Southwest Airlines Company (LUV) — Q1 2016 Earnings Call Transcript

Thank you, Tom, and good morning, everyone. Welcome to today's call to discuss our first quarter 2016 results. Joining 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 at 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 good morning everyone and thank you for joining our first quarter earnings call. We are absolutely delighted with these results and considering the quality of our operation, the hospitality of our customer service and these strong profits, it is absolutely the best start we've had to a year in over two decades. So, I'm very, very pleased. Of course, a big driver in our 33% earnings per share growth is a lower jet fuel price, but the revenue performance was also superb. This year is essentially the follow-through to a healthy expansion that began back in 2014, with the repeal of the Wright Amendment and then the aggressive expansion out of Dallas Love Field, and that was followed by the integration and conversion of AirTran at the year-end 2014. And that generated a lot of new flights in Southwest as well. Following the AirTran conversion, we launched four new international cities in 2015, as well as a new terminal and domestic gateway at Houston Hobby. So, you add all that up and it's a 9.2% capacity growth here in the first quarter. I would certainly admit that that is a lot, and what is impressive is that our revenue growth kept pace. So, we continue to experience outstanding performance out of Dallas Love Field. The rest of our developing markets are providing a very nice tailwind as well, as they continue along an expected maturity path. Last year at this time, we had about 20% of our system in development, and this year because we have intentionally slowed the additions of new markets, we have only about 5% in development. And of course, as a backdrop, the industry is adding seats aggressively. It's a very competitive environment. Of course, that's all fine with us; we have low cost and we have a great low fare brand, but we've been very pleased with the consistent strong demand for the Southwest product, resulting in yet another record load factor in the first quarter, and numerous other records for that matter. But the point is even in the face of our growth and the intensely competitive environment, we're doing really, really well. And I would attribute that to a couple of things. First and foremost to our people, and the terrific service that they offer our customers every single day; I'm very proud of them. And of course, I congratulate them on these great results and the record profit sharing that they have earned. I also attribute our results to our strong domestic network, where we offer more seats and board more customers than any other airline. Our marketing department in particular has done a terrific job of distilling our message with our advertising campaign on Transfarency. The customer awareness of the low fare value that you get with Southwest is very high. And that timing of that campaign matches perfectly with the incredible momentum that we have had with our Rapid Rewards loyalty program. So, we have a strong profitable network, we have great service, low fares with nothing to hide. We have an award-winning loyalty program and all of that served up by outstanding employees. So, we are exceptionally well positioned to compete and grow and we intend to keep it just that way. Before I turn it over to Tammy, I have noticed in some of the reports this morning, a little bit of confusion. So, I did want to make an opening clarifying point, which is – with the now earlier retirement of our Classic fleet, I just want to be sure that everyone understands that what we said in our press release is that means that the growth rate will be less, not that our capacity will be less. So, we will still grow available seat miles under any scenario that we've contemplated in 2017 compared to 2016, and then the same would be true also for 2018 as compared to 2017. The point is, is that the growth rate in 2017 will no doubt be less than it could have been. So, Tammy with those opening remarks, let me just turn it over to you to take us through the quarter, please.

Thanks, Gary, and welcome everyone. We're thrilled to report on our exceptionally strong first quarter results. Net income, excluding special items, increased almost 26% year-over-year to a record $567 million and earnings per share grew 33%. This represented our 12th consecutive quarter of record profits. Our revenue results remained at record levels, and we continued to benefit from low fuel prices and our ongoing fleet modernization efforts. We expanded our operating margins, excluding special items to 19.7%, which is the highest it's been in more than 35 years. And our pre-tax return on invested capital excluding special items for the 12 months ended March 2016 was 33.4%, which well exceeded our cost to capital on an after-tax basis. Just a fantastic start to the year, and I'd also like to congratulate our wonderful employees on these outstanding results and the record first quarter profit sharing of $155 million. Our strong revenue performance in the first quarter was a significant driver of our record first quarter earnings. Operating revenues grew to a record $4.8 billion, and our passenger revenues also grew to record levels. Strong demand for our low, friendly fares and the overall strength of our network were contributing factors to our 9.3% increase in revenues. We're pleased with the performance of our development markets that resulted in about a point in that tailwind to RASM in the first quarter. International markets also performed in line with our expectations, including our new Houston market and Dallas continues to produce solid results with load factor expansion and strong margins in the first quarter. Our Rapid Rewards revenue production was very strong in the quarter, including approximately $125 million year-over-year incremental revenues from our amended co-brand agreement with Chase last July. And our ancillary revenues continue to perform very well. Our revenue growth was in line with our capacity, resulting in flat RASM, which was industry-leading and notable considering the one-point to two-point impact from our stage and gauge increase in the first quarter. Overall, we're very pleased with the first quarter revenue performance. While the weak yield environment has continued into the second quarter, demand so far has remained solid. And based on our current bookings and revenue trends, we are expecting a modest growth in second quarter 2016 RASM performance year-over-year. Just as a reminder again, this outlook includes roughly $125 million from the Chase agreement and an accounting change. But just as a reminder, that we will lapse that year-over-year benefit in the third quarter. Our freight revenue was down slightly year-over-year and other revenue production was boosted by the Chase agreement, but also by a 12% increase in ancillary revenues mostly from growth in EarlyBird and our upgraded boarding product. We currently expect second quarter 2016 freight and other revenues to increase from second quarter last year. Turning to our costs, we are very pleased with our first quarter cost performance. Our operating unit costs excluding special items decreased 2.6% year-over-year from ongoing fleet modernization benefits, milder weather, and lower jet fuel prices. Our economic fuel price per gallon declined 11% year-over-year to $1.78. The year-over-year decline was driven primarily by lower crude and heating oil prices, offset by higher hedging settlements year-over-year. We ended up a little higher than our previous guidance at the beginning of March, simply due to the increase in the crude and heating oil since that time. Based on market prices as of Monday and our second quarter hedge that remains unchanged, we currently expect our fuel price per gallon to be in the $1.75 to $1.80 range. For full year 2016, we currently expect to fall in the $1.85 to $1.90 range based on current market prices. Excluding fuel and special items, our unit costs were comparable to the first quarter last year and down slightly when you also exclude profit sharing. This was better than our previous guidance due to milder weather and the associated cost avoidance, as well as shift in project spend to later this year. Based on our current cost trends, we expect second quarter 2016 CASM, excluding fuel, special items, and profit sharing, to increase approximately 2% year-over-year, and roughly one point of the year-over-year increase is driven by accelerated depreciation from our Classic retirements, with the remainder of the cost inflation largely due to timing of advertising and technology investments. For the full year 2016, we continue to estimate a modest 1% increase in our unit cost, excluding fuel, special items, and profit sharing, driven entirely by the accelerated depreciation. Our balance sheet and cash flows remain very strong. Our cash and short-term investments were $3.6 billion at the end of the quarter. We allowed our cash to build a bit as we plan to fund our 2015 profit-sharing accrual later this month. We also intend to launch a $200 million accelerated share repurchase, which will be completed next month. Our record free cash flow was $1.2 billion as a result of strong operating cash flow of $1.6 billion and $438 million of capital spend. For our full-year 2016, we continue to estimate manageable CapEx of approximately $2 billion. We returned $596 million to shareholders in share repurchases and dividends in the first quarter. As I previously mentioned, we will be launching a $200 million accelerated share repurchase this month to complete our current $1.5 billion repurchase authorization. This was on the heels of returning $1.4 billion to our shareholders in 2015. Returning significant value to our shareholders remains a priority, along with preserving the strength of our balance sheet and cash flows. Our leverage, including balance sheet leases, remains in the low-to-mid 30% range, and we are very proud of our strong balance sheet as we remain the only domestic airline with an investment grade rating from all three rating agencies. Before I wrap up, I'd like to spend just a little bit of time going over our announcement this morning regarding our Classic retirement fleet plans. As you will recall in January, we announced our intent to retire our Classic fleet no later than mid-2018. Earlier this month, we made the decision to refine the acceleration date to no later than the third quarter of 2017 to allow for our Classic fleet to be retired ahead of our planned operating date of the Boeing 737-8 MAX aircraft. By doing so, we'll alleviate the potential training complexities related to operating both the Classic and MAX aircraft. Boeing and the FAA aren't expected to determine their training requirements for operating the Classic and MAX pair until May of 2017 at the earliest, which doesn't allow adequate time to be trained and operationally ready for a 2017 MAX launch. So, our preference to address the undefined FAA requirement was to segment Classic and MAX flying. We've been working with the SWAPA negotiating team to come up with a mutually beneficial solution to address the segmentation, but unfortunately, we've been unable to come to an agreement. To move forward with our plan to launch the MAX, we must proceed with a solution, which retiring our Classic fleet no later than third quarter 2017 provides. As a result of this decision, we'll have about 50 fewer aircraft than previously planned in the fourth quarter of 2017, which obviously also creates less capacity. Again, as Gary mentioned, we intend to have capacity growth, but just this decision alone creates less capacity than what we had previously planned. That said, we're evaluating our options given these circumstances and believe we have a lot of flexibility to manage through the temporary dip in our fleet as we did with the 717s, including utilization of our fleet. We continue to expect our year-over-year fleet growth for the three years ended 2018 to average no more than 2%, and again, our annual year-over-year capacity over that period is still expected to peak this year at 5% to 6%. While we continue to evaluate our fleet plans based on where we are today, our aircraft CapEx forecast remains in the $1.3 billion to $1.4 billion range for this year. While I mentioned before our preference for a number of reasons would have been to segment our fleet, we still estimate EBIT improvement of at least $200 million from accelerating the Classics from the 2021 timeframe to 2017, largely driven by maintenance and fuel savings. This is net of the impact of the estimated accelerated depreciation of approximately $130 million that will largely be expensed during 2016. Accelerating our Classic retirements results in improved customer service faster with a fully equipped Wi-Fi fleet by the end of the third quarter of next year. Regarding capacity, just to be clear, we continue to plan for 5% to 6% year-over-year growth this year. Our second quarter and third quarter ASMs will increase in the 4% to 5% range, and we will be publishing our fourth quarter schedule in May, which will go through January 4 of next year. The majority of 2016's capacity growth is related to the annualized impact of 2015's unique expansion opportunity. While our capacity plans beyond 2016 are yet to be determined, we do expect 2017 and 2018 year-over-year ASM growth to bend down from 2016's level. We will remain disciplined in our approach to growth with a focus of flexibility to adjust if needed and with a goal to preserve strong returns and margins. In conclusion, we had another record quarter with or without the benefit of substantially lower fuel prices. Our earnings and margins improved year-over-year. Demand remained strong, producing record revenues, and our outlook for the second quarter suggests positive operating unit revenue growth. Our cost outlook for the year is for modest inflation driven largely by our decision to accelerate the retirement of the Classic fleet even faster than we had previously announced, which is expected to produce significant cost savings and EBIT improvement of at least $200 million. Fuel prices remain lower year-over-year, and we have had very strong free cash flow this year, and our balance sheet is strong as ever. We've continued our commitment to return value to shareholders and intend to complete our current authorization with the launch of a $200 million ASR by the end of this month. We will continue to prudently manage our capital spend, and we'll remain disciplined in our valuation of future growth opportunities. Again, our pre-tax return on invested capital was an exceptional 33.4%. Our outlook for the second quarter supports another quarter of strong margins, likely in excess of the first quarter's 19.7%. With that, I'd like to close by thanking our employees again for another fantastic quarter. Tom, we'll be happy to open it up for questions now.

Hi, guys. Thanks for the time. Can you just talk about the RASM trend from here? Obviously, you've got a nice increase going into the second quarter. But as we think about just the rest of the year, and well I think the credit card deal, is it going to be hard for you to stay in that positive territory, that's the first question. And then the second is, you talked about kind of evaluating or looking at a range of options to address some of the Classic flying. Can you just talk about what those range of options are? Is there the potential for more CapEx or more orders or anything like that? Thank you.

Hi, Rajeev. I'd be happy to start with your question regarding RASM trends. So, I'll just walk you through the quarter a bit. So, just at the highest level, January and February RASM were slightly down and then March was slightly up, which got us to the roughly flat unit revenue comparison with about $15 million of benefit from Easter in March. So, April RASM adjusted for Easter is currently running in line with March, and as you think about the comparisons as we move forward in the quarter, we expect those to improve as a result of the increased competitive environment that we began experiencing in May and June of last year. And then, of course, as a reminder again, we'll continue to have the year-over-year benefit from the Chase agreement – at least through the second quarter here. So, again I think we're positioned very well here as we start the second quarter, and I would just characterize the demand environment as solid. And so at this point just we're continuing to see the same sort of trends that we saw in the first quarter.

I'm sorry. What about just the rest of the year and keeping that trend going, especially with the Chase agreement lapsing?

I think that's the one. Yeah, so it's always hard to predict further out in the year. Certainly, we're off to a good start here in the second quarter. And as you pointed out, the comparisons do become more difficult in the second half, because we lapsed the benefit of the Chase agreement.

So I might take up the – unless you have any more questions on that Rajeev, I might take up the fleet question for a second. I think it is the usual suspects that are available to us. We can tweak the utilization of the aircraft, which translates to a longer duty day for the airplane. I'm not sure that that's what we want to do, but that is an option. In other words, just flying later earlier and later in the day. We can search the used market for more 700s and we can – we'll have some options as you know by our fleet chart, we have options that can be exercised as well, which would translate to more – to be clear that would be more capital spending, that's not in Tammy's capital spending guidance that in other words, the capital spending guidance does not assume the exercise of any options to be clear. In no scenario that we've talked about would we bring in 50 more airplanes, and Mike, I don't recall exactly how many aircraft would be ultimately retired under the previous scenario, but I'm going to guess it was around 30 that would have been retired in one step – a 30-ish. So, the 50 is not quite as large as it might sound, although again that's a real number, but we were already going to retire a fair number of aircraft in 2018. This is all manageable, it's not preferable, but it's all manageable. The first thing that we wanted to share with all of our team and of course you all as well is that, that is going to happen that being the Classic retirement acceleration. The company can go to work on translating that into maintenance programs for that fleet to retire earlier, that will avoid some maintenance spending, as Tammy's already made clear. We can explore other options as far as bringing either leased equipment in or exercising some options and spending a little bit more capital. The other thing just to make sure that everybody is clear in their head is that, our projected fleet at the end of 2018 is unaffected by any of this. So, you're simply talking about accelerating retirements from 2018 into 2017. And that makes this all for us a little bit easier and another reason why we'll want to be thoughtful about bringing on more airplanes to replace that. All of that is still an open question and as soon as we make some choices there, I am sure we'll be sharing those.

Helpful. Thanks, Gary. Thanks, Tammy.

Hey, guys. Gary, on the topic of the Classics, is the decision potentially reversible, and how much lead time would you need if you did negotiate a solution to keep these airplanes in the fourth quarter of 2017? I'm trying to assess at lower capacity is it a done deal here or if this is merely a shot across SWAPA's bow that could be revisited at the negotiating table?

Well, I read your note earlier, so I'm glad you asked me the question because one thing I wanted to clarify is this is not a shot, contrary to the way our industry has worked with employees in the past, that's not the way we do business here at Southwest. So, you know that, I just wanted to be sure that all of our listeners know that, but that's not what this is about. We're here to take care of our people and clearly accelerating this retirement is not going to be a good thing for our employees, this is not a bad thing, but we are not at war with our people, we're at war with our competitors, number one. With respect to whether it is negotiable, well, in that spirit, of course, we want to continue to work with the pilot union in particular to do what we can to keep our cost competitive and grow this airline, so that we can be as competitive as possible. I don't realistically see a scenario, Mike, where we can – I mean that's why we're sharing this today, it's not so much that it is a decision, I don't see that we have any choice because we have to begin to put plans into effect for training, maintenance and then if we are going to go out and try to mitigate the earlier retirement, we've got to get working on that and I'm sure that sooner than later, we want to make commitments there. So, as a practical matter, I think that's a done deal. And to be blunt, I just don't see SWAPA moving on their position regarding segmentation. So, as a practical matter, I think it's a done deal.

Okay, I appreciate the color. On the topic of SWAPA and the pilot offer from last month, it did look pretty rich to us and represented over two points of CASM by our analysis. Again, that's just the pilots, all in it's getting hard to imagine how the entirety of your new contracts won't increase ex-fuel CASM by four points, possibly more if it was rolled up into a single year. What assurances, Gary, can you give us that you possess sufficient revenue initiatives that can offset this cost pressure or do we just have to assume that post-labor, Southwest will have lower, still very good, but lower margins than today on a fuel neutral basis?

Well, great questions. Obviously, it is very important for us to maintain our low fare brand and our low fare brand is not negotiable. In order to have a business in a low fare brand, we have to have that supported by low cost. So, that's what the company was founded on 45 years ago and we're certainly not going to re-trade that. All these negotiations, they are complex, they take a long time and especially in light of the fact that we are in mediation where the mediator has asked us to maintain confidentiality about what is discussed. I know you don't expect me to go into any detail, but I certainly want to honor that request for confidentiality. All of this just has to be addressed at the negotiating table, with an eye towards rewarding our people, and compensating them handsomely, but doing that in a way where we maintain industry leading productivity and efficiency so that we sustain our low cost structure. What I can give you assurance on is that we have not wavered on our desire to achieve that goal, and we'll have to continue to work together with our union leadership to be able to live up to that.

Gary, I appreciate the color, and thanks for even finding the time to read our short blurb this morning. I'm flattered. So thanks again.

Jamie, we're fascinated by it. So, I would never miss it.

Hi, guys. Thanks for taking the question. I appreciate it. So, Gary or maybe Bob if he's there too, when you think about the heavy mix of connecting traffic at Love Field, even more specifically on the Wright Amendment routes being so high like well above 40%, I think it looks like you may have sort of inadvertently created a bit of a rolling hub there. So, thinking about that in the context of the new market development, how satisfied are you right now with your ability to manage yields in Dallas on an O&D basis given all those connections, and is that an opportunity that is sort of new for you guys that maybe has a little bit of underappreciated upside that even you yourselves are unable to quantify right now?

Well, I'm going to let Bob speak to that as well, and he is here, he's sitting right by me. No actually I feel like the Dallas Love Field operation is pretty much in line with what I would have expected except as I admitted to you all before, the rapid development of those markets and the full flights actually took me a little bit by surprise. I thought it would take us a while longer to produce the kind of results we have there. Tammy, I did glance this morning earlier, the returns out of Dallas are still right at system average, maybe just a hair below for the first quarter. Simply meaning, Hunter, that it is, I would not call Dallas in development, clearly Bob is going to disagree and say there are certain markets that he wants to see better performance but overall as an entity, it looks really good. I've never noticed any remarkable difference in the O&D mix versus connects at Dallas versus any other place. Sounds like you've been studying this, but our intent would be to have Chicago, St. Louis, Phoenix, Baltimore, all of those very large operate – Houston, all of those very large operations look roughly the same. I have not seen anything that says that it is remarkably different, and I certainly haven't seen anything so far to suggest that there is any disappointment whatsoever in Dallas.

No. No. Hunter, this is Bob. Thanks for the question. I think a couple of things; our Dallas performance is right in line with system as Gary said. Now, we built Dallas up in a series sort of tranches of adding flights and so some groupings of flights are more mature than others. I’ll tell you that the last couple of groupings that we added, which are obviously younger, are continuing to develop and we'll see that I'm confident over time. So, there's still room for improvement in Dallas, even though it is right at system average. On the traffic mix, just because Dallas is constrained, remember, we would love to have more flights in Dallas than we can have. And so, because of that, we're always going to bias for local traffic more than we would in a large city like a Chicago for example. We do because we could have more capacity in Dallas. Dallas will always I think slightly underweight the flow and connect traffic compared to what it could be if we were not constrained, because we've got to make room for local traffic, which again there is more local traffic demand than we have room for at the gates and flights that we have in Dallas.

The only thing, I would add to what we both said is that we're conscious of this. There are some analogies to Love Field around the country that I won't mention, but we do have techniques where we can influence one way or the other. So, we're very happy with the way Dallas is performing. Again, it's a constrained market as we know, so we'll have to continue to keep an eye on it. But I don't know if we're hitting the point on your question or not?

Yeah. No, it's – we can maybe take this offline, but that's – I want to ask another question. So that's good enough for now. Thank you for the time. And then if I back out the $125 million credit card benefit, it looks like unless some stuff moved around in the P&L which I'm not aware of, it looks like your other revenue grew by 35%. So first, is that right? And if so, what is that? You only mentioned EarlyBird up, whatever, 12%, and once we lap the credit card, how should we think about that other revenue growth rate in the third quarter and beyond, because again well, I'm just kind of curious of my, first of all, correct my underlying math, and how should we think about it beyond, once we lap the credit card? Thank you.

Yes, Hunter, I'll be happy to help with that. Yeah, we are seeing strong growth in our other – just as a reminder of our – just so you know where the components of the benefit from our credit card fall, about – the net is the $124 million, and other revenues increased by about, call it, $175 million, and passenger revenues decreased by about $50 million. I'm not sure if you did your math exactly right there, but that's the split of the net roughly $125 million benefit from Chase. But we're continuing to see strong ancillary revenues. We had strong EarlyBird revenues but again aside from that, there's a collection of the ancillary revenue products that have done quite well and I think we will continue to see strong trends there.

Well, we had more bag fees, we had more Wi-Fi, we had more pets.

Yes. So, just...

And I would think – I think your question was should that continue, Tammy, I would think that we would continue to see that.

I think so, again, just with the caveat of course that we'll lapse the benefit of the Chase benefit in July.

Okay. Thanks a lot.

Hi, good afternoon. Thanks for the time and the questions. I guess, Gary, you spoke about this in your prepared remarks, but one of the reasons you have been posting industry-leading revenues of late has been the maturation of many of your routes. As you look at the impact over the course of the year, do you think this maturation is having a bigger impact on revenues today or call it the first half of the year, or do you think this accelerates into the back half of the year? I guess, any color you can provide around the timing of that would be helpful.

Yeah. Feels like it will trend away from us. So in other words, it's higher today than it should be a year from now. I also think that there is quite a bit of art work that we're debating internally about how to define a development market. So, we're seeing really broad strength in our cities. If we call an additional frequency in a market that's existing, we don't call that "development." So I think the impact is likely larger than the point that Tammy shared with you. I think all of our folks agree with that. So we may be a little bit conservative, and that may be a conservative outlook as a consequence of that. But the other thing is – not only is the existing maturing, but we're also slowing down the pace of stuffing in new, and that's all intentional. So we'll have a pretty conservative year here in 2016 in terms of incremental flying being added between now and the end of the year, and that will help as well. So the tailwind should exist all year long. I think it will begin to diminish roughly a year from now.

Okay. That's very helpful. Thank you. And I also just wanted to kind of touch upon the balance sheet and capital returns. I guess, with no change right now in terms of your CapEx spend, do you think we could see a pick-up in the pace of buybacks, particularly as I guess fuel stays a little bit lower for longer now? I guess maybe any color you could provide in terms of how you think about buybacks, returns to shareholders versus new growth at the company? Thanks.

Sure. We are just continuing to balance all the above. We, as I mentioned, will be completing our current share reauthorization here next month. So we'll be taking up that question with the board here very soon. But as you can tell from our outlook, we're expecting our cash flows to continue to be very healthy this year, as we've mentioned a number of times, we expect our capital expenditures to be very manageable, and we're continuing to be very committed to returning value back to our shareholders through share repurchases and dividends, but you'll just have to stay tuned in terms of what we might do beyond this most recent $200 million accelerated share repurchase.

Yes. The only thing that I would add to that very thorough answer is that obviously free cash flow is a very significant guardrail in the way we think about all this. If you believe that our free cash flow is going to continue to grow, well then that just gives us more latitude to think about it. Likewise, if you're concerned that free cash flow may go the other way, well then that would influence us also. But it is very prominent in our thinking and the next step obviously is to wrap up the existing authorization, and then we'll revisit this question with the board.

Yes. And just the only other comment I would add just to kind of round out the discussion is just on our leverage. We've been managing to kind of low-to-mid 30% range, and we don't really have any plans to change that at least at this juncture.

Great. Thank you very much.

Hi, there.

Hi, Julie.

Gary, a question on growth. So, there's still a lot of growth opportunity for you guys, including resurgence of short haul, international expansion out of Fort Lauderdale and Houston, and eventually Hawaii. Does the changed fleet plan impact how you think about prioritizing that growth over the next two years?

I have to smile at Julie because Bob Jordan is shaking his head, as you're talking about all these opportunities. He is lathering up here. I have to cool him off. I think we have a tactical challenge to work through a step down in the fleet in the late third quarter next year, I think is the primary challenge. By the end of the next year – by the end of 2018, we'll be back to our fleet plan. We haven't given you a precise number there yet, so that's a little P plan. It's not etched in stone, but we'll work through all of that. In the meantime, it may affect a priority or two. It's a little premature to say. That's one of the reasons that we need to give our team this guidance now because Bob Jordan and his commercial team are working right now on what the schedule will be in the fourth quarter of 2017, and they've got to know how many airplanes we're going to give them to schedule. Those are questions that we'll be immediately thrashing through. One thing that's a priority for next year that we won't waiver on is Fort Lauderdale completing the construction of the new international five-gate terminal and then following through the launch of international flights there. So that will be a very high and hard priority for 2017 that we'll have to potentially work around as one example. But I have said several times, I think that this is manageable and we can handle it, and we'll obviously get to work on it here. But, Bob, I don't see any change in priority because of that.

Okay. Is there a timing – go ahead, Bob.

I agree with Gary. It's tactical. You've got a period of time where you have to manage our wants and our needs. A lot of what you mentioned, we're going to always pace our growth here. Some of the things you mentioned are already in our sights for 2018 or beyond anyway. So those are really unaffected because once you get into the mid-to-late 2018, we're sort of back to where we expected. So it's really just a short-term challenge, but it will be painful.

Yes, it will be painful. We'll have hard decisions. The thing that we've liked here in 2016, as a pretty vivid example, the plan that we had for this year did not include any new cities, and we will very likely have four as it turned out for 2016 with three Cuba cities and Long Beach. So, it's nice to have that flexibility. Those four markets don't require a lot of aircraft time, but we did have enough in reserve where we could jump on those opportunities. We may have to forego some things like that if they appear during that time period in 2017, 2018, but again we'll be able to manage and I don't think that this really impacts our strategy long-term.

Okay. And, Gary, can you just remind us the timing on the expansion out of Fort Lauderdale, if there is any update on the construction of the new facility?

I don't believe we have any new updates. It's in the first half of next year. I think a decent assumption, I think, that we've been sharing publicly is midyear but we don't have a precise date yet.

That's right.

Okay, great. Thanks for the color.

You bet.

I just wanted to ask about Houston. Since the international gates opened there, I've been a little surprised I think there's maybe up to 10 daily flights out of Houston internationally. Just wondering how many gates are you using there and what the plan is and maybe what similarities we might have as we think about the growth out of Fort Lauderdale International?

Well, and Mike can help me here or Bob for that matter. Let me give it a try and see if I'm answering your question. If not, please redirect this. Our rough estimate with five gates, assuming that we have access to five, we have four under lease and as long as the fifth is open and available to us, we can use five. So the capacity for five gates international flying is roughly 25 departures. I think today we're maybe 11 international departures, 12 international departures out of Hobby. Our folks at the airport will also use those gates as they need to for domestic flights. We're where we expected to be by the way at Houston Hobby, not a year later. We did not expect to be at capacity that fast. Bob will continue to have Houston as a priority to continue to add international flights there in the future. I can't give you a prediction on when we might be at capacity in the terminal, but we've got plenty of capacity now. It's a great facility. Our customers absolutely love it, and we'll continue to have flights in Houston. Is that responsive to your question?

That's exactly what I was looking for. Thanks, Gary.

And then Fort Lauderdale, I think again it's a little bit premature to tell you exactly what our plans are, but they're not similar from what I've described at least in concept. It's another five-gate facility.

It's all five, yes.

I think it's the same scenario as we have in Houston. So I'm going to guess that we have roughly the same 25 departure a day capacity there. And now Cuba, assuming that all gets approved, our request is to add flights out of Fort Lauderdale. So if we start Cuba flying this year, we'll already have some international flights even before the terminal opens, which was in our original plan. Fort Lauderdale could ramp up faster than Houston has, I just don't know yet. It's a little bit premature to say.

Yes, Savi, the only other thing to add is because we have a lot of local traffic out of Houston, which is fantastic, we have probably even more flow and connect than we expected, which is also fantastic. So we're really happy. We're right on what we expected.

So, we’re really pleased, we're pleased with our network. It's been under construction for years and the results look really good. Revenue management has done a phenomenal job in a very competitive environment. And the marketing, no one has asked us about it, but I think the marketing and messaging has been absolutely superb, presenting Southwest competitive advantages in a very clear and colorful way. They're going to continue on that course and I think it's going to continue to drive strong revenues for us as well.

Okay. Thank you. And if I may just follow-up on the unit revenue front, Tammy, I know you provided color. So if I'm thinking about 2Q correctly, you do have a nice – a slowdown in capacity I'm guessing, should help unit revenue and you have easier comparisons and possibly the only headwind being the Easter shift. Am I thinking about that correctly?

Yes, I wouldn't dispute any of that, Savi. I think you're thinking about that exactly right.

Thanks very much. Hi, everybody. Thank you very much for the time. As I look at your cash flow statement, Tammy, you've got air traffic liability declining on a year-on-year basis from $717 million last March to $685 million this March, and you've got 5.5% more capacity growth. Should I be worried about that decline?

No, not at all, Helane. So there's no concerns. Just based on our outlook and just our cost outlook and feel we're expecting healthy cash flows, and no concerns on the air traffic liability. Of course, you've got to take into considerations the Rapid Rewards impact of that. But when you adjust for that, there is nothing unusual going on there.

Okay. Good. Thank you. And then my other question is with respect to – I'm sorry, I haven't paid attention to this. Is there anything new at Love Field with respect to Delta and their access to your gates, your one gate?

No, there is nothing new there. Where it stands is the judge ruled and Southwest is in the process of appealing that ruling. So there is really no new news and nothing further to discuss on that. But I was just kind of curious by your cash flow question on air traffic liability. I'll bet you that it's just a timing of Easter. Where all that burned off earlier, but you asked a good question...

Yes.

...but everything looks really good. I am analytically kind of curious about your question.

Yes, there is...

... I am analytically kind of curious about your question.

Hey, good afternoon, everyone. Just on the Classics, how practically do you expect to do this? Do you want to fly them as long as you can before the MAX shows up and have one big wave of retirements or should we be thinking about a step down as you get closer?

No, no. We have to have every pilot trained to sit in every cockpit. And so it's all or nothing is the way that this has been presented to us. Now we don't know exactly what training requirements Boeing and the FAA and Southwest would ultimately work out, but we can't wait that long to develop a training program and then get all of our pilots through it. So, no, there will be a day and one day we'll be flying 50 Classics and the next day we'll be flying zero.

Okay. It will be a hard stop.

Yes. It will be a hard stop. In reference to Julie's earlier question, that's really the task at hand is to figure out how to smoothly do that.

Okay.

David, I think a way to think about it is, when we put the last AirTran aircraft down at the end of 2014, we put them down in a lump and we began a new schedule the next day and that is exactly the way we're going to manage this.

And I think Bob makes it – I'm so glad you mentioned that, because the point is, we have had practice at this and know how to do it. I don't think the world knew a thing. We knew it internally. But we got through it and everything worked out just fine. So, I think, like I said, I think we can manage it and I'm not overly concerned about it.

Yes.

Okay. Shifting gears a little bit, Long Beach, I know it's a small new city opened, but can you talk a little bit? Obviously well established in California. How does the launch fit in? Is that somewhere you'd like to turn into more full-size Southwest city or what happens there?

Well, I think we're ecstatic to get a foothold into Long Beach here. So we had no avenue for a long time. Just to be able to have a modest schedule to Oakland is great. The airport interacts really well with our other LA area service, so we don't feel like there will be a cannibalism or anything like that. This will really be new traffic for us. Obviously there are constraints. We'd love to have more flights over time. I don't see a case where we would add dozens and dozens of additional flights, but if we could get another two, another four over time, I think that would be wonderful because I think the traffic is there. Our bookings look good. We're really happy with the traffic build so far and we're looking forward to starting service.

You probably know this, David, but we're the number one airline in the five-county area among the four airports. So I think this will be really awesome. We'll be able to provide more flexibility to customers to go out of one airport and back to another. If we can get more slots, we would love to do that.

Okay. And if I can sneak one last one in about geography and RASM performance. I would think California best, Houston worse. Is that right or is just any color around what you're seeing around the country?

We're seeing California as strong and we're seeing just general strength across the network and as we've called out before, just we have had a high percentage of our markets under development over the last year. Some of those markets that have come on more recently, those are ramping up, but general strength across the system.

I think you're referring I guess to oil and gas and Houston looks fantastic, Midland looks fantastic.

Yes, we're just not seeing the impact.

Our business is held up quite well, I think it would be fair to say that it's not as strong as it was, but it's still really strong. So I feel real good about that. But I agree with Tammy's first reaction, which is it's mostly a function of where we have developing markets. So I think our strength is very, very broad and consistent across the U.S. And again, we're really pleased; we're pleased with our network. It's been under construction for years and the results look really good, revenue management has done a phenomenal job in a very competitive environment.

Thank you very much. At what point do you see faster yields for domestic travel becoming positive?

Well, I'll let Tammy explain that, but we are predicting positive unit revenues in the second quarter. We were actually slightly positive, although in fairness I call it flat, but we were actually up 0.1%. So, I'm not answering your question literally, but it's a little more complicated than that, but I would say that the substantive answer to your question is, we are already seeing that. But Tammy, you want to explain?

Yes, if you're referring to our yields per revenue passenger mile, I would just attribute that to, as we mentioned earlier in the call, we are continuing to see a very competitive environment, and I would characterize that as weak, but we've been offsetting that with a strong demand for our service. That's netting to – we had a flat unit revenue performance in the first quarter and then as we've guided, we're expecting that to turn positive here in the second quarter based on our current trends. I don't know that I can specifically answer when we're going to see our yields turn positive, but what we really focus on, of course, is our unit revenues and our outlook for unit revenues is favorable here in the second quarter.

In other words, the yields are distorted year-over-year due to an accounting change and you can make a lot of sense out of that; I was redirecting you just to look at total revenues per available seat mile. I think is a better way to evaluate our performance right now.

Right.

You can see that in our fares, our fares were down year-over-year by about $4 on average and that's even with an increased stage length. So, which supports the weak yield environment, but we've been generating record load factors and again offsetting that by strong demand.