion or $3.52 per diluted share, which was an increase of 75% year-over-year. Our fourth quarter performance was also record-setting, and represented 11 consecutive quarters of profit. Fourth quarter net income excluding special items increased 46% year-over-year to $591 million or $0.90 per share, which was in line with consensus. Operating income excluding special items was a record $992 million, which produced a 5-point improvement in operating margin of 19.9%, which is the best fourth-quarter margin we've seen since 1978, and it's also worth noting like last quarter with and without the benefit of substantially larger rail prices, our earnings and margins improved year-over-year. And the record that really stands out is free cash return on invested capital, excluding special items of 32.7%. I would like to congratulate all of our outstanding employees on these fantastic results and like Gary, I'm thrilled we can reward our employees with a record-breaking profit-sharing of $620 million for 2015. Our total operating revenues in the fourth quarter were a record $5 billion, up 7.5% year-over-year on a capacity increase of 8.4%. Passenger revenues were also a record $4.6 billion. Demand for our low fares remained very strong throughout the quarter, resulting in more than 11% growth in traffic, and an all-time fourth quarter record high load factor. A softer yield environment resulted in a 7% decline in passenger revenue yields and an $8 decrease in our average fares. Our fourth-quarter operating revenues included a $125 million net benefit from the amended Chase contract and the required accounting treatment, and this $125 million benefit was about a 2 to 3-point improvement to RASM. For 2016, we expect to realize a year-over-year incremental benefit from the amended Chase agreement and accounting change, but once we reach the third quarter, we will, of course, lapse the year-over-year benefit. For our first quarter 2016, our estimated incremental benefit is approximately $110 million, and that is included in the RASM guidance that we provided. Our developmental markets continue to perform in line with our expectations, and Dallas continued to outperform the system on margins and return. International is also developing as planned, including our inaugural service from Houston, which was launched during the fourth quarter. Our fourth quarter RASM declined 0.7%, which was in line with our guidance. Considering a point impact from development markets and roughly a 2-point impact from increased competition, we're very pleased with our fourth quarter record and likely industry-leading revenue performance. Thus far in January, demand for our low fares remained strong, soft yet stable yields have continued thus far into the first quarter, and based on our current bookings and revenue trends, we are estimating first quarter 2016 RASM will be flat year-over-year. In light of the current yield environment, we're very pleased with our first quarter revenue outlook at this juncture. Our freight and other revenue production was also favorable. In addition to the incremental benefit from the amended Chase card that I mentioned earlier, our ancillary revenue production was strong, led by growth in EarlyBird and our upgraded boarding revenues. And we currently expect first quarter 2016 freight and other revenues to be comparable with fourth quarter 2015. I'll turn to our cost performance now, and our fourth-quarter unit cost, excluding special items decreased just under 7%, year-over-year due to substantially lower fuel prices and cost control, particularly our fleet modernization efforts. Our economic fuel cost decreased almost $200 million year-over-year, driven by a 23% decline in fuel prices. With the current state of the oil market and the oversupply situation, we currently expect another year-over-year decline in first quarter and full year 2016 economic fuel cost. Based on our current hedge portfolio for this year and market prices as of last Friday, we expect our first quarter fuel price to be approximately $1.70 per gallon, and I'll also provide you our estimates by quarter here. The second quarter is expected to be approximately $1.60 per gallon, and the second half we expect that to be in the $1.80 to $1.95 per gallon range, again based on last Friday. And that brings us to a full year 2016 fuel price per gallon in the $1.70 to $1.75 range. So with respect to our hedge book, our strong profit margins today call for a more conservative approach to hedging in this low fuel environment. We will continue to manage our existing portfolio to minimize costs as we burn off our 2016 and 2017 position. Prospectively, we'll focus on catastrophic protection with no downside risk, particularly in this environment for 2018. As we reported, we are 35% hedged, and that’s with all calls and call spreads. So while our hedging philosophy has not changed, our tactics have in this environment. And we will manage through our portfolio and just in the fourth quarter of 2015, we participated in 85% of the market decline. So I’ll take you through our non-fuel costs quickly. Excluding fuel and special items, our unit costs were flat, including a 30% year-over-year increase in profit sharing that our employees earned for fourth quarter 2015. Our profit-sharing expense accrued in the fourth quarter was $136 million, and that brings again the total for the year to an astounding $620 million, which again was a 75% year-over-year increase. Excluding profit sharing and special items, our non-fuel unit costs decreased 1.1% year-over-year, which was towards the more favorable end of our cost guidance, due primarily to a reduction in advertising and lower airport costs than we had expected. Our fleet modernization produced the expected $700 million in EBIT this year, and that’s even with the drop in fuel prices. Based on our current cost trends, we expect first quarter 2016 CASM, excluding fuel, special items, and profit sharing to increase approximately 2% year-over-year. And keep in mind that roughly one point of the year-over-year increase is driven by accelerated depreciation, which of course is a non-cash charge from our recent decision to accelerate the retirement of the Classic fleet that Gary took you through. For our full year 2016, we are currently estimating a 1% year-over-year increase in our unit cost, excluding fuel, special items, and profit sharing. And again, this modest cost inflation is almost entirely driven by the accelerated depreciation. And as a quick reminder, as we noted in our press release this morning, this cost guidance only reflects our current labor contracts. Therefore, it does not include the impact from the tentative agreement currently out for vote with our ramp operations provisioning and cargo both. I’ll move to our balance sheet and cash flows. And of course our balance sheet and cash flows remain very strong. We ended the quarter with $3.1 billion in cash and short-term investments and that's as opposed to being $835 million in cash collateral to third parties. We generated $3.2 billion in operating cash flow in 2015 and incurred $2 billion in capital expenditures. For 2016, we continue to estimate CapEx of approximately $2 billion, and I’ll cover our aircraft CapEx when I’ll review our fleet plans shortly. We returned $1.4 billion to shareholders in 2015, which exceeded our free cash flow of $1.1 billion. And we will have $200 million remaining on the $1.5 billion purchase program after we launch our $500 million accelerated share repurchase, which we will be doing soon. We repaid $213 million in debt and capital lease obligations during 2015, and issued a $500 million senior unsecured note at an all-time low 2.65%. And this was in light of our debt maturities of approximately $600 million here in 2016. Our leverage including off-balance sheet aircraft leases remains in the low to mid 30% range, and of course, we are very proud of our strong balance sheet, with an aggressive investment-grade rating that was further strengthened during the fourth quarter with an upgrade to BBB+ and that followed an upgrade in July by Moody’s to BAA1. We’re focused on preserving the strength in our balance sheet and cash flows, while continuing our long-standing track record of returning significant value to our shareholders. I’ll move now to our fleet and capacity plans. We ended 2015 with 704 aircraft in our fleet as planned and outlined in this morning's release. Our press release also included our future delivery schedule that I pointed to, which we restructured at the end of December in conjunction with our decision to further accelerate the retirement of our Classic fleet. I’ll quickly take you through the revisions that they included, the conversion of our remaining 25 NextGen-700 from orders to NextGen-800 from orders. And it included the addition, as Gary mentioned, of 33-800 firm deliveries and as he noted, some of those were options that we had exercised. And we had two additional -700s. We now intend to retire our Classic fleet no later than mid-2018, compared to our previous plan that had retirement skewing into 2021. We had a 129 Classic aircraft in our fleet at year-end. Roughly two thirds of our Classic aircraft were impacted by our decision to further accelerate the retirement; and the incremental leakage aircraft in our restructured order book is intended to backflow these aircraft while maintaining our current plans to keep our year-over-year fleet growth over the next three years to no more than 2% on average. The accelerated retirement plan is estimated to produce cumulative EBIT improvement of approximately $200 million over the acceleration period, primarily through maintenance and fuel cost savings. And I'd also note that this incorporates the approximate $100 million in accelerated depreciation that I referred to earlier. The overall customer experience will improve as well with a fully Wi-Fi equipped more modernized fleet. Our future capital commitments increased approximately 400 million as a result of the order book revisions and our 2015 capital expenditures increased $200 million to $300 million, primarily related to restructuring our order book. Our aircraft CapEx for 2016 is still estimated to fall in the $1.3 billion to $1.4 billion range, and our average aircraft CapEx for 2017 and 2018 combined is currently estimated to be in a similar range as 2016, which was very manageable. While the details of our Boeing agreement are confidential, the economics of our new order book are very supportive of our continued fleet modernization efforts. Overall, the internal rate of return on accelerating the retirement of our Classic fleet is estimated to exceed our return on investment, which we reported to you in 2015 of almost 21%. So it was a very easy decision for us. We are still optimizing our retirement schedule over the next few years, but we expect in 2016 to have roughly 720 aircraft. With regards to capacity, we ended 2015 as planned and we continue to plan for 5% to 6% year-over-year growth this year. And as we previously noted, the majority of 2016 capacity growth is related to the annualized impact of our 2015 expansion. So in conclusion, we ended an exceptionally strong 2015 with a record fourth quarter, and our outlook for first quarter calls for another quarter of strong operating margins approaching 20%. Despite a soft yield environment, demand held strong, producing record revenues. We currently estimate our first quarter RASM will be flat year-over-year based on revenue and booking trends. That's for 2016, which suggest the continuation of the strong demand in a soft yield environment. Substantially lower fuel prices and other cost controls contributed to our favorable cost performance in 2015, and our outlook for 2016 calls for modest cost inflation excluding fuel, special items, and profit sharing, driven largely by our decision to accelerate the retirement of our Classic fleet, which is expected to produce significant cost savings and EBIT improvement in the $200 million range. We continue to benefit from lower fuel prices and currently estimate this year's fuel cost to be more than $500 million lower year-over-year, based on Friday's prices and including our current fuel hedge. Our balance sheet is industry-leading, and our cash flows remain strong, and as ever we are committed to creating value, and we are very pleased that we were able to return over 100% of our free cash flow to shareholders in 2015. And as we announced this morning, we will be launching our $500 million accelerated share repurchase, which will leave $200 million remaining on our outstanding $1.5 billion buyback authorization. And again, our pretax return on invested capital was an astounding 32.7%. I would like to close by thanking all of our employees for their outstanding contribution to these very strong results. So with that Tom, we are ready to take questions.

I'm hoping to ask two and a half questions here. The half-question Tammy mentioned also relates to two TAs currently out, as they guided this morning regarding the impact assuming ratification. Are you prepared to provide similar guidance on what that would mean for the XL cabin guidance you just provided?

No Jamie, just out of respect, we will update that as we progress here.

Sure understood. So why don't we move on to Gary here, and another question on labor. Given your history of profitability, it's no surprise that your 737 wage rates came to represent the peak for U.S. Airlines easily over the last decade. But as the competitor wage bar begins to rise above yours currently, is it inevitable the Southwest path must establish a peak with every successful contract; or put differently, is your business model predicated on maintaining above-market pay scales, or was that just a byproduct of how poorly the competition was at one point?

I will try to answer your question while being respectful of the negotiation process. Our business model, Jamie, focuses on delivering great service at a low cost. Every employee at Southwest Airlines is committed to that, and we all need to keep working hard to uphold those principles. Our goal has never been to be the highest paying airline in the industry. If we are able to offer competitive wages while achieving great results, that's fantastic, but it all needs to be negotiated with our labor groups. The primary aim for us is to maintain a healthy company that is safe and financially strong. To achieve this, we must continue providing excellent service and strive to be the low-cost producer while upholding our low fare brand promise.

And as a follow-up to that last point you've made, and I guess this echoes the discussion that you and I had at the Wings Club. You've never faced a larger percentage of competitive capacity that have lower costs than your own than you currently do. In fact, last time you faced a formidable competitor with a superior cost structure, as near as I could tell, you brought them. So I'm wondering how growth at Spirit and Frontier, given their cost structures alters how you think about your own business going forward?

Let me just affirm virtually everything you said. The only edit I would make is that actually when we acquired AirTran, their costs were not lower than ours interestingly enough, at least by my analysis. But clearly there are carriers today whose costs are lower. On that point you and I certainly agree. And first of all, I think that is inevitable that overtime that an industry will get more competitive, especially when there is a disrupter as there has been with Southwest Airlines. So it is not shocking at all that we have more intense competition today than at any time in our history. And it is a challenge for our company and something that I'm very confident that our people will rise up to that challenge. But indeed, it will put an obligation on us to continue to innovate and work very, very hard so that we don’t lose our low fare leadership position in the country. So absolutely, it is different and I think we recognize that the industry is more competitive today than it has been ever. I would quickly add, by the way, that Southwest has never been stronger. We've never had the route network. We've never had the depth and the breadth of the service that we offer. And we've never had a balance sheet this strong, we've never had earnings this strong. So it's really up to us to continue to make sure that we compete and be the best at service and price.

So the hedge liabilities you called out for '16 and '17, appreciate that detail. I'm just wondering, can that change or is it fully locked in at this point? In other words, if fuel goes higher, does it shrink?

If fuel prices increase, our expenses will decrease. I want to emphasize that while our positions are not completely locked in, the key point is that as prices fall, our fuel costs also decrease. I've provided detailed information regarding our hedging strategy, and I believe we are well-prepared. We understand how to manage our situation, whether fuel prices rise or fall from this point.

And then as we think about the capacity that you had in development last year and specifically the Redmond markets, can you help us quantify the benefit you expect, having less of that capacity in development? And if you can help us with sort of the full pie, maybe you could just talk about the markets that you launched in late 2014 that you should've had basically a year of experience with by the fourth quarter, if you saw sort of significant RASM improvement there. And thanks for taking the questions?

Duane, we understood your question despite some audio issues. Yes, we can quantify the internal opportunity we see. I want to highlight that this assumes a constant situation, and I'm sure you and others are aware of that.

Yes, I have a few comments that might assist you, Duane. As you mentioned, a high percentage of our markets are still in development. You are aware of these markets, and I want to emphasize that these high percentages include the market transitioning from AirTran to Southwest. It's important to note that not all markets are the same. We've shared a lot of information about Dallas Love Field and are pleased with its progress. However, we wouldn't expect our international markets to develop at the same pace as Dallas or the former AirTran markets. Each market has its own characteristics, but I can at least provide some insight into the expected impact for the first quarter. In terms of development markets, we anticipate perhaps about a minimal impact, around 1 point. Moving into 2016, I expect that we will see some benefits as these development markets continue to mature.

I have two questions for you. First, with oil prices dropping significantly, how do you foresee this affecting your business in terms of revenue or capacity? Second, regarding the aircraft order you announced today, what led to the change in acceleration over the past couple of months? It seems like this opportunity has been available for a while.

Tammy, I'll take a moment to respond, and feel free to add your thoughts. I must acknowledge that this year has started with concerning headlines globally. It feels as though we are in a different reality here at Southwest, and I've noticed similar sentiments from our competitors. While our business remains robust, I cannot overlook the troubling news out there. This naturally leads to concerns about oil prices; having lived in Texas my whole life, I recognize this is an oil and gas state, and the potential impact on companies, debt obligations, and jobs is indeed worrisome. The United States has undeniably benefited from the oil and gas resurgence in recent years, especially following the recession, so these concerns are valid, and we share them. However, in terms of how this affects our business, we are not currently seeing negative impacts. Even in our oil and gas markets, which have faced yield pressures, we achieved strong results in the fourth quarter. Many markets continue to deliver attractive returns despite these pressures. That said, we will maintain vigilance regarding these trends. I mention this to highlight that we are aware of the world we are operating in, and we must stay alert and cautious. I also want to note that we believe our plan for 2015 was sound, and it has proven to be. Our follow-on plan for 2016 is likewise solid, albeit more conservative than our previous commitments. As Tammy and I have stated, we have not altered our capacity outlook for 2016, which still stands in the 5% to 6% range. We must be prepared to adjust if travel demand diminishes and discuss potential responses. However, we do not plan to increase our capacity to take advantage of lower energy prices. Tammy, would you like to add anything before we move on to the next question?

No, I think that was perfect. And in terms of your question on why did we decide to accelerate the Classics. I guess, I just have to say, we’ve been very pleased with the benefits from our fleet modernizations so far, and as we've continued to evaluate just the operating cost of operating Classic as it dwindles in size. We just really took out our pencils, evaluated it, and we were able to come up with a plan that actually is going to enable us to improve our EBIT at very modest capital levels. So I think you know our Southwest well. We prefer a simplified fleet, and even though the Classic fleet is a 737, we'd much prefer to operate 700s and 800s. It certainly simplifies a lot of the operations, and also just improves reliability in terms of just less downtime from a maintenance perspective. So I think we’ll also get a boost from the productivity of our fleet, which certainly was part of the EBIT contribution that we’re expecting. So all-in-all when we set down and evaluated it, it became pretty compelling to go ahead and accelerate the Classics. So hopefully that helps provide a little color as to what went into the decision-making process. Gary, did you have anything?

Tammy, regarding the timing of our decision, it's a valid question: why now? The answer lies in a combination of factors. We're currently at a fleet size that makes it reasonable to consider accelerating the retirement of older models. These older airplanes require more maintenance and are out of service more frequently than the rest of our fleet, which Tammy pointed out. It's important to stress that new airplanes will provide significantly better productivity compared to the Classics, which allows us to replace them without necessarily doing it one-by-one, although that is our plan. Additionally, we had the opportunity to work with Boeing, who had delivery positions available. We were able to reach an agreement that benefited both parties. This aspect was crucial. Furthermore, when considering our teams, such as pilots, flight attendants, and mechanics, operating the newer models is much easier compared to the Classics. This transition will streamline operations for all three groups, particularly for our pilots. Overall, if everything goes as planned, this will enhance the experience for our customers. We're pleased that we have this option now and that we could coordinate everything by the end of the year. The groundwork for this decision was laid out and vigorously pursued in late 2015, and we're fortunate that it all came together.

And just again on the cost obviously, as always, it's just part of our DNA at Southwest. We're very focused on costs and being the low-cost producer, and this is just yet another way to help us as we’re managing our costs here over the next several years.

It appears that for the first time in nearly five years, you did not buy back stock this quarter. You still allocated funds in the repo and executed the $500 million ARS. However, I expected you would have considered buying back stock after revising the revenue guidance. Did the decision not to buy back stock relate to the $800 million in hedge collateral, or can you share the reasoning for putting it on hold this quarter?

No, it had nothing to do with the fuel hedge collateral, and honestly, I wouldn't read anything into that at all. We are more focused. As we said this morning, we are launching a $500 million accelerated share repurchase and we'll get that launched soon. After that, we will have $200 million remaining on our $1.5 billion purchase program, which was approved at our shareholder meeting last night. We've gone through that authorization fairly quickly, returning more than 100% of our free cash flow in 2014 to our shareholders. I'm very proud of what we accomplished in 2014 regarding the share repurchases, which included our dividends. I don’t think there is anything more to it than that.

That's true. That was already a record amount, and we were also starting to have important discussions with Boeing about how that cash flow might come from that deal. I think what's important is that we have announced the $500 million today.

Thank you. It seems you are reducing capacity in the Love Field markets to LaGuardia and Reagan, and shifting some of that to the west. Is this related to the operational issues you are facing at Love Field due to the ongoing legal dispute and competition, or is it unrelated and based more on market demand? Any insight into this would be appreciated if the information is accurate.

Yes, our operations team has done an excellent job. They are managing around ten turns a day on a gate with less than full utilization of 18 gates. This means our operations are functioning well and once we gain full access to all the gates, we will be able to schedule more flights. While we typically make adjustments all over the country, the changes in Dallas are not as dramatic. However, we do make significant seasonal adjustments in markets like Seattle and Fort Myers, Florida. I also mentioned this morning that we have introduced a lot of new flights since October 2014. With these new routes, we acknowledge that in some areas we may have an excess of flights while in others we may not have enough, which requires continuous fine-tuning. At Love Field, we will still have 180 daily departures, which summarizes everything and addresses your questions effectively. Overall, we have some pros and cons with routes, and that is completely normal.

I was curious about the unit cost growth. With the increased capacity in the first half, I was surprised by the 2% growth. I know there was one point related to depreciation, but I am wondering about the timing or what contributed to such a significant increase in the first quarter.

Yes. You are exactly right, Savi. The guidance for the full year is more 1%. So you are exactly right. It's just the timing of when our expenses are falling.

Got it. Regarding the USCC question that was brought up earlier, Gary, do you have any thoughts on this? It seems the industry is experiencing some segmentation. I know that Southwest aims to be the leading low-cost, low-fare airline, but there's a difference in products and performance, whether that be in the product offering or the service provided. I'm curious about your thought process on whether you need to offer the lowest fare, considering there are product differences. Additionally, what are your thoughts on customer segmentation? Is there a customer segmentation at play, or is this simply a commodity business where the focus is on having the lowest fares?

I appreciate your question, and it's a good one to discuss. We aim to provide the best service at the lowest price. It's essential to compare unbundled pricing with our bundled approach. Overall, I want Southwest Airlines to have the lowest prices. Success comes from having the best service alongside that low price, which has been our tradition and foundation for growth. Accepting higher costs and fares based on service can be risky, as there are many examples of airlines that have followed that strategy without success. Southwest has managed to achieve both quality service and low costs. It's important to note that companies can change, and while some competitors may not prioritize service now, that could shift in the future. Thus, we must continually strive to excel in both areas, and even if we don't have all the answers at any given time, this principle should guide us.

Two quick ones here. When we started the quarter, the guide was for RASM to be up about 1%, and as we moved through much of the quarter, that number was out there. And then, about a month back you took guidance down. And when I think about across the industry, we did see some, some of the carriers come in with weaker than expected at revenues. Some of it was fuel surcharges, some of it was FX, some of it was the Paris attacks. Those are to take some things that I didn’t think impacted you on one hand. Then on the other, we did hear that some airlines just ran a better operation because the winter weather wasn't that bad. So I am curious with your exposure on the energy patch, was that some of it, that you saw some demand weakness in your core energy markets, or is it just a better run operation? What drove that down so much?

Mike, I don't think Tammy would either. I wouldn't hold the energy markets responsible at all, although as I mentioned earlier, there is a noticeable softness in RASM year-over-year, but the markets remain quite sturdy. What stands out to me was Thanksgiving. We were tracking along with our forecast until that point. If you remember our discussion about November traffic, the pricing environment was atypical at that time. The Christmas holiday period returned to normal. Looking ahead, Tammy might have more insights to share about current trends, but for me, the key takeaway from the fourth quarter was that the yields during the Thanksgiving holiday travel were lower than we anticipated due to unusual discounting in the industry. Tammy, do you want to add anything?

Yes, Gary, I agree. That was mainly what differed from our forecast going into the quarter. By the end of the year, the holiday performance in December met our expectations. As we sort through this, our expectation for the first quarter, based on what we've observed so far in January, is that demand appears strong. We're continuing to see robust load factors, although these are coming in at weaker yields. Overall, I would say that our bookings seem to have stabilized.

Mike, I would like to mention that we had a similar question after the Thanksgiving incident and the Paris attacks. It's difficult to determine the impact on bookings for us and our competitors. Additionally, if you examine the fourth quarter GDP results, they were not very strong. This suggests that the industry may have experienced a decline in demand, which led to more aggressive discounting. Furthermore, the industry is growing at a pace faster than GDP. It wouldn't be surprising to encounter a rough patch while trying to balance supply and demand at the appropriate price. However, beyond that, we are actively managing our developing markets and monitoring competitive changes, which include various ups and downs in activity. Overall demand, as we've mentioned, contributes to a solid outlook. I want to emphasize again that our results are not adjusted for differences in stage, length, and gauge. If those adjustments are made, we achieved positive unit revenue performance in the fourth quarter and for the entire year of 2015, which we expect to continue into the first quarter.

You make a good point. Regarding capacity, I apologize if this was mentioned earlier, Tammy, but I believe you projected the full year number to be between five and six, which remains the same. Typically, around this time of year, we would receive this information by the end of the quarter. It looks like it will be front end loaded, likely due to the leap day. Do you have an estimate of what those rates will be by quarter so we can model it for the year?

Well, she did say 8 to 9 for the first quarter.

Yeah, 8.

It is – I think it was 8.3 in the fourth quarter or so. The high watermark is going to be this quarter and then it will start trending down from there, but I will defer to you on the rest of the quarters, Ms. Romo.

Thank you, Mr. Kelly. Yes, so after this quarter, the second quarter is in the 4% to 5% range.

Thank you and good afternoon. If you go ahead and queue up, Tom you can give them instructions and we'll get started up on the media Q&A.

Has Southwest recently exited any pure hedge contracts early for further participation in the fuel price decline? And if so, at what cost?

Yes, I'm happy to answer that. We have reduced our hedges in 2016. So the answer to your question is yes. We're reviewing what we last communicated regarding our hedge percentages, with the main change occurring in the second half of 2016. We significantly reduced our hedges there due to the falling fuel market, decreasing from about 60% to 70% in the second half of 2016 to closer to 30% to 35%.

And a brief follow up to make sure I understood your earlier comments correctly. Is Southwest relying more heavily on call options this year than last?

That would be going forward, and that's correct. And in fact our 2018 position only represents call options. That's exactly right.

So in other words, we were already long with a position for '16 and '17 as 2015 unfolded. So Tammy and her team are continuing to work those positions off as best they can, but then any additional hedges that they're doing, they're doing with the call options to answer your question there.

So, the call options are also for 2016 and 2017 in addition to 2018.

Actually anything that we've added, just to be fair to your question, well…

Yes.

The majority of what we've added in 2015 has been calls because all we have is 2018. But yes, I think that would be fair.

Thank you so much Tom. If anyone in our media community has any follow-up questions, please reach out to us 214-792-4847 or shoot us a question over to www.swamedia.com. Thanks, and have a great afternoon.