Southwest Airlines Company (LUV) — Q2 2017 Earnings Call Transcript

Thank you, Tom, and good morning, everyone, and thanks for joining us for our second quarter 2017 conference call. I am very pleased to report another very strong quarter. Record EPS and that is despite higher labor contract costs since 2016 and also somewhat higher fuel prices. We had strong cash flow. We completed our 2016 share repurchase authorization. I was also pleased to see growth in average fares for the first time in about two years. And despite some drag from our reservation system conversion, we had a solid unit revenue performance of an increase of 1.5%, which was right in line with our expectations. Without the reservation system conversion, it would have been closer to a 2.5% growth on 5.1% capacity growth, a very solid revenue performance with corrective actions planned before year-end on some of our reservation system issues. Our third quarter outlook is in line with second quarter, the year-ago comps, taking those into consideration. The new reservation system penalty is a little bit more in the third quarter, the July 4 holiday timing softens the third quarter performance. And the sequential comp second quarter is harder with the full Easter benefit showing up in the second quarter. Net all that out, and up 1% year-over-year is what we would expect, what you all should expect, relative to the trends from the second quarter. Our cost forecast for the year is higher than we last reported. I'm not really happy about that. We're certainly not satisfied with that. We'll be working hard during the second half of this year to rein it back into our original 2017 plan. I was very pleased with the second quarter cost performance and can at least confirm that trend-wise we'll see our unit costs pressure year-over-year begin to ease here in the third quarter and then again in the fourth quarter. Tammy will explain further, but I did want to offer some commentary on our capacity forecast. It's being updated today for the full year 2017. We have a large number of airplane deliveries scheduled for this year. If you will note in the press release, it's 71. 18 of those are pre-owned airplanes. They go through an extensive conversion process to match the Southwest livery and convert to our maintenance configuration. So we conservatively planned for the completion of that prior to committing those airplanes into revenue service. And our tech ops folks are doing a fantastic job. And what we're finding here in 2017 is the aircraft are being delivered earlier than we had planned. We have put those early deliveries into revenue service this year, in essence, as a spare. And that's driven our cancellations down, and therefore our ASM production higher, all compared to our forecast. And that's all as compared to a 3.5% annual forecast. So knowing that for the second half of the year, we've updated our forecast. And we've also decided to implement some scheduled flying with some of this available aircraft soon. And that will be for flying beginning in the fourth quarter. We expect the incremental capacity to be profit-accretive, of course, or we wouldn't do it. The fourth quarter will still result in very modest year-over-year capacity growth somewhere in the 1% to 2% range. And as of now, we aren't expecting any change to the rough 2018 estimates that we provided last quarter and then updated today. The highlight for this year and for this quarter was our new reservation system. I am very proud of our people, the job that they did in designing, building, testing, and deploying this new technology. It was literally a flawless deployment. We discovered some design issues, if you will. And as I said, I expect those to be remedied quickly. Next, I am very proud of all the front-line employees along with all of our training folks; they worked exceptionally hard to learn and use a totally new system. It has been very hard work, but they have made it look easy for our customers. So again, my hat is off to them. So aside from what I would describe as normal break-in issues that one would expect from a system effort that is this massive, it is all we expected it to be. We'll work hard to hit our $200 million run rate of incremental annual revenues by the end of next year. And that does not include fixing the problems that we discussed that affect the second and third quarter. We achieved another important second quarter milestone with the completion of the new international concourse at Fort Lauderdale, and then the launch of the new international flights from Fort Lauderdale. And that included a new destination on our route network, which was Grand Cayman. We opened Cincinnati in the quarter to a very warm welcome from the community. We're off to a great start there. And we are in the final lap this quarter preparing for the launch of the 737 MAX 8 on October 1 along with the retirement of our Classic fleet in late September. So I do want to thank all our people again for a very strong performance, congratulate them on a superb quarter that earned them profit sharing of $202 million. And with that very quick overview, I'd like to turn it over to our Chief Financial Officer, Tammy Romo, to take us through the quarterly financials.

Hi. Thanks, Gary, and welcome, everyone. Our employees did a great job again this quarter providing their legendary customer service. And I'd like to thank them for that and congratulate them on a great quarter. Our second quarter profits were a strong $746 million and excluding special items, $748 million. And our earnings per share, excluding special items, was a record performance. Margins were very healthy and our operating margin exceeded 21%. Our balance sheet, cash flows, and liquidity remained strong, and I am delighted with our recent upgrade to A3 by Moody's. We're committed to our investment-grade ratings and as always, the prudent management of our capital structure. Overall, I'm very pleased with the second quarter and would like to congratulate our employees on the $202 million in profit sharing. On the revenue side, our second quarter passenger and operating revenues hit an all-time quarterly high. Our unit revenues have turned positive and were up 1.5% year-over-year. This performance was right in line with our guidance, even with the greater-than-expected impact from the new reservation system cutover. The RASM pressure from the reservation system transition was less than a point year-over-year for the second quarter. Adjusting for this unfavorable impact, our RASM performance looks to be at least on par with the industry, which is notable considering our very significant outperformance in the second quarter last year. As noted in our earnings release, the RASM pressure from the transition to our new reservation system is temporary. And these items are relatively minor, considering the significance of the technology efforts. And we expect to have the necessary technology and procedural fixes in place by the end of this year. For our third quarter, we expect year-over-year RASM growth to be approximately 1%, which includes about one point of unfavorable impact from the reservation system cutover. We do not expect a significant impact beyond the third quarter. Our third quarter revenue trends were also impacted by the timing of the July 4 holiday, as well as last year's outage, which roughly offset each other on a unit basis. Adjusting for the timing of July 4, sequential trends look to be in line with, if not slightly ahead of, historical trends. We had nice growth again in other revenues for the second quarter, which increased 7.6% year-over-year, driven primarily by increased Rapid Rewards. And we expect another year-over-year increase in other revenues in the third quarter. So turning to cost now, our second quarter cost performance was slightly better than expected. Similar to first quarter, fuel prices were higher in the second quarter this year as compared with the same period last year. We saw fuel efficiency gains in the quarter, with the capacity increase outpacing the increase in gallons used. This is meaningful and is being driven by fleet modernization and other fuel savings initiatives. Based on market prices last Friday and our current third quarter hedge position, we expect our third quarter fuel price per gallon to be in the $1.95 to $2 per gallon range, which is below a year ago. The third quarter fuel cost estimate includes $0.35 in hedging losses, which is comparable to the amount of hedging loss we currently expect for fourth quarter. With fuel hedge losses significantly below where they were last year and the second half of this year, we currently expect our economic fuel price per gallon in fourth quarter to also decrease year-over-year. Excluding fuel, special items, and profit sharing, unit costs came in a little better than we expected, primarily due to lower advertising spend. We were up 5.3% for the quarter, largely due to higher wage rates from labor contracts as well as technology implementation costs associated with the new reservation system and our operational initiatives. We expect these cost pressures to ease as we go through the remainder of the year. Based on current trends, we expect third quarter CASM, excluding fuel, special items, and profit sharing, to increase in the 2% to 3% range year-over-year. Last year's amendments to our labor agreements are driving 3.5 points of the year-over-year increase, which is being partially offset by a slowing technology spend and continued benefits from the retirements of the Classics. And we continue to expect fourth quarter unit cost, excluding fuel, special items, and profit sharing, to be comparable with year-ago levels. Considering our modest capacity growth plan for the fourth quarter, I am encouraged by our fourth quarter unit cost outlook, which does reflect our focus on lowering costs. And we intend to do that as well as we move into 2018. We ended the quarter with our industry-leading investment-grade balance sheet as strong as ever. Our year-to-date free cash flow of $1.4 billion was solid and was driven by strong operating cash flow and manageable CapEx levels. Our expectation for CapEx in 2017 remains at roughly $2.3 billion, with $1.4 billion related to aircraft spend. During the second quarter, our board of directors approved a 25% increase in our quarterly dividend as well as a new $2 billion share repurchase authorization. For the first half of this year, we have returned $1.1 billion in buybacks and dividends to our shareholders. $400 million of these returns were from the accelerated share repurchase program that was launched during the second quarter and completed this month, which completed the previous $2 billion buyback authorization. And in June, we paid our 163rd consecutive dividend, which totaled $76 million. Our leverage, including off-balance sheet aircraft leases, is now just over 30%. And as ever, preserving our strong balance sheet and cash flows remains a priority for us. Turning now to fleet and capacity, all said, there haven't been any significant changes to our fleet or capacity plans. We ended the second quarter with 735 aircraft in our fleet. And as a result of the Classic retirements, we expect our fleet to decline to 688 at the end of the third quarter. We'll grow our fleet to 707 aircraft by year-end 2017, and we still expect to be at 750 aircraft at year-end 2018. With respect to our Classic fleet, we had 69 Classic aircraft in our fleet at the end of the second quarter and are down to 67 today. We intend to retire all 67, of course, by the end of this quarter. As we continue to manage through the retirement of these aircraft, we purchased two of our 300s previously under operating lease during the second quarter. And the lease termination cost associated with this was approximately $8 million, which was recorded as a special item. At the end of the second quarter, we had 21 Classics under operating leases remaining in our fleet. And we expect to record a charge of approximately $60 million as a special item related to these aircraft, which is primarily related to the lease payments due as of the date we cease use of the Classics. There could be additional charges recorded in the third quarter associated with certain lease return requirements that may need to be performed on the aircraft prior to their return to the lessor, but we don't expect these charges to be significant. And just as a reminder, these charges were contemplated in the estimated $200 million even improvement from accelerating the Classics from 2021 to 2017. Turning to our order book, we made just some tweaks to the order book. And in short, we added four pre-owned 700s. And with the acquisition of these aircraft, we deferred our four remaining 737-800 options and converted them to four MAX 8 options, two in 2021 and two in 2022. And we're gearing up for the MAX 8 and we're looking forward to that and expect even more fuel efficiency gains from that aircraft. We'll get our first MAX delivery in August, and we will have 10 by the end of third quarter. The MAX will enter service on October 1, immediately following our Classic fleet retirement. With this fleet plan, capacity growth in third quarter 2017 is expected to be approximately 4% to 5% and fourth quarter growth in the 1% to 2% range year-over-year. And our expectations for 2018 year-over-year capacity growth continue to be less than 4% for the first half of the year and less than 2016's 5.7% for the full year. Our domestic network remained strong, and our international flying is maturing nicely. And we continue to grow our network prudently and profitably. So to close, I'll congratulate our employees again on a great quarter. Our reservation system is up and running. And our employees are doing an outstanding job navigating the new system. Service began in June to Grand Cayman and Cincinnati, and we are excited about our upcoming service to Turks and Caicos in November. The international terminal at Fort Lauderdale opened earlier this month, which supports our current international flying as well as future growth opportunities. The MAX 8 is almost here. And we will be retiring the remaining Classics by the end of this quarter, which is by far the most aircraft we've ever retired in a single quarter in our history. These are very significant accomplishments. And our people, once again, demonstrated their warrior spirit and that they are the best in the industry with their unmatched hospitality. And with that, Tom, we're ready to take questions.

Hi, guys. This is actually Conor in for Helane. So we appreciate the color on 2018 capacity growth, but can you help break it down a little bit further? I know that the schedules aren't final, but how much of your growth should we expect to be in the domestic market versus international overall? Thanks.

Tammy, I believe that the split is roughly with what is published right now. With the updated forecast for the improved completion factor, I believe it's roughly 3.1 points coming from domestic and the balance coming from international. So the domestic mix is still near 3%.

Yes, it's still near 3%. That's correct.

That doesn't include the additional flights that I mentioned that we are planning to publish soon. And those are domestic flights as well. So that might boost that by a tenth or two, but it'll obviously be very modest since it's just one quarter.

Just to be clear, that's for 2018 or 2017?

I beg your pardon. So that was 2017.

Was your question 2018?

Well, we haven't shared that yet. And quite frankly, we haven't made our final choices yet. So you'll have to stay tuned on that one. We opened the schedule today at least through April.

Okay. Fair enough. In terms of the reservation system and the cost tailwind that we should associate for that for 2018, so what was the – was there any cost associated with the reservation system in the second quarter of this year? And what was it again for the third quarter?

On the reservation system cost, I'll give you kind of a breakdown. As we move through the year here, we expect that to ease. And we've got, just from the technology for the full year, it's going to net to something relatively small. But for the second quarter alone, if you'll just bear with me one second, we'll pull that for you. If you'll bear with me, we'll get back to you with the number for the second quarter.

Great, thanks.

Hey. Good morning or good afternoon, everyone. And thanks for taking my questions. So look, forgive me because I'm just an equity analyst. But can we talk a little bit more about precisely what's happening with the rollout of the reservation system, why that's negatively impacting RASM and why you think that's only going to be contained in the third quarter? I'd be appreciative.

We have a handful of items. I would just identify in my mind three that are very isolated. The new system for these three items does not work like the old system. So and Southwest is unique. So one of the items that's pretty easy to visualize is we have a product called Business Select that we sell that allows customers to have the first 15 boarding positions and their choice of seats once they get on the airplane. There is a corollary product that we call Upgraded Boarding for any seats that have not been sold yet as Business Select; our customer service agents can sell those seats for a price at the gate. So this is when you're there for departure. And that particular product is not working as we would intend it to work, and we are not getting the Upgraded Boarding revenue. It's not a huge amount of money, but it's an example that we're describing. So you think about just the vast majority of our customers; the new system is working very, very well with no real change in our – in the new system versus the old system. There are a couple of items like that. The more material one is a little harder to explain, and it's with our groups. So we do have a product for 10 or more people that are traveling. And a lot of that in the back office is manual. So the new system is a little bit harder and more cumbersome, I think is probably the easiest way for as a lay person to describe it. The issue is when we have groups that cancel; it is harder for our people to identify those cancellations, go in and reopen that seat inventory, and then resell those seats. And that's where we're seeing a revenue penalty, if you will, from the groups. So there's a couple – and that's the biggest one. So there's a couple of items like that. There's fixes are already designed. The construction is underway. And now it's just a matter of when will they be done. And obviously, Tammy and I are hopeful that they'll be done yesterday. But those – and we intend – we expected that we would have some things like that, but those were a couple that we just didn't anticipate. In fairness, we have some things that are positives too that went into effect with the new system. But these negatives are offsetting the positives right now. So it has nothing to do with the elegance of the system, whether it meets our needs, whether it will be able to realize our benefits. These are just a couple of one-off items that we found that we'll fix and we'll get behind us.

Okay. I appreciate going a little bit more in depth there. And then I wanted to talk to your comments as well as you're getting the aircraft in the fleet a little bit faster this year. It sounds like you're still talking about 4% capacity growth in the front half of 2018. Does that mean you're finding incremental opportunities for capacity next year, given that that growth was most likely slated for earlier in the year in 2018?

If I understand your question, I think what we are about to publish in terms of additional flights, they are flights that we have already planned for next year, and we're simply accelerating them to 2018, if that's the answer to your question.

Yeah. Sorry, it was a convoluted way to ask it...

In other words, if you fast forward to the end of 2018, we're not doing anything right now that would end up more trips, in theory at least, than what we were contemplating before. That's just with the caveat that we're only published through April, and we are still working on what we want to do for the balance of 2018. But I think conceptually, all we're doing with the additional fourth quarter flying is we're accelerating already planned adds into the fourth quarter. The other color commentary I would offer up there is it's a little painful for us here in the fourth quarter to ground the Classics. And in order to continue with funding of some additional flying that's already committed for end 2017, we're having to make cuts in areas that we don't like. So this is an opportunity for us to restore some of those more painful cuts. And as I mentioned before, these are kind of no-brainer opportunities for us where we're very confident that there'll be profit added to the quarter. They were planned additions in the first place. We just found the airplane time available and been able to accelerate it.

Appreciate it. Thank you.

And if I could jump in here, Gary, just to add a little color on the first question. The technology year-over-year impact in the second quarter was in the $10 million to $15 million range. And for the first half of the year, we had pretty heavy spending in the first quarter. And that was probably another, call it, $35 million. So for the first half of the year, the impact is about $50 million, and which will be a headwind as we or rather a tailwind as we move into the second half. As we move into the second half of the year, we'll see the basically the year-over-year comparisons essentially go away. So we'll be back in line for the most part in third quarter and fourth quarter with respect to our technology spend.

There's kind of a punch list along those lines. The technology spend may be a little bit more complicated to think about for the future. But we have ramped up our training. There's overtime hours associated with that. So that's a cost bubble, if you will, during this second quarter for our operations team. We've staffed up significantly in our call centers to handle the cutover, and we have committed plans for that, through attrition, for that head count to trend back down. So that will be somewhat of a cost bubble not just for the second quarter. So that will ease back over time. And then there is some amount – there's tens of millions – call it $10-ish million that is related to simply having payment for two reservation systems simultaneously. It's a smaller number, but that will cease as well. So there's a fair number of things there. The hard part about the technology is we have a lot of work to do in our technology group. And the question then becomes, well, do we replace that technology spend that was for that new reservation system and put that money to something else? So that's not what we want to do. We haven't set our budget yet for 2018 for that. But there's clearly a handful of items here that will result in some material improvement, I think, going forward.

Hey. Good morning. Since we're on the topic – on the cost side, it looks like you're kind of exiting the year at a flat year-over-year rate. Any reason we should believe that cost could be down year-over-year next year on the...

Yes, you're exactly right, Savi. As we get to the fourth quarter, we'll be trending towards a flat year-over-year due to a number of tailwinds. And as we look forward to 2018, I do think we have opportunities to improve our cost. We're working through our 2018 plan now, and that certainly would be the goal.

That'd be the objective, yes.

But I'd like to come back and give guidance later this year. But that's certainly what our desire is, is to bring unit cost down year-over-year in 2018, excluding fuel, special items, and profit sharing. And by the way, Savi, just looking at the market as we get past our fuel hedge losses, we'll have relative to the market this year, we'll have nice comparisons on the fuel side as well. So as we end the year here and move into next year, I'm feeling pretty good about our cost position.

I am too. I think these are all qualitative thoughts. In fairness to both of us, we just haven't put a pencil to it yet. We haven't worked through all of our wants and needs for 2018, but the Classics are gone. Some of these reservation transition costs won't be repeated. And just the benefits of having the MAX in the fleet and just overall fleet modernization, and we'll grow a little more next year than we're growing this year. And that's beneficial on the cost side too. So I think those are all reasonable assumptions at this point. And just give us another quarter or so to finalize our plans, and we can give you better guidance for next year.

That's helpful. And just somewhat tied to that, we're hearing on several – a couple of different calls that there are kind of these certain areas, aggressive pricing going on even in the walk-up fares in certain hubs. And I'm just kind of curious if you're seeing that. And two, if you're going to see cost lower next year, is there as much pressure to kind of push through pricing increases? I think that was discussed this year just because of the level of cost increases. But how do you think about pricing out there?

Well again, I would kind of go back to my earlier comments, which I feel like the second quarter was a very strong revenue performance. I think that the third quarter outlook is more of the same. It is very competitive. It's competitive now. It's been competitive for years, as we all know. So there's a lot of action. There's adds, there's subtracts. And despite all of that, we had a really strong second quarter. And I think again, we'll have a strong third quarter. So implicit in that is stable is my report. Now, are we seeing fare activity along the lines that you described? Absolutely. But one statistic I think that you all would enjoy that I did jot down for this quarter as an example is, for the first time in a while, the majority of our markets are showing unit revenue gains year over year. And for a while, it was a minority of the markets over the past year or so, to my recollection. You can see the granular strength market by market. There are some markets that are under pressure. But overall, net-net, we're seeing more strength than we are weakness. And the other thing that is encouraging is we purposefully slowed our growth for 2017. We purposefully reduced the mix of markets under development in the system in 2017. So we're now down to what is a more normal level of about 3% to 4%. And just looking at the quote, developing markets as an entity, they showed very nice same-store year-over-year gains in the second quarter, which again is very encouraging. So we want to be as aggressive as we dare with our capacity. But overall, we want to be cautious and we want to make sure that we're hitting our revenue and our profit targets. As to next year and the way to think about it, we'll start the year, I'm sure, with a goal to have positive unit revenue performance in 2018. But I know our leadership team would agree that the overall goal is to sustain or grow our margins. So I think we've got an opportunity to do that. We've already talked about the all other than fuel cost outlook for 2018, which right now we're all kind of excited about that. But in addition to that, we're going to have a fuel price decline next year. So it's set up very well. We're not intending to grow aggressively at all next year, although the percentage increase will be higher than 2017. But we want to manage it in such a way that we drive unit revenue gains and strong margins.

That's all very helpful. Thank you.

Yeah. Thanks very much. Tammy, just given some of the tweaks to the fleet, can you just update us on where you see CapEx in 2018? I think at the Investor Day, the charts that you had showed aircraft CapEx down about $600 million or $700 million. Is that still what you guys are expecting?

Yeah, even with the tweaks, we're still expecting our total CapEx to be – we're hoping to bend it down from the $2.3 billion level, but I would say at or below the $2.3 billion is our goal for next year. So I think at least with the fleet changes that we have, we'll be within that guidance.

Okay. I mean, I guess that's a lot different than what the message was from Investor Day. Have there been changes on the aircraft side?

Changes from the aircraft side? No, other than the – so the goal is to bend down from the $2.3 billion, which is in line, that's total CapEx.

Okay. Yeah, maybe I can just follow up offline because aircraft and non-aircraft should be down pretty substantially next year. I guess, is that not what you're saying? I mean instead of bending down, it should be down quite a bit.

Well, we, as I said earlier, we are working through our plan next year for CapEx.

Take it down in 2019 for sure off of the top-line there.

It's down, yeah. So we'll be down next year, but we're finalizing all of the non-aircraft spend. So technology, of course, is a piece of that. So we're finalizing what that is going to be for next year. And with this year, just to give the magnitude of that, that's $250 million. And facilities, that's running about $300 million this year. So we're working through all those details for our plan next year, with our goal to bring the total CapEx spend down. But I just don't have a number to give you today, Joe.

You didn't necessarily ask for the philosophy, but I'll just pile on to what Tammy said. The – I agree with your – the direction of your question, which is corporate finance theory would suggest there's a more optical rating, let's say, BBB, maybe BBB+. But we want – we'd like to have some cushion because there will be bad times and our strong balance sheet has served us very well. You know the 46-year history, and there is no airline that comes remotely close. And the balance sheet strength is one of those shock absorbers that has really helped us in bad times. The philosophical point to argue here is we are still going to manage the company under the assumption that there will be very difficult times again. I've heard comments about things are different now. Maybe, but we're going to make sure that Southwest is very well positioned to weather the storm. And so we're delighted to have that upgrade and still want to have adequate leverage. But we're not trying to fine-tune this – we're not trying to hit the BBB. We're trying to be better than that, so that we can absorb the blow if times get bad and we don't fall into junk. And over the past 15 years, there's been risk of that at times. And bad things happen there, and we don't want that to happen.

Hi. Thanks for the time. Just a question for you on the Classics, as you look to retire those going into the fourth quarter or end of the third quarter. So can you maybe just provide some color on the impact that has to unit revenues? Do Classics tend to have higher RASM? I'm just trying to make sure I'm aware of any dilutive potential as we move forward, or the opposite, if that makes sense, Gary?

Yes. I think your – on the revenue side of things, it's not so much that it's the Classic per se; it's just the gauge. So we're – we'll definitely be back to Hunter's previous question. A lot of the growth that's anticipated in 2018 is gauge-related. So you're swapping out a 137 or a 143-seater for a 175-seater. I think in most cases, we're getting some 700s. So yes, there will be – you've seen that up-gauging since 2013. So that will continue. Tammy, I don't know if you're ready to give a gauge and a gauge guidance for next year, but there'll be some gauge inflation, if you will.

Yes, I would expect.

On the cost side – I think you know all that, and I think Tammy, it's also fair to say on the gauge, to the extent that there is some revenue dilution, that's all factored into your $200 million EBIT number through 2020.

Okay. Sorry but on the Classic, the RASM is I guess typically higher than on some of these other aircraft, just given the smaller gauge? Is that fair?

No. Well, again, it is the seats. So we have – the 700s are the same seats as the Classics. So I probably didn't make that clear. The 700s are the majority of our fleet. So for the most part, I would assume about 80% of the Classics will be replaced with a higher-gauge aircraft, tail for tail, under the assumption that we schedule the 800 in a way that it's full. And we've done a pretty good job of that. My hat's off to our folks. We had another record load factor in the second quarter. So that's all good stuff related to the Classics.

Okay, helpful. And then just a quick one, Tammy or Gary, you made some comments about the rating upgrade at Moody's, et cetera. I guess, you're now A rated. Is that sort of the goal longer term? I mean to me, it seems like that might be maybe too strong of a position on the leverage side, but just want to hear your thoughts.

Yeah, we're trying to strike the right balance there. We do want to maintain our investment-grade rating, but at the same time manage our capital structure. In terms of our kind of leverage goals over the longer term, and historically these have ebbed and flowed over the years, but just sort of as a longer-term goal, maintaining a leverage somewhere in the low 30% range feels about right. So certainly, don't intend to drive our leverage down really below where we are today. But somewhere in the low to mid-30% range feels about right. So – but we've always had a strong balance sheet as one of our top priority. So that certainly isn't going to change. But we certainly want to continue to optimize our capital structure as well. So I think we're balancing all of that pretty well.

You didn't necessarily ask for the philosophy, but I'll just pile on to what Tammy said. The – I agree with your – the direction of your question, which is corporate finance theory would suggest there's a more optical rating, let's say, BBB, maybe BBB+. But we want – we'd like to have some cushion because there will be bad times, and our strong balance sheet has served us very well. You know the 46-year history, and there is no airline that comes remotely close. And the balance sheet strength is one of those shock absorbers that has really helped us in bad times. The philosophical point to argue here is we are still going to manage the company under the assumption that there will be very difficult times again. I've heard comments about things are different now. Maybe, but we're going to make sure that Southwest is very well positioned to weather the storm. And so we're delighted to have that upgrade and still want to have adequate leverage. But we're not trying to fine-tune this – we're not trying to hit the BBB. We're trying to be better than that, so that we can absorb the blow if times get bad and we don't fall into junk. And over the past 15 years, there's been risk of that at times. And bad things happen there, and we don't want that to happen.

Great. Good afternoon. Thanks for squeezing me in here. Just wanted to ask a couple of quick ones for Tammy. Could you maybe comment for a moment or just expand somewhat around the higher unit cost in the back half of the year. Sort of what specific buckets would be driving those when we think about your prior guidance?

Sure. So I was having a little bit difficult time hearing you there, Jack. But I think what your question was, is, as we move through the year, how should we expect our comparisons to – how should the second half comparisons be relative to the first half of the year? So, we do have a number of tailwinds and just to recap those for you. We have of course as we get to the fourth quarter, we'll lapse the impact of the labor contracts. So that's about a one to two-point tailwind as we move into the second quarter. And as I mentioned earlier, we have about, call it $50 million in technology costs that represent about a point. So we'll see some – our cost pressures ease in that area and then...

Why is it higher than our previous?

Well, we had heavy spend again last year, and also just some one-time costs associated with our reservation system. So we have about a one-point tailwind as we move into the second half. And then the benefits from just our Classic fleet is about another point. And then as Gary was mentioning earlier kind of wrapped up in other is just some of the training costs and so forth that will ease as we move into the fourth quarter. So that's how we end up, and the fourth quarter with kind of flat unit cost comparison. So it's coming from a number of different areas.

I wasn't able to hear his question. I'll just repeat it, Jack.

I'm sorry.

His question was our previous guidance was one thing, and now it's higher. What's driving the increase in the guidance?

Oh, I apologize. I did hear your question differently. What's driving our guidance from where we were previously is we have, I guess, just at a high level kind of going back to the technology; it's really related to that. We were seeing our overall technology spend hasn't really changed dramatically. But we are seeing a shift of that spend to more of an operating mix than what we had anticipated in our forecast. So the overall spend isn't really changing, but we are seeing a little more operating expense pressure than what we had planned for. So I'm going – and so really the flip of that is in our CapEx. So, I do think we'll come in a little bit lower than our $2.3 billion CapEx for the year. And offset there is on our operating costs.

Okay, okay. Thank you for that. And sorry if I was coming through faint on my question.

No, I apologize. You were very faint, but it's good to hear your voice.

Good morning, guys. Thanks for taking my question. Gary, I was just wondering what's your thoughts on from what you've seen in Washington D.C. around the air traffic control debate. Are you optimistic that that is proceeding as you'd hoped and that there might be progress made on that before the end of the year?

Well, let me answer it this way. I am delighted that we have the focus from the administration. I'm grateful for that. I'm delighted that we have the focus from Chairman Shuster. And we have wonderful alignment between the commercial airlines, Chairman Shuster and the administration. There is just a lot of controversy about the change, and I'd be the first to recognize that. There is good momentum. Congressman Sam Graves from Missouri signed on to the legislation. And I thought that that was a very significant move. And he is very concerned about private aircraft operators. Chairman Shuster, I should say, was able to convince him along with the industry that there were protections in the proposed bill there. So I remain hopeful that we can get something done. But, Conor, I have to admit that there is just a lot, a lot of work to do. And I don't know that there is a vote scheduled in the House yet, which means that they may not have all the votes that they feel like they need. The Senate, of course, is far behind where the House is, and there is a lot of work left to be done there. But we need to make progress in the House first to have any hope of getting something done. My concern overall is that if we don't accelerate the pace, that we will face a real capacity crisis in the air. Because it takes longer and longer to operate flight segments, so the air space is getting less and less efficient. Our air traffic controllers do a wonderful job of keeping the airplanes safe, but they do that by slowing things down more and more and more. And of course, for air traffic controllers to use the old technology that they're forced to use is very, very cumbersome. And they're understaffed. So there is just a lot of things that must change if our country is to continue to grow air travel and people want to fly. So I think that's – we need to keep our eye on the ball and worry less about some of the other politicking that's going on. And so hopefully, we will make some progress this year.

Oh, good afternoon. Gary, I was reading about this new plane. I think it's called the 737 MAX. You might have heard of it. I think Tammy said you were due to get 10 in the third quarter. What are you expecting in the fourth quarter and kind of tied to that, have you sort of picked up anything from those who have already started operating the MAX? And given some of the issues in the engine supply chain, which do seem to be spreading to leap a little bit, do you have confidence that none of those are going to slip into 2018?

We will have 10 on October 1 when we start service. And then we'll end the year with 14. Mike, do you want to talk about the airplane and what you've heard from Boeing and other operators around the world?

That airplane has been just really from the day that they designed it until the day that they delivered it, they have been on their timeline. And it appears to be a better airplane, more efficient airplane today than what we thought we were buying years ago. I haven't heard of any issues, or Boeing has not made me aware of any issues that caused me any concern with respect to our delivery schedule or in-service dates or the operation of those airplanes.

Hi, thank you for taking my call. How does Las Vegas' performance stack up this quarter compared to previous quarters and do you have any visions for expansion plans or where does Las Vegas fall in terms of I don't know near-term future plans?

Well, you know how important Las Vegas is to Southwest. And it's just another opportunity to thank you for representing Las Vegas for all the support we get from your communities. We have a great relationship with the community. We get tremendous support from the airport. We're the largest airline in terms of customers at Las Vegas, and have been for many, many years. And it's a very stable market. I think I will characterize it as very strong. To your benefit in the community, there is a lot of competition there, and we welcome that. So we certainly hold our own with competition, but Las Vegas will always be an important part of our plans. And we don't have any plans to do anything significantly different here in the near-term. But again we will always keep an eye on Las Vegas and its needs. And Las Vegas, I believe today is about the third largest operating point that we have in our system. And it, oftentimes, it vies for second and sometimes first. So right now, it's over 200 daily departures, which for us is very, very large.

Good day, everyone, and welcome to the media representatives who are on our call today. We can go ahead and get started with the Q&A portion of the call for the news media. Tom, if you will give them some instructions to queue up for questions.

Good morning, guys. Thanks for taking the question. Gary, I was just wondering what's your thoughts on from what you've seen in Washington D.C. around the air traffic control debate. Are you optimistic that that is proceeding as you'd hoped and that there might be progress made on that before the end of the year?