Southwest Airlines Company (LUV) — Q4 2017 Earnings Call Transcript

Thank you, Tom. And welcome, everyone to our fourth quarter earnings call. Joining me today we have Gary Kelly, Chairman of the Board and CEO; Tom Nealon, President; Mike Van de Ven, Chief Operating Officer; Tammy Romo, Executive Vice President and CFO and other members of senior management. Please note today’s call will include forward-looking statements. And because these statements are based on the Company’s current intent, expectations and projections, they are not guarantees of future performance and a variety of factors could cause actual results to differ materially. As this call will include references to non-GAAP results, which excludes special items, please reference this morning’s press release in the Investor Relations section of southwest.com for further information regarding forward-looking statements and reconciliations to non-GAAP results to GAAP results. Gary will begin with an overview of our performance, followed by Tammy with a detailed review of our fourth quarter results and our current outlook. Following Tammy’s remarks, we will be available to answer questions. And at this time, I’d like to turn the call over to Gary.

Thank you, Ryan. And thanks everybody for joining our fourth quarter 2017 earnings call. It was an excellent quarter all the way around, and I want to thank all of our 56,000 plus employees for an exceptional year and congratulate them on another very strong profit sharing for 2017 of $543 million and an addition to the $70 million tax reform bonus that we shared. After two years of modest unit revenue declines, we turned the corner in 2017, and that’s despite a very competitive industry environment. Unit revenues were up in the quarter 1.9% and just under 1% for the full year. We’re currently estimating 1% to 2% unit revenue growth on strong load factors and bookings for the first quarter 2018, and our goal is for positive unit revenue comparisons again for this year. Better revenue management tools and techniques, enabled by our new reservation system, will help mitigate any competitive pressures this year. I expect those benefits from the new system to begin in the second quarter. Fuel prices are up over the last quarter, and when the futures prices become reality, we’ll see some cost pressure there. But the federal tax rate reduction more than offsets that pressure. And excluding fuel profit sharing and special items, our unit cost outlook for the year is excellent, with a goal of moving unit cost down slightly. Depending on fuel prices, our goal is to realize operating margin expansion for 2018. Given the tax reform, in addition to that, we expect to realize even greater net margin expansion. And both of those will drive stronger future cash flows. It is worth repeating that in addition to the margin expansion, we’ve reduced our federal income tax liability at the end of 2017 by $1.4 billion, and that cash flow benefit will be felt in the future years in addition to the cash flow benefit from future margin expansion. Our growth plans for 2018 are unchanged. We ended the year with 750 aircraft, which recovers the classic fleet retirement in the end of or the third quarter last year, growing our fleet by 27 airplanes effectively over a 24 month period, which I’m measuring from year-end 2016 to year-end 2018. Work is well underway to begin flying to Hawaii, which is a focus for this year. We announced this morning our intention to add Paine Field in Everett, Washington later this year to complement our presence at TTAC. Aside from the modest growth plans, our focus for 2018 will be on the basics. Unlike the past seven years, we have no major strategic initiatives landing in 2018, which allows a more intense focus on running a greater line, offering outstanding customer service, and controlling our costs. Capital spending will also be down this year. 2017 closed out on a very positive note. 2018 looks even better for all the reasons I just outlined. And with that very quick overview, I’d like to turn it over to Tammy Romo, our Chief Financial Officer, to take us through the quarter.

Thank you, Gary, and thank you all for joining us today. I want to first thank our employees for their hard work and congratulate them on another successful year, earning $543 million in profit sharing. 2017 was a year of many accomplishments and it ended with a strong fourth quarter performance. Fourth quarter net income was easily a record with profits of $1.9 billion or $3.19 per share. As we announced in our 8-K filing earlier this month, we recorded a very large tax adjustment as a result of tax reform. In reevaluating our deferred tax liabilities and assets to reflect a lower future tax rate, we reported a one-time non-cash tax benefit of $1.4 billion during the fourth quarter, which we called out as a special item. Excluding the tax reform adjustment and normal hedge accounting special items, fourth quarter net income was a strong $459 million or $0.77 per diluted share, up hitting ahead of our first call consensus. We were proud to celebrate the passage of tax reform with our employees and a $1,000 bonus to each of them earlier this month. The employee bonus of $70 million was included in our non-GAAP results and impacted our earnings per share by $0.07. With these strong returns and another year of strong operating cash flow in 2017, we were able to make prudent investments in our business, take care of our people and return significant value to our shareholders. We’re off to a great start this year. In addition to covering more detail on our fourth quarter results, I will also provide an outlook for 2018. Starting with revenue, we ended 2017 with record fourth quarter operating revenue of $5.3 billion, driven largely by record passenger revenue of $4.7 billion. Strong demand for low fares resulted in a fourth quarter record load factor of 85%. Passenger revenue yields were slightly down year-over-year but improved sequentially from the third quarter as expected. Demand was strong during Thanksgiving and the December holiday period. Flight revenue also performed well during the peak season, resulting in a 7.1% increase year-over-year. Our Rapid Rewards and EarlyBird revenues were also strong. In fact, our EarlyBird revenue for fourth quarter 2017 alone was approximately $100 million, which was our initial target for EarlyBird when we first called out the boarding option. Overall, we were pleased with our record fourth quarter operating revenue performance and outpaced our capacity growth to produce a RASM increase of 1.9% year-over-year, which was in line with our expectations. We were also pleased to achieve a goal of unit revenue growth for the full year 2017, albeit modest considering the unprecedented national disasters in a competitive industry environment during 2017. Looking ahead to the first quarter of 2018, passenger revenues appear stable and travel demand and bookings are solid. As we expect favorable year-over-year trends in the first quarter 2018 freight and other revenue. Based on these trends and our current outlook, we expect first quarter 2018 RASM to increase in the 1% to 2% year-over-year range. Later this quarter, we will issue an investor update. This 8-K will reflect a typical guidance update as well as potential changes to our guidance as a result of accounting changes based on new accounting standards related to revenue recognition. We plan to utilize our investor updates on a quarterly basis as needed, and therefore, we will no longer report RASM guidance at our monthly traffic releases, beginning with the report of January traffic results early next month. Turning to fuel, our fourth quarter 2017 economic fuel price per gallon was $2.09, which included $0.19 of fuel hedging losses. However, our fuel hedging losses are behind us now, and our hedge portfolio for 2018 and beyond provides us with nice protection against cash drop prices and energy prices without the forward exposure. It enables us to make prudent adjustments to our business in a rising fuel price environment in order to maintain our financial goals and reduce our volatility in our earnings. For 2018, we plan to early adopt an accounting standards update related to hedging where we will begin reporting fuel hedging premium expenses within the fuel and oil expense above the line rather than within other gains and losses below the line on the income statement. As such, we are providing our 2018 fuel price per gallon guidance, including fuel hedging premiums as shown in this morning's earnings release and we’ll recast prior periods later in the first quarter as part of our 8-K update. Moving on now to our outlook on fuel. Based on market prices and our hedging portfolio as of January 19th, for the first quarter 2018, we expect our economic fuel price per gallon to be in the $2.10 to $2.15 range, including approximately $34 million or $0.07 per gallon in fuel hedge premium and an approximate $0.05 per gallon hedging gain. For the full year 2018, we currently expect our economic fuel price per gallon to also be in the $2.10 to $2.15 range, including approximately $135 million or $0.06 per gallon in fuel hedge premium and $0.04 per gallon hedging gain. At current market prices, our 2018 fuel hedge positions began to produce modest gains at about $65 per barrel Brent crude, with more material hedge gains hitting in at our $75 per barrel range and higher. Before I move to non-fuel costs, I want to spend a moment on fuel efficiency. As announced, we retired our remaining Classic fleet in the third quarter 2017 and introduced a more fuel-efficient 737 MAX 8 into our fleet in the fourth quarter. As we’ve continued to modernize our fleet, we have seen a nice increase in available seat miles per gallon, improving 1.3% year-over-year in the fourth quarter. For 2018, we currently expect a 2 to 3% improvement year-over-year in available seat miles per gallon. Excluding fuel, profit sharing, and special items, our fourth quarter unit cost increased 4.6% year-over-year. Putting aside the year-end items for just a second, fourth quarter unit cost trends were in line with our original expectations as we saw expected increases in salary, wages, benefits, advertising spend, and shifted from third quarter, along with incremental technology costs that included ramping up for ETOPS in preparation for Hawaii. As disclosed in our January 2nd 8-K, we have 3.5 points of incremental cost pressure at year-end, primarily driven by the employee bonus. Based on current cost trends, we expect first quarter CASM, excluding fuel, special items, and profit sharing, to increase in the half point to 1.5% range year-over-year. The primary drivers of the year-over-year increase include inflationary increases in salary, wages, and benefits, which include higher costs related to an extended operating day driven by our costs of retirement and our current fleet deficit. We also expect increases in airport landing fees and rentals and maintenance. Looking ahead to the full year 2018, we expect our CASM, excluding fuel, special items, and profit sharing, to be in the range of flat to down 1% year-over-year, which is a solid performance. For 2018, our largest year-over-year cost tailwind is approximately $200 million related to the Classic retirement and benefits, and depreciation, aircraft rentals, and maintenance expense. We also have some offsetting headwinds in the areas of maintenance of our aging at our 700 fleet as well as airport costs. While the benefits of the Classic retirements are easier to see in depreciation and aircraft rentals, we do have a 2018 and cost of year-over-year benefits within maintenance expense. However, this classic maintenance savings is more than offset by the increased maintenance of our aging -700 fleet. I’ll just make a few comments on the balance sheet and our capital deployment. We ended 2017 with arguably the strongest balance sheet in our history, and we’re very proud of that. Our solid investment grade rating is intact, and we are pleased with the upgrades for both Moody’s and S&P during 2017, along with the recent positive outlook revision by Fitch. Our liquidity is strong with cash and short-term investments of approximately $3.3 billion at year end. During the fourth quarter, we issued $600 million in unsecured debt and among the tighter spreads and lowest yields in Southwest’s history. With this additional capital primarily to refinance existing debt, we continue to target leverage in the low to mid-30% range. Free cash flow for 2017 was a strong $1.8 billion, driven by $3.9 billion in operating cash flow and capital expenditures of $2.1 billion. Our strong cash flow and financial position allow us to return $1.9 billion to our shareholders through share repurchases and dividends. Our 2017 CapEx of $2.1 billion came in below guidance, primarily due to the shift of approximately $115 million out in 2017 and into 2018 related to one MAX 8 delivery and several non-aircraft investments that were just the shift in the spend. We are still expecting our 2018 CapEx to decrease versus 2017, and we currently estimate 2018 CapEx to be approximately $1.9 billion. Included in this total, we expect 2018 aircraft CapEx of approximately $1 billion and non-aircraft CapEx in the $900 million range, including the shifting I previously mentioned from 2017. We continue to effectively balance and manage our overall capital deployment, remaining focused on preserving our strong balance sheet and healthy cash flows, while returning significant value to our shareholders. With the expected future tax savings from tax reform, we’ll continue to evaluate our investments in our company, our people, and our shareholders, including the mix of share repurchases and dividends with an overarching goal to drive long-term value for our shareholders. Moving onto fleet. Of course, the fourth quarter was our first quarter flying all Boeing, NGs, and MAX aircraft on the heels of retiring the remaining Classic fleet. We ended 2017 with 706 aircraft with the delivery of 19 aircraft during the fourth quarter. This is one fewer plane than expected due to MAX delivery shifting into 2018. We currently have 13 MAX 8 aircraft in our fleet. As you saw in our January 2, 8K, we made some minor changes to our Boeing order book. We exercised 40 options for MAX 8 from orders to deliver in 2019 and 2020, deferred 23 MAX 7 from orders to better align with our future -700 retirements and accelerated 23 MAX 8 from orders to 2021 to 2022 timeframe. We will have significant 737-700 NG retirements over the next 10 to 15 years based on their age, and this order book refresh along with our remaining order book and options allows us to manage through those retirements in a measured way, while allowing flexibility for growth. Aircraft CapEx remains very manageable at approximately $1 billion per year on average for the next five years. Our 2018 fleet and capacity plans have not changed, and we continue to expect to end the year with 750 total aircraft based on our current firm aircraft delivery schedules. On the capacity front and in line with our previous expectations, we expect 2018 full year capacity to increase in the low 5% range year-over-year. Our third quarter 2017 of approximately 5,005 cancellations due to the national disasters is driving roughly half a point of our full year 2018 ASM year-over-year growth. We expect our first half 2018 capacity to increase about 3% year-over-year, as we firm up our first half 2018 schedule. The next schedule will be published on February 15th, and that will go out through September 28th. For the second half of 2018, we expect our capacity to increase in the low 7% range with higher year-over-year growth in the fourth quarter of 2018 due to the impact of last year's Classic retirement. We remain excited about our 2018 growth opportunities, and we have a prudent 2018 growth plan that produces positive year-over-year RASM for us based on our current outlook. In closing, we had a really strong 2017 performance, and 2018 is shaping up to be another solid year, which will also benefit significantly from tax reform. As we start the year, we are well positioned for margin expansion, excluding special items. Our employees continue to deliver a reliable operation and product, and they have been proving that they are the best in the industry for the past 45 plus years. I was thrilled that we recognized their hard work with the recent year-end tax reform bonuses, and I am very proud they continue to be recognized for their world-class hospitality. We have a bright future ahead of Southwest, and I am excited for our shareholders with the sustained momentum we have coming into 2018. So with that, Tom, I think we are ready to take questions.

Gary, I consider Southwest to be a point-to-point operator that just happens to have a few very large basis operations that resemble hubs. I am curious to the degree to which you currently schedule and revenue manage for connectivity over places like Baltimore, Nashville, and Denver. How that's changed over time, particularly with the new res platform, and how you think it may evolve from here?

Jamie, I believe your perspective on Southwest is spot on. I recall that back in the 1980s when I joined, about 80% of our origin and destination flights were non-stop, while the remaining 20% were split fairly evenly between through traffic and connections. During the 1980s and 1990s, and likely into the early 2000s, we didn't plan our schedules with connection convenience in mind. Since 2009, we've had a portion of our flights designed to connect intentionally. Interestingly, when I started, our annual load factor was 58%. Twenty years ago, it was 66%, and now it has reached 84-85%. While we've seen a significant increase, the ratio of non-stop to connecting traffic has barely shifted, maybe by 3 or 4 percentage points. As a result, we're carrying more connecting traffic, some of it planned, whereas in the past, it was more accidental. However, there's still a strong emphasis on point-to-point non-stop service, which is the guiding principle for our network planners and our overall strategy. I want to commend them for increasing load factors by 20 to 30 points over the last few decades without shifting to a hub and spoke model that emphasizes connecting traffic. This achievement came from optimizing the flight schedule and enhancing some frequencies in our busy markets, while still maintaining non-stop service. Andrew Watterson, our Executive Vice President over Commercial, is with us and might recall the exact percentage of our capacity that is intentionally connected, but it is clearly not the majority of our sales. Andrew, do you happen to remember that statistic?

I would call it slightly above 20%.

Gary, thank you, that’s terrific. And for a follow-up, the goal to maintain positive RASM for the year, you’re starting respectably at the 1% to 2% levels, presumably the second quarter is no worse, probably better. Given that capacity surge in the second half, your aspiration would seem to imply that you remain in positive territory in each of the four quarters. Assuming that’s directionally accurate, what’s the driving factor that gives you the confidence in second-half positive RASM on a higher base of year-on-year capacity? Is there anything specific?

I do think there are a couple of fundamental specifics. First of all, your direction I believe is correct. Admittedly, a 1% to 2% outlook for the first quarter doesn’t give us a lot of cushion for things to go sideways. So I’ll admit that from the outset and that I think obviously applies even more to quarters two, three, and four since we just don’t have as much visibility. However, when we get to the second half of the year, we should have a much better schedule. I am proud that we achieved pretty healthy unit revenue gains with a not-so-great schedule in the fourth quarter because we retired 50 airplanes in the third quarter. The fleet shrunk. We tried to maintain a scheduled presence that wasn’t that different. You have to take into account seasonal dips that we would have scheduled anyway. But to generate roughly the same amount of flights with fewer airplanes, we had to extend the day of the airplane. Two times of the day that are profitable tend to be 6 PM and 9 PM. All that means is we believe we’ll have a secure schedule that will yield better by the time we hit to the second half of this year. Point number one. Point number two, notwithstanding the angst that I note yesterday and today about the industry, we have a new revenue stream coming online this year that Tammy and our team is still confident will hit in the $200 million range. These are both significant points, but we can't predict the weather, competition, or the economy. However, we would hope tax reform is at least a floor on travel demand. We’re not doing anything overt to plan for a pickup in travel demand because of that, but we’re hopeful it will provide a lift.

Gary, just to start off, I have a couple of tax reform questions. But Tammy referred to this in prepared comments. We would love to get your take as well. Southwest is in a unique position among airlines, because you are the only airline that will benefit from cash tax savings, as well as from the new corporate tax rate. I would love to get your thoughts on how you are prioritizing this increased cash flow? We’ve already seen the special bonus to employees. Beyond that, are you thinking about increased reinvestment in the business, or should we expect a step up in capital returns to shareholders? Because your free cash flow could really step up quite a bit because of the tax reform here.

I'll just offer unsolicited editorial comments that it is about time we level the playing field competitively on this matter, as well as comparing our industry to other sectors. Obviously, Jack, you are well-informed on that. We’re very happy with that. It helps us lower our cost, and we’re not going to squander these savings. It puts us in a much better competitive position. The priorities are not equal, but we want to keep our overall cost structure below to maintain low fares, drive strong load factors, and continue to support our growth plan. There’s enough money available to think about investments in the business. Tammy explained well what we did with our Boeing order, but we have two basic options in terms of putting additional capital to work in the business. We can buy more airplanes to grow the fleet or replace older aircraft. We have opportunities in the latter that we'll be exploring aggressively. However, I want to be clear that we are not thinking about increasing our growth rate by buying more aircraft today. If that happens due to favorable circumstances, I think we'll all be very happy. In terms of taking care of our employees, we're 85% unionized. All compensation has to be negotiated with covered employees, so that is a separate issue. Finally, we aim to support our shareholders and continue to do what we’ve been doing for the past several years, increasing dividends annually and maintaining a healthy share repurchase program. It's worth mentioning that last year was a rough year due to nature and tragedies around the country, but we were able to continue supporting our communities, which is a source of immense pride for Southwest.

Asking about tax reform from another angle. I think folks are under-appreciating the potential for boosting the economy in the near term from tax reform, hitting folks’ pockets sooner rather than later in addition to increasing business confidence. You mentioned earlier that you're not planning for increased travel demand. As you think about how this progresses over the next several quarters and approach the spring/summer travel season, it seems there is an opportunity for a pickup in leisure travel in addition to business travel. I'd love to hear your thoughts on that specific topic.

I agree with you, Jack. I realize there's angst about the growth rate in the industry, but many expect GDP growth to accelerate, which could boost travel demand. People should calm down; this could prove to be much ado about nothing. We’re growing this year and planning to add new service to Hawaii. Our growth plans remain intact. Success is dependent on keeping costs low to attract new customers. If tax reform provides support, we see that as a realistic option in the future. It won’t happen for us in 2018, but we have the potential to push our utilization somewhat, but not much. Any future growth thoughts would be beyond 2018.

Gary, I want to continue the talk about fleet process that we've discussed a bit. Would you consider a new fleet type if there was significant cockpit commonality and overall commonality with the 737, or did your experience with AirTran 717 sour you on that concept?

No, it did not sour me. I will say that the opportunity with 717 versus 737 was a chance to replace a smaller airplane with a bigger one that is common, and it was a no-brainer, worth a couple of hundred million dollars a year. We never fully integrated that aircraft into Southwest Airlines. Every flight after we acquired AirTran was on the AirTran operating certificate. I would assume that in a generation we would be open-minded to your suggestions. However, as far as I can see, there is no work underway to think about a different airplane. I don’t believe we have optimized our fleet mix yet with the MAX 8 and MAX 7. Boeing has other variations, and right now, we are not interested in those planes.

I appreciate the commentary on margin expansion. Just to be clear, that’s even with moving $157 million of option premium expense above the line, you are referring to EBIT margin when discussing margin expansion this year, correct?

Yes, that’s correct, even with that.

And by the way, that $115 million, is that about right, Tammy?

It’s actually $135 million for the year. Since you are asking about that, our goal would be to bring that down in 2019 and budget somewhere in the $80 million range for that. That will be a nice tailwind for us as we move to 2019.

Could you provide a high-level insight on the potential impacts to revenue growth, unit cost growth, and margins in 2018, even though you haven't given guidance based on the new accounting standard?

We are still looking at all that. I would rather wait and provide all that for you in the 8-K. We’re in the middle of finalizing all those results. So if you could just be a little more patient for us, we’ll come back with a very robust report later this quarter.

How are you thinking about the cash tax rate under the new regime?

Our tax rates have been more like the 20% range and I wouldn’t expect that to be any worse than that as we move forward. We're still working through some technicalities on the depreciation rule. By the time we get to later this year, we expect full 100% expensing in the year that we acquire the aircraft. We are working through some of that to finalize it, but obviously it will have a very meaningful impact on our cash taxes for the year. We noted in the earnings release that we expect that to be in the hundreds of millions of dollars both on a P&L and cash basis, so it’s significant.

Just a follow-up, Tammy, on the fuel hedge comments. It sounds like the target to bring the premium down is still in mind. But curious with lot of these competitors not hedging either; with that in mind, what's the state of your hedging strategy? How are you shifting it?

We just look at it differently, Savi. The hedging strategy is really insurance potential for us in the event we see a spike in fuel prices as it'll start kicking in, and we’re already seeing that. It’s designed to provide protection if we see unexpected rises in fuel prices. We expect to keep our premium budget reasonable to provide meaningful protection should prices rise to more catastrophic levels. We think of it more as a protection measure. In terms of the target of $80 million, we achieve that through layering our hedges to build a strong hedge position at reasonable fuel premium levels. We've been layering to mitigate the downside exposure.

Savi, I didn’t check the press release, but there is heavier weight in 2018. So 2019 is a really good hedge, and it has nice balance between how much money we’ve spent on it and the covers that we get. The 2018 has a bit of a mix as I recall Tammy because we had to go in and unwind some of the puts.

That’s all very helpful color, thank you. Just a quick one on unit revenue; you mentioned that the demand was strong during the peak period. What are you seeing in the off-peak? Is there too much supply in the off-peak, and is there anything that can be done about that as we keep layering on supply?

Demand for us, Savi, through the first quarter as you can see from our load factor performance was very strong. We are generating record load factor performances. Of course, the story has been lower yield, and we are working harder for that demand in off-peak seasons. However, we see very nice demand even during off-peak periods.

Andrew, you can comment on this, but we’re getting better and better at varying capacity according to seasonality. In terms of Southwest, I think we finally caught up with the ability to match schedule and seasonality. I believe we may have had a schedule last year that was a bit too long into the seasonally softer period. We’ve planned for that in 2018.

Particularly with some of our new international markets, there’s an opportunity for more seasonal flying. Our commercial folks manage through these peak demand periods effectively.

What we don’t do is vary our operations much by day of the week, and that's an opportunity for us. We've learned that adjusting schedules according to the season is complex but it’s an iterative process.

With oil prices up $20 in the last five or six months, are you seeing better system traffic out of Houston and Dallas than elsewhere on the network?

Midland is the one that’s easy to see plus or minus and it’s really strong. We haven’t suffered in our energy markets like we did decades ago. U.S. oil and gas activity has effectively managed through $50 crude oil so I don’t see a significant variation there. You tend to see the more pronounced activity where there's competitive action.

Over the long horizon, both states have become much more economically diversified with significant industries in the area.

I know you mentioned the investment for ETOPS and how she feels about it. Given the size of the company and higher diversification, is that minimal cost or will it actually reflect in the numbers?

It’s de minimis; that was the investment to get started in Hawaii and the spend related to ETOPS. We're on track for ETOPS, so it's all green with our plans to start service to Hawaii, and the spend related is not significant.

Our goal has always been to be flying by the end of this year, though achieving that is not solely in our control. However, we are right on target in terms of the work we can control at this point. It's encouraging, and we believe we can fly by the end of the year, with selling services likely to occur even sooner.

Tammy, I want to return to margins; when you say that effective time, is that year-over-year hedge gains and losses?

That's right. To be clear, yes.

So if we were to back out hedge loss last year and hedge gains this year, we’re probably going to be flat to down on margins, right?

Are you talking 20…

What is your expectation for identifying a rise in the oil price, your ability to adapt to increasing costs?

We’re not aligned with the rest of the industry; our outlook is superior. We expect operating margin expansion for 2018 based on current fuel prices. Any additional growth opportunities come from tax reform, allowing better net margin expansion.

I was asking about the CapEx for the year; you're guiding to $1.9 billion, with aircraft CapEx at $1 billion. What's driving the high non-aircraft piece?

Our technology CapEx is expected to be down a bit due to the completion of One Res. We’re seeing higher mix in facilities, particularly in our hangar plans and investments in our pilots' training facilities.

What's driving your unit cost guide to be flat to down? What are the major drivers impacting the outlook?

You really nailed it, Mike. The primary driver from the last update we provided was higher expenses due to the employee tax reform benefit. Our comps for 2018 are solid, and we’ll continue to focus on cost control efforts, but that is the primary difference.

You’ve seen United’s announcement as they push more aggressively in some markets. Is that something investors should be concerned about?

Anytime flights are added or subtracted from a market, there is an impact, so I wouldn’t want to play that down. Adding capacity will dilute some traffic, but we focus on nonstop, low fare traffic, while a high-cost legacy airline does not. There are many historical examples where we might have share of seats in a market but a significantly higher share of traffic. We achieved number one airline in the country based on this. Our cost advantage translates to a fare advantage, generating over 130 million customers last year. We also have specific airport advantages due to our significant presence in the impacted markets. So while will it impact us? Yes. Will it harm Southwest Airlines? I hope not. We have the tools we need to continue to perform well.

Regarding tax savings, should we take the CapEx number for this year as the floor? Should we expect it to increase?

It wouldn't go down from here, but any opportunities would be along fleet modernization or essential investments in the business. There’s really no meaningful impact on 2018 CapEx.

Thank you, Tom. I’d like to welcome members of the media to our call today. Before we begin taking questions, Tom would you please give instructions on how everyone should queue up for questions?

Gary, you referred to uses of the tax savings. You noted that compensation with unionized employees has to be negotiated. So what you’re saying is that you would not do a mid-contract pay increase for your employees using some of that savings?

I didn’t say that; we can negotiate. I’m just pointing out that unilaterally we’re not going to increase wages across the board because we can’t by federal law. We have several contracts up for amendment and any long-term commitments need to factor in potential future challenges, and we’re focused on fuel price increases as a significant concern.

But you wouldn’t rule out the possibility that you could do a side agreement to increase pay before the next contract is negotiated?

I don’t believe there’s a change in 2018 versus previous years. We have contracts in place; it takes effort to negotiate, and I’m not suggesting that all of a sudden our unions would want to negotiate mid-contract raises.

If I could clarify one thing you previously said; I didn’t catch what you said about the 737 MAX 9. Did you say you might be interested in that aircraft?

I said that as it stands today, we don’t have an interest. That doesn’t mean we won't change our mind. Our focus is on the 737 MAX 8; we’re working with Boeing on MAX 7. That is our focus.

I’m looking for help to understand how these tax changes will play out longer-term. You reported a $1.4 billion benefit; is that in a similar magnitude expected in 2018 and 2019? How much do you expect that to reduce federal taxes going forward?

The tax return doesn’t match our financial statements, and there’s a tax liability on our books at the 35% rate related to all the years leading up to 2017. Tax rates are now at 21%. That’s what’s driving our overall reduction in liability. The cash amount will flow out over the years in the future; it's not a proxy for our savings each year moving forward. Tammy had mentioned hundreds of millions, considering our earnings for 2018 at a similar level to 2017; it’s a substantial amount.

For Tammy; you mentioned that EarlyBird revenue totaled $100 million in the fourth quarter. Did you mean that was your initial target for the full year when introduced?

Yes, $100 million was indeed our target for the full year when we first launched it in 2009.

Is this the first time that’s hit $100 million a quarter?

Yes, this is the first time we reached that figure for a single quarter.

What’s the total figure for the year on EarlyBird, Tammy?

It was approximately $400 million for the full year.

Any plans to increase the EarlyBird fee given its success?

We are focused on controlling costs and keeping fares low, so I think we have a good opportunity to hold firm here.

A quick follow-up on Hawaii; based on what you said earlier, do you think there's a good chance you start flying there this year?

Our goal is to be flying by the end of this year. Achieving that is not solely in our control, but the work we’ve done already is very encouraging. We are confident that we can at least start selling tickets by the end of this year.

When is the next schedule extension after February 15th?

Roughly 60 days later, probably around April 15th.

Can you talk to me about the fixed appeal of Paine Field? Is there anything more than the fact that SeaTac is constrained?

It’s attractive for a handful of aspects; the opportunity we have to provide our services in a low-cost way helps customers see alternatives. Additionally, we expect significant pool of customers north of the city due to ground traffic constraints. It's a smaller airport, and although that limits flight options, it creates a more pleasurable experience overall. There’s also less competition at Paine Field, and we would be able to accommodate the demand.

Does that mean the daily departures will remain at five?

It’s my understanding they plan for 24 daily departures at the airport, which is the terminal capacity.